In this edition of Fintech Flash, we discuss ways to think about true lender risk in fintech-bank lending partnerships, with a particular focus on how indemnification provisions in program agreements weigh in the balance of the true lender determination. This Flash provides practice tips on drafting indemnification provisions with true lender risk in mind.
"True lender" is one of the biggest risks in a fintech-bank lending partnership. It is a challenge that regulators or plaintiffs' counsel could advance, alleging that the fintech company is really the lender in the arrangement, not the bank. It goes something like this: The fintech did so many activities, got so much of the economic benefit, and took on so much of the program risk that it should be considered the true lender. And, as the true lender, the fintech would not have been authorized to charge as high an interest rate or as much in fees as the bank, and, therefore, the loans should be considered usurious or the fees charged exceeded legal limits.
Game of Pick-up Sticks
Addressing true lender risk is akin to playing a game of pick-up sticks.1 Case law and regulator actions have indicated that the totality of the circumstances must be considered to determine the identity of the "true lender," with key factors (sticks) heaped onto one of six question piles2:
Appearance Pile: Does the bank appear to be the lender to prospects, applicants, and borrowers'really the world?
Stick Example: Do the marketing materials prominently disclose that the bank is the lender?
Non-Ministerial Functions Pile: Does the bank perform or control the non-ministerial functions normally performed by the lender?3
Stick Example: Does the bank approve program loans via approving and adopting the underwriting guidelines and credit criteria, and does the bank require its approval for any changes or deviation from the guidelines and criteria?
Control Pile: More generally, does the bank control the program?4
Stick Example: Does the bank require the fintech to periodically report its compliance and have the right to direct remediation of any reported issues needing attention?
Source of Funding Pile: Is the bank the real source of funding of the program loans?5
Stick Example: Does the bank use its own funds to fund the loans?
Economic Interest Pile: Does the bank have a "predominant economic interest" in the loans?6
Stick Example: Does the bank retain the loan account and some horizontal percentage of the receivables generated by...
