taking security interests under the MLA: Guidance vs. the Law

Can a financial institution take a security interest in a consumer’s existing account through the use of a cross-collateralization clause when the consumer takes out a loan as a covered borrower under the Military Lending Act (MLA)? The answer to this question may depend on who you ask. Some will say “yes,” and others “no.”
 
The MLA was enacted in 2007, and expanded in 2015 (2015 MLA), to protect servicemembers and their dependents from lending-related abuses related to tax anticipation loans, vehicle title loans, payday loans, and consumer loans covered under Regulation Z.
 
Both iterations of the MLA permit creditors to take a security interests in funds deposited after the extension of credit in an account established in connection with the consumer credit transaction [See Section 232.8(e)(3) of the 2015 MLA].
 
The attorneys who say “yes” are relying on guidance provided by the Department of Defense (DoD) Interpretive Rule issued on August 26, 2016. These DoD interpretations, presented in a question and answer format, provide as follows:
 
18. Does the limitation in §232.8(e) on a creditor using a check or other method of access to a deposit, savings, or other financial account maintained by the covered borrower prohibit a creditor from exercising a statutory right to take a security interest in funds deposited within a covered borrower’s account?
 
Answer: No. Under certain circumstances federal or state statutes may grant creditors statutory liens on funds deposited within covered borrowers’ asset accounts. For example, under 12 U.S.C. 1757(11) federal credit unions may “enforce a lien upon the shares and dividends of any member, to the extent of any loan made to him and any dues or charges payable by him.” … Therefore, §232.8(e) does not impede a creditor from exercising a statutory right to take a security interest in funds deposited in an account at any time, provided that the security interest is not otherwise prohibited by applicable law and the creditor complies with the MLA regulation, including the limitation on the MAPR to 36 percent.
 
In a legal action with a covered borrower, it is certainly helpful to have the DoD on your side with regard to a claim the financial institution took an illegal security interest in accounts opened before an MLA was issued.
 
However, it must be noted that in the opening paragraphs of the Interpretive Rule, the DoD makes clear “this interpretive rule does not substantively change the regulation implementing the MLA, but rather merely states the Department’s preexisting interpretations of an existing regulation.” If the regulation is unchanged, does this Interpretive Rule really permit a security interest in an existing account?
 
If you believe it does, here is where the proverbial wheels begin to fall off the argument.
 
Section 232.7(a) of the 2015 MLA includes a preemption provision related to existing state of Federal laws. Specifically, Section 232.7(a) states the 2015 MLA will preempt a state or Federal law, rule or regulation to the extent any such law, rule or regulation provides protection to a covered borrower greater than those provided by the MLA. 
 
The DoD’s preexisting interpretation - not included in the MLA or the DoD’s implementing regulation – regarding a federal credit union’s statutory lien under the Federal Credit Union Act actually benefits the creditor, not the covered borrower.  Therefore, the MLA provisions will override any state or federal law, rule or regulation to the contrary.
 
Still not convinced taking a statutory lien in an existing account involving a covered borrower with an MLA loan is okay based on the DoD guidance? Ask yourself this question: Would the law or a contrary interpretation that does not have the force of law win the day in court when a servicemember sues your financial institution for taking a security interest in an account opened before an MLA loan was approved?
 
So what does your financial institution do with this if you haven’t changed the language of your loan agreements. The following options can be taken:
 

• Amend the language of your loan agreements to provide the statutory lien applies to accounts opened in connection with a covered borrower’s MLA loan;
• If you don’t want to incur the expense of making this change to your printed applications, amend your website loan applications to provide the language, and prepare an addendum to your loan agreement to ensure your borrowers understand a security interest can and may be taken in accounts opened in connection with an MLA loan (until new applications are printed); and/or
• Keep good records of your covered borrowers and ensure the statutory lien provisions related to existing accounts are not enforced.

 
Until the statutory language of the MLA that specifically exempts statutory liens from the security interest and preemption provisions is enacted, it may take a lawsuit to answer this question. It appears, in my opinion, that the DoD guidance does not provide sufficient comfort to support the argument that a security interest in existing accounts would survive a legal challenge.
 
Have a regulatory question? Email me at vmadsen@esteecompliance.com.

Veronica Madsen
 
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