In a state enforcement action alleging violations of California's lending law and seeking to enjoin continued lending to state residents, the California Supreme Court has ruled that the two tribally affiliated entities that operated the internet payday lending businesses at issue had not shown they were entitled to tribal sovereign immunity as "arms of the tribe."

In The People of the State of California v. Miami Nation Enterprises, et al., the Supreme Court reversed the appellate court’s decision affirming the trial court's dismissal of the enforcement action based on the defendants' entitlement to tribal sovereign immunity. After first concluding "that a tribally affiliated entity claiming immunity bears the burden of proving by a preponderance of the evidence that it is an arm of the tribe," the Supreme Court adopted a five-factor test to use in determining whether an entity has met such burden. Those factors are: the entity's method of creation; whether the tribe intended the entity to share its immunity; the purpose for which the entity was created and the degree to which it serves that purpose; the amount of control the tribe has over the entity; and the financial relationship between the entity and the tribe. The Court "emphasize[d] that no single factor is individually dispositive" and all factors will be considered in "an overall assessment" of whether the entity has met its burden of proof.

The appellate court had concluded that absent "extraordinary circumstances," a tribal entity functions as an "arm of the tribe" if it "has been formed by tribal resolution and according to tribal law, for the stated purpose of tribal economic development and with the clearly expressed intent by the sovereign tribe to convey its immunity to that entity, and has a governing structure both appointed by and ultimately overseen by the tribe." In the Supreme Court's view, the appellate court "gave inordinate weight to [such] formal considerations" and overlooked the need to "carefully examine how such arrangements function as a practical matter" so that tribal immunity does not become "a doctrine of form over substance."

Although the tribes had delegated day-to-day management to a nontribal third party, the appellate court had found it persuasive that under the management agreements with the third party, the tribal entities had final authority to approve or disapprove loans, and had oversight and control over day-to-day management. The Supreme Court concluded that despite the language of the management agreements and the ability of tribal members to serve as or appoint the entities' directors, there was "significant evidence" that neither the tribal entities nor the tribes "maintain operational control over the underlying lending businesses." The Supreme Court found that both tribal entities relied heavily on outsiders to manage the lending businesses, with the bulk of the servicing operations conducted outside of the tribes' boundaries. It also found that because routine board meetings were not held, there was an absence of tribal oversight.

The Supreme Court did not disagree with the appellate court's findings that the tribal entities were created under tribal law with the stated intention of extending the tribes' immunity to such entities and for the stated purpose of providing employment opportunities and other economic benefits for tribal members. However, in examining the tribes' financial relationship to the tribal entities, the Supreme Court found "it significant that neither [tribal entity] has stated with clarity the proportion of profits from the lending operations that flow to the tribes or the proportion of the tribal revenue that those profits comprise." It observed that there was evidence to suggest that the lending operations were of minimal economic benefit to the tribes, such as a management agreement under which "the vast majority of revenue from the lending businesses flowed to the management company." According to the court, the tribal entities had not established that a judgment against them would appreciably affect tribal revenues or carried their burden of demonstrating either the tribes' practical control or a close financial relationship between the tribes and the lending businesses, thereby suggesting "that those businesses, in practice, do not meaningfully serve the purpose of [providing employment opportunities and other economic benefits for tribal members]."

The Supreme Court also found that although the tribal entities were created under tribal law, their method of creation did not fully support immunity because the initial capital and intellectual property (i.e. trademarks under which the lending businesses operated) did not come from the tribes but came from a nontribal entity that continued to have a significant role in the lending operations. Finally, despite its finding that the tribes' intent to share their immunity "weighed unequivocally in favor of extending tribal immunity," the court concluded that "such a formal statement of immunity [in the entities' articles of incorporation] is not sufficient here to tip the balance in favor of immunity." The court reversed and remanded the judgment to the appeals court, noting that the trial court could examine on remand whether the parties had an opportunity to fully litigate their claims under the Supreme Court's standard for establishing arm-of-the-tribe immunity.

Tribal payday lending has also been a target of federal regulators. The Ninth Circuit is currently considering the appeal of three tribally affiliated internet payday lenders that are challenging the Consumer Financial Protection Bureau's authority to issue civil investigative demands (CIDs) to entities that are "arms of the tribe." A California federal district court rejected the lenders' argument that the CIDs were barred by tribal sovereign immunity.

In an enforcement action alleging violations of the Federal Trade Commission Act and other federal laws by tribally affiliated internet payday lenders (including one of the tribal entity defendants in the California enforcement action) and by related companies and individuals involved in operating the lending businesses, a Nevada federal district court found that the FTC had authority to regulate Indian tribes, as well as "arms of tribes," their employees, and their contractors and entered summary judgment in favor of the FTC. After several of the corporate defendants settled with the FTC, the district court ruled that the individual defendant could be held liable for the FTC Act and other federal law violations and entered a $1.3 billion judgment in favor of the FTC.

Ballard Spahr's Consumer Financial Services Group is nationally recognized for its guidance in structuring and documenting new consumer financial services products, its experience with the full range of federal and state consumer credit laws throughout the country, and its skill in litigation defense and avoidance.


Copyright © 2016 by Ballard Spahr LLP.
www.ballardspahr.com
(No claim to original U.S. government material.)

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, including electronic, mechanical, photocopying, recording, or otherwise, without prior written permission of the author and publisher.

This alert is a periodic publication of Ballard Spahr LLP and is intended to notify recipients of new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have.