Financial Technology Association challenges CFPB’s BNPL rule | PaymentsSource

The Consumer Financial Protection Bureau has been issuing a barrage of rules and enforcement actions ahead of next year’s change in the White House, including an interpretive rule on buy now/pay later products. It will soon have to defend that rule — and others — in court. 

The Financial Technology Association in mid-October filed suit against the CFPB for its May interpretive rule that redefined buy now/pay later as open-ended credit, similar to credit cards, which put BNPL squarely under the oversight of the Truth in Lending Act and Regulation Z. 

The suit contends that the bureau’s attempt to classify BNPL products as credit cards under TILA is unlawful for three reasons. First, the FTA says the CFPB’s expanded interpretation of a “credit card” is incorrect, and that BNPL products do not fit key elements to previously established definitions of credit cards. 

Second, it contends that the CFPB ignored the Administrative Procedure Act through its interpretive rule. The APA is a federal law that governs the way federal regulators propose and establish new rules. The suit also contends that the rule is “arbitrary and capricious” due to ill-fitting disclosure requirements that demonstrate an “improper understanding” of pay-in-four products and insufficient compliance time, according to the filing with the U.S. District Court of the District of Columbia. 

“Millions of Americans choose to pay in four with Buy Now Pay Later, and our industry welcomes regulation that fits the unique characteristics of these products without duplicating existing rules and protections,” FTA Chief Executive Penny Lee said in a statement. 

“The CFPB is seeking to fundamentally change the regulatory treatment of pay-in-four BNPL products without adhering to required rulemaking procedures, in excess of its statutory authority, and in an unreasonable manner,” she said. “We believe the CFPB’s attempt to impose regulations designed for credit cards on the pay-in-four products offered by many of our members shows an underlying misunderstanding of BNPL.” 

The FTA declined to comment further on the lawsuit. The CFPB also declined to comment.

Open- vs. closed-end credit

Previously, installment loans with four payments or fewer were exempt from TILA, said Kimberly Holzel, a partner at Goodwin, who previously spent four years at the CFPB heading examination teams for large financial institutions. 

But the bureau, in its interpretive rule, is defining pay-in-four products as a credit card product because consumers have digital accounts that they can return to for credit in the future. Installment loans with five payments or more are already covered under Regulation Z. 

“One thing that was interesting to me is this dichotomy between open- and closed-end credit,” Holzel said. “A lot of buy now/pay later loans are just closed-end installment loans that already comply with the Truth in Lending Act. That being said, there’s quite a number of products that were designed around the exemption for pay-in-four with no interest.” 

Marrying the idea that pay-in-four BNPL products are now covered under TILA’s credit card provisions with the notion that pay-in-five BNPL products are covered under TILA’s installment loan provisions might be tricky, Holzel said. Many BNPL providers, including Zip Co., offer BNPL loans that allow consumers to repay in more than four installments. 

“There are some companies out there that provide what [the CFPB is] calling a ‘digital account,’ where the consumer can go back and get repeated loans for all their different purchases, and that digital account is being treated as a credit card,” she said. “It’s very difficult to apply both closed end and open end [rules] in the same breath.” 

Violations to the Administrative Procedure Act

The FTA’s suit also marks a return to a “more traditionally argued Administrative Procedure Act challenge” following years of litigation that used the courts to also challenge the bureau’s constitutionality, said Eamonn Moran, a partner at Holland & Knight, who has worked in the CFPB’s office of regulation. 

“There’s allegations the bureau didn’t follow the APA notice and comment requirements … and that they skipped that by using the interpretive rule, [which is] something that this current CFPB leadership actually seems to be more in favor of,” Moran said, noting that the bureau has also issued formal rules, such as its rule on open banking. 

Generally, agencies will provide a 30- to 60-day comment period for proposed rules, according to the Federal Register. By comparison, the CFPB’s interpretive BNPL rule went into effect July 30, with comments due Aug. 1. Interpretive rules are not subject to APA requirements. 

It is not uncommon for procedural issues to be raised as part of challenges to proposed rules, said Aaron Kouhoupt, member and chief privacy officer at McGlinchey. “There’s always this tension between whether or not any regulatory agency — the CFPB or otherwise — is simply clarifying existing law, or whether they’re creating new law.” 

If the court decides the CFPB is in fact interpreting existing law, it will also decide whether the bureau’s interpretation is on point now that the Chevron deference is no longer applicable, Holland & Knight’s Moran said. 

The Chevron deference was a legal precedent set in 1984 that said courts would defer to an agency’s interpretation of a law it administers as long as that interpretation was reasonable. That was overturned by the U.S. Supreme Court in June, freeing up courts to interpret laws. 

“I do think that the fact that we no longer have the Chevron deference potentially could mean that [the CFPB] is on shakier ground than they would have been otherwise,” Moran said. He noted there have been at least two instances where the bureau has been successful in defending against APA-type challenges in the absence of Chevron. 

“It doesn’t mean that the bureau’s interpretation is automatically going to get struck down,” he said, especially in a D.C. court, where judges may be friendlier to the CFPB than other venues. 

If the suit is successful on procedural grounds, it could open up the door for litigation against the CFPB’s proposed interpretive rule on earned wage access, which used similar procedural elements, McGlinchey’s Kouhoupt said, cautioning that fallout from this case on other CFPB rules was highly speculative. 

“It depends on so many factors as to why a court might accept it [or] why the court might reject it,” Kouhoupt said. “If it’s [accepted] on procedural grounds, it could maybe impact the way the CFPB views its authority to issue rulemaking. If it’s on substantive grounds, it’s really a matter of whether or not the agency got [its interpretation] right.” 

For now, BNPL firms are rushing to get into compliance, Goodwin’s Holzel said. The CFPB has said it would not fine BNPL providers that were “transitioning into compliance in a good faith and expeditious manner,” according to an Aug. 16 blog post by Director Rohit Chopra. 

“Everyone’s in the weeds of sorting out whether their product is going to be subject to this, and racing towards implementation,” Holzel said. “Unlike rules that have an extended APA rulemaking procedure and an extended compliance date, they are saying that this is the rule as it is today. So that makes implementation a lot more rushed.”