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Dollar Loan Center of South Dakota, LLC v. Afdahl

United States District Court, D. South Dakota, Central Division

May 29, 2018

DOLLAR LOAN CENTER OF SOUTH DAKOTA, LLC, Plaintiff,
v.
BRET AFDAHL, [1] Defendant.

          OPINION AND ORDER DENYING DEFENDANT'S MOTION TO DISMISS, GRANTING PLAINTIFF'S MOTION FOR PARTIAL SUMMARY JUDGMENT, AND DENYFNG DEFENDANT'S CROSS MOTION FOR SUMMARY JUDGMENT

          ROBERTO A. LANGE UNITED STATES DISTRICT JUDGE.

         Plaintiff Dollar Loan Center of South Dakota, LLC (DLC) brought this suit under 42 U.S.C. § 1983 against Defendant Bret Afdahl (Afdahl), the director of the South Dakota Division of Banking, alleging Afdahl deprived DLC of procedural due process required under the Fourteenth Amendment when he revoked DLC's money lending licenses. Doc. 1. Afdahl moved to dismiss the action for failure to state a claim, Doc. 8, DLC moved for partial summary judgment, Doc. 11, and Afdahl filed a cross motion for summary judgment, Doc. 19. For the reasons stated below, this Court denies Afdahl's motion to dismiss, denies Afdahl's cross motion for summary judgment, and grants in part DLC's motion for partial summary judgment.

         I. Factual Background

         The South Dakota Division of Banking (Division), an agency within the South Dakota Department of Labor and Regulation, is charged with the supervision and control of activities set forth in SDCL chapter 51A (Banks and Banking). Doc. 21 at ¶¶ 10-11. Afdahl is the director of the Division. Doc. 21 at ¶ 9; Doc. 29 at ¶ 4. As director, Afdahl has authority with respect to entities holding money lending licenses, such as investigations and examinations of business records and accounts, and has powers over licenses themselves including issuing cease and desist orders, approval or denial of applications and renewals, and authority to revoke or suspend in certain circumstances. Doc. 21 at ¶ 13; Doc. 29 at ¶ 5. See SDCL §§ 54-4-41-57.

         DLC applied for a money lender's license under SDCL chapter 54-4 in 2010. Doc. 21 at ¶ 14; Doc. 29 at ¶ 7; Doc. 22-2. DLC's initial application indicated it would not provide short-term consumer loans as defined under South Dakota law.[2] Doc. 21 at ¶ 15; Doc. 22-2. The Division issued a license to DLC, MYL2840, which is considered DLC's main license. Doc. 21 at ¶¶ 16-17; Doc. 29 at ¶ 7. DLC submitted several renewal applications for its lending license, and applied for additional licenses to open branches in different communities in South Dakota. No. renewal application or license application indicated that DLC would provide short-term loans, or that DLC was making any substantive change to its loan products (with the exception in 2012 of a change from a 52 week to a 65 week amortized loan product). Doc. 21 at ¶¶ 18-36; Docs. 22-3, 22-4, 22-5, 22-6, 22-7, 22-8, 22-9. DLC historically made high interest loans at rates exceeding 300 percent per annum and had successfully expanded to twelve locations across South Dakota. Largely to target the lending practices of DLC, Initiated Measure 21 (IM 21) was placed on the South Dakota ballot in 2016 to set a usury rate cap in South Dakota.

         South Dakota voters on November 8, 2016, passed M 21 to set a maximum finance charge for money lenders licensed under SDCL chapter 54-4. Doc. 21 at ¶¶ 1-2; Doc. 29 at ¶ 1. IM 21 prohibits all money lenders licensed under SDCL chapter 54-4 from making a loan that imposes total interest, fees, and charges at an annual percentage rate (APR) greater than 36 percent, or from evading that rate limitation by indirect means.[3] Doc. 21 at ¶¶ 3-4. Following the passage of IM 21, the South Dakota Legislature passed House Bill 1090 during the 2017 Legislative Session which added a new section to Chapter 54-4 which instructed that "late fees, return check fees, and attorney's fees incurred upon consumer default are not fees 'incident to the extension of credit.'" SDCL § 54-4-44.3.

         DLC did not seek renewal of eight branch licenses. Doc. 21 at ¶ 37. Because DLC's then existing loan product offered interest rates that exceeded 36 percent, DLC could no longer originate that product after IM 21 went into effect in November of 2016. See Doc. 21 at ¶¶ 153-163. DLC still held a main office license for its location at 921 West 10th Street in Sioux Falls and four branch licenses for locations in Rapid City, Aberdeen, Watertown, and Sioux Falls. Doc. 21 at ¶ 38; Doc. 29 at ¶ 6.

         DLC advised the Division on June 21, 2017, that it would begin making loans using a new loan contract that differed from those previously disclosed to the Division. Doc. 21 at ¶ 42; Doc. 29 at ¶ 10. DLC counsel Sander Morehead (Morehead) provided a blank copy of the updated loan contract and advised the Division that DLC planned to begin making the loans sometime after July 1, 2017. Doc. 21 at ¶ 43; Doc. 29 at ¶ 10. On June 22, 2017, Division counsel Brock Jensen (Jensen) emailed Morehead and acknowledged receipt of the letter and blank loan contract, and requested a copy of the current loan contract which was to be replaced. Doc. 21 at ¶¶ 47-49; Doc. 29 at ¶ 10.

         In a letter from Jensen to Morehead dated July 7, 2017, Jensen expressed the Division's concern regarding the proposed signature loan product. The letter reads as follows:

         Dear Mr. Morehead:

The South Dakota Division of Banking (Division) received and reviewed your letter with attachment dated June 21, 2017. In your letter, you indicate that your client, Dollar Loan Center South Dakota, LLC (DLC), intends to begin making loans with an updated loan contract sometime after July 1, 2017, after some recent amendments to SDCL Chapter 54-4 go into effect. Specifically, it appears that DLC's new loan contracts attempt to take advantage of a provision of House Bill 1090 (HB1090) that provides that late fees are not "incident to the extension of credit."
Please note that SDCL 54-4-44.1 provides the following regarding the manipulation of fees to avoid the application of the requirements of SDCL 54-4-44:
[text of SDCL § 54-4-44.1 omitted but included herein, supra note 2]
Prior to receiving your June 21 letter, it was the Division's understanding that DLC would not originate, renew, or roll over any new loans after the provisions of Initiated Measure 21 became effective on November 16, 2016. As such, it appears that DLC may intend to use the late fee provision in the new loan contracts as a "device, subterfuge, or pretense to evade the requirements of § 54-4-44."
It is the position of the Division that any effort to exploit the very limited exemptions provided in HB 1090, in order to engage in high cost consumer lending, will not be permitted. Please consider this letter to be notice that the Division intends to conduct a full examination of DLC within the next thirty days in order to more fully understand the actions and intent of DLC in this matter.
If you have any questions or need more information, please feel free to contact this office. Thanks.

Doc. 22-13. In response, Morehead replied in a letter dated July 12, 2017, that DLC would fully cooperate with the examination and "has not and has no intention of violating SDCL Chapter 54-4." Doc. 22-14 at 1.

         The Division conducted a target examination on July 13, 2017, at the DLC office in Sioux Falls, South Dakota, where the operations of the Sioux Falls branch and the Rapid City branch of DLC were examined. Doc. 21 at ¶¶ 53, 57, 58; Doc. 29 at ¶ 14. DLC Regional Manager Beau Fritts (Fritts) and DLC's outside counsel, attorney Justin Smith (Smith), were present for the target examination. Doc. 21 at ¶ 61; Doc. 29 at¶ 14. Fritts provided the examiners with a copy of DLC's South Dakota Operations Training Manual (OTM) along with access to DLC's loan software system known as Infinity. Doc. 21 at ¶ 63; Doc. 29 at ¶ 14. Fritts provided the examiners with a brief tutorial on how to navigate the Infinity software, and an examiner provided Fritts and Smith with a list of requested items and reports needed for the examination. Doc. 21 at ¶¶ 69-70; Doc. 29 at ¶ 14. The examiners reviewed several loans, read through the OTM, and received several of the requested items from Smith. Doc. 21 at ¶¶ 71-72, 75; Doc. 29 at ¶ 14, 16. At approximately 1:30 p.m., the examiners asked to meet with Fritts and Smith to make further inquiries after reviewing the selection of loans. Doc. 21 at ¶ 76; Doc. 29 at ¶ 14. The examiners reviewed the request list with Fritts and Smith and inquired about items that were still outstanding. Doc. 21 at ¶ 77; Doc. 29 at ¶ 14. The examiners communicated a desire for reports that would present a "more high-level overview" on the performance of the new loans. Doc. 21 at ¶¶ 79, 81; Doc. 29 at ¶ 17. Fritts explained that the examiners already had reports which included information on each loan originated, and that no reports existed at that time matching the criteria sought by the examiners. Doc. 21 at¶¶ 79, 80, 81, 82; Doc. 29 at ¶ 17.

         The Division determined after the target examination that additional information and a larger loan sample were needed to complete the examination of DLC. Doc. 21 at ¶ 84; Doc. 29 at ¶ 19. At the time of the target examination, DLC's new loan product was 10 days old and only 27 loans had reached their seven day maturity period.[4] Doc. 21 at ¶ 85, 87. The Division found that of those 27 loans, 16 were past due. Doc. 21 at ¶ 87. On July 18, 2017, the Division sent an email to Fritts with a list of follow-up questions requesting a response as soon as possible. Doc. 21 at ¶ 88; Doc. 29 at ¶ 19. There were six questions, some with subparts, which requested certain information about the signature loan product and lending practices of DLC:

1. The New Signature Loan Product that DLC began offering on July 3, 2017 (Signature Loan) has an APR that is capped at 36%, which is the same as the interest rate cap on active military members through the Military Lending Act (MLA). Does DLC offer Signature Loans to active military members?
a. Does the Signature Loan comply with the MLA?
b. If the Signature Loan complies with the MLA but is not currently offered to active military, please provide your reasoning for this.
2. Based on the contents of the Operations Training Manual (OTM), applicants' income is one of the key criteria in determining whether to approve a loan. On Page 18 of the OTM, "Gets paid weekly or bi-weekly" is listed as a "Pro-Positive risk factors that strengthen an application." If a borrower only get [sic] paid bi-weekly, but the loans mature in seven days, why is this a "Pro" instead of a negative factor?
3. On 17 of the 20 loans we reviewed, we noted that the borrowers didn't get paid until after the loan was scheduled to mature. Does management currently track this information?
i. If a DLC employee/manager notes that the applicant isn't scheduled to get paid until after the loan matures, are they required to perform additional due diligence on how the applicant intends to repay the loan by the contractual due date?
4. According to reports provided to the examiners, DLC approved/funded 27 loans from July 1-July 5th. Sixteen of those 27 loans (59.25%) were past due as of July 13th (no other loans originated could have been past due on July 13th due to the standard seven day loan term). This equates to 17.77% (16 of 90) of the total number of all loans outstanding being past due. This is substantially higher than the 1.37% of loans past due that was reported in the Statement of Loan Activity in DLC's 2017 Money Lender Renewal Application for South Dakota. What do you attribute this significantly higher rate of past due loans to?
5. The loan Agreement states that DLC "may report information concerning performance of this Agreement to one or more consumer reporting agencies. Late payments, missed payments, or other defaults may be reflected in Borrower's credit report". Does DLC currently, or at any time in the past, report late payments, missed payments or other defaults to any credit reporting agencies?
6. Is there a level of loan volume where DLC can be profitable offering Signature Loans on only interest collected (no late fees)?
a. Has there been any analysis done regarding this?
i. If so, please provide documentation of this, or a description of the analysis if it was not documented.
b. Is there a level of past due fees needed in order to be profitable?

Doc. 1-3.

         DLC through Morehead responded to the inquiries on July 26, 2017, with relatively brief responses. Doc. 1-4; Doc. 22-18. In that response letter, Morehead made clear that DLC had concerns that the Division sought information that went beyond the scope of the target examination, namely the legality of DLC's signature loan product. Doc. 1-4 at 1; Doc. 22-18 at 1.

         The Division replied to DLC's response on August 10, 2017, stating that it deemed DLC's responses to the July 18, 2017, questions as "incomplete and unresponsive." Doc. 22-19 at 1. The Division also viewed DLC's purported failure to provide complete and responsive answers to Division questions as a "refusal of the money lender to permit the Director to make an examination" pursuant to South Dakota law, and that such a refusal would constitute "good cause" for the Director to take action against the licenses of that lender pursuant to SDCL § 54-4-49.[5]Doc. 22-19 at 1. The Division requested detailed and complete answers to the previously submitted questions and provided notice that a full scope examination of DLC would commence at the Sioux Falls location beginning at 9:00 A.M. on August 17, 2017. Doc. 22-19 at 1-2.

         Morehead, on behalf of DLC, responded to the Division on August 15, 2017, and disputed that DLC had not been fully responsive to all aspects of the target examination, including the July 18, 2017 questions. Doc. 22-20 at 1. Morehead nevertheless provided further responses of DLC to the interrogatories, including a lengthy legal analysis arguing that the late fees associated with DLC's signature loan product were "bona fide" late fees, and thus not in violation of SDCL § 54-4-44. l's proscription against the use of "any device, subterfuge, or pretense to evade the requirements of § 54-4-44." Doc. 22-20 at 2-6. Morehead indicated that this analysis was being provided in part because of the Division's earlier concern that the late fees associated with the signature loan product constituted a means of evading the 36 percent APR limitation, and further stated that "DLC assumes this is at least one reason the Division has taken such an interest in the Signature Loan Product, and will now conduct a second examination in a little over 30 days' time, after conducting few, if any, during DLC's first seven years of operation." Doc 22-20 at 2.

         The full scope examination took place on August 17 and 18, 2017, at DLC's Sioux Falls location where Fritts and Smith were once again present. Doc. 21 at ¶ 105; Doc. 29 at ¶ 25. The examiners determined that DLC originated 633 loans from July 1 to August 17, and selected 308 of those loans for examination. Doc. 21 at ¶¶ 106-07. In examining DLC's Payments Report covering July 1 to August 17, the examiners found that late fees paid by DLC customers totaled $10, 050.00 and interest paid was only $1, 091.81. Doc. 21 at ¶ 126. The examiners ultimately concluded that the late fees associated with DLC's signature loan product were "anticipated late payments" which they believed were not excluded from finance charge calculations under Regulation Z.[6] Doc 21 at ¶ 132. When these payments were included in the finance charge, the examiners determined the APR of DLC's signature loan product ranged from 350.83 percent to 487.64 percent, depending on the loan amount. Doc. 21 at ¶ 139. The Report of Examination (ROE) submitted to Afdahl included a finding that DLC's signature loan product violated SDCL § 54-4-44 because the APR exceeded 36 percent. Doc 21 at ¶ 149. Apart from examination of the loans, the Division considered the OTM from 2011 which dealt with DLC's old signature loan product-a very high interest loan with a term of 52 weeks that was later changed to a term of 65 weeks, which DLC could no longer offer after IM 21 went into effect-and compared it to the new OTM which dealt with DLC's new signature loan product. The comparison of these OTM's revealed that DLC did not alter the criteria used in the loan decision processes after it began offering the new signature loan product. The Division further determined that the high delinquency rate of the new signature loan product generated a seven percent weekly late fee, much as the old signature loan product generated a seven percent weekly interest fee, and these factors contributed to the Division's conclusion that the late fees associated with DLC's new signature loan product were "anticipated" and subject to the interest charge calculation. Doc. 21 at ¶¶ 153-182.

         On September 13, 2017, Afdahl issued Order No. 2017-2, a Cease and Desist and License Revocation Order (Order). Doc. 10-1 at 7-12. The Order instructed DLC to "cease engaging in the business of money lending in South Dakota" and to notify all consumers who were issued loans after June 21, 2017, that the loans were void and uncollectible as to "any principal, fee, interest, or charge pursuant to SDCL 54-4-44." Doc. 10-1 at 11. The Order further required DLC to surrender all of its South Dakota money lender licenses and return them to the Division. Doc. 10-1 at 11. The Order contained a "Findings of Fact" section, a "Conclusions of Law" section, and a notice that "any person aggrieved by this order" could within 30 days file a request for a hearing before the South Dakota Banking Commission. Doc. 10-1 at 8-12. Among the findings of fact, Afdahl determined that the APR for DLC's signature loan product ranged from 300.86 percent to 487.64 percent, that DLC was not licensed by the Division to originate and service "short term consumer loans" but only loans with maturities longer than six months, and that DLC's signature loan product was designed to incur late fees. Doc. 10-1 at 9. In his conclusions of law, Afdahl determined that DLC was engaging in practices that violated SDCL chapter 54-4 by providing short term consumer loans and offering a loan product that was in practice a "device subterfuge, or pretense to evade the requirements of SDCL 54-4-44." Doc. 10-1 at 10. Afdahl further concluded that he had good cause to revoke DLC's money lending licenses because DLC had "violated statutes related to consumer credit, engaged in unfair practices involving lending activity, " and found that the license applications submitted by DLC were "materially incomplete" and contained statements which were "false or misleading with respect to material facts." Doc. 10-1 at 10-11. Afdahl also issued a "Statement from the Division of Banking on Dollar Loan Center" informing the public that the Order revoked all money lending licenses held by DLC because its practices had been found to violate South Dakota law. Doc. 21 at ¶ 191; Doc. 22-23.

         The Division emailed Morehead on September 15 and 18, 2017, inquiring as to whether DLC was in compliance with the Order. Doc. 1-7; Doc. 1-8. On September 15, counsel for the Division expressed a belief that DLC was continuing to service loans and emphasized that DLC was no longer a licensed money lender pursuant to the Order and was required to cease all lending activity. Doc. 1-7. On September ...


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