[Editor’s Note: This is a guest post from Scott Stewart, CEO of the Innovative Lending Platform Association. ]
Courts are distorting credit markets in a way that hurts Main Street small businesses, and Congress now has an opportunity to fix it.
Imagine you opened a salon two years ago with a chair for both you and your business partner. Over the years, you built a small clientele and grew steady revenues. Your business is profitable, and you want to add two more chairs to your shop. You estimate that the expansion will cost $20,000 but will yield $40,000 annually in new revenue.
Together, you discuss taking out a small business loan with both large and small banks, but they turn you down citing your 640 personal credit score and the lack of two years of business tax returns as the reason for the decline. So, you reach out to online lenders in the hopes of securing the capital you need to expand and grow your business.
After reviewing your application, an online lender offers your business a $20,000 loan that can be funded in a day and paid back in weekly installments over a six-month period. The APR seems high – it’s about 40% – but the total cost of capital is only $2,115. That means you’ll pay $2,115 to borrow $20,000 to fuel your expansion, and that expansion is expected to yield a $40,000 return on your investment. You and your partner decide to seize the opportunity.
Unfortunately, a recent decision by the Second Circuit Court of Appeals in Madden vs. Midland Funding, is making it difficult for online lenders to offer businesses the funds they need to grow and succeed. The Madden decision undermined the legal doctrine known as “valid when made,” which has been a cornerstone of banking law for over 100 years. The principle is simple. If a loan is legal with respect to its interest rate, then it does not become invalid or unenforceable when sold to another party. Numerous bi-partisan and non-partisan groups have come out in opposition to the Madden decision, in part because of the dangerous uncertainty it has inserted into the financial markets that are critical to supplying credit to individuals and small businesses.