By Jody Godoy

A California judge is poised to decide if an online lender offering small loans at over 150% interest violates state law, which would deal a blow to finance companies that critics argue have skirted rate caps to profit from cash-strapped borrowers.

The California Department of Financial Protection and Innovation (DFPI) is seeking a ruling that would block Chicago-based Opportunity Financial (OppFi) from offering loans with an interest rate above California's maximum of 36%.

Los Angeles Superior Court Judge Timothy Dillon is expected to rule any day. Legal experts say that if California wins, it could embolden other states to take action against lenders that make high-interest loans to low-income borrowers using what critics call "rent a bank" partnerships.

Critics say the partnerships allow some fintech lenders, which offer quick loans online, to get around the interest-rate caps most states impose on nonbanks by partnering with banks in states like Utah, where there is no interest rate cap.

The lenders themselves say the partnerships help smaller state banks compete and fill a void for borrowers with low credit scores who need emergency cash for unexpected expenses like car repairs and medical care.

According to a 2022 survey by the Federal Reserve, 37% of adults in the U.S. do not have the cash to cover an unexpected expense of $400.

A spokesperson for OppFi did not reply to a request for comment, and a spokesperson for DFPI declined to comment.

Lauren Saunders, associate director at the National Consumer Law Center said California's fight with OppFi could set an example for other states.

"The more they succeed, the more you will see other states join in and pursue predatory lenders," she said.

Several nonbank lenders have already exited California, said Saunders, whose group tracks high-interest lenders.

"TRUE LENDER"

A few state regulators have reached settlements with fintech companies such as EasyPay Finance and Elevate Credit that limited the interest rates they charge or barred them from lending in the state.

In California, OppFi took the unusual step of preemptively suing to try to block the state from taking action.

Federal law allows state-chartered banks to lend across state lines at the interest rate legal in their home state.

But state lawmakers decide how much interest nonbank lenders can charge. California capped annual interest rates on loans between $2,500 and $10,000 at 36% in 2020.

OppFi offers loans through Utah-based FinWise Bank. OppFi has stressed in court that the bank is the lender, as it oversees loan marketing and origination, funds the loans initially, keeps 5% of each loan on its books and answers to regulators.

California has urged Dillon to recognize that OppFi decides who to lend to and has a deal with the bank to purchase the loans.

"People always try to find loopholes and technicalities to evade the laws, to maximize their profits," state attorney Allard Chu said at a July hearing in the case.

The state has asked Dillon to block OppFi from collecting on or making new loans at more than 36% interest while the case is in progress.

OppFi has said that would effectively oust it from the California market and jeopardize its partnership with FinWise, because 36% is not a viable rate at which to make such risky loans.

OppFi has aruged that there is no state law or regulation specifying when a bank partner should be considered the "true lender" and that the DFPI is trying to create one in court.

If the judge agrees, it may derail the case.

In that instance, experts think the state may attempt to regulate or legislate the issue.

One option is to follow Colorado, which recently passed legislation invoking a long-dormant right embedded in the federal law to opt out of importing other states' interest rates.

"It's very obscure," said Saunders, but "a powerful right."

Some in the lending industry have questioned whether the Colorado law will apply to bank partnerships, because it depends on whether the loan is considered to have been made in the borrower's home state or the lender's.

"That's really the million dollar question," said Ron Vaske, an attorney at Ballard Spahr who counsels fintech companies.

(Reporting by Jody Godoy in New York; editing by Andy Sullivan)