Appeal from the United States District Court for the Southern District of Indiana, Indianapolis Division. No. 1:07-cv-1479-SEB-DML-Sarah Evans Barker, Judge.
The opinion of the court was delivered by: Posner, Circuit Judge.*fn1
Before POSNER and FLAUM, Circuit Judges, and DERYEGHIAYAN, District Judge.
An Illinois loan company, Midwest Title Loans, Inc., sued under 42 U.S.C. § 1983 to enjoin, as a violation of the commerce clause, the application to Midwest of Indiana's version of the Uniform Consumer Credit Code (a model code, provisions of which have been adopted in several states). Ind. Code §§ 24-4.5-1-101 et seq. The district court entered a permanent injunction, and the state appeals.
A provision added to the Indiana version of the model code in 2007 and aptly termed the "territorial application" provision states that a loan is deemed to occur in Indiana if a resident of the state "enters into a consumer sale, lease or loan transaction with a creditor... in another state and the creditor... has advertised or solicited sales, leases, or loans in Indiana by any means, including by mail, brochure, telephone, print, radio, television, the Internet, or electronic means." § 24-4.5-1-201(1)(d). If the territorial-application provision is triggered, the lender becomes subject to the code and must therefore get a license from the state to make consumer loans and is bound by a variety of restrictions that include a ceiling on the annual interest rate that a lender may charge. The ceiling is the lower of 21 percent of the entire unpaid balance, or 36 percent on the first $300 of unpaid principal, 21 percent on the next $700, and 15 percent on the remainder. § 24-4.5-3-508. (There is an exception, inapplicable to this case, for payday loans. § 24-4.5-7-101 et seq.) A lender required to have a license who fails to obtain it or violates any of the statutory restrictions exposes himself to a variety of administrative and civil remedies. §§ 24-4.5-6-108, 24-4.5-6-110, 24-4.5-6-113. The failure to obtain a license also voids the loan-the borrower doesn't have to repay even the principal. And a borrower who has paid finance charges in excess of those permitted by the code is entitled to a refund. § 24-4.5-5-202.
Midwest Title is what is known as a "[car] title lender." "Cash loans, variously called car title pawn, car title loans, title pledge loans, or motor vehicle equity lines of credit, are the latest, fast-growing form of high cost, high risk loans targeting cash strapped American consumers. Storefront and online lenders advance a few hundred to a few thousand dollars based on the titles to paid-for vehicles. Loans are usually for a fraction of the vehicle's value and must be repaid in a single payment at the end of the month. Loans are made without consideration of ability to repay, resulting in many loans being renewed month after month to avoid repossession. Like payday loans, title loans charge triple digit interest rates, threaten a valuable asset, and trap borrowers in a cycle of debt." Jean Ann Fox & Elizabeth Guy, "Driven into Debt: CFA Car Title Loan Store and Online Survey," p. 1 (Nov. 2005), www.consumerfed.org/pdfs/Car_Title_ Loan_Report_111705.pdf (visited Dec. 4, 2009); see also Michael S. Barr, "Banking the Poor," 21 Yale J. Reg. 121, 164-66 (2004).
Until it received a letter in August 2007 from Indiana's Department of Financial Institutions advising it of the addition of the territorial-application provision to the code, Midwest had made title loans to Hoosiers (as Indianans like to call themselves) at annual percentage interest rates almost ten times higher than the maximum permitted by the code. They had a maturity of 12 to 24 months, were secured by the title to the borrower's motor vehicle, and were for no more than half the vehicle's estimated wholesale value. The loans were made only in person, at Midwest's offices in Illinois-it had no offices in Indiana. The loan would be in the form of a cashier's check payable to the borrower, drawn on an Illinois bank. The borrower was required to hand over a set of his car keys at the closing to enable Midwest to exercise self-help repossession of the car in the event of a default, so that it wouldn't have to go to court to enforce its lien should the borrower default. (In this respect, title lending is like pawn-broking-hence the alternative name "car title pawns.") A suit to enforce the lien would be infeasible because of the small size of the loans relative to the costs of litigation.
Midwest would notify the Indiana Bureau of Motor Vehicles of the loan as soon as it was made, so that it would be noted on the official record of the borrower's title, thus protecting Midwest's rights as a creditor from subsequent creditors to whom the debtor might grant a security interest in the vehicle. Repossessions occurred, naturally, in Indiana. Midwest would arrange with an Indiana firm to auction off the repossessed vehicle, and the auction would be held in Indiana.
Midwest advertised the loans on Indiana television stations and through direct mailings to Indiana residents. In 2006 it made more than two thousand such loans to Hoosiers, amounting to 9 percent of its loans that year. The two states adjoin and many Hoosiers live within a short drive, or even a walk, of Illinois. Ten of Midwest's 23 offices in Illinois are within approximately 30 miles of the Indiana border. Midwest discontinued its lending to residents of Indiana when it received the notice that the Indiana code applied to that lending.
The state asserts an interest in protecting its residents from what it describes as "predatory lending." There is a considerable body of thought that many consumers are incapable of making sensible decisions about credit. E.g., Oren Bar-Gill & Elizabeth Warren, "Making Credit Safer," 157 U. Pa. L. Rev. 1, 44-45 (2008); Paige Marta Skiba & Jeremy Tobacman, "Payday Loans, Uncertainty, and Discounting: Explaining Patterns of Borrowing, Repayment, and Default" (2008), http://bpp.wharton.upenn.edu/ tobacman/papers/payday.pdf (visited Dec. 4, 2009); Ronald J. Mann & Jim Hawkins, "Just Until Payday," 54 UCLA L. Rev. 855, 881-82 (2007); Amanda Quester & Jean Ann Fox, "Car Title Lending: Driving Borrowers to Financial Ruin," pp. 6-7, Apr. 2005, www.consumerfed.org/pdfs/ driving_borrowers_rpt.pdf (visited Jan. 13, 2010); Lynn Drysdale & Kathleen E. Keest, "The Two-Tiered Consumer Financial Services Marketplace: The Fringe Banking System and Its Challenges to Current Thinking About the Role of Usury Laws in Today's Society," 51 S. Car. L. Rev. 589, 605-10 (2000). According to this literature, many consumers can't make sense of the interest rates and other fees charged by loan companies, in part because of the complexity of most loan documents. They end up paying absurdly high rates when they could borrow at much lower rates from a bank or, without having to borrow at all, could draw upon savings that earn low interest. Many of the borrowers, lacking self-control-but unaware of this and therefore unable to take countermeasures-are incapable of moderating their desire for goods and services and end up overindebted.
The literature is mainly about payday loans but appears applicable to title loans as well. (See the articles by Fox & Guy and by Barr.) These and related forms of lending have been called "fringe banking," Ronald Paul Hill, "Stalking the Poverty Consumer: A Retrospective Examination of Modern Ethical Dilemmas," 37 Journal of Business Ethics 209, 214-15 (2002), but the pathologies identified in the literature may extend to more conventional forms of credit transactions. Bar-Gill & Warren, supra, 157 U. Pa. L. Rev. at 26-43; Oren Bar-Gill, "Seduction by Plastic," 98 Nw. U. L. Rev. 1373, 1375-76, 1395-1401 (2004). Congress is considering enacting a statute, pro-posed by the Treasury Department, that would create a federal Consumer Financial Protection Agency empowered to adopt regulations designed not only to prevent outright fraud in credit transactions but also to protect consumers of financial products from their cognitive limitations, limitations emphasized by behavioral economists. Consumer Financial Protection Agency Act of 2009, H.R. 3126, 111th Cong. (July 8, 2009); Adam J. Levitin, "The Consumer Financial Protection Agency," Am. Bankr. Inst. J., Oct. 2009, pp. 10, 66-67; Joshua D. Wright & Todd J. Zywicki, "Three Problematic Truths About the Consumer Financial Protection Agency Act of 2009," Lombard Street, Sept. 14, 2009, pp. 29, 30-31; Editorial, "The State of Financial Reform," New York Times, Oct. 25, 2009, p. 7.
A contrary school of thought points out that people who cannot borrow from a bank because they have poor credit may need a loan desperately. If a ceiling is placed on interest rates, these unfortunates may be unable to borrow because the ceiling may be too low for the interest rate to compensate the lender for the risk of de-fault. As a result, they may lose their house or car or other property or find themselves at the mercy of loan sharks. See Todd J. Zywicki, "Consumer Welfare and the Regulation of Title Pledge Lending," Mercatus Center Working Paper No. 09-36 (Sept. 2009), www.mercatus.org/ sites/default/files/pu b lic ation/W P0936_Consum er_ Welfare_and_Regulation_of_Title_Pledge_Lending.pdf (visited Dec. 4, 2009); Jonathan Zinman, "Restricting Consumer Credit Access: Household Survey Evidence on Effects Around the Oregon Rate Cap," 34 J. Banking & Finance (forthcoming 2010); Donald P. Morgan & Michael R. Strain, "Payday Holiday: How Households Fare after Payday Credit Bans" (Federal Reserve Bank of New York Staff Reports No. 309, Feb. 2008), http://ftp.ny.frb.org/ research/staff_reports/sr309.pdf (visited Dec. 4, 2009); Mann & Hawkins, supra, 54 UCLA L. Rev. at 884-94 (2007); Gregory Elliehausen, "Consumers' Use of High-Price Credit Products: Do They Know What They Are Doing?" (Networks Financial Institute Working Paper No. 2006-WP-02, May 2006), http://papers.ssrn.com/sol3/papers. cfm?abstract_id=921909) (visited Dec. 4, 2009). An annual interest rate of 300 percent is astronomical. But a person who borrows $5,000 at that rate and repays it two weeks later pays only $577 in interest, and the loan may have enabled him to avert foreclosure on his house, or some other dire event that would have cost him more than $577.
Against this benign view of "fringe banking" it has been argued that many of the borrowers end up rolling over their loans from month to month, which runs counter to the theory that these are short-term loans rationally incurred, despite their high cost, as a temporary response to unexpected setbacks. See Michael A. Stegman & Robert Faris, "Payday Lending: A Business Model That Encourages Chronic Borrowing," 17 Economic Development Quarterly 8, 19-21 (2003); Quester & Fox, supra, at 6-7; Drysdale & Keest, supra, 51 S. Car. L. Rev. at 605-10; and the passage quoted earlier from Fox & Guy.
We need not take sides in the controversy over the merits of "fringe banking." It is enough that Indiana has a colorable interest in protecting its residents ...