Stephen G. Harveyharveys@pepperlaw.com

www.pepperlaw.com

November 14, 2006

PAYDAY LOAN BAR ASSOCIATION ANNUAL

CONFERENCEConstitutional Issues Raised by State Regulation Of Interstate

Lending

Three Separate But Closely Related Constitutional Issues

• When can a lender can be subject to suit in a foreign jurisdiction (personal jurisdiction).

• When can the law of a foreign jurisdiction be applied to a transaction with a lender (choice of law)?

• When can a foreign jurisdiction regulate a lender (adjudicative jurisdiction)?

Relevant Constitutional Provisions

• The Full Faith and Credit Clause

• The Due Process Clause of the 5th Amendment

• The Commerce Clause

Constitutional Limitations on Personal Jurisdiction

• Traditional test of minimum contacts with forum state.

• In the Internet context, the leading case is Zippo Mfg. Co. v. Zippo Dot Com, Inc. 952 F. Supp. 1119 (W.D. Pa. 1997).

Constitutional Limitations on Choice of Law

“[F]or a State’s substantive law to be selected in a constitutionally permissible manner, that State must have a significant contact or aggregation of contacts, creating state interests such that choice of its law is neither arbitrary nor fundamentally unfair.” Allstate Ins. Co. v. Hague, 49 U.S. 302, 312-13 (1981).

Constitutional Limitations on Choice of Law

In the class action context, one State’s law cannot be applied to the claims of persons in other States without “a significant contact or significant aggregation of contacts of contacts to the claims asserted by each member of the plaintiff class.” Phillips Petroleum Co. v. Shutts, 472 U.S. 797, 821 (1985).

Constitutional Limitations on Adjudicative Jurisdiction

• In addition to the limitations imposed by the Full Faith and Credit and Due Process Clauses, the Commerce Clause imposes a significant limitation on States’ effort to regulate out-of-state conduct.

• Dormant Commerce Clause prohibits protectionist state legislation that discriminates against out-of-staters.

• Discriminatory state laws are subject to strict scrutiny.

Constitutional Limitations on Adjudicative Jurisdiction

For state laws that appear non-discriminatory on their face but nonetheless impinge on interstate commerce, courts apply a balancing test: “Where the statute regulates evenhandedly to effectuate a legitimate local public interest, and its effects on interstate commerce are only incidental, it will be upheld unless the burden imposed on such commerce is clearly excessive in relation to the putative local benefits.” Pike v. Bruce Church, Inc., 397 U.S. 137, 142 (1970).

Constitutional Limitations on Adjudicative Jurisdiction

• In addition to strict scrutiny and the Pike balancing test, there are two other tests.

• Dormant Commerce Clause prohibits legislation that regulates extraterritorially. See, e.g., Healy v. Beer Institute, 491 U.S. 324 (1989).

• It also prohibits state regulations that “adversely affect interstate commerce by subjecting activities to inconsistent regulations.” CTS Corp. v. Dynamics Corp. of America, 481 U.S. 69, 88 (1987).

Constitutional Limitations on Adjudicative Jurisdiction

• Federal district court in American Libraries Ass’n v. Pataki, 969 F. Supp. 160 (S.D.N.Y. 1997), applied Dormant Commerce Clause to enjoin enforcement of a New York statute that prohibited the intentional use of the Internet “to initiate or engage” in certain pornographic communications deemed to be “harmful to minors.”

• Conventional wisdom is that the Dormant Commerce Clause requires invalidation of state Internet communication regulations.

Constitutional Limitations on Adjudicative Jurisdiction

• Pioneer Military Lending, Inc. v. Dufauchard, 2006 WL 2053486 (E.D. Ca. July 21, 1996), applied the Dormant Commerce Clause in the military lending context and enjoined the Commissioner of the California Department of Corporations from requiring the plaintiff military lenders to obtain licensure.

• Pioneer Military Lending, Inc. made loans through third party agents in California from its headquarters in Tacoma, WA, to U.S. military personnel stationed in California who were not state residents pursuant to their Leave and Earning Statements.

Constitutional Limitations on Adjudicative Jurisdiction

• The court applied the Pike balancing test and considered the burden to the lender in the form of excessive start-up costs versus California’s interest in protecting non-residents from the activities of a lender regulated by another state.

• “[D]efendant has provided no evidence to support how plaintiff’s activities constitute unfair lending practices or hurt California’s sound economic climate. Nor does the evidence suggest how Pioneer’s ‘ReadiLoan’ program might circumvent California law or negatively affect its residents.”

Constitutional Limitations on Adjudicative Jurisdiction

• Pioneer Military Lending of Nevada, Inc. made loans through the Internet from its headquarters in Las Vegas, Nevada, to military borrowers whose physical location is unknown at the time of the loan.

• The court declined to apply the “extraterritorial effects” or “inconsistent regulations” tests, and permitted defendant to regulate transactions with borrowers who indicated that their residence was California on their Leave and Earning Statements.