Brewing Disharmony: Addressing Tribal Sovereign Immunity Claims in Bankruptcy.

AuthorMartin, Nathalie

Introduction I. The Uniformity and Collectivist Nature of Bankruptcy, The Importance of the Automatic Stay, and the Application of The Bankruptcy Code to Tribes A. Bankruptcy as Collective Action B. The Contours of the Automatic Stay C. The U.S. Constitution, Bankruptcy Code, Tribes and Section 106 of the Bankruptcy Code 1. The Applicability of Central Virginia Community College v. Katz to Tribes 2. Section 106 and Tribes II. High-Cost Loans in General and the Birth of Tribal Payday Loans A. High-Cost Loans in General B. The Birth of Rent-a-Bank, Rent-a-Tribe, and Tribal Payday and Installment Loans III. Sovereignty, Sovereign Immunity, The True Lender Rule, and the Arm of the Tribe Test A. The Concept Behind Sovereign Immunity and its Relationship to Sovereignty B. The True Lender Rule and The Arm of the Tribe Test Used by Courts, and the Related Valid When Made Rule 1. The True Lender Rule 2. The Arm of the Tribe Test 3. The "Valid When Made" Test i. What is the Valid When Made Test and to What Does it Apply? ii. Why the Valid When Made Rule is Irrelevant in the Context of Enforcing the Bankruptcy Stay iii. Why the Valid When Made Rule is Inapplicable to Tribal Lending in any Context C. The True Lender Rule in Congress IV. Enforcing The True Lender Rule In Bankruptcy Court A. Demanding Full Discovery and Proof of True Lender Status B. Parties Must Know Not to Sue or Continue Suing a Tribal Entity That Is Not the True Lender under the True Lender Rule V. Conclusion The U.S. Constitution mandates that Congress establish a uniform bankruptcy system. Uniformity requires that the system apply to all creditors and thus permit all debts to be addressed in one forum at one time. Section 362 of the Bankruptcy Code stays the collection efforts of all creditors. This automatic stay is a bedrock of the bankruptcy system and violations of the automatic stay are taken very seriously. As a result, bankruptcy courts have broad authority to award both actual and punitive damages for intentional violations of the automatic stay.

In 2020, for the first time in history, a payday lender claiming to be a Native American tribe continued to collect from a bankruptcy debtor, claiming that it was not bound by the automatic stay due to tribal sovereign immunity. In reality, the actual lender was lively not a tribe but rather a payday or other high-cost lender that lent its own money, assumed the risk of nonpayment for the loan, and merely formed a contractual alliance of convenience with a tribe in order to get the benefit of sovereign immunity.

High-cost lending, including payday lending, is a billion-dollar business. Lenders will do whatever necessary to continue lending in a market even after a state caps interest rates and forbids the loans. For decades, payday lenders have teamed either with national banks located in states with no interest rate caps, or Native American tribes who can assert tribal sovereign immunity from suit, hoping to avoid state interest rate caps. Under both models, known respectively as "rent-a-bank" or "rent-a-tribe," lenders assert the legal benefit of their lending partner in order to skirt state usury laws.

Congress, state legislatures, and courts outside of bankruptcy have taken steps to close this loophole, by legislating or deciding in court decisions that the "true lender" is the one with the ongoing economic interest in the loan, not the entity merely named as the lender in the loan documents or otherwise contracting with the true lender in exchange for a small percentage of the profits on the loans. This rule, known as the "true lender" rule, looks at the economic reality of a credit transaction to determine who the lender truly is. In the case of tribal lending, if that lender is not a tribe, then it does not get the benefit of tribal sovereign immunity and can be sued for violations of state usury laws. In the case of tribal lending, there is also a second test called the "arm of the tribe" test that further limits which tribal businesses are entitled to sovereign immunity.

Now that payday lenders have moved their tribal sovereign immunity defense to federal bankruptcy court, knowledge of the true lender rule, and perhaps also the arm of the tribe test, is critical for bankruptcy litigants and the court. After all, payday lenders may not be the only creditors who see the benefits of these tribal alliances.

In a 2020 case in which tribal sovereign immunity was pled in response to a complaint to recover damages for violation of the stay, the bankruptcy court held that the debtor could not sue for stay violations due to tribal sovereign immunity. H[degrees] Proof of tribal immunity was requested or required, nor was the true lender doctrine raised or considered.

This case is now on appeal on the issue of whether tribes constitute governmental entities that have had their sovereign immunity abrogated under Bankruptcy Code [section] 106. The true lender rule is established law, however, which may make it unnecessary to decide this [section]106 issue. Under the true lender rule, in few if any cases will the true lender be a tribe. If bankruptcy courts look at the economic realities of a credit transaction whenever tribal sovereign immunity is alleged, they can preserve the uniform bankruptcy system mandated by the U.S. Constitution.


On December 4, 2019, a gentleman with a public persona reluctantly filed a chapter 13 bankruptcy in Massachusetts. (1) He felt sad having to do so and proposed a 100% chapter 13 plan. Like all bankruptcy debtors' attorneys, this debtor's attorney told him that once he filed his bankruptcy case, creditors were forbidden from contacting him again about his pre-petition debt. The debtor was also told that bankruptcy courts have the authority to award large damages for violations of the automatic stay, particularly if those violations are willful.

In this case, one creditor or creditor conglomerate continued to call, harass, and do whatever possible to collect on its debt despite the bankruptcy filing. This creditor had provided the debtor with an online payday loan, (2) a loan that was illegal under Massachusetts state usury laws. This lender also claimed to be a federally recognized Native American tribe. This loan was provided by a collective of "lenders" who lent using a tribal payday loan model under which existing payday lenders team with tribes in order to get the benefit of the tribe's sovereign immunity. Creating shell corporations and complex contractual relationships with Native American tribes has become a common way to skirt state usury laws and make high-cost loans in states where state law forbids the loans. In this case, the entities claiming to be the lender were Lendgreen ("Lendgreen"), L.D.F. Business Development Corporation ("BDC"), L.D.F. Holdings, LLC ("Holdings"), and the Lac du Flambeau Band of Lake Superior Chippewa Indians (the "Tribe"). This entire collective of lenders claimed to be not bound by the Bankruptcy Code as a result of tribal sovereign immunity. (3)

After these lenders continued calling and collecting, the debtor attempted to take his own life. The debtor then sued the conglomerate of lenders for violating [section]362(a) of the Bankruptcy Code, requesting damages under [section]362(h) and (k). The bankruptcy court in the case was unfamiliar with the true lender rule and the arm of the tribe test, neither of which were raised in the case, and dismissed the complaint for violation of the automatic stay. (4) The bankruptcy court held based upon allegation alone that the entire conglomerate of lenders was immune from the automatic stay, even though only one was a tribe. This dismissal happened before the real issue in the case was raised, namely whether the tribe was the actual lender involved or whether the true lender was another party not entitled to immunity. (5)

While the attorneys in this case relied on an interpretation of the Bankruptcy Code's provision abrogating sovereign immunity to argue that the stay was violated, in a case that is working its way through the First Circuit Court of Appeals and perhaps eventually, the Supreme Court, (6) there is a more direct method of enforcing the automatic stay and the other provisions of the Bankruptcy Code against creditors claiming to be tribes. The court' made "true lender" rule has been embraced by state and federal courts, and also now appears in recent federal legislation. (7) The "true lender" doctrine has been used primarily in payday loan cases in state and federal courts, to deter' mine whether a lender has violated a state usury statute. (8) The issue raised in this article has nothing to do with enforcing usury laws, but the same rule applied in those usury cases can be used to ensure that all creditors comply with the Bankruptcy Code, particularly the automatic stay imposed by [section]362 of the Bankruptcy Code. (9)

Under the true lender rule, courts outside the bankruptcy context follow the money to determine which entity is putting its money at risk in the transaction. (10) If the entity that is advancing funds and bearing the risk of borrower nonpayment is someone other than a tribe, tribal sovereign immunity does not apply, the true lender must comply with all provisions of the Bankruptcy Code, and, naturally, the true lender can be sued for willful violations of the automatic stay. (11)

True lender analysis addresses one simple question that is at the heart of any credit transaction: who, based on economic realities, is the party making the loan, determined by assessing which party is controlling the transaction (including the decision to lend), and which party has taken on the financial risk of nonpayment. Bankruptcy courts know how to follow the money and that real creditors risk real dollars. The true lender rule is one incarnation of this "follow the money" approach, one that is intuitive and in keeping with the substance over form...

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