Federal Court Rejects Challenge to CFPB's Constitutionality

Alan Kaplinsky

A California federal district court hearing the CFPB’s enforcement action against Morgan Drexen has rejected Morgan Drexen’s challenge to the CFPB’s constitutionality.  Although similar challenges have been made in other cases, this appears to be the first decision to rule on the merits of such a challenge.

The CFPB’s enforcement action followed the filing of a lawsuit by Morgan Drexen in a Washington, D.C. federal district court in which Morgan Drexen claimed that the CFPB’s structure was unconstitutional.  In its enforcement action, the CFPB alleged that Morgan Drexen had charged unlawful advance fees for debt relief services and engaged in deceptive acts and practices in violation of the Telemarking Sales Rule (TSR) and the Consumer Financial Protection Act (Dodd-Frank Title 10) (CFPA).  A motion by the CFPB to dismiss the Washington, D.C. lawsuit was successful, with the court finding that Morgan Drexen could raise its constitutional challenge as a defense in the CFPB’s enforcement action.  Morgan Drexen thereafter filed a motion with the California federal court to dismiss the enforcement action on the grounds that the CFPB was unconstitutional and had failed to state a claim for relief.

In its decision denying Morgan Drexen’s motion to dismiss, the court rejected all of Morgan Drexen’s arguments  in favor of dismissal.  Morgan Drexen had argued that the CFPB was unconstitutional because certain of its structural features violated separation of powers principles.  The features cited by Morgan Drexen were (1) the President’s authority to only remove the CFPB Director for cause, (2) the vesting of the CFPB’s leadership in a single Director rather than a multi-member commission, (3) the CFPB’s funding through Fed earnings rather than regular congressional appropriations, (4) the CFPB’s authority to prohibit abusive acts or practices, and (5) the level of deference Dodd-Frank requires courts to give CFPB interpretations.  The court found that none of these features rendered the CFPB unconstitutional.

In its enforcement action complaint, the CFPB alleged that Morgan Drexen employees providing services to an affiliated attorney would have consumers sign a Debt Relief Contract and, in the vast majority of cases, a Bankruptcy Contract.  The CFPB also alleged that while the Debt Relief Contract did not require payment of an up-front fee, various up-front fees were required to be paid under the Bankruptcy Contract.  The court rejected Morgan Drexen’s argument that the TSR claims should be dismissed because the Debt Relief Contract did not require payment of up-front fees.  As the CFPB’s complaint also alleged that little or no bankruptcy work was performed for consumers signing the Bankruptcy Contract, the court found that the CFPB’s allegations plausibly suggested that Morgan Drexen received up-front fees for debt relief rather than bankruptcy services.

The court also rejected Morgan Drexen’s argument that the CFPA claims should be dismissed based on the limits Dodd-Frank places on the CFPB’s supervisory and enforcement authority as to attorneys.  The court found that the CFPB’s allegations plausibly suggested that Morgan Drexen did not actually support attorneys in the practice of law and  its services were not offered as part of, or incidental to, the practice of law.  Finally, the court rejected Morgan Drexen’s argument that the Tenth Amendment required dismissal on the grounds that the CFPB was attempting to intrude on the practice of law.

There would appear to be a much stronger constitutional challenge available with respect to Section 1028 of Dodd-Frank, the provision which practically delegates to the CFPB Director the right to ban or regulate out of existence arbitration provisions in consumer financial services contracts and thereby create an exemption for such contracts from the Federal Arbitration Act.  Morgan Drexen’s constitutional challenges did not include a challenge to Section 1028.  Such a challenge will not be ripe unless and until the CFPB issues a final regulation banning or regulating arbitration provisions in consumer financial services contracts.

Alan S. Kaplinsky is a senior partner in the Business and Finance Department at Ballard Spahr LLP and Chair of the Consumer Financial Services Group. He is also a member of the Higher Education, Mortgage Banking, and Bank Regulation and Supervision Groups.

His group produces the CFPB Monitor, a blog that focuses exclusively on important CFPB developments.