In a case challenging the Consumer Financial Protection Bureau’s (CFPB) 2017 payday lending rule, the U.S. Fifth Circuit Court of Appeals has ruled the agency’s funding structure is unconstitutional.

Since its inception, the CFPB has received its funding directly from the Federal Reserve, rather than from periodic congressional appropriations. This removes some of the congressional influence on the bureau and thought to insulate it from political pressure. The court stated Congress’ decision to abdicate its appropriations power violates the Constitution’s separation of powers provision.

“The Fifth Circuit’s decision to invalidate the CFPB’s payday lending rule because it is the product of an unconstitutional funding scheme calls into question the validity of all of the agency’s actions to date,” U.S. Senate Banking Committee Ranking Member Pat Toomey (R-Pa.) said in a release.

“The CFPB has been an unconstitutional and unaccountable agency since its inception,” he added. “I’ve long argued that the CFPB should be subject to congressional appropriations. As the Constitution requires, the people’s representatives shall determine how their tax dollars are spent. I’m glad to see the court agrees.”

The case, Community Financial Services Association of America and Consumer Service Alliance of Texas v. CFPB and Director Rohit Chopra, was in opposition to the payday lending rule finalized by former CFPB director Richard Cordray. The rule had two components: one prohibiting lenders from making covered loans without reasonably determining that consumers could repay the loans according to their terms (the underwriting provision) and another limiting a lender’s ability to obtain loan repayments via preauthorized account access (the payment provision). The underwriting provision has since been repealed, but the payment provision is still being challenged by the current case.

Want to read about the case involving the underwriting provision? Check it out here.

The ruling addressed the four issues plaintiffs raised on their appeal from the lower court, who previously found the CFPB’s funding mechanism did not violate the appropriations clause. Plaintiffs asserted the payment provision of the payday lending rule is invalid because the rule’s promulgation violated the Administrative Procedures Act, the rule was promulgated by a director unconstitutionally insulated from presidential removal, the bureau’s rulemaking authority violates the nondelegation doctrine and the bureau’s funding structure violated the Constitution’s appropriations clause.

The court, comprised of three district court judges appointed by former President Donald Trump, was unpersuaded by the first three arguments. However, after considering a concurring opinion in another court case, CFPB v. All Am. Check Cashing, Inc., the court was swayed by the plaintiffs’ appropriation clause argument.

“Given that the executive is forbidden from unilaterally spending funds, the actual exercise by Congress of its power of the purse is imperative to a functional government,” the court stated. “The appropriations clause thus does more than reinforce Congress’s power over fiscal matters; it affirmatively obligates Congress to use that authority ‘to maintain the boundaries between the branches and preserve individual liberty from the encroachments of executive power.’”

The legislation that created the CFPB dual-insulated the agency’s funding structure, the court stated, first by allowing the CFPB to request funds directly from the Fed, but also requiring the bureau maintain a separate fund outside of the Treasury. The fund is managed by a Federal Reserve bank, is under the control of the CFPB director and is permanently available to the director without any further act of Congress.

As a result of the CFPB not being financially dependent on Congress, the opinion stated, it is also no longer accountable to the legislative body. Because of this, the funding structure causes an unconstitutional violation of the separation of powers doctrine.

“The court acknowledged that like the bureau, the Federal Reserve, which funds the bureau, is not funded directly by Congress, but by the Treasury Department. However, according to the court’s logic, the remittance by the Federal Reserve of the excess to the Treasury, who is appropriated funds by Congress, ties the Federal Reserve to the constitutional appropriations clause,” Francis “Trip” Riley, III, partner and co-chair of the consumer financial services litigation group at Saul Ewing Arnstein & Lehr, LLP, said. “This reasoning is not logical. The Treasury does not fund the Federal Reserve: it benefits from any excess funds the Federal Reserve doesn’t need. Moreover, if the Federal Reserve’s funding of itself passes Constitutional muster for the reason stated by the court, how could its funding of the bureau not also be Constitutional?

“The immediate significance of this holding is that all regulations and rules, past and current investigations and enforcement actions in the Fifth Circuit are now subject to challenge because according to the court all such actions are being funded in violation of the Constitution and thus invalid,” he added. “It also opens the door to challenges to the CFPB’s actions as unconstitutional in those states within Federal Circuits that have not previously held the funding mechanism to be constitutional.”

The CFPB has yet to state whether it will appeal the decision. As it differs from what other circuit courts have said when challenged, there is a possibility the case will be heard by the Supreme Court.

U.S. Senator Elizabeth Warren (D-Mass.) called the decision “lawless and reckless” in a tweet. She went on to state the CFPB’s work in returning billions of dollars to consumers and its funding is clearly constitutional. The judges, she said, are throwing into question “every rule CFPB enforces to protect consumers and businesses alike.”

“This decision is highly likely to be affirmed by the U.S. Supreme Court given its makeup,” Marx Sterbcow, managing attorney at The Sterbcow Law Group, LLC, told RESPA News. “If Democrats have any interest in preserving the agency, they better fix this before the next Congress is sworn in.”

CFPB spokesperson Sam Gilford told Politico: “There is nothing novel or unusual about Congress’s decision to fund the CFPB outside of annual spending bills. Other federal financial regulators and the entire Federal Reserve System are funded that way, and programs such as Medicare and Social Security are funded outside of the annual appropriations process. The CFPB will continue to carry out its vital work enforcing the laws of the nation and protecting American consumers.”

RESPRO President and Executive Director Ken Trepeta said the funding structure for the bureau is fairly novel, and the Supreme Court could find fault with it, similar to the way it found fault with the director provision in Seila Law v. CFPB.

“I think there are a number of things wrong with the way the CFPB was structured, including the fact that when it takes administrative law actions like the PHH case, the director acts essentially as judge and jury in determining the validity of the [administrative law judge] decision and imposing his own will,” Trepata said. “A firm can be years and tens or hundreds of thousands of dollars into a case before it can get before impartial members of the judiciary.

“Both the structure and funding are suspect, but courts have been loath to dig too deep here and instead seem to want to leave it up to Congress to fix,” he added. “I suspect this will be appealed either to the Supreme Court or the en banc Fifth Circuit and it will be up to either to decide whether it is their job or Congress’ to fix this.”

As an effort to insulate itself from this decision before it gets to the Supreme Court, Riley said the bureau might join forces with state attorneys general on investigations and enforcement actions under the Consumer Fraud Act (CFA).

“It can do so because states are granted the authority to enforce the CFA,” he said. “So, the bureau can help from a logistical investigatory stance, but let the state attorneys general serve the subpoenas/CIDs [civil investigative demands] and be the face on any consent order or enforcement action. And remember: this issue has settled in favor of the bureau in six other circuit courts and the D.C. circuit. The bureau won’t slow down in those states.”

Subscribers have free access to an October Research webinar on this ruling here.