Chairman & Managing Director
Lenders Compliance Group
The Dodd-Frank
Wall Street Reform and Consumer Protection Act retained much of the existing
framework regarding federal preemption of state laws. But included a number of
significant changes that opened the door to a larger role for state involvement
in the activities of federally chartered institutions.
For example, the
Dodd-Frank Act clarified that states generally may, if they so choose, provide
greater protection to consumers than Title X of Dodd-Frank (its Consumer
Financial Protection Act) provides.
Specifically, Dodd-Frank
§ 1041 specifies that “a statute, regulation, order, or interpretation in
effect in any state is not inconsistent with the provisions of this title if
the protection that such statute, regulation, order, or interpretation affords
to consumers is greater than the protection provided under this title.”
Recently, a Chief Compliance
Officer at a large financial services institution, a national bank, told me
that he had received a call from a borrower who lives in California. The
borrower contended that this financial institution should be paying him
interest on his mortgage escrow account. The compliance officer was concerned
about how this request should be met under Dodd-Frank.
After getting some facts
regarding the institution’s regulatory framework, I offered the following
guidance.
Based on my call
with him, it sounded as though the bank had made the decision to comply with
state interest-on-escrow laws, even though the Office of the Comptroller of the
Currency (OCC) and others have questioned whether a national bank is required
to comply. A decision of the U.S. Court of Appeals for the 9th Circuit suggests
that compliance with state interest-on-escrow laws is a good idea, certainly
for institutions located within the jurisdiction of the 9th Circuit (viz., Alaska,
Arizona, California, Hawaii, Idaho, Montana, Nevada, Oregon, Washington, Guam,
and the Northern Mariana Islands).
Suffice it to
note that national banks and federal savings associations interested in
avoiding litigation of the matter would be well-advised to comply with state
interest-on-escrow laws.
Dodd-Frank § 1044
amended the National Bank Act to clarify the preemption standards for national
banks and § 1046 amended the Home Owners’ Loan Act to set the same preemption
standards for federal savings associations. Dodd-Frank provides that state
consumer financial laws are preempted only if:
• Application
of a state consumer financial law would have a discriminatory effect on
national banks (or federal savings associations), in comparison with the effect
of the law on a bank (or savings association) chartered by that state;
• In
accordance with the legal standard for preemption in the decision of the
Supreme Court of the United States in Barnett Bank v. Nelson, 517 U.S. 25
(1996), the state consumer financial law
prevents or significantly interferes with the exercise by the national bank (or
federal savings association) of its powers; and any preemption determination
may be made by a court, or by regulation or order of the Comptroller of the
Currency (OCC), on a case-by-case basis in accordance with applicable law; or
• The
state consumer financial law is preempted by a provision of federal law other
than Title X of the Dodd-Frank Act.
On July 20, 2011,
the OCC amended its regulations to reflect its understanding of the Dodd-Frank
preemption standards as applied to national banks and federal savings
associations (which Dodd-Frank moved from OTS to OCC control). Since 2011,
several court decisions have considered how much change Dodd-Frank wrought.
The 9th Circuit
noted that “[a]lthough Dodd-Frank significantly altered the regulatory
framework governing financial institutions, with respect to NBA preemption, it
merely codified the existing standard established in Barnett Bank….”
The 9th Circuit
also addressed Dodd-Frank Act § 1461, the Act’s “interest on escrow” amendment
of the Truth-in-Lending Act (TILA). Section 1461 added 15 U.S.C. § 1639d(g)(3) to the escrow account provision of TILA that applies to any
consumer credit transaction secured by a first lien on the principal dwelling
of a consumer. This subsection provides that: “if prescribed by applicable
State or Federal law, each creditor shall pay interest to the consumer on the
amount held in any…escrow account that is subject to this section in the manner
as prescribed by that applicable State or Federal law.”
The State of
California has an escrow interest law that requires financial institutions to
pay at least two percent annual interest on the funds held in borrowers’ escrow
accounts (i.e., the type of escrow account often set up in conjunction with mortgage
loans, either as a condition set by the lender or at the request of the
borrower).
Here are the fine
points. Lusnak, a borrower, sued Bank of America for failing to pay any
interest on the positive balances in mortgage escrow accounts.[i]
Lusnak’s loan agreements provided that his mortgage loan “shall be governed by
federal law and the law of the jurisdiction in which the Property is located.”
The parties agreed that his loan terms required Bank of America to pay interest
on escrow funds if required by federal law or state law that is not preempted.
They differed as to whether or not the state law was preempted. The bank
acknowledged that it did not comply with state escrow interest laws and that
its chief competitor (Wells Fargo) did, but it contended that no federal or
“applicable” state law required it to pay interest on Lusnak’s escrow account
funds.
The district
court dismissed the action, holding that the National Bank Act (NBA) preempted
the state statute because the state law prevented or significantly interfered
with banking powers. In so holding, the district court determined that TILA’s
interest-on-escrow provision did not affect the preemption analysis.
The 9th Circuit reversed.
According to the 9th Circuit, the NBA did not preempt the California statute
because no legal authority established that state escrow interest laws “prevent
or significantly interfere” with the exercise of national bank powers. In
addition, Congress, in enacting Dodd-Frank § 1461 (the TILA interest-on-escrow
provision) indicated that they do not.
In the Dodd-Frank
Act, Congress underscored that Barnett
Bank continues to provide the preemption standard; that is, state consumer
financial law is preempted only if it “prevents or significantly interferes
with the exercise by the national bank of its powers.”
The Court cited
the Dodd-Frank interest-on-escrow provision quoted above. This language
expressed Congress’s view that such laws would not necessarily prevent or
significantly interfere with a national bank’s operations. Accordingly, the
California statute did not prevent or significantly interfere with the bank’s
exercise of its powers.
The Court allowed
Lusnak to proceed on a state law Unfair Competition Law (UCL) claim on the
theory that the bank had violated the UCL by failing to comply with the escrow
interest statute. It also allowed him to proceed on a breach of contract claim.
In 2011, the OCC
amended § 34.4(a) to reflect the language of Dodd-Frank, but in the preamble to
this amendment the OCC concluded that “the Dodd-Frank Act does not create a
new, stand-alone “prevents or significantly interferes with” standard, but
rather incorporates the conflict preemption legal standard and the reasoning
that supports it in the Supreme Court’s Barnett
decision.”
The OCC argued
that the suggestion that Dodd-Frank intended to adopt a new “prevent or
significantly interfere” preemption test failed to take account of the entire
phrase of the Dodd-Frank provision, that is, that a state consumer financial
law as applied to a national bank (or federal savings association) would be
preempted only if “in accordance with the legal standard for preemption in the
[Barnett] decision…, the State consumer financial law prevents or significantly
interferes with the exercise by the national bank of its powers….” According to
the OCC, the “legal standard for preemption” employed by Barnett was conflict
preemption and “prevent or significantly interfere” was not the “legal
standard for preemption in the decision.”
In other words,
as a first step, a court must apply a
conflict preemption standard in accordance with the Court’s reasoning in Barnett. Then, the “prevent or
significantly interferes” phrase would provide a “touchstone” to that conflict
preemption standard and analysis.
The net result,
according to the OCC, was to leave in place precedents consistent with that
analysis, such as the OCC rules. The OCC admitted, though, that its existing
“obstruct, impair or condition” formulation of the Barnett standard had created confusion and that Dodd-Frank’s use of
the phrase “prevents or significantly interferes” may have been intended to
reject the OCC’s “obstruct, impair, or condition” approach. Accordingly, the
OCC deleted that phrase when it amended its rules in 2011, although it insisted
that the change did not “effect any substantive change” and specifically
mentioned “escrow standards” as laws that would meaningfully interfere with the
business of national banks.
The 9th Circuit,
addressing this argument, stated that “to the extent that the OCC has largely
reaffirmed its previous preemption conclusions without further analysis under
the Barnett Bank standard [citing the
preamble contained in 76 Federal
Register 43549 (July
21, 2011)], we give it no greater
deference than before Dodd-Frank’s enactment, as the standard applied at that time
did not conform to Barnett Bank” [boldface added]. In
effect, the Court applied the “prevents or significantly interferes” as more
than the “touchstone” mentioned by the OCC.
Perhaps the U.S.
Supreme Court eventually will decide who is right - the 9th Circuit or the OCC.
[i] Lusnak
v. Bank of America, N.A., 2018 U.S. App.; 9th Cir. Mar. 2, 2018
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