Sunday, March 25, 2018

FYI: 9th Cir Holds No NBA Preemption for State Law on Escrow Accounts, TILA Escrow Account Rules Not Retroactive

The U.S. Court of Appeals for the Ninth Circuit recently held that that the National Bank Act did not preempt California's state escrow interest law, which requires financial institutions to pay at least 2 percent simple interest per annum on escrow account funds.

In so ruling, the Court also held that the federal Truth In Lending Act provisions for escrow accounts, at 15 U.S.C. § 1639d, did not apply to loans originated before the 2013 effective date of the provisions.

A copy of the opinion is available at:  Link to Opinion

In July 2008, the plaintiff purchased a home in California with a mortgage loan from a lender.  As a condition for obtaining a mortgage, the plaintiff was required to open a mortgage escrow account into which he paid $250 per month.  A bank purchased the lender and assumed control over the plaintiff's mortgage loan and escrow account. 

The plaintiff's mortgage loan provided that it "shall be governed by federal law and the law of the jurisdiction in which the Property is located."  The parties agreed that the terms of the mortgage loan documents required the bank to pay interest on escrow funds if required by federal law or state law that was not preempted.

The plaintiff sued the bank on behalf of himself and a putative class of similarly situated customers, alleging that the bank violated the "unlawful" prong of the California Unfair Competition Law ("UCL"), because the bank supposedly violated both California state law, Cal. Civ. Code § 2954.8(a), and federal law, 15 U.S.C. § 1639d(g)(3), by failing to pay interest on his escrow account funds.  The plaintiff also brought a breach of contract claim, alleging that the bank's failure to pay interest violated his mortgage agreement. 

The bank filed a motion to dismiss on the ground that California Civil Code § 2954.8(a) was preempted by the National Bank Act ("NBA").  The trial court granted the bank's motion to dismiss, concluding that California's escrow interest law "prevent[ed] or significantly interfere[d] with" banking powers and was preempted by the NBA.  This appeal followed.

The central issue for the Ninth Circuit Panel was whether the NBA preempted California Civil Code 2954.8(a).  As you may recall, section 2954.8(a) provides:

Every financial institution that makes loans upon the security of real property containing only a one- to four-family residence and located in this state or purchases obligations secured by such property and that receives money in advance for payment of taxes and assessments on the property, for insurance, or for other purposes relating to the property, shall pay interest on the amount so held to the borrower. The interest on such amounts shall be at the rate of at least 2 percent simple interest per annum. Such interest shall be credited to the borrower's account annually or upon termination of such account, whichever is earlier.

California Civil Code § 2954.8(a).

Section 1639d(g)(3) of the federal Truth in Lending Act, 15 U.S.C. 1601, et seq., ("TILA"), states:

(3) Applicability of payments of interest
If prescribed by applicable State or Federal law, each creditor shall pay interest to the consumer on the amount held in any compound, trust, or escrow account that is subject to this section in the manner as prescribed by that applicable State or Federal law.

15 U.S.C. § 1639d(g)(3).

The plaintiff borrower argued that TILA's plain language -- which requires creditors to pay interest on escrow fund accounts like his if "prescribed by applicable" state law -- made clear that Congress perceived no conflict between state laws like California Civil Code § 2954.8(a) and the powers of national banks, and therefore Congress did not intend for these state laws to be preempted by the NBA.

The bank countered that such state laws were preempted because they prevent or significantly interfere with the exercise of its banking powers, and a preempted law cannot be an "applicable" law under section 1639d(g)(3).

The Ninth Circuit Panel began its analysis by examining Dodd-Frank's amendments to the NBA preemption framework.  As you may recall, Dodd-Frank addressed the preemptive effect of the NBA in several ways.

First, it emphasized that the legal standard for preemption set forth in Barnett Bank of Marion County, N.A. v. Nelson, 517 U.S. 25 (1996), applied to questions of whether state consumer financial laws were preempted by the NBA.  12 U.S.C. § 25b(1)(B).

Second, it required the Office of Comptroller of the Currency ("OCC"), which regulates national banks, to follow specific procedures in making any preemption determination.  12 U.S.C. § 25b(1)(B), 25b(b)(3)(B).

Third, it clarified that the OCC's preemption determinations were entitled only to Skidmore deference.  12 U.S.C. § 25b(b)(5)(A); Skidmore v. Swift & Co., 323 U.S. 134, 140 (1944) (explaining that an agency 's views were "entitled to respect" only to the extent that they had the "power to persuade").

Before Dodd-Frank, as the Ninth Circuit explained, the Supreme Court of the United States held in Barnett Bank that states were not "deprive[d] " of the power to regulate national banks, where "doing so does not prevent or significantly interfere with the national bank's exercise of its powers" under the NBA.  Barnett Bank of Marion County, N.A., 517 U.S. at 33.

Following Barnett Bank, the OCC issued in 2004 its interpretation of the NBA preemption standard:  "Except where made applicable by Federal law, state laws that obstruct, impair, or condition a national bank's ability to fully exercise its Federally authorized real estate lending powers to not apply to national banks."  12 C.F.R. § 34.4(a) (effective Jan. 13, 2004).

Thus, according to the Ninth Circuit, only the Dodd Frank Act amendment that required the OCC to follow specific procedures in making preemption determinations was a change in the law.  The Court further notes that the other amendments merely codified existing law as set forth by the Supreme Court.

Although the Panel had never addressed whether the OCC's interpretation was inconsistent with Barnett Bank, or whether the regulation was owned deference while it was in effect, the Panel acknowledged that the Supreme Court has ruled that the regulations of this kind should receive, at most, Skidmore deference -- and even then, only as to a conflict analysis, and not as to the legal conclusion on preemption.  See, e.g., Wyeth v. Levine, 555 U.S. 555, 576-77 (2009).

The Panel determined that under Skidmore, the OCC's regulation was entitled to little, if any, deference in light of Barnett Bank, even before the enactment of Dodd-Frank.  In other words, the OCC simply adopted the Supreme Court's articulation of the applicable preemption standard in prior cases, but did so inaccurately according to the Panel, because it did not conduct its own review of the specific potential conflicts on the ground. 

The Ninth Circuit explained that in Dodd-Frank, Congress underscored that Barnett Bank continued 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" under the NBA. 12 U.S.C. § 25b(b)(1)(B).  Thus, the Panel determined that the bank must demonstrate that the state law prevented or significantly interfered with its national banking powers.

The Court then turned to the issue of whether section 2954.8(a) prevented the bank from exercising its national bank powers or significantly interfered with the bank's ability to do so.

The Ninth Circuit noted that TILA requires banks to pay interest on escrow account balances "[i]f prescribed by applicable State [] law."  15 U.S.C. § 1639d(g)(3).  The Supreme Court recently explained that "applicable" meant "capable of being applied: having relevance" or "fit, suitable, or right to be applied: appropriate."  Ransom v. FIA Card Servs., N.A., 562 U.S. 61, 69 (2011). 

This language, according to the Ninth Circuit, expressed Congress's view that such laws would not necessarily prevent or significantly interfere with a national bank's operations.  

The bank relied on the OCC's pre-Dodd-Frank preemption rule, 12 C.F.R. § 34.4(a) (2004).  The bank argued that state escrow interest law necessarily prevented or significantly impaired its real estate lending authority. 

However, the Ninth Circuit noted that the OCC's rule specifically altered the language of section 34.4(b) to clarify that state laws "that [were] made applicable by Federal law" (which would include Dodd-Frank's TILA amendments) "are not inconsistent with the real estate lending powers of national banks -- to the extent consistent with [Barnett Bank]."  12 C.F.R. § 34.4(b)(9)(2011).

Thus, the Court rejected the bank's argument based on the pre-Dodd-Frank preemption rule.

Additionally, the Ninth Circuit was not persuaded by the bank's cited cases. 

Flagg v. Yonkers Savings & Loan Association, 396 F.3d 178, 182 (2d Cir. 2005), concerned the Office of Thrift Supervision's ("OTS") authority to regulate federal savings associations, and the Second Circuit based its ruling on the OTS's field preemption over the regulation of such associations.  Unlike the OTS, as the Panel noted, the OCC did not enjoy field preemption over the regulation of national banks.

First Federal Savings and Loan Association of Boston v. Greenwald, 591F.3d 417, 425 (1st Cir. 1979), concerned a direct conflict between a state regulation requiring payment of interest on certain escrow accounts and a federal regulation expressly stating that no such obligation was to be imposed on federal savings associations "apart from the duties imposed by this paragraph" or "as provided by contract."  The Panel explained that unlike the regulation in First Federal, there was no federal regulation in this case that directly conflicted with section 2954.8(a).

Because the Court held that the bank did not demonstrate that state escrow interest laws prevented or significantly interfered with its exercise of national bank powers, and because Congress in enacting Dodd-Frank indicated that they do not, the Ninth Circuit Panel concluded that the NBA did not preempt California Civil Code § 2954.8(a).

Next, the Ninth Circuit examined the plaintiff's two claims for relief. 

The bank argued that the plaintiff's UCL claim cannot proceed because his escrow account was created before section 1639d's effective date of January 21, 2013. 

As you may recall, section 1639d(a) states that "a creditor, in connection with the consummation of a consumer credit transaction secured by a first lien on the principal dwelling of the consumer … shall establish, before the consummation of such transaction, an escrow or impound account … as provided in, and in accordance with, this section."  15 U.S.C. § 1639d(a).

The Ninth Circuit held that the use of the language "shall establish, before the consummation of such transaction" indicated that Congress intended section 1639d to apply to accounts established pursuant to that section after it took effect in 2013. 

Because the plaintiff obtained the subject mortgage loan in 2008, the Ninth Circuit Panel concluded that the plaintiff cannot rely on section 1639d to prosecute his UCL claim.

However, the Panel found that the plaintiff could still obtain relief under the UCL because California Civil Code § 2954.8(a) was not preempted by the NBA.  Because the bank was required to follow the state law, the Ninth Circuit held that the plaintiff borrower could proceed on his UCL claim based on the theory that the bank violated the UCL by failing to comply with section 2954.8(a).

Additionally, the Court also held that the plaintiff may proceed on his breach of contract claim because his mortgage required the bank to pay escrow interest if "Applicable Law requires interest to be paid on the Funds." 

Accordingly, the Ninth Circuit Panel reversed the trial court's dismissal of the putative class action.

Eric Tsai
Maurice Wutscher LLP 
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