By Thomas G. Wolfe, J.D.
Recently, a three-judge panel of the U.S. Court of Appeals for the Ninth Circuit ruled that the National Bank Act does not preempt California’s mortgage-escrow interest law. The federal appellate court was called to address a borrower’s proposed class action against Bank of America, N.A., claiming the bank violated both California and federal law by failing to pay interest on funds in the borrower’s mortgage escrow account. In its March 2, 2018, decision (Lusnak v. Bank of America, N.A.), the panel noted that the Dodd-Frank Act essentially codified the existing preemption standard enunciated by the Supreme Court in its 1996 Barnett Bank of Marion County, N.A. v. Nelson decision, and the panel applied that Barnett Bank standard. Further, the panel held that although the borrower could not rely on federal Truth in Lending Act amendments that took effect after his mortgage escrow account had been established, the borrower was not prevented from seeking relief under the theory that the bank violated California’s Unfair Competition Law by failing to comply with the state’s mortgage-escrow interest law.
As a result, the Ninth Circuit panel reversed the rulings of the lower federal trial court and remanded the matter, allowing the borrower to proceed with his California Unfair Competition Law and breach-of-contract claims against Bank of America.
Backdrop. In keeping with the terms of a 2009 mortgage refinancing agreement and a 2011 loan modification agreement between the borrower and Bank of America, both federal and state law governed the contracts. The borrower and the bank agreed that the mortgage required Bank of America to pay mortgage interest on escrow funds if required by federal law, or by state law when not preempted. As a condition for obtaining his mortgage, the borrower was required to open and maintain an escrow account, and he paid $250 per month into this account.
Complaint. In his class-action complaint, the borrower alleged that the bank was able to “enrich itself by earning returns on funds in his account” without paying him interest, as required under California’s escrow interest law and the federal Truth in Lending Act (TILA). The borrower also claimed that the bank breached the underlying mortgage agreement. In response, Bank of America acknowledged not paying any interest on the escrow account, but argued that it was not required to do so under federal law and that any state interest-usury law requirements were preempted by the National Bank Act.
The lower federal court agreed with Bank of America’s assessment and granted the bank’s request to dismiss the borrower’s complaint. From the trial court’s perspective, California’s escrow interest law was preempted by the National Bank Act because the state law prevented or significantly interfered with the “banking powers” of Bank if America. The borrower appealed that decision to the Ninth Circuit.
State, federal law. Under the pertinent provision of the California Civil Code, every financial institution is required to pay “at least 2 percent simple interest” per year on escrow account funds. Meanwhile, under Dodd-Frank Act amendments to TILA covering the “applicability of payment of interest,” every creditor, if prescribed by applicable state or federal law, “shall pay interest to the consumer on the amount held in any impound, trust, or escrow account that is subject to this section in the manner as prescribed by that applicable State or Federal law.”
The borrower argued that the Dodd-Frank Act provision made it clear that Congress did not perceive any conflict between the California state law and the powers of national banks and did not intend for these types of state laws to be preempted by the National Bank Act. In contrast, Bank of America argued that such state laws are preempted because they still “prevent or significantly interfere” with the exercise of a national bank’s banking powers, and a preempted law could not be construed to be “an applicable law” under the Dodd-Frank Act amendments to TILA.
Preemption decision. After reviewing the guiding principles of federal preemption and the National Bank Act’s preemption framework, the Ninth Circuit panel stated that “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.” Notably, the panel also indicated that to the extent that the Office of the Comptroller of the Currency “has largely reaffirmed its previous preemption conclusions without further analysis under the Barnett Bank standard, … 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.” Moreover, other regulatory changes under the Dodd-Frank Act requiring the OCC to make determinations on a “case-by-case basis,” evaluating state consumer laws, and consulting with the Consumer Financial Protection Bureau, “have no bearing here where the preemption determination is made by this court and not the OCC.”
In holding that the NBA does not preempt California’s mortgage-escrow interest law, the panel determined that “no legal authority establishes that state escrow interest laws prevent or significantly interfere with the exercise of national bank powers, and Congress itself, in enacting Dodd-Frank, has indicated that they do not.” In reaching its conclusion, the panel asserted: (i) minor interference with federal objectives is not enough; (ii) the California state law governing mortgage-escrow interest accounts does not significantly interfere with Bank of America’s exercise of its banking powers; (iii) while the Dodd-Frank Act does not define “applicable law,” the dictionary definition of “applicable” law “would appear to include any relevant or appropriate state laws that require creditors to pay interest on escrow account funds;” and (iv) the pertinent legislative history supported the court’s decision.
State claims for relief. Turning to the borrower’s claims for relief under California’s Unfair Competition Law, the panel further determined that the borrower could not rely on the Dodd-Frank Act amendments to TILA because the borrower’s escrow interest account was set up before those amendments took effect. However, that determination did not prevent the borrower from obtaining relief under the state’s Unfair Competition Law on the theory that the bank failed to comply with California’s escrow interest law. Likewise, according to the panel, in connection with the borrower’s breach-of-contract claim, a jury could find that the “Applicable Law provision of the contract also requires that Bank of America pay interest on funds in [the borrower’s] escrow account.”
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