Regulators’ Silence on Preemption Could Spell Troubles for Banks

By Dawn Causey, Thomas Pinder and Andrew Doersam

The legal standard for federal preemption in banking was established by the U.S. Supreme Court case of Barnett Bank of Marion County, N.A. v. Nelson, which was later codified in Section 1044 of the Dodd-Frank Act. Barnett held that the National Bank Act preempts state laws that significantly interfere with a national bank’s exercise of its banking power. However, Section 1639d(g)(3) of Dodd-Frank complicated the issue in mortgage lending by allowing banks to pay interest on escrow accounts if required by state law. 

One such example is the recent decision by a three-judge panel of the Ninth Circuit Court of Appeals that reversed the dismissal by a district court judge in Lusnak v. Bank of America. In this case, the court ruled that the NBA did not preempt a California law requiring banks to pay interest on borrowers’ escrow accounts.

Plaintiff Donald Lusnak alleged that B of A violated California’s escrow interest law and the Truth in Lending Act by failing to pay interest on escrow account funds. B of A disagreed, asserting that state escrow laws requiring the payment of interest are preempted because they prevent or significantly interfere with the exercise of its banking powers and therefore are not “applicable” under Section 1639d(g)(3) of Dodd-Frank.

The court ruled to the contrary. It reasoned that the TILA requirement for “banks to pay interest on escrow account balances if prescribed by applicable State law” suggests that Congress did not view such laws as necessarily preventing or significantly interfering with a national bank’s operations. The categories of bank activities listed in the OCC’s current preemption rules have been treated as off-limits to state regulation. However, the Lusnak decision upended this approach, meaning that more tug-of-war battles will likely proceed. Breaking its silence, the OCC has stepped into the fray, supporting B of A for a rehearing en banc. 

Another battle is taking place in Colorado, where the state won its first match against fintech company Avant. In Meade v. Avant, the court limited the valid-when-made doctrine, which provides that a loan that is valid when it is made does not become invalid (i.e., usurious) when it is sold or assigned to a third party.

Avant is a Colorado state-supervised lender that entered into a lending program agreement with WebBank, a Utah-chartered industrial bank. Following a compliance examination, the state’s commercial code administrator brought suit against Avant in state court, alleging that Avant charged excess finance and delinquency charges in violation of Colorado law. 

Avant countered, seeking to remove the administrator’s claims to federal court. Avant argued that because a state-chartered bank originated the loans under the Federal Deposit Insurance Act, federal law preempted Colorado state laws. However, the Colorado district court remanded the claim to state court. The court found that the FDIA did not completely preempt the administrator’s claims because the administrator’s claims, on their face, failed to raise a federal issue. The federal district court did not have jurisdiction over those claims.

ABA filed an amicus brief in the case contending that the administrator’s claims were an attack on the bank’s power to originate and sell loans and also on the long-standing “valid-when-made” rule. The court recognized the significance of that issue, but ruled that the valid-when-made rule is not relevant to the complete preemption argument. Yet the FDIC was conspicuously mute. 

The lack of participation of the federal banking agencies in these federal preemption cases appears to have emboldened the states to continue encroaching on the powers of banks under the NBA. If preemption teeters toward the states, banks of all charters could find themselves with greater compliance and other costs rather than focusing on empowering economic growth for their customers and communities.  

Dawn Causey is general counsel at the American Bankers Association, where Thomas Pinder is SVP for litigation and Andrew Doersam is a paralegal.