‘Hotel California’ Captures National Banks

By Dawn Causey, Thomas Pinder and Andrew Doersam

For over 100 years, national banks have relied on the protections of the National Bank Act to operate without being unduly encumbered by state regulations that interfered with their operations. It was thus a shock to the regulatory system when a California law that required banks to pay twice the prevailing interest rate on escrow accounts was not routinely overturned by the Ninth Circuit as violating the NBA. Lusnak v. Bank of America held that the NBA does not preempt a California law requiring lenders to pay a minimum 2 percent interest rate on mortgage escrow accounts. Moreover, the Supreme Court’s refusal to review Lusnak and correct the Ninth Circuit’s mistake may expose national banks to an irregular patchwork of mortgage escrow interest laws.

Most bankers have become numb to California’s aggressive regulatory posturing, so the state’s escrow statute was not surprising. However, many were shocked that the Supreme Court case from 1996, Barnett Bank v. Nelson was not deemed sufficiently dispositive to dismiss the state regulation. Barnett Bank held that the NBA preempts any state regulation that prevents or significantly interferes with a national bank’s exercise of its powers. To that end, the OCC issued a regulation clarifying that national banks may make real estate loans without regard to state law limitations on escrow accounts. And building off the Barnett case, Section 1044(a) of Dodd-Frank codified Barnett as the preemption standard for national banks.

In the Lusnak case, the U.S. district court sided with Bank of America, ruling that California’s escrow interest law significantly interferes with the bank’s powers and therefore is preempted by the NBA. But in a surprise move, in March 2018, a unanimous Ninth Circuit panel reversed. The panel explained that Dodd-Frank’s requirement for banks to pay interest on escrow account balances, “if prescribed by applicable state law,” expresses Congress’s view that such laws would not significantly interfere with a national bank’s operations. The Ninth Circuit surmised that the OCC’s regulation did not accurately adopt the Barnett standard, and as a result, the regulation is “entitled to little, if any, deference.”

The OCC vehemently disagreed. In an amicus brief urging the full Ninth Circuit to rehear the case, the OCC explained that the Barnett standard finds preemption when the state law stands as an obstacle to the purpose of the NBA, or if a state law burdens one of the powers granted to national banks by the NBA. According to the OCC, California’s escrow interest law significantly interferes with national banks’ exercise of that power, because the law imposes burdens on national bank lending activity, adds an inflexible interest rate on national bank escrow account activity and subjects national banks to potentially diverse and duplicative requirements across other states.

The American Bankers Association also weighed in, urging the Supreme Court to overturn the Ninth Circuit’s decision. ABA asserted that the Ninth Circuit’s decision misunderstands the critical importance that a national bank must set terms and conditions of products and services without state regulation; the importance mortgage escrow accounts hold in the U.S. lending system; and the NBA’s history and goals.

Lusnak must be followed by federal courts in the Ninth Circuit (California, Oregon, Washington, Arizona, Nevada, Idaho, Montana, Hawaii and Alaska). Banks in other jurisdictions will try to gauge whether their respective circuits are more likely to adopt the Ninth Circuit’s reasoning or agree with the OCC’s interpretation.

The Supreme Court’s denial creates uncertainty over whether the Barnett standard will slowly be reengineered with more deference to the states. Lusnak represents a departure from decades of precedent limiting the states’ ability to regulate national banks. It appears as if the preemption national banks relied on since the early years of the Civil War is being diluted or, at the very least, significantly curtailed.

Dawn Causey is general counsel of ABA, where Thomas Pinder is SVP for litigation and Andrew Doersam is a paralegal.