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Federal Preemption Of State Consumer Laws – Reports Of Its Demise At The Hands Of Dodd Frank Are Premature – Consumer Law


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When Dodd Frank was adopted in 2010, a political trade off
resulted in the inclusion of a provision defining when national
banks could benefit from federal preemption of state consumer laws.
Many commentators then predicted the demise of federal preemption,
which allowed national banks to ignore many restrictive state
consumer protection laws. Dodd Frank limited federal preemption to
only three circumstances:

  1. if a state law discriminates against national banks;

  2. if state law prevents or significantly interferes with the
    exercise by a national bank of its powers; or

  3. if state law is preempted by a provision of Federal law.

Discrimination against national banks (#1) was unlikely and
express preemption (#3) by federal law was easy to spot, so the
focus of debate was on #2 – does state law
“significantly” interfere with national bank powers. In a
decision announced on September 15, 2022, the United States Circuit
Court (one step below the Supreme Court) for the Second Circuit
(covering New York) decided that the New York law requiring
mortgage lenders to pay interest on residential mortgage tax and
insurance escrow accounts was preempted by federal law. The court
said that national banks were not required to comply with the state
requirement. Federal preemption existed even though the economic
burden imposed by the low required interest payment might be
relatively minor.

In 2018, the Ninth Circuit Court (covering California) issued
the exact opposite opinion regarding a very similar California
statute requiring the payment of interest on escrow accounts. The
US Supreme Court has not weighed in on the subject of federal
preemption under Dodd Frank, so the conflict between the circuit
courts remains unresolved. Supreme Court intervention may now occur
since the Second Circuit and the Ninth Circuit came to completely
opposite decisions, which is a hallmark for Supreme Court

Why did the court hold that New York’s low level of economic
interference could still be significant? Because significant can
mean “important” or “meaningful” as well as
simply meaning “big.” Since national banks were given the
power to make loans as a core banking activity, the court decided
that the regulation of that lending authority by the states was
important or meaningful.

How far does this principle go? It is hard to answer with
certainty because each state law or regulation must be analyzed on
its own. However, we believe that some New York statutes and
regulations will fall by the wayside if the Second Circuit’s
analysis is upheld. The most obvious casualty, which had been
considered preempted before Dodd Frank, is the New York law
prohibiting lenders from passing on 0.25% of the mortgage tax to
residential mortgage borrowers. Well before the adoption of Dodd
Frank, the courts held that preemption applied so national banks
could require borrowers to pay the extra tax.

National banks may be exempt from complying with other New York
laws because of federal preemption. Two obvious candidates are (1)
the “zombie housing law” which requires lenders with
residential mortgages in foreclosure to secure and maintain the
property under certain circumstances; and (2) the statute which
requires residential mortgage lenders to pay condo common charges
and cooperative apartment maintenance during a foreclosure action
if the homeowner fails to pay. These statutes impose significant
costs on the lender, and, at least in the case of condominiums,
they reduce the value that national banks expect from their

Some national banks do not take advantage of federal preemption
in order to maintain competitive equality in the marketplace.
Others have decided that the cost of state compliance is too high.
However, this is a business decision, not a legal one, and is at
the discretion of each bank.

Whether federal preemption applies to a specific law or
regulation is further complicated by the question of whether
preemption continues after a national bank lender sells the loan.
Is the purchaser of a loan from a national bank benefitted by
preemption even if it is not a national bank? Historically, if a
loan was legal when made, it continued to be legal when it was
sold. However, at least one recent court decision provides that the
purchaser of a loan with an interest rate that was legal when made
by a national bank cannot charge that high interest rate after the
purchase if state law does not authorize such a high interest

We cannot predict how the courts, Congress and bank regulators
will finally resolve the uncertainty, but stay tuned for our future
blogs as developments occur. If you are interested in the history
of this issue, which goes back to the 1819 Supreme Court case of
McCulloch v. Maryland, often discussed in high school
civics texts, we would be happy to send you the Second Circuit
decision, which includes an extensive review of the history of
federal preemption of state law.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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