The Supreme Court unanimously ruled on May 30 that a federal appeals court used the wrong legal standard when it found that a New York state law that requires banks to pay interest on mortgage escrow accounts was preempted by the National Bank Act.
When federal preemption takes place, this means that a state law that conflicts with federal law is invalid.
The homeowners who brought a class action lawsuit against Bank of America argued that if federal law were allowed to preempt state escrow-interest laws here, the regime of laws governing consumer finance could be jeopardized, leading to market instability.
The case was originally brought in federal court by three New York residents, including lead petitioner Alex Cantero, who bought homes using mortgages from Bank of America.
Their mortgage contracts, which required them to cover property taxes and insurance payments by putting money in escrow accounts held by the bank, stated that they were to be governed by New York law.
Despite this contractual provision, the bank refused to pay the 2 percent interest required by state law, the homeowners stated in their petition.
The Supreme Court determined that the U.S. Court of Appeals for the Second Circuit failed to conduct a proper analysis of whether New York’s interest-on-escrow law was consistent with the Dodd–Frank financial reform law and existing precedent.
Bank of America was challenging New York’s escrow interest law. The state statute provides that banks must pay at least 2 percent interest on accounts that contain the extra money that borrowers pay for insurance and property taxes.
Thirteen states have similar pro-borrower laws.
Bank of America argued that such state laws are preempted by federal law.
The Civil War-era National Bank Act establishes a system of federally chartered national banks whose banking powers come exclusively from federal law and are extensively regulated by federal banking authorities, primarily the Office of the Comptroller of the Currency (OCC).
Because national banks are created by the federal government, states “can exercise no control” over them, “nor in any wise affect their operation, except in so far as Congress may see proper to permit,” the bank’s brief stated, citing Supreme Court precedent.
A national bank’s federal banking powers are thus “not normally limited by, but rather ordinarily preempt ... contrary state law,” the brief states, also citing Supreme Court precedent.
In the case at hand, the Second Circuit ruled that the National Bank Act preempted the New York statute.
That ruling was at loggerheads with a 2018 U.S. Court of Appeals for the Ninth Circuit decision in Lusnak v. Bank of America, which held that neither the National Bank Act nor OCC regulations preempt a similar California law.
A subsequent decision from the Ninth Circuit that applied the Lusnak decision is now the subject of a petition that the justices are considering in Flagstar Bank v. Kivett. The Supreme Court last considered the petition at the justices’ private conference on Oct. 13, 2023, but took no action. It is unclear when the court will consider the petition again.
In the new Supreme Court ruling, Justice Kavanaugh wrote that federal law “extensively regulates” national banks such as Bank of America and preempts some state laws that regulate national banks.
This case is about the proper standard courts should use when determining if state laws that regulate national banks are preempted. The Dodd–Frank Act of 2010 specifically incorporated the standard that the Supreme Court articulated in Barnett Bank of Marion County v. Nelson (1996), he wrote.
The standard asks whether a state law “prevents or significantly interferes with the exercise by the national bank of its powers.”
“Because the Court of Appeals in this case did not apply that standard in a manner consistent with Dodd–Frank and Barnett Bank, we vacate and remand,” Justice Kavanaugh wrote.
The National Bank Act gives national banks the powers they need to organize and operate, such as the powers to “make contracts,” to “sue and be sued,” and to “elect or appoint” a “board of directors.”
The statute also bestows “banking-specific powers” on national banks, such as allowing them to administer home mortgage loans, as well as “all such incidental powers as shall be necessary to carry on the business of banking.”
When national banks originate home mortgage loans, they often offer mortgage escrow accounts, which are designed to protect both the bank and the borrower. When the borrower makes a mortgage payment, he deposits money into an escrow account administered by the bank. The bank uses the escrow funds to pay the borrower’s insurance premium and property taxes on his behalf, which helps to simplify the borrower’s expenses and budgeting. This also benefits the bank by ensuring that the insurance and tax bills are paid in a timely manner, which protects the loan collateral—the borrower’s home. Most home mortgages are accompanied by escrow accounts, the justice continued.
A federal district court ruled for the borrowers, holding that nothing in the National Bank Act or any other federal law preempted the New York law.
But the Second Circuit reversed, finding that the New York law was preempted as applied to national banks, and citing “an unbroken line of case law” going back to McCulloch v. Maryland (1819). The court found that federal law preempts any state law that “purports to exercise control over a federally granted banking power,” regardless of “the magnitude of its effects.”
Because the state law “would exert control over” national banks’ authority “to create and fund escrow accounts,” the court concluded that the law was preempted.
But Dodd–Frank provided that the National Bank Act preempts a state law “only if” the state law discriminates against national banks as compared to state banks, and the state law “prevents or significantly interferes with the exercise by the national bank of its powers” as laid out in the Barnett Bank precedent, Justice Kavanaugh wrote.
“New York’s interest-on-escrow law does not discriminate against national banks,” the justice added.
The question of whether the state law is preempted must therefore be analyzed using Dodd–Frank’s “prevents or significantly interferes” preemption standard, which incorporates the holdings in Barnett Bank, he wrote.
It is unclear when the Second Circuit will take up the remanded case.
