The U.S. Court of Appeals for the Second Circuit recently held that: (1) New York’s interest-on-escrow law is preempted by the National Bank Act of 1864 under the “ordinary legal principles of pre-emption,” Barnett Bank of Marion Cnty., N.A. v. Nelson, and (2) the amendments to the NBA in the Dodd Frank Wall Street Reform and Consumer Protection Act did not change this analysis.
A copy of the opinion in Cantero v. Bank of Am., N.A. is available at: Link to Opinion.
The plaintiff borrowers in two putative class actions took out home mortgage loans from a national bank, one before and the other after the effective date of certain provisions of the Dodd Frank Act. The loan agreements, which were governed by the laws of New York and by federal law, required the borrowers to deposit money in escrow accounts for property taxes and insurance payments for each mortgaged property.
When the bank paid no interest on the escrowed amounts, the borrowers sued for breach of contract, claiming they were entitled to interest under New York General Obligations Law Section 5-601, which sets a minimum 2% interest rate on mortgage escrow accounts.
The bank moved to dismiss on the ground that GOL Section 5-601 does not apply to mortgage loans made by national banks because, as applied to such banks, it is preempted by the NBA. The trial court disagreed and denied the motion. The bank timely appealed.
As you recall, the Supremacy Clause of the United States Constitution provides: “the Laws of the United States” made “in Pursuance” of the Constitution “shall be the supreme Law of the Land . . . [the] Laws of any State to the Contrary notwithstanding.” U.S. Const. art. VI, cl. 2.
Under “ordinary legal principles of pre-emption,” a court asks whether the federal and state provisions are in “irreconcilable conflict.” Barnett Bank of Marion Cnty., N.A. v. Nelson, 517 U.S. 25, 31, 37 (1996). In that regard, the Second Circuit noted that, when the NBA grants “powers” to national banks, “both enumerated and incidental,” those powers are “not normally limited by, but rather ordinarily pre-empt, contrary state law.” Id. at 32.
The borrowers here argued that state laws are preempted by the NBA only if they “prevent the exercise of a national bank’s power [or] come close to doing so.” And to make that determination, the borrowers urged the Second Circuit to look to the “degree of interference,” which they claimed was “minimal” because the law requires payment of only a “modest amount of interest.” Id. at 34–35.
However, the Second Circuit made it clear that the question is not how much a state law impacts a national bank, but rather whether it purports to “control” the exercise of its powers. McCulloch v. Maryland, 17 U.S. (4 Wheat.) 316, 431 (1819); see also United States v. Washington, 142 S. Ct. 1976, 1984 (2022); Farmers’ & Mechs.’ Nat’l Bank v. Dearing, 91 U.S. 29, 34 (1875); Watters v. Wachovia Bank, N.A., 550 U.S. 1, 11 (2007); Easton v. Iowa, 188 U.S. 220, 230 (1903).
Additionally, the Court held that control is not a question of the “degree” of the state law’s effects on national banks, but rather of the kind of intrusion on the banking powers granted by the federal government. McCulloch, 17 U.S. at 430–31.
In light of the foregoing, the Second Circuit concluded that GOL § 5-601 was preempted.
The Second Circuit explained that the banking power at issue here was the power to create and fund escrow accounts, and the Court determined that GOL § 5-601 would target, curtail, and hinder a power granted to national banks by the federal government. By requiring a bank to pay its customers in order to exercise a banking power granted by the federal government, the law would exert control over banks’ exercise of that power.
Thus, the Court concluded that no interest was due to the borrowers under federal law and the law of New York State and the borrowers failed to state a claim for breach of contract.
Furthermore, the Dodd Frank Act provides that “State consumer financial laws” are preempted in three circumstances: (A) if they have a “discriminatory effect on national banks” as opposed to state-chartered banks; (B) if “in accordance with the legal standard for preemption in the decision of the Supreme Court of the United States in [Barnett Bank],” the law “prevents or significantly interferes with the exercise by the national bank of its powers”; or (C) if the law “is preempted by a provision of Federal law other than title 62 of the Revised Statutes.” 12 U.S.C. § 25b(b)(1).
The borrowers admitted that the Dodd Frank Act codified Barnett Bank, but they nonetheless urged a close textual analysis of the phrase “significantly interferes” — language from the Dodd-Frank Act mirroring the Court’s opinion in Barnett Bank. See 12 U.S.C. § 25b(b)(1)(B); Barnett Bank, 517 U.S. at 33.
However, the Second Circuit reasoned that, when Congress “ha[s] before it the meaning” a case gave “to the words it selected …, [the court] give[s] the language found … the meaning ascribed [to] it” by that case. Slack v. McDaniel, 529 U.S. 473, 483 (2000). In turn, the Court held that the borrowers’ focus on the words “significantly interferes” in isolation was misguided because Barnett Bank was explicit in that it was applying the “ordinary legal principles of pre-emption,” not announcing a new standard. 517 U.S. at 37.
However, even under the borrowers’ interpretive approach, the Second Circuit was unpersuaded by their arguments.
The borrowers’ assumed that “significantly” must mean of high “degree.” But although “significant” can mean “[f]airly large in amount or quantity,” the Court concluded that it can also mean “important” or “meaningful” — as in, interference is significant if it is important in relation to the banking power at issue. Significant, American Heritage Dictionary of the English Language (4th ed. 2000).
In short, the Court held, the Dodd Frank Act amendments did not change the analysis applicable to this case.
Accordingly, the Second Circuit reversed the trial court’s order and remanded for further proceedings consistent with its opinion.