Insights

For the past six months, national banks and federally chartered savings banks have been struggling to figure out the extent to which the Dodd-Frank Wall Street Reform and Consumer Protection Act has changed the rules on when a federally chartered bank will be subject to state laws in connection with consumer financial services transactions. Many people have overlooked the fact that while Dodd-Frank codified a new preemption rule with several new procedural hurdles for most consumer financial services products, Dodd-Frank made only one change to the preemption rules for real estate lending transactions. This one change made by Congress is important, however. Dodd-Frank increased the scrutiny courts will give to the Comptroller’s existing real estate lending regulations and any future real estate lending rules.

Section 1044 of the Dodd-Frank Wall Street Reform and Consumer Protection Act included a new express preemption standard that becomes effective on the designated transfer date, which is currently set for July 21, 2010. That new standard works as follows: a state law affecting a consumer financial services transaction is preempted if (1) the law discriminates against a national bank (as compared to a state bank chartered in the state), (2) the law is preempted under the “Barnett” standard, or (3) the law is preempted by Federal law “other than Title LXII.” “Title LXII” refers to Title LXII of the Revised Statutes of the United States, commonly known as the National Bank Act and generally found at 12 USC 21 et. seq. [The annotations at 12 USCA 21 provide a handy list of all sections of the US Code that are part of Title LXII.]

The real estate lending authority for national banks is found in 12 USC 371. While section 371 is located in the midst of provisions that are part of the National Bank Act, it is actually a part of the Federal Reserve Act. The OCC based its current real estate lending rules, found in 12 CFR Part 34, on the real estate lending authority located in 12 USC 371, not Title LXII. As a result, Dodd-Frank does not require preemption questions that arise in connection with a federally chartered bank’s real estate lending authority to be analyzed under the new “discrimination” test or the Barnett standard. In addition, Dodd-Frank does not impose the same procedural hurdles on how and when the OCC may issue preemption determinations in connection with state laws that affect real estate lending as it does in connection with state laws that affect other consumer financial transactions. For example, the OCC may only issue preemption determinations in connection with laws found in Title LXII on a “case-by-case basis” and any preemption determinations based on Title LXII must be supported by “substantial evidence”. In addition, preemption determinations under Title LXII may only be issued after consultation with the Bureau of Consumer Financial Protection, and the Comptroller may not delegate the authority to make such determinations. These procedural hurdles do not apply, however, to Part 34 and any future real estate lending preemption determinations based on 12 USC 371.

Nevertheless, Dodd-Frank changes the landscape for real estate lending in one very major way. Both the current Part 34 and any new regulations or preemption determinations issued by the Comptroller will be subject to greater scrutiny by the courts. Dodd-Frank lowered the level of “deference” a court must pay to OCC preemption determinations and regulations, whether issued under Title LXII or 12 USC 371. Before Dodd-Frank, courts applied “Chevron deference” to the OCC’s preemption determinations. Under the Chevron standard, first established in the U.S. Supreme Court decision of Chevron U.S.A. v. NRDC, 467 U.S. 837 (1984), if the intent of Congress is not clear from the face of the federal statute at issue, a court will defer to an agency’s interpretation of the statute if the agency’s interpretation is based on a “permissible construction” of the statute:

“If the statute is silent or ambiguous with respect to the specific question, the issue for the court is whether the agency’s answer is based on a permissible construction of the statute.” [emphasis added]

Thus, in the past the Comptroller did not necessarily need to reach the right answer, or even the best answer when deciding whether a federal law preempted a state consumer financial law. As long as there was any ambiguity in the federal statute, the Comptroller’s interpretation just had to be one of the permissible ways to construe the federal statute.

Under Dodd-Frank, courts are given a new standard to apply when asked to review an OCC preemption determination, including 12 CFR Part 34:

(A) Preemption. A court reviewing any determinations made by the Comptroller regarding preemption of a State law by this title or section 24 of the Federal Reserve Act (12 U.S.C. 371) shall assess the validity of such determinations, depending upon the thoroughness evident in the consideration of the agency, the validity of the reasoning of the agency, the consistency with other valid determinations made by the agency, and other factors which the court finds persuasive and relevant to its decision. §5136B(b)(5)(A) of the Revised Statutes of the United States, as added by Dodd-Frank

Therefore, the rules in Part 34 will be subject to more stringent judicial review than applied before Dodd-Frank. A court will have to consider the thoroughness of the considerations, the validity of the reasoning and the consistency with other valid determinations, as well as any other factors the court finds important. Thus, while the state preemption rules in Part 34, or any future real estate lending regulations do not have to pass muster under the procedural hurdles established in Dodd-Frank, a court must still find them to be well-reasoned, consistent and persuasive.

Even if a national bank or a federal savings bank is comfortable that Part 34 will survive this heightened judicial scrutiny, the bank may still have practical concerns about relying on the broad preemption found in Part 34. First, we are waiting for the Obama Administration to appoint a new Comptroller. It is unlikely that the next Comptroller will be an aggressive advocate of federal preemption. The new Comptroller could decide to rewrite Part 34 to weaken its strong stance on preemption. Second, the OCC has often filed amicus briefs and provided other assistance to national banks in cases involving preemption issues. It may be less likely that the OCC will be an advocate for preemption under the current Administration. And, it is even possible that the OCC would intervene against a federally chartered bank in a preemption case.

In summary, national banks and federal savings banks continue to enjoy a strong preemption foundation in connection with real estate lending. Part 34 continues to support the notion that real estate lending by national banks and federal savings banks is largely a matter of federal law and that most of the state consumer financial laws would not apply. However, after the designated transfer date, courts will assess the validity of an OCC preemption determination under a much more stringent standard. In addition, the OCC may retreat from its adopted role as preemption’s champion.

And one final note, whatever else Dodd-Frank did, it certainly ended the notion that an operating subsidiary steps into the preemption shoes of its parent bank. Congress spelled this out in no less than three places in the legislation.

Robert A. Cook is a partner in the Maryland office of Hudson Cook, LLP. Robert can be reached at 410-865-5401 or by email at rcook@hudco.com;

Timothy P. Meredith is a partner in the Maryland office of Hudson Cook, LLP. Tim can be reached at 410-865-5404 or by email at tmeredith@hudco.com.