Today's Trends in Credit Regulation

Using State Law to Preempt State Law
By Elizabeth C. Yen

Much has been written about the Dodd-Frank Act’s curtailment of federal preemption for federally-chartered banks and their operating subsidiaries. This may be a good time to dust off some longstanding, tried and true state law principles that may provide a different way to preempt some (not all) state laws, especially for financial services companies that allow consumers to request and obtain products and services using interstate commerce (including direct mail, telephone, and Internet).

“Choice of law” or “conflict of law” principles, although they do vary from state to state, generally allow the parties to a contract to mutually agree in the contract that a certain specified state’s substantive laws will apply to the contract, provided that the specified state has a substantial relationship to the origination and performance of the contract, and no other state has a strong, overriding, fundamental public policy reason to have its own substantive laws apply to the contract, in place of the laws of the state specified in the contract.

For example, suppose a consumer lives in State B and applies for a financial services product by telephone, Internet, or direct mail from State B. Suppose that application is received, evaluated, and approved or denied by a financial services company in State A. After the consumer’s application is approved in State A, a financial services contract is prepared in State A and sent to the consumer in State B for completion, signing, and return to the financial services company in State A. The consumer’s signed contract is “accepted” by the financial services company in State A, and the consumer’s account is opened in State A. Suppose also that all required payments are sent to State A, all significant account origination and account servicing decisions are made in State A, account-related communications to the consumer originate from State A, and the contract specified that the substantive laws of State A would apply to the contract. In such a case, it is possible that a combination of the interstate commerce clause of the U.S. Constitution (limiting states’ ability to regulate interstate commerce), as well as State B’s own laws about enforcing reasonable “choice of law” contract provisions, would cause courts in State B to uphold the parties’ contractual agreement to have the substantive laws of State A apply to the contract, especially if the financial services company does not maintain physical retail offices in State B and does not send employees or agents into State B to originate business.

In this hypothetical scenario, certain aspects of the laws of the consumer’s state of residence (State B) would still need to be considered, including laws governing such things as (for example) the legal age of majority for contract purposes, community property and similar laws (if the consumer lives in a community property or quasi-community property state), how to perfect and enforce a security interest in the consumer’s property, abandoned property (escheat) rules, inheritance and probate issues (if the consumer passes away), power of attorney issues (if the consumer becomes disabled or incompetent), and similar matters. In case a contract dispute ultimately might need to be resolved in the consumer’s home state (State B), some attention should also be paid to such things as State B’s requirements concerning signed, written contracts (so-called “statutes of frauds”). Federal law applicable to federally-chartered banks and their operating subsidiaries has not preempted these types of state laws, however, so complying with these types of local laws should not create significant new compliance burdens for financial services companies that previously relied on federal preemption to override certain state substantive consumer protection requirements.

Well-developed and longstanding principles concerning the unenforceability of contract provisions that require a contracting party to use a court (or a nonjudicial dispute resolution forum) in a far-away, distant, inconvenient location would continue to apply. But even if the consumer might be able to have contract disputes resolved physically within the consumer’s state of residence (State B), the substantive laws of State A could nonetheless continue to apply to the contract under “choice of law” or “conflict of law” principles. Courts in State B could apply the substantive laws of State A to the contract dispute.

A consumer might argue that her home state (State B) has a strong, overriding, fundamental public policy against enforcing certain contract provisions (such as class action waivers), and that the substantive law of State A should not apply to the contract for that reason. Courts may resolve these types of arguments in different ways – including by applying State B’s law only to nullify a specific contract provision (such as a class action waiver) and by otherwise applying State A’s substantive laws (under the theory that this would be consistent with the parties’ contractually agreed-upon choice of substantive law, while also deferring to State B’s overriding public policy concerns relating to one specific aspect of the contract). This result might be facilitated if the contract included a “severability” provision (to the effect that if any contract provision is ultimately found to be unenforceable, the remaining provisions of the contract shall not be affected and shall remain in full force and effect).

A consumer also might argue that her home state (State B) has a significantly stronger interest to protect its own residents, as compared to State A, through enforcement of State B’s disclosure requirements, even if the contract is legitimately subject to State A’s substantive laws. If the disclosures required by State A serve substantially the same consumer protection purposes, however, it might be possible to persuade a court that State A’s disclosure requirements should apply, in addition to State A’s substantive requirements. This result might be facilitated if State B’s disclosure requirements conflict with State A’s substantive requirements.

The analysis of which state’s law should apply to a contract-related dispute may also depend on whether a party to the contract is claiming a “tort” or fraudulent act or misrepresentation has occurred, independent of (although related to) the contract itself. Although the contract might be governed by the substantive law of State A, the analysis of which state’s law should apply to a “tort” or fraud claim may focus on such things as where the allegedly injurious (negligent, tortious, or fraudulent) act occurred, not on where the contract was approved, accepted, serviced, and so forth.

Plaintiffs and defendants will often disagree about which state’s substantive laws should properly apply to a given contract-related dispute, especially if one state’s laws would provide a significant advantage or disadvantage to one party in the dispute. In some cases, a judge’s ruling on the issue of which state’s substantive law should apply may cause litigants to undertake serious settlement discussions, if (for example) the ability to assert certain claims or defenses or to seek certain punitive damages effectively disappeared with the judge’s “choice of law” ruling.

“Choice of law” issues have been extensively litigated over the years, especially by parties that did not have the benefit of federal preemption arguments. In view of the Dodd-Frank Act’s pending curtailment of federal preemption arguments for federally-chartered banks and their operating subsidiaries, it might be useful to revisit state “choice of law” principles.

Elizabeth C. Yen is a partner in the Connecticut office of Hudson Cook, LLP, headquartered in Maryland. She is admitted to practice in Connecticut only. The views expressed herein are personal and not necessarily those of any employer, client, constituent or affiliate of the author. Elizabeth can be reached at 203-776-1911 or by email at

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