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Financial Services Law Insights and Observations

California Federal Court Dismisses State Law Claims Against National Bank on Preemption Grounds

State Issues

On March 15, the U.S. District Court for the Northern District of California held that federal law preempts several state law claims brought against a national bank. O’Donnell v. Bank of America, N.A., Case No. C-07-04500 (N.D. Cal. Mar. 15, 2010). In this putative class action, the plaintiff borrowers alleged that the defendant bank “did not adequately disclose the ‘actual’ interest rate and the certainty of negative amortization” in its adjustable rate mortgage (ARM) loan agreements, and brought claims of breach of contract, as well as fraud and unfair competition under the California Unfair Competition Law (UCL). Regarding the UCL claims, the court held that the claims were preempted because they impermissibly “regulate [the bank’s] disclosures for its ARM loans and to require it to make additional disclosures about negative amortization, applicable interest rates, and payment schedules.” The court further noted that the Office of the Comptroller of the Currency (OCC) has promulgated regulations authorizing national banks to make ARM loans secured by interests in real estate without interference from state law, and to make real state loans without regard to state law with respect to (i) “[t]he terms of credit, including schedule for repayment of principal and interest, amortization of loans, balance, payments due, [and] minimum payments,” (ii) “[d]isclosure and advertising,” (iii) “origination…of…mortgages,” and (iv) “[r]ates of interest on loans.” Hence, the court explained that the “OCC’s regulations…expressly preempt plaintiffs’ ability to use state law to reach [the defendant’s] ‘disclosures’ about its Option ARM loans and the ‘amortization of [the Option ARM] loans,’ including how the amortization and interest rate features are disclosed.” In dicta, the court clarified that its “holding does not mean that state laws of general application…are necessarily preempted if applied to a national bank;” instead, “a state law is preempted only if it requires affirmative action by a national bank in an area covered by a national bank regulation,” as in this case where the borrowers sought “to impose disclosure obligations other than those mandated by” federal law. In addition to its preemption analysis, the court also dismissed breach of contract claims against the bank on the theories that (i) the bank failed to apply monthly payments to both principal and interest on a fully-amortizing basis – because the note stated that "[e]ach monthly payment will be applied as of its scheduled due date and will be applied first to current interest, then to prior unpaid interest, and the remainder to Principal,” and (ii) the bank "switched the interest rate charged on the loans to a much higher rate than the one they promised” and “demanded payments in amounts that exceeded those permitted by the Notes” – because “[a]lthough the interest rates that could be charged were arguably not ‘clearly and conspicuously’ set forth as required by TILA, a careful reading of the loan documents reveals that they did explain how interest rates would be charged and payments credited.”