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Financial Services Law Insights and Observations

2nd Circuit: NY law on interest payments for escrow accounts is preempted

Courts State Issues Appellate Second Circuit New York Mortgages Escrow Interest National Bank Act Class Action Dodd-Frank RESPA TILA Consumer Finance

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On September 15, the U.S. Court of Appeals for the Second Circuit held that New York’s interest-on-escrow law impermissibly interferes with the incidentals of national bank lending and is preempted by the National Bank Act (NBA). Plaintiffs in two putative class actions obtained loans from a national bank, one before and the other after certain Dodd-Frank provisions took effect. The loan agreements—governed by New York law—required plaintiffs to deposit money into escrow accounts. After the bank failed to pay interest on the escrowed amounts, plaintiffs sued for breach of contract, alleging, among other things, that under New York General Obligations Law (GOL) § 5-601 (which sets a minimum 2 percent interest rate on mortgage escrow accounts) they were entitled to interest. The bank moved to dismiss both actions, contending that GOL § 5-601 did not apply to federally chartered banks because it is preempted by the NBA. The district court disagreed and denied the bank’s motion, ruling first that RESPA (which regulates the amount of money in an escrow account but not the accruing interest rate) “shares a ‘unity of purpose’ with GOL § 5-601.” This is relevant, the district court said, “because Congress ‘intended mortgage escrow accounts, even those administered by national banks, to be subject to some measure of consumer protection regulation.’” Second, the district court reasoned that even though TILA § 1639d does not specifically govern the loans at issue, it is significant because it “evinces a clear congressional purpose to subject all mortgage lenders to state escrow interest laws.” Finally, with respect to the NBA, the district court determined that “the ‘degree of interference’ of GOL § 5-601 was ‘minimal’ and was not a ‘practical abrogation of the banking power at issue,’” and concluded that Dodd-Frank’s amendment to TILA substantiated a policy judgment showing “there is little incompatibility between requiring mortgage lenders to maintain escrow accounts and requiring them to pay a reasonable rate of interest on sums thereby received.” As such, GOL § 5-601 was not preempted by the NBA, the district court said.

On appeal, the 2nd Circuit concluded that the district court erred in its preemption analysis. According to the appellate court, the important question “is not how much a state law impacts a national bank, but rather whether it purports to ‘control’ the exercise of its powers.” In reversing the ruling and holding that that GOL § 5-601 was preempted by the NBA, the appellate court wrote that the “minimum-interest requirement would exert control over a banking power granted by the federal government, so it would impermissibly interfere with national banks’ exercise of that power.” Notably, the 2nd Circuit’s decision differs from the 9th Circuit’s 2018 holding in Lusnak v. Bank of America, which addressed a California mortgage escrow interest law analogous to New York’s and held that a national bank must comply with the California law requiring mortgage lenders to pay interest on mortgage escrow accounts (covered by InfoBytes here). Among other things, the 2nd Circuit determined that both the district court and the 9th Circuit improperly “concluded that the TILA amendments somehow reflected Congress’s judgment that all escrow accounts, before and after Dodd-Frank, must be subject to such state laws.”

In a concurring opinion, one of the judges stressed that while the panel concluded that the specific state law at issue is preempted, the opinion left “ample room for state regulation of national banks.” The judge noted that the opinion relies on a narrow standard of preempting only those “state laws that directly conflict with enumerated or incidental national bank powers conferred by Congress,” and stressed that the appellate court declined to reach a determination as to whether Congress subjected national banks to state escrow interest laws in cases (unlike the plaintiffs’ actions) where Dodd-Frank’s TILA amendments would apply. 

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