Legal Bulletins

Contributing Editor - Mary Murphy Powers, Esq., AllRegs

As it was published in the AllRegs E-Alert Weekly Digest for the week preceding October 31, 2005 If your company currently collects odd-days or per diem interest on first mortgages at loan closing, you might want to reconsider that practice. Such a reconsideration may be warranted because of the recent decision by the United States Court of Appeals for the Ninth Circuit in Wells Fargo Bank, N.A. v. Boutris, 419 F.3d 949 (9th Cir. 2005). In a "good news, bad news" ruling, the court in Wells Fargo upheld the preemption of state visitorial and licensing powers under the National Bank Act ("NBA"), but rejected the argument that the federal Depository Institutions Deregulation and Monetary Control Act of 1980 ("DIDMCA"), 12 U.S.C. § 1735f - 7a(a)(1), preempts a California law restricting the charging of interest during the period before a mortgage is recorded. This ruling calls into question the preemptive effect of DIDMCA upon laws not only in California, but perhaps in other states as well, that limit when interest can begin to accrue or limit collecting interest in advance of accrual.

GENERAL BACKGROUND

Odd-days or per diem interest refers to interest that accrues during the period between the loan closing date and the beginning of the regular interest accrual period, which typically is a monthly period that starts on the first day of the next month following loan closing. California and other states have enacted various laws that restrict the collection of interest or other fees in advance or restrict when interest may begin to accrue. For example, a Maryland law expressly prohibits collecting interest in advance in connection with first mortgage loans. Md. Code Ann., Com. Law II § 12-103(b)(1)(vi). DIDMCA preempts the "laws of any State expressly limiting the rate or amount of interest" for first mortgage loans. Before the Wells Fargo decision, many experts understood this preemption in DIDMCA allowed lenders to ignore state-law restrictions on collecting interest in advance or on when interest may begin to accrue. See, e.g., 73 Md. Op. Att'y Gen. 144 (1988) (based on guidance from federal regulators, the Maryland Attorney General opined that DIDMCA preempted the statutory restriction on interest in advance. No court has ruled on this Maryland law question to date.).

THE WELLS FARGO DECISION

The Wells Fargo decision is the latest in a series of lawsuits involving various state efforts to regulate national bank operating subsidiaries. Courts in the Second, Fourth and Sixth circuits ruled against the state regulators. Wachovia Bank, N.A. v. Burke, 414 F.3d 305 (2d Cir. 2005), Nat'l City Bank v. Turnbaugh, 367 F. Supp. 2d 805 (D. Md. 2005), Wachovia Bank, N.A. v. Watters, 334 F. Supp. 2d 957 (W.D. Mich. 2004), appeal docketed, No. 04-2557 (6th Cir. Oct. 14, 2004). Here, the California Commissioner of Corporations (the "Commissioner") attempted to conduct audits of residential mortgages originated by the operating subsidiaries of Wells Fargo Bank, N.A. and National City Bank (the "Banks"). The Commissioner sought to determine whether the subsidiaries had overcharged interest and provided unduly low estimates of settlement fees in violation of California law. In response to these efforts, the Banks filed suit, seeking declaratory and injunctive relief. The Banks argued that the Commissioner's attempts to conduct an audit of their activities were preempted by federal law.

On appeal, two questions were presented to the court. The first question was whether the NBA prevents California from exercising investigatory and licensing authority over the operating subsidiaries of national banks. The second question was whether section 501 of DIDMCA preempts California's per diem loan-interest statute. In 2003, the trial court below ruled for the Banks, answering yes to both questions. Wells Fargo Bank, N.A. v. Boutris, 265 F. Supp. 2d 1162 (E.D. Calif. 2003). The regulators then appealed.

FIRST ISSUE - PREEMPTION UNDER THE NATIONAL BANKING ACT

Turning first to the question of preemption under the NBA, the appellate court explained the history and purpose of national bank preemption, as well as the role of Comptroller of the Currency (the "OCC") in interpreting the scope of that preemption. It then reviewed the OCC's operating subsidiary regulations, 12 C.F.R.§§ 5.34; 7.4006, considering whether the OCC has the authority under the NBA to both authorize and regulate operating subsidiaries. Convinced that it does, the appellate court agreed with the trial court's decision, holding that the California laws authorizing the Commissioner to exercise visitorial and licensing powers over national bank operating subsidiaries are preempted.

SECOND ISSUE - DIDMCA PREEMPTION

However, on what may turn out to be the more important question in this case, the Ninth Circuit reversed the district court on the second issue. The appellate court held that DIDMCA's preemption of the "laws of any State expressly limiting the rate or amount of interest" for first mortgage loans does not preempt California's law that restricts when interest may be collected.

Remember that the lower court had concluded in 2003 that the per diem statute, by limiting the time during which interest could be charged, expressly limited the rate or amount of interest that may be charged and, thus, was preempted by DIDMCA. See Cal. Civ. Code § 2948.5(a). The Ninth Circuit disagreed, however, and adopted the analysis of the First Circuit in the case of Grunbeck v. Dime Savings Bank, 74 F.3d 331 (1st Cir. 1996). In Grunbeck, the court rejected the argument that a New Hampshire law limiting how interest could be calculated was preempted, reasoning that the language in DIDMCA is concerned only with the rate and amount of interest. The court in Wells Fargo agreed and concluded similarly that California's per diem law concerns only the timing of when interest can be collected, not the rate or amount, which "remain fully adjustable so that banks can obtain the same return that they would have otherwise." 419 F.3d. at 969.

In addition, the appellate court emphasized the unusual qualifier in the language of DIDMCA, which preempts only express state limitations on rates and amounts of interest. Again, the court followed the First Circuit's conclusion in Grunbeck that the express limitation requirement in DIDMCA means that it does not operate to preempt state laws based on "likely impact" if there is no express limitation on interest rates or amounts. Id. The Banks had argued that the California per diem statute did expressly limit the rate and amount of interest - to zero - for the period of time prior to recordation. The court rejected this "clever" argument.

CONCLUSION -- WHAT SHOULD YOU DO?

The case was remanded to district court for further proceedings. Even so, as a result of the DIDMCA preemption holding in Wells Fargo, prudent lenders, especially state-chartered mortgage lenders and banks, may want to reconsider the credit laws that govern their first mortgage loans to determine whether any applicable state laws may restrict when or how interest may be charged. Although the Wells Fargo decision is controlling only in the Ninth Circuit, courts in other circuits could find it persuasive. If courts in other jurisdictions follow the reasoning in Wells Fargo, lenders could face significant penalties, fines, and/or refunds for unintentionally violating state law restrictions that the lenders had previously believed in good faith to be preempted.