Flagstar v. Kivett

Case Summary: ABA filed a coalition amicus brief urging the Ninth Circuit to reverse a district court decision which ruled that the NBA does not preempt California’s interest-on-escrow (IOE) statute.

Section 1044 of the Dodd-Frank Act codified the NBA preemption standard from the Supreme Court’s decision in Barnett Bank of Marion County N.A. v. Nelson, 517 U.S. 25 (1996), ruling the NBA preempts state law if it “prevents or significantly interferes with the exercise of a national bank’s power.”

Flagstar loaned $400,610 to William Kivett to finance a 2012 real estate purchase in California. Kivett filed a class action alleging Flagstar failed to pay interest on his mortgage escrow account. Kivett also asserted a claim under California’s Unfair Competition Law, which mandates financial institutions pay at least 2% interest annually on escrow accounts associated with certain residential mortgage loans. In response, Flagstar argued the NBA preempts state laws requiring national banks to pay interest on mortgage escrow accounts. A California federal district court ruled the NBA did not preempt California’s IOE law, and the Ninth Circuit affirmed, highlighting its prior ruling in Lusnak v. Bank of America, N.A., which rejected the preemption challenge to California’s IOE statute.

On May 30, 2024, the U.S. Supreme Court vacated the Second Circuit’s decision in Cantero v. Bank of America, ruling courts must conduct a practical assessment of the nature and degree of the interference when determining whether a state regulation significantly interferes with the national bank’s exercise of its powers and is thus preempted under Barnett Bank. In light of Cantero, the U.S. Supreme Court granted Flagstar’s petition vacating the Ninth Circuit’s decision and remanded the case to the Ninth Circuit for further consideration. On remand, a unanimous Ninth Circuit panel reaffirmed the district court’s decision ruling California’s IOE law is not preempted by the NBA. The panel ruled it was bound by its prior Lusnak decision, which upheld the same California provision. The panel concluded “Cantero suggests that Lusnak was correctly decided,” because Lusnak “properly applied” the Barnett preemption analysis.

In its brief supporting Flagstar Bank, ABA argued mortgage escrow accounts are critical tools in the U.S. banking system. The brief emphasized how these accounts are indispensable in residential mortgage lending by enhancing efficiency and stability within the banking and financial systems. ABA also stressed that mortgage escrow accounts provide more than just convenience. Mortgage escrow accounts help manage property-related obligations effectively, protecting loan collateral from tax foreclosure and uninsured damages. By mitigating risks associated with tax liens and property losses, lenders can offer homeowners loans with lower interest rates with lower equity.

ABA also argued California’s price control “significantly interferes” with the exercise of national bank powers. Applying Cantero, ABA explained that California’s pricing scheme is preempted. Cantero declared that in assessing the “significance” of state-level interference, the precedent is instructive: “if the state law’s interference with national bank powers is more akin to the interference where preemption was found, the state law is preempted.” In the brief, ABA highlighted the “paradigmatic example of significant interference” in Franklin National Bank of Franklin Square v. New York, which involved a New York law prohibiting banks from using the word “saving” or “savings” in their advertising or business. The Court held the law interfered with banks’ statutory powers to receive savings deposits. ABA emphasized that the interference in California’s pricing scheme is far more significant than the law in Franklin. During Cantero oral arguments, Justice Kavanaugh remarked “the pricing of the product almost by definition interfere[s] more with the operations of a bank than something that affects advertising.”

ABA highlighted why each of the plaintiffs’ arguments failed. First, the plaintiffs claimed this case differs from Supreme Court precedents like Franklin and Barnett because California’s IOE law does not interfere with an “express power.” However, ABA countered that this distinction made no difference. ABA pointed to the U.S. Supreme Court’s decision in Watters v. Wachovia Bank, which held that states cannot burden national banks' lending power or restrict their efficient exercise of any incidental or enumerated power. Second, the plaintiffs argued that the level of interference in their case resembles rulings such as Anderson National Bank v. Luckett, where the Court upheld state laws. But ABA refuted this comparison, explaining that Anderson turned on the absence of interference with a national bank’s power—not on the level of interference being minimal. Moreover, ABA stressed that California’s pricing scheme is unlike generally applicable State contract, property, and debt-collection laws that courts have allowed to apply to national banks. Rather, by imposing mandatory interest rates for escrow accounts. California’s pricing scheme is clearly more akin to other pricing schemes that significantly interfere with the operational autonomy of national banks and have been consistently found to be preempted by the NBA.

In addition, ABA argued that courts should apply Cantero without requiring extensive factual development. Although the Court established a clear legal framework to determine whether state laws are preempted, the plaintiffs pushed for a fact-intensive approach. ABA emphasized that their insistence on a detailed factual inquiry contradicts the Supreme Court’s guidance. In Cantero, the Court ruled that determining whether a state law is preempted depends on whether it significantly interferes with national bank powers—a legal question that does not require prolonged factual investigation.

ABA also argued that the Office of the Comptroller of the Currency’s (OCC) regulations support the conclusion that California’s pricing scheme significantly interferes with national bank powers. In 2004, the OCC issued a final rule listing certain state laws preempted by the NBA, including those related to “escrow accounts” for real estate loans. The OCC based this regulation on its experience in identifying state laws that conflict with national banks’ real estate lending powers. The plaintiffs wrongly claimed that courts should disregard the OCC regulations because the agency failed to comply with Dodd-Frank’s limits on its preemption authority. However, Congress did more than simply codify the Barnett standard in Dodd-Frank. As part of a broader compromise on changes to the national bank system, Congress chose not to overrule the OCC’s prior preemption determinations. While Dodd-Frank now requires the OCC to assess preemption on a case-by-case basis, it did not invalidate past decisions. Additionally, Dodd-Frank did not alter the substantive preemption standard, meaning the OCC’s pre-Dodd-Frank Barnett analysis remains equally instructive today.