United States: New Federal Preemption Regulations Level the Playing Field for National Banks

In a bold stroke of the regulatory pen, the Office of the Comptroller of the Currency ("OCC") has given national banks genuine reason to celebrate the new year. On January 13, 2004, the OCC published final regulations that clarify and confirm that federal law largely preempts state law in governing the banking activities of national banks and their operating subsidiaries. The new regulations, which take effect on February 12, 2004, are designed to put national banks and their operating subsidiaries on a par with federal savings associations and their subsidiaries, which have enjoyed broad preemption authority for many decades. Actually, there are two distinct regulations, one addressing preemption and another addressing the "visitorial powers" of the OCC.

In issuing the first new set of regulations (the "Preemption Rule"), the OCC announces that its purpose is to specify the types of state laws that do not apply to a national bank’s activities, as well as the types that generally do apply. In drawing the distinctions, however, the OCC removes any doubt that federal law is the exclusive source of all of a national bank’s powers.

Deriving its guiding principle from a long history of U.S. Supreme Court decisions, the OCC holds that state laws are preempted if they "obstruct, impair, or condition a national bank’s exercise of its lending, deposit-taking, or other powers granted to it under Federal law." The regulations are structured to apply this principle to virtually all national bank activities, including both real estate loans and non-real estate loans.

At considerable length, the OCC explains that its actions are prompted by the profound changes that have occurred in the financial services marketplace. It identifies these changes as resulting from the fact that technology has facilitated instantaneous credit transactions, interstate banking authority has contributed to the expansion of markets, and American society has become increasingly mobile. In addition, the OCC notes that the advent of divergent state and local requirements covering fees, disclosures, loan conditions and licensing have resulted in higher costs for banks and, ultimately, their customers. All this has militated forcefully in favor of consistent, national standards by which to conduct the banking business.

The Preemption Rule amends the national bank real estate lending activities regulation (12 C.F.R. Part 34) and adds three new interpretive rulings addressing deposit-taking (12 C.F.R. § 7.4007), non-real estate lending (12 C.F.R. § 7.4008), and other federally authorized activities (12 C.F.R. § 7.4009), respectively. The OCC makes clear that none of these regulations creates any new powers or expands existing powers of national banks and their operating subsidiaries. Rather, they preempt state laws that impermissibly limit or interfere with a bank’s exercise of a federally authorized power. The OCC expressly retains the ability to resolve, through later interpretation and regulation, issues concerning the application of state laws not specifically addressed.

In amending its regulations governing real estate lending (Part 34), the OCC first reaffirms that national banks may make, arrange, purchase or sell loans secured by real estate subject only to interagency safety and soundness standards, and any other restrictions and requirements that the OCC may prescribe. Part 34 then addresses the preemption of state law in considerable detail. The OCC expands the existing list of five types of preempted provisions to fourteen. Accordingly, national banks may make real estate loans without regard to state law limitations concerning:

• Licensing, registration (except for purposes of service of process), filings, or reports by creditors 
• A creditor’s ability to require or obtain private mortgage insurance, insurance for other collateral, or other credit enhancements or risk mitigants 
• Loan-to-value ratios 
• Terms of credit, including schedule for repayment of principal and interest, amortization of loans, balance, payments due, minimum payments, or term to maturity of the loan, including the circumstances under which a loan may be called due and payable 
• Aggregate amount of funds that may be loaned on the security of real estate 
• Escrow accounts, impound accounts, and similar accounts
• Property that secures a loan, including leaseholds
• Access to, and use of, credit reports
• Disclosure and advertising, including laws requiring specific statements, information, or other content to be included in credit application forms, credit solicitations, billing statements, credit contracts, or other credit-related documents 
• Processing, origination, servicing, sale or purchase of, or investment or participation in, mortgages 
• Disbursements and repayments
• Rates of interest on loans ¹ 
• Due-on-sale clauses except to the extent provided in federal law ²
• Covenants and restrictions that must be contained in a lease to qualify the leasehold as acceptable security for a real estate loan

Regarding state laws that only incidentally affect the exercise of national bank real estate lending powers, the OCC confirms that these are not preempted. Accordingly, national banks generally remain subject to state laws in these areas:

• Contracts 
• Torts
• Criminal law
• Homestead laws
• Rights to collect debts 
• Acquisition and transfer of real property
• Taxation
• Zoning 
• Any other law not inconsistent with national bank real estate lending operations, as determined by the OCC

The OCC approaches deposit-taking and non-real estate lending in similar fashion. In asserting the power of national banks to receive deposits and engage in activities incidental to deposit-taking, new § 7.4007 preempts the following state law limitations:

• Abandoned and dormant accounts (presumably including state escheat laws)
• Checking accounts (presumably including "basic checking" laws)
• Disclosure requirements
• Funds availability
• Savings account orders of withdrawal
• State licensing or registration requirements (except for purposes of service of process)
• Special purpose savings services

State laws that only incidentally affect the exercise of national bank deposit-taking powers are not preempted. Accordingly, virtually the same areas of law not preempted for national bank real estate lending activities also are not preempted by § 7.4007 for their deposit-taking activities.

The OCC makes no appreciable distinction between a national bank’s authority to make real estate loans and its authority to make loans that are unsecured or secured by non-real estate collateral. Accordingly, § 7.4008 asserts the power of national banks to make, sell, purchase, participate or otherwise deal in non-real estate loans, except as the OCC may circumscribe, and identifies a list of preempted state laws similar to that contained in Part 34.

Since the OCC seeks to apply preemption principles uniformly, virtually the same areas of law not preempted for national bank real estate lending and deposit-taking activities also are not preempted by § 7.4008 for their non-real estate lending activities.

Rounding out the Preemption Final Rule, the OCC adopts new § 7.4009, which confirms the exclusive authority of federal law over all aspects of national bank operations. Where state law applies to national bank operations, the new regulation makes clear that it does so only because federal law so directs. Again, virtually the same areas of law not preempted by the other provisions of the Preemption Rule also are not preempted by § 7.4009. Visitorial Powers Rule In its second major new regulation (the Visitorial Powers Rule), the OCC continues to explore the reaches of federal preemption. Here, however, there is no actual preemption of substantive state laws, but, rather, the OCC endeavors to clarify that it is the appropriate agency to enforce both state and federal laws that apply to national banks and their operating subsidiaries.

Although the new regulation is fairly short, amending 12 C.F.R. § 7.4000 (Visitorial Powers), the preamble extensively analyzes the exclusivity of the visitorial powers over national banks granted to the OCC under the National Bank Act. In reviewing a rich history of caselaw, the OCC asserts that courts have found no presumption against preemption in the national bank context, even in the wake of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. Accordingly, the OCC finds the meaning of the law unmistakable, namely, that the OCC is given the power to examine, supervise and regulate the affairs of national banks—to serve as the "visitor" of those banks—and that visitorial power is exclusively held by the OCC unless federal law creates an exception. The OCC recognizes that both state and federal courts have proper jurisdiction over the actions of national banks. Nonetheless, it emphasizes that the National Bank Act never was intended to allow state officials to use the courts to exercise supervisory authority over national banks and thereby erode the OCC’s exclusive visitorial powers.

Recognizing that the preemption of certain state consumer protection laws will raise concerns about the ability of the Federal Government to protect consumers against predatory lending practices, the OCC defends its record in combating consumer abuse and incorporates into the Preemption Rule two new anti-predatory lending standards that apply to consumer loans only. The first standard prohibits a national bank from making any type of consumer loan, whether secured by real estate or not, based predominantly on the potential foreclosure value of the collateral and without regard to the borrower’s ability to repay the loan. This standard is designed to prevent borrowers from unwittingly finding themselves in a situation where only by seizing their collateral can the lender reasonably expect to be repaid. To determine a borrower’s ability to repay, a national bank is permitted to use a wide range of reasonable methods. Although the regulation makes no mention of an exception, the OCC declares in the preamble that a loan could legitimately be made where the borrower and lender agree that the collateral will be used to repay the loan, for example, a reverse mortgage.

The second standard prohibits national banks from engaging in unfair and deceptive practices, as defined under § 5 of the Federal Trade Commission Act, in connection with any type of consumer loan. Although the Federal Reserve Board has the exclusive power to issue regulations designating what banking practices are unfair and deceptive for national banks, the OCC has the exclusive power to enforce those regulations. The combination of exclusivity of visitorial powers, preemption of state law, and creation of federal anti-predatory lending standards would appear to reserve to the OCC, and not, for example, any state attorney general, the power to bring an action challenging unfair and deceptive practices by national banks and their operating subsidiaries.

Not only national banks, but also national bank operating subsidiaries come within the ambit of the new regulations. OCC’s analysis of its authority over operating subsidiaries spans both preambles. Preexisting OCC regulations subject operating subsidiaries to the same terms and conditions as apply to their parent national banks. Accordingly, although the new regulations speak only of national banks, the OCC contends that their reach automatically extends to operating subsidiaries. The OCC further emphasizes that operating subsidiaries are the equivalent of internal bank divisions, engaging only in activities traditionally permitted for national banks and differing only in corporate form. In contrast, the Preemption Rule does not govern financial subsidiaries, which engage in activities other than those permitted for national banks.

Under the Visitorial Powers Rule, according to the OCC, enforcement of an operating subsidiary’s compliance with state laws also falls within the OCC’s exclusive purview. Noting that this result directly parallels OTS authority over the operating subsidiaries of federal savings associations, the OCC asserts that it also does not violate the 10 th Amendment to the U.S. Constitution, which preserves states’ rights, because, despite their state-chartered corporate status, operating subsidiaries conduct all of their activities pursuant to federal license duly granted under OCC regulations.

The new regulations have emerged amidst a groundswell of criticism from various members of Congress, as well as state regulatory officials. It is possible that legal action will be brought in federal court to delay or cancel their effect. At a minimum, we can expect that hearings will be held on Capitol Hill to examine their impact on the dual banking system and provide a forum for public debate. Several commentators, while applauding the OCC’s action, have expressed concern that the OCC chose not to preempt the entire field as the OTS has done for federal savings associations. This may have an effect on the ability of national banks to prove that certain areas of law are fully preempted. Also, it is important to understand that the route taken by the OCC to reach this result has been far more circuitous and gradual than the route taken by the OTS. This is likely to mean that the endurance and overall impact of the new regulations will need to be established over a long period of time through an extensive interpretive process, as well as litigation.

For now, if you are a national bank or operating subsidiary, consider these practical thoughts:

• Litigation — If you are defending a state law claim, consult counsel about developing a preemption defense.
• New/Existing Products — Review state laws that you have heretofore observed and consult counsel to explore which, if any, you feel should not be applicable any longer.
• Loans Relying Solely on Collateral — Identify any products or loan criteria that may run afoul of the new "anti-predatory lending" standards.

This article is presented for informational purposes only and is not intended to constitute legal advice.