National Bank Exempt from NY Law Requiring Escrow Interest Payments

Earlier this month, a three-judge panel in the Second Circuit ruled in favor of a multinational investment bank (the Bank), finding national banks to be preempted from a New York escrow interest law, requiring lenders to pay interest into mortgage escrow accounts.  The ruling resolves two consumer protection suits that were consolidated in 2019, each alleging the Bank failed to comply with New York General Obligations Law § 5-601(GOL § 5-601).

Under GOL § 5-601, following the Dodd-Frank Act, issuing financial institutions are required to make a deposit equal to 2% of the mortgage to escrow accounts to be used for property taxes and insurance payments.  According to the consolidated consumer protection claims, the Bank breached the loan agreements between the institution and the borrowers by failing to make deposits into the escrow accounts, as required under state law.

In defense, the Bank alleged that, as a federally chartered financial institution, it was not subject to GOL§ 5-601, as the state law is preempted by the National Bank Act of 1864 (NBA).  The District Court disagreed, finding GOL § 5-601 was not preempted by federal law, and therefore the Bank could not avoid its depository obligations under the GOL § 5-601, regardless of its national status under the NBA.

On Appeal, the Second Circuit found the lower court erred in its analysis that found the 2% payment requirement to be so minimal that it would not be burdensome enough to the Bank to justify finding the state law interfered with its functions under federal law.  The Second Circuit found that GOL§ 5-601 would, “exert control over a banking power granted by the federal government, so it would impermissibly interfere with the national banks’ exercise of that power.”  The Second Circuit concluded that GOL§ 5-601 impermissibly regulated the broad powers granted to the Bank to carry on the business of banking, thereby violating the NBA. 

In its decision, the Second Circuit referenced a similar consumer protection suit brought against the Bank in the Ninth Circuit in which the court found in 2018 that a similar mortgage escrow interest law did not interfere with the Bank’s exercise of federally granted power.  The Second Circuit noted the Bank did not try and distinguish that case from the present case, and instead alleged it to be wrongly decided.  SCOTUS eventually declined the review the decision.