Bank of America escrow case met with skepticism in Supreme Court

The U.S. Supreme Court seemed skeptical of both sides in a case involving state preemption of the National Banking Act.

Whether national banks need to pay interest on mortgage escrow accounts in New York — and likely elsewhere — will turn on how the Court determines what constitutes substantial interference with their activities.

But the justices in their questioning seemed to be "very uncomfortable" in trying to explain what is meant by the relevant statute, the National Banking Act, said Joseph Lynyak, a partner at the law firm of Dorsey & Whitney.

"The basis of the problem is the very poorly drafted statutory language that adopted Section 25b when Dodd-Frank was written," he said in a statement. "For example, several of the Justices wondered whether 'significantly interferes' should be understood purely as statutory language, or whether the term was intended to be understood as used in the Barnett Banks decision (which is directly named in Section 25b)."

The justices asked tough questions for both sides: petitioners Alex Cantero, Saul Hymes and Ilana Harwayne-Gidansky and for Bank of America. The Solicitor General also appeared before the Court after the petitioners spoke. In hearing the arguments, the justices suggested that, depending on the interpretation, nothing or virtually every action could be preempted, Lynyak noted.

Answering a question from Justice Brett Kavanaugh, petitioner attorney Jonathan Taylor admitted "I would concede that it's not a bright-line test. Congress didn't want a bright-line test."

In response to Justice Sonia Sotomayor, Lisa Blatt, representing Bank of America, attempted to establish when the preemption would apply.

"When the state dictates the attribute of the product and service as opposed to the interaction with the consumer, it's preempted," said Blatt. "Under that definition, you have banking-specific laws that aren't preempted, like laws that prohibit racial discrimination and whatnot. You have laws that prohibit fraud by banks."

Although the case dealt with a decision from the Second Circuit that ruled in favor of Bank of America, the Ninth Circuit in a similar case involving Flagstar said the bank had to comply with California law.

Flagstar filed an amicus brief supporting Bank of America, and pointed to its own situation: "Under that incorrect ruling, Flagstar is subject to a $9 million judgment and a permanent injunction requiring it to pay interest on escrow to its California customers going forward."

That case is on hold pending this decision.

The Mortgage Bankers Association joined a number of bank groups — the Bank Policy Institute, the American Bankers Association, the Consumer Bankers Association and the Mid-Size Bank Coalition of America — also in support of Bank of America.

But the Conference of State Bank Supervisors and the American Association of Residential Mortgage Regulators supported the petitioners.

Part of the conundrum for the court, said Matthew Lambert, CSBS' deputy general counsel of policy, is that the Dodd-Frank Act, which subsumed the National Banking Act, calls for a process in these matters.

"That process has not occurred in the 15 years or so that Dodd-Frank has been in existence," Lambert said. "The OCC is supposed to make a determination on a case by case basis with evidence on the record and that just has not happened."

At one point, Justice Kavanaugh asked Taylor if the 1819 case of McCullough v. Maryland, which was cited in the Second Circuit decision, still holds.

Taylor agreed it does, although in the CSBS amicus brief said that prior court erred.

Lambert noted that the ruling in the case, which involved the Second National Bank of the United States, would not apply to "mere private corporations," then-Chief Justice John Marshall said in a subsequent ruling, Osborn v. Bank of the United States.

What Lambert did find surprising is that current laws around escrow accounts were not raised during the arguments.

Lambert is hopeful that the Supreme Court looks to the text of the law to find an answer to these substantive issues because procedure has not been followed. "If that procedure is followed, I think these cases become much easier."

Another attorney that listened to the arguments did detect the likelihood of the justices upholding the Second Circuit ruling.

"It appeared to me that more of the justices in the way they asked their questions were looking at, in my opinion, favoring the [national] preemption," said Jay Beitel, a principal at the mortgage law firm of Polunsky Beitel Green.

As an indicator of how they are likely to rule, he pointed to the justices' questions about a prior preemption ruling involving Franklin National Bank against New York in 1954, which held that a state prohibition on commercial banks using the term "savings" was unconstitutional.

The Solicitor General, represented by Malcolm Stewart, in Lynyak's view, might have provided a solution.

"Perhaps the answer in this instance was the suggestion by the Department of Justice, which argued that further development by the lower courts was warranted, and that the case should be vacated and the preemption language of Section 25b and the standard to be employed postponed until additional lower court decisions could be issued," Lynyak said.