The Potential Impact of the Supreme Court’s Preemption Ruling

On May 16, the Supreme Court ruled that the Court of Appeals Second Circuit used the wrong legal analysis in determining that federal banks were not subject to a New York law mandating that banks and credit unions provide minimum interest payments on mortgage escrow accounts. The Court did the legal equivalent of giving the lower court back its homework assignment by instructing it to look more closely at the preemption provisions of the Dodd-Frank Act.

For federally chartered credit unions in one of the 10 states, including New York and California that have similar statutes, the decision has direct financial implications. But there is also the indirect question of how this decision will indirectly affect the analysis of preemption issues related to the credit union industry.

As I noted, at issue in this case is a New York law mandating that financial institutions pay interest of at least 2% on all mortgage escrow accounts. The statute has been around for years and has been preempted as applied to national banks and credit unions for almost as long. In 1991, the NCUA issued an Opinion of Counsel letter preempting a Wisconsin law mandating that financial institutions pay more than 5% interest on mortgage escrow accounts. It concluded that the law was preempted by the NCUA’s regulations because “the decisions whether an account will receive dividends and if so what rate will be paid are matters affecting the maintaining of a share account and are therefore decisions to be made by an FCU’s Board of Directors.” Federal banks and Savings and Loans Associations were also exempt from these statutes.

Fast forward to 2010. Like a ticking time-bomb in an Alfred Hitchcock movie, Dodd-Frank included preemption language that the financial industry knew was there but was largely able to ignore until the May 16 decision. 12 U.S.C.A. 25b’s stated purpose is to clarify preemption standards for national banks and their subsidiaries. Under this clarification, state consumer financial laws are preempted “only if A) application of the state law would have a discriminatory affect on national banks in comparison with state chartered banks; B) in accordance with the legal standard for preemption in the decision of the Supreme Court of the United States in Barnett Bank of Marion County, N. A. v. Nelson, Florida Insurance Commissioner (1996), the State consumer financial law prevents or significantly interferes with the exercise by the national bank of its powers.”

To be clear, this statute does not apply to credit unions. The NCUA of course has its own preemption regulations, which are more narrowly drawn than corresponding regulations issued by the OCC. However, the framework for analysis is similar across institutions.

In Cantero v. Bank of America (2024), two plaintiffs sued Bank of America, a federally chartered bank, for failing to pay interest on their escrow as required under New York State law. The plaintiffs won at the district court level, but the Court of Appeals for the Second Circuit reversed. It held that an unbroken line of case law since McCulloch v. Maryland dictated that federal banks not be required by state law to pay minimum interest to consumers.

In the unanimous decision written by Justice Kavanaugh, the Supreme Court chastised the Court of Appeals for not using the Dodd-Frank provision as a starting point for analysis. This is a big deal. First, the Court noted that under §25b, federal banking law does not “occupy the field” in any area of state law. In plain English, this means that no matter how comprehensive a federal statutory scheme may be, a court cannot categorically assume that a state statute on the issue is preempted. Second, the Court noted that by codifying Barnett Bank into statute, courts are now required to closely analyze this case in making any preemption determination. This case is best known for holding that a state banking statute should be invalidated only if the law “prevents or significantly interferes with the exercise by a national bank of its powers.”

At the time the statute was enacted, it was not entirely clear just how significant the Barnett reference was or would become. In the case, the Supreme Court preempted a Florida law that prohibited larger banks from directly selling insurance. However, in its decision, the Court made it clear that an analysis of Barnett must extend beyond the court’s holding and instead be used “to guide judicial application of the preemption standard.”

Whether this new dictate substantially alters the outcome of preemption determinations of course remains to be seen, but at the very least, expect to see greater emphasis on fact sensitive inquiries. As the Court explained, Barnett sought to carefully account for and navigate the Court’s prior preemption cases. However, Barnett also ruled that some but not all nondiscriminatory state laws that regulate national banks are preempted. Going forward, state banking laws can be preempted only if the law prevents or significantly interferes with a national bank’s powers.

As state legislatures such as New York’s rush to enact new laws before the close of their sessions, this case will encourage those legislators willing to pass state laws that previously would run afoul of preemption standards. The case may also have the affect of making it more difficult to get regulators and courts to preempt state laws. After all, the power to tax is not necessarily the power to destroy unless it significantly interferes with the exercise of a federal charter’s powers.

Henry Meier is the former General Counsel of the New York Credit Union Association, where he authored the popular New York State of Mind blog. He now provides legal advice to credit unions on a broad range of legal, regulatory and legislative issues. He can be reached at (518) 223-5126 or via email at henrymeieresq@outlook.com.