In a surprising quick turn of events, on remand from SCOTUS, the 9th Circuit, on August 23, 2024, issued its unanimous unpublished panel opinion in Kivett v. Flagstar Bank, FSB (Kivett II) in which it essentially re-affirmed its earlier panel opinion holding that there is no preemption of a California state law which requires the payment of 2% interest on residential mortgage escrow accounts. Regardless of whether you think the new opinion is right (and we do not), we think that all parties are perplexed as to why the panel (which was the same panel that heard the earlier case (Kivett I)) did not invite briefing from the parties as to what the panel should do in reaction to the Supreme Court opinion in Cantero.

In order to better understand and evaluate the new panel opinion in Kivett II, it is appropriate to review the history of the Kivett case, another pre-Kivett 9th Circuit opinion in Lusnak v. Bank of America, N.A., the SCOTUS opinion in Cantero and the just-issued Kivett II opinion. (Unlike the 9^th Circuit in Kivett II, the Second Circuit in Cantero ordered new briefing from the parties.)

First Kivett Opinion in 9th Circuit

On May 17, 2022, the 9th Circuit in Kivett I affirmed the opinion of the Federal District Court for the Northern District of California holding that there was no preemption of the California statute which requires mortgagees to pay 2% interest on residential mortgage escrow accounts. The District Court based its decision on the earlier 9th Circuit opinion in Lusnak mentioned above. In Lusnak, as discussed below, a 9th Circuit panel held that there was no preemption based on an amendment to the Truth-in-Lending Act (“TILA”) which requires the payment of interest on mortgage escrow accounts for certain high-priced mortgages. The District Court concluded at that time that the Lusnak opinion was binding precedent. (This conclusion, of course, was reached well before the recent SCOTUS opinion in Cantero). The 9th Circuit in Kivett I affirmed the District Court on the same basis as the District Court — namely, that the 9th Circuit opinion in Lusnak was binding precedent. The Bank filed a petition for a writ of certiorari to the Supreme Court in Kivett I.

On June 10, 2024, shortly after the Supreme Court’s issuance of its opinion in Cantero, the Supreme Court granted the petition for a writ of certiorari and issued a summary disposition in Kivett I. The Supreme Court vacated the judgment of the 9th Circuit in Kivett I and remanded the case to the 9th Circuit for further consideration in light of the Supreme Court’s decision in Cantero.

Cantero v. Bank of America, N.A.

On May 30, 2024, in a unanimous decision, the Supreme Court reversed the Second Circuit’s decision in Cantero, and remanded the case back to the Second Circuit and instructed the Circuit Court to analyze whether New York’s law requiring lenders to pay interest on mortgage escrow accounts is preempted under the Dodd-Frank Act by applying the Barnett Bank of Marion County, N.A. v. Nelson, 517 U.S. 25 (1996) standard. No bright line test for preemption was articulated by the Court; instead, the Court relied on Barnett Bank and its earlier precedents dealing with National Bank Act (NBA) preemption. On remand, the Second Circuit was instructed by SCOTUS to conduct a “nuanced comparative analysis” under Barnett Bank and its earlier precedents dealing with NBA preemption and “[i]f the state law prevents or significantly interferes with the national bank’s exercise of its powers, the law is preempted.”

As stated above, in remanding the Kivett case to the 9th Circuit, SCOTUS vacated Kivett I and, in doing so, implicitly concluded the 9th Circuit opinion in Lusnak was at best not binding precedent in the 9th Circuit and, at worst, wrongly decided. The Supreme Court further instructed the 9th Circuit to further consider Kivett II in light of Cantero. In remanding the case to the 2nd Circuit, the Supreme Court in Cantero instructed the Second Circuit to conduct a “nuanced comparative analysis” under Barnett Bank and earlier Supreme Court precedents dealing with National Bank Act preemption.” The 9th Circuit in Kivett II completely failed to conduct the “nuanced comparative analysis” and instead affirmed Kivett I based entirely on its conclusion in Kivett II that the Lusnak opinion was and still is correctly decided even though the Lusnak opinion did not contain a “nuanced comparative analysis”. Let’s now take a close look at the reasoning employed by the 9th Circuit in Lusnak.

Lusnak v. Bank of America, N. A.

The issue before the 9th Circuit in Lusnak was identical to the issue before the 9th Circuit in Kivett II — namely, whether the NBA preempts the California statute which requires the payment of interest on mortgage escrow accounts.

In finding no preemption, the 9th Circuit reasoned (with excerpts directly quoted from the opinion) as follows:

1. “[B]ecause this case involves state regulation of consumer credit, Bank of America must affirmatively demonstrate that Congress intended to preclude states from enforcing their escrow interest laws.”
2. The Dodd-Frank Act did not change the standards to be applied to claims of NBA preemption. “Dodd-Frank addressed the preemptive effect of the NBA in several ways. First, it emphasized that the legal standard for preemption set forth in Barnett Bank, applies to questions of whether state consumer financial laws are preempted by the NBA. 12 U.S.C. § 25b(b)(1)(B). Second, it required the OCC to follow specific procedures in making any preemption determination. See id. §§ 25b(b)(1)(B) (requiring the OCC to make any preemption determination on a “case-by-case basis”); 25b(b)(3)(B) (requiring the OCC to consult the Bureau of Consumer Financial Protection when making a preemption determination). And third, it clarified that the OCC’s preemption determinations are entitled only to Skidmore deference. 12 U.S.C. § 25b(b)(5)(A); see Skidmore v. Swift & Co., 323 U.S. 134, 140 (1944) (explaining that an agency’s views are ‘entitled to respect’ only to the extent that they have the ‘power to persuade’). Of these, only the second amendment was an actual change in the law. The first and third amendments merely codified existing law as set forth by the Supreme Court.”
3. “Before Dodd-Frank, the Supreme Court held in Barnett Bank that states are not ‘deprive[d] . . . of the power to regulate national banks, where doing so does not prevent. or significantly interfere with the national bank’s exercise of its powers.’ 517 U.S. at 33. This is because ‘normally Congress would not want States to forbid, or to impair significantly, the exercise of a power that Congress explicitly granted.’ Id.”
4. “Barnett Bank continues to provide the preemption standard; that is, state consumer financial law is preempted only if it ‘prevents or significantly interferes with the exercise by the national bank of its powers,’ 12 U.S.C. § 25b(b)(1)(B). Congress also made clear that only Skidmore deference applies to preemption determinations made by the OCC. See id. § 25b(b)(5)(A). The OCC has recognized as much. See, e.g., 76 Fed. Reg. at 43557 (conceding that section 25b(b)(1)(B) ‘may have been intended to change the OCC’s approach by shifting the basis of preemption back to the [Barnett Bank] decision itself’). Therefore, to the extent that the OCC has largely reaffirmed its previous preemption conclusions without further analysis under the Barnett Bank standard, see 76 Fed. Reg. at 43556, we give it no greater deference than before Dodd-Frank’s enactment, as the standard applied at that time did not conform to Barnett Bank. That is, the OCC’s conclusions are entitled to little, if any, deference.”
5. “Applying that standard here, we hold that California Civil Code § 2954.8(a) is not preempted because it does not prevent or significantly interfere with Bank of America’s exercise of its powers. Again, section 1639d(g)(3) of Dodd-Frank states, ‘If prescribed by applicable State or Federal law, each creditor shall pay interest to the consumer on the amount held in any . . . escrow account that is subject to this section in the manner as prescribed by that applicable State or Federal law.’ 15 U.S.C. § 1639d(g)(3). This language requiring banks to pay interest on escrow account balances ‘[i]f prescribed by applicable State [] law’ expresses Congress’s view that such laws would not necessarily prevent or significantly interfere with a national bank’s operations.” Section 1639(d) of the Dodd-Frank sets forth when a creditor must establish an escrow account in connection with first lien residential mortgage loans, including when required by federal or state law and, subject to exceptions, when the loan is a higher-priced mortgage loan governed by Regulation Z section 1026.35.
6. “Although we need not resort to legislative history, we note that it, too, confirms our interpretation of section 1639d(g)(3). A House Report discusses how mortgage servicing, and specifically escrow accounts, contributed to the subprime mortgage crisis. H.R. Rep. No. 111-94, at 53–56. The Report notes that mortgage servicers are typically ‘large corporations’ who ‘may . . . earn income from the float from escrow accounts they maintain for borrowers to cover the required payments for property insurance on the loan.’ Id. at 55. The Report’s section-by-section analysis of Dodd-Frank then explains Congress’s purpose behind section 1639d(g)(3), stating: Servicers must administer such accounts in accordance with the Real Estate Settlement Procedures Act (RESPA), [Flood Disaster Protection Act], and, if applicable, the law of the State where the real property securing the transaction is located, including making interest payments on the escrow account if required under such laws. Id. at 91. This passage shows Congress’s view that creditors, including large corporate banks like Bank of America, can comply with state escrow interest laws without any significant interference with their banking powers.’

Did 9th Circuit Adhere to Instructions of the Supreme Court in Cantero?

Clearly, Kivett II did not comply with the Supreme Court instructions to conduct a “nuanced analysis” of Barnett Bank and other earlier precedents dealing with NBA preemption. As stated above, Kivett II, in finding no preemption, relied entirely on Lusnak which in turn relied almost entirely on the provision added to TILA by Dodd-Frank which requires the payment of interest on certain mortgage escrow accounts to the extent required by applicable federal or state law even though the TILA provision did not apply to the mortgages in Kivett and Lusnak. In the Cantero opinion, the Supreme Court noted that all parties had acknowledged that the TILA provision was inapplicable. As a result, the Second Circuit is unlikely to give any weight to the Kivett II opinion as the Court decides how to apply the Supreme Court’s opinion in Cantero. The Second Circuit has ordered fresh briefing by the parties

We would be remiss if we did not explain why the reasoning in Lusnak is wrong. We don’t think the TILA provision should be a factor in connection with the interest-on-escrow issue. The Dodd-Frank act was the result of a mortgage industry meltdown. One key factor was that various lenders did not take into account consumer obligations to pay taxes and insurance, which was particularly an issue with subprime loans. So Dodd-Frank in various ways sought to rectify that situation. The provision referencing when an escrow account is required by federal or state law, actually provides that such an account may not be established except in certain cases, including when required by federal or state law. We do not read that provision as subjecting all mortgage lenders to all state law escrow requirements. We read it as Congress allowing the creation of escrow accounts in certain cases, including when required by federal or state law, to address what had been a poor practice in the mortgage industry. That is far from a blanket federal authorization of all state law mortgage escrow account requirements.

We would expect Flagstar to file a petition for rehearing en banc in the 9th Circuit or a petition for a writ of certiorari in the U.S. Supreme Court.

Hopefully, the Second Circuit in Cantero and the First Circuit in the Citizens Bank case will adhere more faithfully to the directive of the Supreme Court in Cantero.

We are hoping that the Acting Comptroller of the Currency will soon fulfill his promise to review the OCC’s preemption determinations and, specifically, the issue before the three Circuit Courts.

For more information about the Cantero Case, you may want to listen to our podcast in which we featured four outside guests who filed amicus briefs in Cantero in the Supreme Court.

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