On May 30, 2024, the Supreme Court reversed the Second Circuit’s holding that New York General Obligation Law § 5–601, which mandates banks to pay borrowers the interest accumulated on a balance held in an escrow account for residential mortgages on certain types of properties, was preempted by the National Bank Act (NBA) because the Second Circuit did not conduct the requisite comparative analysis codified in Dodd-Frank.

Case Background

In Cantero, petitioners obtained home mortgage loans from Bank of America—a national bank chartered under the NBA, which inter alia required petitioners to make monthly deposits into escrow accounts. Bank of America did not pay interest on the balances held in petitioners’ escrow accounts and informed them that the New York interest-on-escrow law was preempted by the NBA. Petitioners then filed putative class actions.

District Court’s Ruling

Initially, the District Court determined that “the New York interest-on-escrow law applied to national banks such as Bank of America, concluding that nothing in the National Bank Act or other federal law preempted the New York law,” and therefore, “New York law required Bank of America to pay interest on the escrow account balances.” Bank of America appealed.

Second Circuit’s Reversal

On appeal, the Second Circuit reversed and held that “federal law preempts any state law that ‘purports to exercise control over a federally granted banking power,’ regardless of ‘the magnitude of its effects.’” The Second Circuit reasoned that because the New York interest-on-escrow law “would exert control over the power of national banks to create and fund escrow accounts,” it was preempted as applied to national banks. Petitioners thereafter successfully sought certiorari with the Supreme Court.

At the outset, the Supreme Court noted that the NBA expressly grants national banks the power to administer home mortgage loans, which often involve escrow accounts designed to protect the bank and the borrower by ensuring the availability of funds to pay the insurance premium and property taxes on the borrower’s behalf. Additionally, the Court observed that although such escrow accounts are extensively regulated under the Real Estate Settlement Procedures Act (RESPA), “[this statute] does not mandate that national banks pay interest to borrowers on the balances of their escrow accounts.” Meanwhile, New York law expressly obligates banks with mortgage loans on certain types of New York real estate to pay interest accumulated on borrowers’ escrow accounts.

Proper Preemption Analysis After Dodd-Frank

The Court next noted that “Dodd-Frank ruled out field preemption” by providing that federal banking law “does not occupy the field in any area of State law” and that, hence, not all state laws affecting national banks are preempted. The Court further specified that following the enactment of Dodd-Frank, a state law is preempted by the NBA “only if” such state law: (A) discriminates against national banks as compared to state banks, or (B) prevents or significantly interferes with national bank’s exercise of its powers.

Supreme Court’s Application of the Barnett Bank Preemption Standard

Since the interest-on-escrow law did not discriminate against national banks, the Court concluded that preemption thereof by the NBA must be analyzed through Dodd-Frank’s “prevents or significantly interferes” lens.

Based on prior precedent, the Court found that:

“[a] court applying that Barnett Bank standard must make a practical assessment of the nature and degree of the interference caused by a state law. If the state law prevents or significantly interferes with the national bank’s exercise of its powers, the law is preempted. If the state law does not prevent or significantly interfere with the national bank’s exercise of its powers, the law is not preempted. In assessing the significance of a state law’s interference, courts may consider the interference caused by the state laws in Barnett Bank, Franklin, Anderson, and the other precedents on which Barnett Bank relied. If the state law’s interference with national bank powers is more akin to the interference in cases like Franklin, Fidelity, First National Bank of San Jose, and Barnett Bank itself, then the state law is preempted. If the state law’s interference with national bank powers is more akin to the interference in cases like Anderson, National Bank v. Commonwealth, and McClellan, then the state law is not preempted.”

Supreme Court’s Ruling

Because the Second Circuit did not conduct such comparative analysis of where New York’s interest-on-escrow law falls on the significant-interference line, but rather articulated “a categorical test that would preempt virtually all state laws that regulate national banks, at least other than generally applicable state laws such as contract or property laws,” the Court held that the Second Circuit failed to analyze whether New York’s interest-on-escrow law, as applied to national banks, is preempted by the NBA in a manner consistent with the Dodd-Frank Act and the Court’s decision in Barnett Bank. Accordingly, the Court remanded the case for further proceedings in accordance with its opinion.

Future Considerations and Implications for National Banks

It remains to be seen whether the nature and degree of interference caused by New York’s interest-on-escrow law to national banks’ exercise of their statutory powers under the NBA is found to be akin to interference resulting from laws governing businesses in general or to undue burden and infringement on the national banks’ statutory functions.

By requiring national banks to pay their customers in order to exercise the express power to create and maintain escrow accounts, the New York law may still exert an impermissible degree of control over national banks’ exercise of such power. Further, the states’ ability to set minimum interest rates for such accounts could unduly infringe on national banks’ power to use mortgage escrow accounts altogether. Varying state-set rates could result in burdensome financial consequences that substantially impact national banks’ competitiveness in different states and practically preclude national banks from exercising their power to administer mortgage escrow accounts in those states, pursuant to RESPA, due to prohibitive costs.