Daily Development for Thursday, July 8, 2004
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin Kansas City, Missouri dirt@umkc.edu

PREEMPTION; USURY; LOAN FEES: State reenactment of law limiting loan fees following adoption of the federal preemption of interest rates in DIDMCA satisfied the "repreemption window" of the federal statute and thus preserved the state limitations, even though the state legislature expressed no intention to repreempt and simply reenacted the state regulations as part of a general revision of the consumer protection laws.

U.S. Nat'l Assoc. v. Clark, 807 N.E. 2d 1109 (Ill App. 2004)

This was a consolidated class action in which plaintiffs sought remedies under the Illinois Interest Act because defendants allegedly had violated the Act by charging loan fees in excess of 3% on loans carrying interest rates in excess of 8%. The loans were junior mortgage loans on residential real estate, and apparently most fit within the definition of “alternative mortgage loans” within the very broad definition of that term in the Alternative Mortgage Transaction Parity Act. The defendants alleged that the Illinois Interest Act was preempted both by Federal Depository Institutions Deregulation and Monetary Control Act of 1980 ("DIDMCA") and, in certain cases, by the Alternative Mortgage Transaction Parity Act of 1982 ("Parity Act").

The Illinois appellate court reversed the decision of the circuit court, which had dismissed the debtors' claims under the Illinois Interest Act ("Interest Act") because it ruled that the interest restrictions in the Act were preempted under the federal legislation.

Sec. 4.1a of the Interest Act (which was enacted in 1979 and amended in 1992) provides (in relevant part) that where there is a charge in addition to the stated rate of interest, whether denominated "points," "service charge," "discount," "commission," or otherwise, the percentage of the principal amount of the loan represented by all such charges shall first be computed, which in the case of a loan with an interest rate in excess of 8% per annum secured by residential real estate, shall not exceed 3% of such principal amount.

Sec. 501(a) of the DIDMCA provides that the laws of any state that limit the rate or amount of interest, discount points, finance charges, or other charges shall not apply to any loan secured by a first lien on residential property.

The parties in this case stipulated that the loans at issue (1) were made after March 1, 1980 (when the DIDMCA was enacted); (2) satisfied the terms of Sec. 527(b) of the National Housing Act; and (3) were not purchase-money first liens on the debtors' residential real estate.

The appellate court stated that it had previously decided the very issue raised in this case, in Fidelity Financial Services, Inc. v. Hicks, 214 Ill. App. 3d 398 (1991), where it concluded that the loan at issue was not within the scope of the DIDMCA because "it was unclear that the trust deed securing the loan was a first lien" and that the "first lien on residential property" language in Sec. 501 applied only to purchase-money mortgages. In addition, according to the appellate court, it had also ruled in Hicks that when Sec. 4 of the Interest Act was originally enacted in 1979, the three-point limit found in Sec. 4.1a "was not implicitly repealed." But in so ruling, the appellate court acknowledged that it was declining to follow the analysis "in dicta" in a seventh circuit decision, Currie v. Diamond Mortgage Corp., 859 F.2d 1538 (7th Cir. 1988) -- which came to the opposite conclusion and ruled that Sec. 4.1a was preempted by Sec. 501 of the DIDMCA.

But the appellate court brushed these all these arguments and precedents aside, stating that "neither the trial court nor this court is required to rely on the authorities cited above" (?!). The appellate court then proceeded to scold the trial court for having the audacity to rule that the appellate court's language in the Hicks case regarding the preemption issue was dicta and not necessary to the appellate court's holding in that case. (According to the appellate court, "it is the absolute duty of the circuit court to follow the decisions of the appellate court"). The appellate court referred to its analysis of the preemption issue in the Hicks case as "judicial dicta" that was "necessary to the proper disposition of the case" (and therefore binding) and not "obiter dicta," i.e., comments unnecessary to the disposition of the case.

The appellate court then pointed to what it deemed the "changed circumstances" following the Hicks decision, i.e., after the enactment of the DIDCMA, Illinois passed an amended version of Sec. 4.1a of the Interest Act, which was effective January 1, 1992. The debtors argued, and the court agreed, that Sec. 4.1a was covered by Sec. 501(b)(4) of the DIDMCA, which states that at any time after the enactment of the DICMCA, "any State may adopt a provision of law placing limitations on discount points or any other such charges on any loan, mortgage, credit sale, or advance . . ." The creditors argued (quite persuasively) that the 1992 amendment to Sec. 4.1 of the Interest Act did not change the limitations on imposing fees in excess of 3% where the interest rate is in excess of 8%, and that where an amendatory statute does not change certain provisions, those provisions should be deemed a continuation of the old statute and not as the enactment of a new statute or the repeal of t!
he for
mer statute.

The creditors cited two Illinois cases for this proposition, but the appellate court ruled that they were "clearly distinguishable" and stated that "the parties have cited no Illinois case that is addressing the precise situation presented here."

The appellate court noted the uncertainty of Illinois law in this area, but relied on an earlier Illinois Supreme Court decision (although not exactly on point), Davis v. City of Chicago, 59 Ill. 2d 439 (1974), to bolster its conclusion that in reenacting a statute, any language that is the same in the prior statute may be construed as a new enactment and not necessarily as a continuation of the prior provision. According to the court, "the superior law here specifically allows states to override the federal law and adopt limits on discount points."

The appellate court then turned to the issue of whether Sec. 4.1 of the Interest Act satisfied the override provision in Sec. 501(b)(4) of the DIDMCA. The court again "found no case law directly on point." But the court managed to find an Eleventh Circuit case, Doyle v. Southern Guaranty Corp., 795 F.2d 907 (11th Cir. 1986), which (although dealing with different federal statutory provisions applicable to FHA- and VA-insured mobile home agreements) it believed provided for such an override. But the creditors pointed to the statement of the court in Doyle that "unlike the FHA preemption, the DIDMCA preemption is clear in mandating specific language in the state override provision." But the appellate court countered that the Doyle court was referring to another section of the DIDMCA, Sec. 501(b)(2), and not to Sec. 501(b)(4). According to the appellate court, "the difference between Sec. 501(b)(2) and Sec. 501(b)(4) . . . demonstrates that Congress did not require specific lan!
in a state law to override the federal preemption under the latter section." The appellate court reasoned that under rules of statutory construction, if a statute is amended "after the courts have interpreted a prior version of that statute, the legislature is presumed to have been aware of the judicial decisions [the court referred to the Currie and Hicks, decisions, supra, which were decided after Sec. 4.1 of the Interest Act was amended] and to have acted with that knowledge."

The creditors pointed out that the legislative history of the amendment to Sec. 4.1 did not refer to either the Currie or the Hicks decisions. But the appellate court also dismissed this argument, stating that "legislative silence upon the judicial interpretation of a statute does not rebut the presumption that the legislature was aware of the case law when the statute was amended." The creditors also relied (justifiably) on a footnote in a prior reported Illinois bankruptcy case, In re Smith, 280 B.R. 436, 443 n.5 (Bankr. N.D. Ill. 2002), which stated that "Illinois has not exercised its right to invoke its own usury statute, even though it effectively amended portions of Sec. 4.1a in 1992." The appellate court summarily rejected the bankruptcy court's conclusion on this issue (surprise!), questioning the use of the word "invoke" [it depends on what the meaning of "is" is?!], basically finding that the bankruptcy court didn't know what it was talking about.

The creditors argued that the discussion of the preemption issue in Hicks was dicta and that in this case Sec. 4.1a was not preempted because the loans were not purchase-money mortgages. The creditors relied on Currie, as well as several unpublished federal cases in support of their argument for preemption. They also relied on a 1996 Illinois Attorney General's Opinion and a 1998 interpretive letter issued by the state Office of Banks and Real Estate, as well as opinion letters by the OTS, all of which supported their position. The appellate court rejected consideration of all of these cases and opinions.

The appellate court next turned to consideration of the Parity Act (the debtors claimed that six of the consolidated appeals were preempted by the Parity Act), where its reasoning appeared to be on more solid ground (if not rock-solid terra firma). The parties agreed that the Office of Thrift Supervision ("OTS") was the appropriate regulatory agency whose rules governed the loans in question (the OTS regulations cover all "housing creditors" who are not commercial banks or credit unions). The applicable federal OTS regulation is 12 U.S.C. Sec. 3803(a),(c)(2000), which provides that an "alternative mortgage transaction" may be made by a housing creditor in accordance with Sec. 3803 "notwithstanding any State constitution, law, or regulation." The debtors argued (convincingly) that the preemption under this section applies only to transactions made in accordance with regulations governing AMTs as issued by the appropriate federal regulatory agency (in this case, the OTS).

The appellate court (correctly) noted that the OTS regulations, identified in Sec. 560.220, address only four aspects of mortgage financing: late charges; prepayments; adjustments to home loans; and disclosures for variable rate transactions. The court (as well as the creditors) referred to a Seventh Circuit decision, Ill. Ass'n. of Mortgage Brokers v. Office of Banks & Real Estate, 308 F.3d 762 (7th Cir. 2002), in which the Seventh Circuit ruled that preemption applied to override state exemptions "to the extent they block state lenders from extending credit on terms open under federal regulations, when the lenders actually comply with the federal regulations." The Illinois appellate court noted however, that the Seventh Circuit had remanded the case for further consideration because it had not been "determined which, if any, of the sate regulations has a prohibited effect." Therefore, the Illinois appellate court reasoned, the Seventh Circuit had declined to resolve the p!
ive scope of the Parity Act as a matter of law.

The appellate court also cited with approval the decision of the Ninth Circuit in Ansley v. Ameriquest Mortgage Co., 340 F.3d 858 (9th Cir. 2003), which held that the Parity Act did not preempt all state laws relating to alternative mortgage transactions. The appellate court (obviously delighted in finally finding a case that it actually agreed with), stated that "this court gives considerable weight to Ansley, given the importance of maintaining uniformity of decision in interpreting federal statutes" -- a most remarkable and ironic statement, given that the appellate court has little or no regard for "uniformity of decision" with respect to its ruling on the DIDMCA issue. The appellate court next pointed out (correctly) that OTS admitted, in a rule issued in 2002, that it had never identified its rule as applicable to state housing creditors under the Parity Act, which the court found "lends support to the conclusion that OTS has not otherwise issued the kind of blanket pr!
ion of state regulation of loan-related fees that the creditors in the cases believe exists."

The appellate court then ruled that the 3% fee limit on loans with interest rates in excess of 8%, as set forth in Sec. 4.1a of the Interest Act, was not preempted by the Parity Act because it did not "regulate either the elements of the loans which purportedly make them alternative mortgage transactions or the terms of such loans identified ins Sec. 560.220 of the OTS regulations."

Comments by Reporter Jack Murray:

Reporter's Comment 1: This ruling has shocked and angered the banking and lending community in Illinois, and is virtually certain to be appealed to the Illinois Supreme Court. Amici curiae briefs were filed with the appellate court by the Illinois Bankers Association, the Illinois Association of Mortgage Brokers, and the American Financial Services Association, There also were amici curiae briefs filed by consumer groups on behalf of the debtors. The appellate court noted, in a footnote, that "The creditors and entities filing briefs as amici curiae have all expressed their [understandable] displeasure with the current Attorney General for agreeing with and intervening on behalf of the debtors in this case, given the office's prior opinion."

Reporter's Comment 2: The Clark decision is something of an abomination (at least if you're an Illinois residential lender). This ruling, if it stands, will put Illinois housing creditors (at least those that are bound by OTS regulations) at a distinct disadvantage with respect to federal lenders and other lenders that are not bound by OTS regulations. It is hard to understand how this will serve to make credit more readily available to consumers in Illinois. Lenders in Illinois have for some time justifiably relied on the concept that Sec. 501 of the DIDMCA overrode the provisions of Sec. 4.1a of the Interest Act, based on existing case law and the lack of any legislative history to the contrary. Since the appellate court basically acknowledged that is was deciding a case of first impression and making new law in this area, it should have made its ruling prospective and not applicable to existing loans. There will likely be a legislative push by banking and lending lobbyi!
ng gr
oups to again amend Sec. 4.1a of the Interest Act to confirm that it was not intended to override the preemption provisions of Sec. 501 of the DIDMCA.

Reporter's Comment 3: As noted above, with respect to alternative mortgage transactions, the Parity Act," which regulates residential loans made by "housing creditors" (as defined in 12 U.S.C. § 3802(c)), authorizes state-chartered housing creditors to make, purchase, and enforce "alternative mortgage transactions" without regard to any State prohibitions or restrictions on such loans. ("Alternative mortgage transactions" are loans other than traditional fixed-term, fixed-rate loans). The Parity Act expressly preempts state laws that prohibit alternative mortgage transactions, and provides that state-chartered lenders may make variable-interest home mortgage loans and other alternative mortgage transactions on the same terms as federally chartered lenders, "notwithstanding any State constitution, law, or regulation." 12 U.S.C. §§ 3803(c) and 3804. At the time of enactment, states were allowed to opt out of the preemption, but the general understanding of most observers is t!
hat o
nly six have done so: Arizona (in part); Maine; Massachusetts; New York; South Carolina; and Wisconsin (in part).

Federal associations may include prepayment penalty clauses in commercial loan documents and enforce such clauses according to their terms regardless of any state law to the contrary (including equitable principles) because C.F.R. §§ 545.2 and 545.34(c), as amended at 49 F.R. 43044, authorize a Federal association to include a prepayment penalty clause in any loan it makes and to enforce such a clause in accordance with its terms regardless of any state law - including equitable principles in a foreclosure action - which purports to prohibit the collection of a prepayment penalty under certain circumstances.

To rely on the Parity Act, certain state-chartered housing creditors must comply with regulations affecting alternative mortgage transactions issued by the OTS. In 1996, the OTS adopted a regulation, 12 C.F.R. § 560.220, which, by reference to 12 C.F.R. § 560.34, clarified that state housing creditors, like their federal counterparts, were authorized to charge prepayment penalties and that this regulation preempted contrary state laws. 12 C.F.R. § 560.220 specifically permitted prepayment penalties where the transaction was covered by regulations of the OTS. This regulation was particularly significant because it preempted local law with respect to all other housing lenders (except credit unions and commercial banks, which are not regulated by the OTS) under the terms of the Parity Act.

But (as also noted above) on September 26, 2002, the OTS published a final rule identifying the OTS regulations that apply under the Parity Act. See 12 C.F.R. Parts 560, 590, and 591 (67 F.R. 60542, 60554). Surprisingly, the OTS revised and amended 12 C.F.R. § 560.220 -- primarily in response to arguments from consumer groups that the federal preemption encouraged predatory-lending practices by lenders in the form of excess charges and fees -- and stated that it would no longer enforce its regulations governing prepayment penalties (C.F.R. § 560.33) and late charges (12 C.F.R. § 560.34) for state-chartered housing creditors (which includes most state-licensed mortgage lenders and state-chartered insured depositories). 67 F.R. 76, 304. The OTS delayed the effective date of the amended rule ("Amended Rule") until July 1, 2003, when it officially removed the federal exemption for state-chartered lenders. 67 F.R. 76,304. Non-federal lenders now are bound by applicable state-law !
ictions on prepayment charges and fees when making alternative mortgages, such as adjustable-rate loans. The Amended Rule sets forth a number of arguments by the OTS supporting its conclusion that in adopting original 12 C.F.R. § 560.220, it had acted arbitrarily and capriciously and exceeded the authority granted to it by Congress. The OTS reasoned that prepayment-penalty and late- fee restrictions apply to traditional real estate lending transactions in general and are not peculiar to alternative mortgage transactions, and therefore there was no reason to distinguish those particular provisions from other general lending rules that were not identified as applicable to state housing creditors. (The OTS also revised its limits on the amount of late charges that may be assessed on loans secured by first liens on residential manufactured homes under part 590, which addresses the preemption of state usury laws. In addition, the OTS made a minor technical change to the definitio!
n of "
reverse mortgage" in part 591, which addresses the preemption of state due-on-sale laws.)

Reporter's Comment 4:. Recent decisions regarding preemption of the Parity Act have not been consistent. As noted by the appellate court in Clark, the court in Ansley, supra, held that the Parity Act did not completely preempt all California laws relating to alternative mortgage transactions so as to create exclusive federal jurisdiction. In so holding, the court in Ansley noted that "[t]he California law at issue here . . . simply imposes a reasonable limit on the amount of the prepayment penalty [as opposed to a complete prohibition]." See also Black v. Financial Freedom Senior Funding Corp., 112 Cal. Rptr. 2d 445, 456 (Cal. Ct. App. 2001) (concluding that Parity Act did not preempt all state laws concerning alternative mortgage transactions and stating that, "[g]iven the breadth accorded the states in regulating 'housing creditors'. . . the preemption language of 12 United States Code section 3803(c) can certainly be interpreted as not extending to state laws that concer!
n asp
ects of those transactions other than those addressed by the four applicable federal regulations.").

In another recent case decided by the U.S. District Court for the District of Columbia, Nat'l Home Equity Mortg. Ass'n v. Office of Thrift Supervision, 271 F.Supp. 2d 264 (D.D.C. 2003), the plaintiff (a national trade association including state-chartered housing creditors) challenged the OTS determination, effective July 1, 2003, which revised the regulations relating to prepayment penalties and late fees so that they were no longer applicable to state housing creditors. The court ruled that the OTS had the authority and ability to take such action, and that adoption of the Amended Rule was not "arbitrary and capricious." The court stated that, "Congress intended to preempt regulations authorizing AMTs [Alternative Mortgage Transactions], not all regulations governing AMTs." The court stated further that, "the parity [Congress] sought to achieve between state and federal lenders is the ability to engage in AMTs, not competitive equality." Therefore, because the court found!
the interpretation of the Parity Act by the OTS was permissible, it determined that it would defer to the OTS' interpretation and its ability to issue regulations thereunder and would further defer to the OTS' conclusion that prepayment fees and late charges were not "essential or intrinsic" to the ability of state housing creditors to provide alternative mortgage transactions. The court further stated that, "[e]ven greater deference must be accorded here because OTS has made a predictive judgment within the field of its expertise (citation omitted)." Finally, the court rejected the plaintiff's argument that the OTS' change in policy was not entitled to deference because its interpretation had been inconsistent, stating that, "a change in OTS' interpretation of the Parity Act does not undermine . . . the deference this Court must afford OTS' Amended Rule." Id. at 275. The court noted that although the OTS' interpretation of the Parity Act changed in 1996, its current posit!
ion wa
s consistent with its interpretation of the Parity Act from 1982 through 1996, at which time it first diverged from its original position and concluded that its regulations regarding prepayment penalties and late charges were applicable to state housing creditors.

However, in another recent decision, by the New Jersey Supreme Court, Glukowsky v. Equity One, Inc., 848 A.2d 747 (N.J. 2004), the New Jersey Supreme Court reversed the holding of the appellate court, which had ruled that the plaintiff's state-law claims regarding the prepayment fees charged by the lender were not preempted by 12 C.F.R. § 560.220 because the regulation was adopted arbitrarily and exceeded the scope of authority Congress delegated to the OTS under the Parity Act. The New Jersey Supreme Court stated that, "We accept OTS's explanation that its 1996 rulemaking represented one permissible interpretation of the Parity Act." The court reasoned that because the OTS is the agency responsible for enforcing that Parity Act, its interpretation of the Act is entitled to "substantial deference." The court cited several other federal court decisions for the proposition that the OTS acted, in issuing its rule in 1996, within the scope of the authority delegated to it by C!
ss by incorporating § 560.34 into § 560.220 to allow state-chartered lenders to impose prepayment penalties in alternative mortgage transactions. This action, the court determined, was a "sensible interpretation of the language of the Act in 1996, and the fact that the OTS later altered its position with respect to prepayment penalties did not require a conclusion that its position until that time was an impermissible construction of the statute or that the final rule would apply retroactively. The court stated that, "We cannot conclude, based on the language of the Parity Act of its legislative history, that Congress would not have sanctioned OTS's interpretation of the Act."

Reporter's Comment 5: Title insurance is not likely to provide any comfort to Illinois lenders with respect to the usury issued raised by the Clark decision. The title insurer is protected by Exclusion 5 in the ALTA Loan Policy form, which denies coverage for claims "based upon usury or any consumer credit protection or truth in lending law." In Illinois, unless and until the Clark case is overruled by the Illinois Supreme Court, it is unlikely that title insurers will issue a usury endorsement deleting this exclusion in connection with residential mortgage loans where the loan falls within the parameters of Sec. 4.1a of the Interest Act and the rate exceeds the limits set forth in the Act..

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