Daily Development for Tuesday, October 16, 2001

 

By: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
prandolph@cctr.umkc.edu

 

MORTGAGES; FEDERAL PREEMPTION; PARITY ACT: The Alternative Mortgage Instrument Parity Act is not a complete preemption of state regulation; rather, state consumer protection laws will apply except in those areas as to which directly inconsistent federal regulations apply.

Black v. Financial Freedom Senior Funding Corp., 2001 WL 1174187 (10/5/01)

Borrowers entered into a "reverse annuity loan" arrangement with an apparently related set of institutions.  This device is designed to permit older people to benefit from the appreciated value of their homes without having to either sell them or make payments on a mortgage.  Lender makes a loan that will not require any repayment until the borrower either dies or ceases living in the home.  At that time, the lender will receive the principal back, plus interest.

In this case, on a loan of $305,000, borrowers paid about $17,000 in fees.

Lender got a future interest equal to 70% of the current value of the home, plus a right to any appreciation in value.  The home was worth $1,060,000.  This interest would accrue to the lender even if the borrowers died or ceased to live in the home only a week or so after the transaction closed.

Borrowers then used a substantial amount of the loan proceeds to acquire an annuity from a company apparently related to the lender.  Under the terms of the annuity, borrowers forfeited most of it if they failed to make a second payment.  They did so fail, and wound up trading away over $700,000 value in their home for a sum of about $125,000 and an annuity of $719.58 per month.  Clearly the court was offended by the terms of this loan, and was sympathetic to the allegations of borrower's counsel that lender had misled borrowers and failed to disclose vital information, all in violation of state law.

Lender responded that state law had no impact here, as the loan transaction was an "alternative mortgage" and insulated from state regulation by federal law.

This case considers particular language of the Alternative Mortgage Instrument Parity Act, part of the GarnSt. Germaine Act of 1982, an omnibus banking statute that also contained the federal preemption of state regulation of due on sale clauses.

The Parity Act was intended to follow the lead of the due on sale clause preemption and provide a comfortable environment for the then developing breed of alternative mortgage instruments.  The concept "alternative mortgage instrument" was defined to include virtually any home loan that was not a fixed rate, level debt service, long term loan.

The benefits of the Act passed to a wide range of institutional lenders virtually anyone subject to Truth in Lending. Specifically, any lender within this group that was  not directly controlled by a federal agency (either the Bank Board  now the Office of Thrift Supervision, the Comptroller of the Currency, or the NCUA), could lend under the authorization of the regulations adopted by the federal regulator that regulated its class of lenders.

The idea was to remove any competitive advantage to federally chartered entities, who were protected from federal regulation, as had been underscored by the De La Cuesta decision from the U.S. Supreme Court in 1978 (involving due on sale clauses).  As a result of De la Cuesta, and in response to the extremely high interest rates prevailing at that time, many institutions had converted from state chartered to federally chartered institutions simply to take advantage of the federal regulatory preemption of due on sale clauses.  GarnSt. Germaine removed that advantage by preempting due on sale clauses completely, and the Parity Act was intended to provide similar protection to alternative mortgage instruments.  It was thought that the federal agencies would be able to provide an environment that would provide market experimentation and national programs, so that the various new lending concepts could develop and prosper.

Interestingly, there has been precious little case law concerning the Parity Act over the years.  Only in the past few years have we seen cases being brought on the issue of whether the Parity Act protects nonfederal lenders from state regulation of prepayment premiums.  The decided cases tend to favor preemption.  The two most widely circulated cases are National Home Equity Mortg. Ass'n v. Face, 239 F.3d 633 (4th Cir.2001); and  Shinn v. Encore Mortg. Services, 96 F.Supp.2d 419 (D.N.J.2000), which constituted the DIRT DD for March 15, 2001.

The Face decision suggested that the meaning of the Parity Act was that lenders who complied with the federal regulations in this area were free to act without regard to any other state regulation. The notion was that the statute intended "across the board" preemption of state regulation.

The argument for such an interpretation is that the various federal regulatory agencies might well have intended to say nothing about a particular area of conduct precisely because they did not want to have it regulated at all.  If non federal agencies were to enjoy "parity" with their federal counterparts, they deserved the same protection.

The plaintiffs in the instant case, Black, however, argued that the Parity Act supported preemption only as to those areas that the federal regulatory agencies specifically and expressly elected to regulate or insulate from regulation.  Although such an interpretation is inconsistent with the notion of establishing parity treatment, it is supported by the general concept that federal preemption should be read narrowly wherever possible.

The court analyzed the critical language of the Parity Act as follows:

"In order to prevent discrimination against Statechartered depository institutions, and other nonfederally chartered housing creditors, with respect to making ... alternative mortgage transactions, housing creditors may make ... alternative mortgage transactions, except that this section shall apply(1) with respect to banks, only to [transactions made in accordance with certain regulations issued by the Comptroller of the Currency]; [P] (2) with respect to credit unions, only to [transactions made in accordance with other regulations issued by the National Credit Union Administration Board]; [P] (3) with respect to all other housing creditors ... only to transactions made in accordance with regulations governing alternative mortgage transactions as issued by the Director of the Office of Thrift Supervision for federally chartered savings and loan associations, to the extent that such regulations are authorized by rulemaking authority granted to the Director of the Office of Thrift Supervision with regard to federally chartered savings and loan associations under laws other than this section."

On the subject of preemption, the Parity Act provides:

"[A]n alternative mortgage transaction may be made by a housing creditor in accordance with this section, notwithstanding any State constitution, law, or regulation."

The court also pointed out that the federal statute contained a note directing the various regulatory agencies to "identify, describe, and publish those portions or provisions of their respective regulations that are inappropriate for (and thus inapplicable to), or that need to be conformed for the use of, the nonfederally chartered housing creditors to which their respective regulations apply...."   The Office of Thrift Supervision (the relevant regulator in this case) adopted such as statement, and identified as critical preemptive regulations its rules on late charges, prepayments, loan adjustments, and disclosure of loan adjustments.  All other federal regulations were "deemed inappropriate and inapplicable."

From this statement, the court drew the inference that only those identified areas of regulation were critical concerns of the federal lender, and that states were free to regulate in other areas.  The charged offenses of state laws in this case did not involve the preempted areas, and consequently were subject to state law.  The court rejected the argument of the lender that the purpose of the statute was to permit nonfederal housing creditors to be as free of state regulation as federal housing creditors were.  The lender argued that if a lender complied with the identified federal regulations, it was making an "alternative mortgage transaction" in accordance with the federal law, could be made "notwithstanding any State constitution, law, or regulation," just like the statute says.

The court noted that in general preemption is authorized in the interest of promoting a nationally uniform program.  But here, since the federal regulations are so limited in reach, the nonfederal lenders would enjoy an "anything goes" environment  hardly conducive to uniformity.  The court backed up its argument by citing a recent regulatory pronouncement of the Office of Thrift Supervision that claimed that the Parity Act did not preempt all state regulation.

Comment 1: Candidly, the Alternative Mortgage Instrument Parity Act has outlived its usefulness, and the Congress should consider a different balance between state and federal regulatory authority.  It was designed to create a nurturing cradle for newly developed lending devices.  But these devices, 20 years later, are now robust and active, and in some cases  need more  to be corralled than nurtured.

Nevertheless, it was the editor's view, at the time the Act was enacted, that it was a complete preemption of state regulation of alternative mortgage lending practices.  There were no comprehensive existing federal regulations, and there was certainly the notion in existence that the economy needed to have the "market find its own level."

Comment 2: The editor, of course, would prefer that the Congress, and not the California Court of Appeals, determine what the appropriate next regulatory step will be.  But this little disagreement may be moot.  If lenders have assumed that they are exempt from local laws, and now suddenly find their national programs subject to the welter of contradictory and inconsistent state regulations, they'll take their problem to the Congress and we'll get a different approach.

MORTGAGES; FEDERAL PREEMPTION; PARITY ACT: The Alternative Mortgage Instrument Parity Act is not a complete preemption of state regulation; rather, state consumer protection laws will apply except in those areas as to which directly inconsistent federal regulations apply.

Black v. Financial Freedom Senior Funding Corp., 2001 WL 1174187 (10/5/01)

Borrowers entered into a "reverse annuity loan" arrangement with an apparently related set of institutions.  This device is designed to permit older people to benefit from the appreciated value of their homes without having to either sell them or make payments on a mortgage.  Lender makes a loan that will not require any repayment until the borrower either dies or ceases living in the home.  At that time, the lender will receive the principal back, plus interest.

In this case, on a loan of $305,000, borrowers paid about $17,000 in fees.

Lender got a future interest equal to 70% of the current value of the home, plus a right to any appreciation in value.  The home was worth $1,060,000.  This interest would accrue to the lender even if the borrowers died or ceased to live in the home only a week or so after the transaction closed.

Borrowers then used a substantial amount of the loan proceeds to acquire an annuity from a company apparently related to the lender.  Under the terms of the annuity, borrowers forfeited most of it if they failed to make a second payment.  They did so fail, and wound up trading away over $700,000 value in their home for a sum of about $125,000 and an annuity of $719.58 per month.  Clearly the court was offended by the terms of this loan, and was sympathetic to the allegations of borrower's counsel that lender had misled borrowers and failed to disclose vital information, all in violation of state law.

Lender responded that state law had no impact here, as the loan transaction was an "alternative mortgage" and insulated from state regulation by federal law.

This case considers particular language of the Alternative Mortgage Instrument Parity Act, part of the GarnSt. Germaine Act of 1982, an omnibus banking statute that also contained the federal preemption of state regulation of due on sale clauses.

The Parity Act was intended to follow the lead of the due on sale clause preemption and provide a comfortable environment for the then developing breed of alternative mortgage instruments.  The concept "alternative mortgage instrument" was defined to include virtually any home loan that was not a fixed rate, level debt service, long term loan.

The benefits of the Act passed to a wide range of institutional lenders virtually anyone subject to Truth in Lending. Specifically, any lender within this group that was  not directly controlled by a federal agency (either the Bank Board  now the Office of Thrift Supervision, the Comptroller of the Currency, or the NCUA), could lend under the authorization of the regulations adopted by the federal regulator that regulated its class of lenders.

The idea was to remove any competitive advantage to federally chartered entities, who were protected from federal regulation, as had been underscored by the De La Cuesta decision from the U.S. Supreme Court in 1978 (involving due on sale clauses).  As a result of De la Cuesta, and in response to the extremely high interest rates prevailing at that time, many institutions had converted from state chartered to federally chartered institutions simply to take advantage of the federal regulatory preemption of due on sale clauses.  GarnSt. Germaine removed that advantage by preempting due on sale clauses completely, and the Parity Act was intended to provide similar protection to alternative mortgage instruments.  It was thought that the federal agencies would be able to provide an environment that would provide market experimentation and national programs, so that the various new lending concepts could develop and prosper.

Interestingly, there has been precious little case law concerning the Parity Act over the years.  Only in the past few years have we seen cases being brought on the issue of whether the Parity Act protects nonfederal lenders from state regulation of prepayment premiums.  The decided cases tend to favor preemption.  The two most widely circulated cases are National Home Equity Mortg. Ass'n v. Face, 239 F.3d 633 (4th Cir.2001); and  Shinn v. Encore Mortg. Services, 96 F.Supp.2d 419 (D.N.J.2000), which constituted the DIRT DD for March 15, 2001.

The Face decision suggested that the meaning of the Parity Act was that lenders who complied with the federal regulations in this area were free to act without regard to any other state regulation. The notion was that the statute intended "across the board" preemption of state regulation.

The argument for such an interpretation is that the various federal regulatory agencies might well have intended to say nothing about a particular area of conduct precisely because they did not want to have it regulated at all.  If non federal agencies were to enjoy "parity" with their federal counterparts, they deserved the same protection.

The plaintiffs in the instant case, Black, however, argued that the Parity Act supported preemption only as to those areas that the federal regulatory agencies specifically and expressly elected to regulate or insulate from regulation.  Although such an interpretation is inconsistent with the notion of establishing parity treatment, it is supported by the general concept that federal preemption should be read narrowly wherever possible.

The court analyzed the critical language of the Parity Act as follows:

"In order to prevent discrimination against Statechartered depository institutions, and other nonfederally chartered housing creditors, with respect to making ... alternative mortgage transactions, housing creditors may make ... alternative mortgage transactions, except that this section shall apply(1) with respect to banks, only to [transactions made in accordance with certain regulations issued by the Comptroller of the Currency]; [P] (2) with respect to credit unions, only to [transactions made in accordance with other regulations issued by the National Credit Union Administration Board]; [P] (3) with respect to all other housing creditors ... only to transactions made in accordance with regulations governing alternative mortgage transactions as issued by the Director of the Office of Thrift Supervision for federally chartered savings and loan associations, to the extent that such regulations are authorized by rulemaking authority granted to the Director of the Office of Thrift Supervision with regard to federally chartered savings and loan associations under laws other than this section."

On the subject of preemption, the Parity Act provides:

"[A]n alternative mortgage transaction may be made by a housing creditor in accordance with this section, notwithstanding any State constitution, law, or regulation."

The court also pointed out that the federal statute contained a note directing the various regulatory agencies to "identify, describe, and publish those portions or provisions of their respective regulations that are inappropriate for (and thus inapplicable to), or that need to be conformed for the use of, the nonfederally chartered housing creditors to which their respective regulations apply...."   The Office of Thrift Supervision (the relevant regulator in this case) adopted such as statement, and identified as critical preemptive regulations its rules on late charges, prepayments, loan adjustments, and disclosure of loan adjustments.  All other federal regulations were "deemed inappropriate and inapplicable."

From this statement, the court drew the inference that only those identified areas of regulation were critical concerns of the federal lender, and that states were free to regulate in other areas.  The charged offenses of state laws in this case did not involve the preempted areas, and consequently were subject to state law.  The court rejected the argument of the lender that the purpose of the statute was to permit nonfederal housing creditors to be as free of state regulation as federal housing creditors were.  The lender argued that if a lender complied with the identified federal regulations, it was making an "alternative mortgage transaction" in accordance with the federal law, could be made "notwithstanding any State constitution, law, or regulation," just like the statute says.

The court noted that in general preemption is authorized in the interest of promoting a nationally uniform program.  But here, since the federal regulations are so limited in reach, the nonfederal lenders would enjoy an "anything goes" environment  hardly conducive to uniformity.  The court backed up its argument by citing a recent regulatory pronouncement of the Office of Thrift Supervision that claimed that the Parity Act did not preempt all state regulation.

Comment 1: Candidly, the Alternative Mortgage Instrument Parity Act has outlived its usefulness, and the Congress should consider a different balance between state and federal regulatory authority.  It was designed to create a nurturing cradle for newly developed lending devices.  But these devices, 20 years later, are now robust and active, and in some cases  need more  to be corralled than nurtured.

Nevertheless, it was the editor's view, at the time the Act was enacted, that it was a complete preemption of state regulation of alternative mortgage lending practices.  There were no comprehensive existing federal regulations, and there was certainly the notion in existence that the economy needed to have the "market find its own level."

Comment 2: The editor, of course, would prefer that the Congress, and not the California Court of Appeals, determine what the appropriate next regulatory step will be.  But this little disagreement may be moot.  If lenders have assumed that they are exempt from local laws, and now suddenly find their national programs subject to the welter of contradictory and inconsistent state regulations, they'll take their problem to the Congress and we'll get a different approach.

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last six years, these Reports have been collated, updated, indexed and bound into an Annual Survey of Developments in Real Estate Law, volumes 1‑6, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Maria Tabor at the ABA. (312) 988 5590 or mtabor@staff.abanet.org

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