CALIFORNIA COURT LIMITS THE PREEMPTIVE EFFECT OF OTS LENDING POWERS REGULATION 12 C.F.R. § 560.2
A California Court of Appeals has held that the state’s Unfair Competition Law (“UCL”), Cal. Bus. & Prof. Code §§ 17200 et seq., which is a statute of general applicability, was not preempted by the Office of Thrift Supervision’s (“OTS”) regulation, 12 C.F.R. § 560.2, that explains and illustrates the scope of preemption for federally-chartered savings associations. Gibson v. World Savings and Loan Assoc., 103 Cal. Rptr. 2d 1291, 1306 (Ct. App. 2002).
The case arose from a class action alleging that a federally chartered savings association committed unfair business practices. The plaintiffs were borrowers of secured loans from World Savings and Loan Association (“World”) who failed to maintain their hazard insurance. After default, World purchased replacement insurance that was more expensive than the borrowers’ insurance and shifted the cost to the borrowers. The cost that World shifted to the borrowers, however, not only represented the cost of the replacement insurance, but also administrative costs associated with tracking hazard insurance for the entire loan portfolio, which included borrowers who had not permitted their own hazard insurance to lapse. The borrowers’ deeds of trust permitted World to shift the cost, but limited World to advance funds on behalf of the borrowers only to the extent necessary to protect World’s rights. The plaintiffs claimed and the court found that the premiums World charged the borrowers were higher than the actual cost of replacement insurance charged to World, which violated the “extent necessary” clause in the deed of trust, and World misrepresented the cost of replacement hazard insurance.
The issue remained, however, whether the UCL applied to World because of the OTS’s regulation. The court quoted the proposition of law that the “state cannot dictate to the Bank how it can or cannot operate, but it can insist that, however the Banks chooses to operate, it does so free from fraud and other deceptive business practices.” Id. at 1299 (quoting Fenning v. Glenfed, Inc., 47 Cal. Rptr. 2d 715, 715 (Ct. App. 1995)). The court found that as to each state law claim the appropriate question is whether the legal duty that is the basis of the claims constitutes a requirement or prohibition of the sort that federal law expressly preempts. The court found the plaintiffs’ claims were based on the duties of a contracting party to comply with its contractual obligations, to act reasonably to mitigate its damages in the event of a breach by the other party, to refrain from unfair business practices and not to misrepresent material facts. The court stated that these duties are not requirements or prohibitions of the sort that Section 560.2 preempts, but instead were duties that govern any contracting party, not just those in the lending business. The court then analyzed the issue using the OTS’s formula but concluded the result would be the same.
Even though federally-chartered savings associations enjoy broader preemption rights than other institutions, there are limits to those rights. Federally-chartered savings associations should examine state statutes of general applicability and ensure compliance with ones that would not appear to be preempted.