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Dodd-Frank’s Preemption Problem

The Dodd-Frank Wall Street Reform and Consumer Protection Act, signed into law in 2010, seeks to tighten the reins on national banking institutions by strengthening the legal standards for the preemption of state laws, thereby making it harder for banks to avoid liability under state law. Prior to Dodd-Frank, national banks and their subsidiaries could escape lawsuits filed under many state laws by claiming that such laws were “preempted,” or displaced, by federal law that already governed the practices of national banks. When the defense of preemption is asserted and found applicable, the effect is dismissal of the entire claim at issue.

Dodd-Frank, however, has added various obstacles that must be overcome before a bank can claim the protection of preemption. In order to minimize the potentially harsh effect of Dodd-Frank’s new rules, banks should make an effort to frame their preemption arguments before courts in ways that result in favor of preemption.

Higher Bar for Preemption

Dodd-Frank’s enactment altered the preemption landscape with respect to loans that originated on or after July 21, 2010; a state law claim against a national bank is preempted if it arises from a state “consumer financial law” that discriminates against national banks or that “prevents or significantly interferes with” the exercise of a national bank’s powers. Further, the Act strips subsidiaries of national banks from the same level of protection they previously shared with the national banks themselves. The Act also dismantled the “field preemption” of the Home Owners’ Loan Act (HOLA) by stating that HOLA no longer occupies the field “in any area of state law.”

Under the Dodd-Frank preemption analysis, a state law prohibiting abusive debt collection practices has been held not preempted, as the law was not intended to specifically regulate financial transactions, and, therefore, was not a consumer financial law that could be preempted. A claim that a bank falsely inflated a borrower’s income on a loan application was also held not preempted under Dodd-Frank, as the claim was not found to interfere with the bank’s lending powers. Interestingly, similar claims have been held to be preempted under traditional HOLA preemption principles.

While the distinctions between the preemption analyses before and after Dodd-Frank may appear nuanced and complicated, it is clear that Dodd-Frank was intended to make it harder for banks to claim preemption. Because it is now harder to argue that state laws affecting consumer finance should be preempted, banks should expect more state law claims to survive the initial dismissal stage.

In order to maximize the likelihood that a particular state law will be preempted, and therefore dismissed, banks should find a way to frame the law at issue as significantly interfering with national banks’ powers, conflicting with or standing as an obstacle to federal law, imposing additional obligations on banks with regard to lending, or discriminating against national banks. When defending a claim on a loan that was originated prior to July 21, 2010, banks should also argue that Dodd-Frank should not apply retroactively, so that the bank can benefit from the more lenient pre-Dodd-Frank preemption rules.

In essence, the bank should make the strongest case possible that the state law claim acts as a financial regulation that is duplicative of, or conflicting with, federal law, and that the law is not one of general applicability, such as an ethical prohibition or consumer protection statute. It is still unclear how strictly courts will enforce the Dodd-Frank preemption standards, but banks should be prepared to defend these claims in ways that allow them to benefit from preemption principles as much as possible.

Mr. Elliott and Mr. Keller are partners and Ms. Friedman an associate at Burr & Forman LLP in Birmingham, Ala., in the firm’s Financial Services Litigation Practice Group. Mr. Elliott may be reached at [email protected].