Thursday, April 11, 2013

FYI: Cal App Ct Holds CA Late Fee Limit for Brokered Loans Implicitly Incorporated, But Preempted Under NBA and HOLA

The California Court of Appeal, Second District, recently held that, although California's limitation on late payment charges was implied into all mortgage loans negotiated by licensed mortgage brokers regardless of whether the loans were extended by entities exempt from such limitation, the borrowers' breach of contract claims against loan servicers that had taken over the servicing of the loans were preempted by the National Bank Act and the Home Owners' Loan Act. 


A copy of the opinion is available at:


Plaintiffs borrowers ("Borrowers") obtained home mortgage loans that were secured by deeds of trust and negotiated by mortgage loan brokers with different state-regulated mortgage bankers or finance lenders.  The mortgage notes expressly permitted late fees to be applied only once to an overdue payment, but all the loans had a grace period of at least 10 days before late fees were assessed.  


Defendants federal loan servicers ("Servicers") took over the servicing of the loans and, when Borrowers failed to make their payments when due, assessed late fees.  Servicers applied the late payments to the past due installments in the order they became due, even though certain payments had been made within 10 days of scheduled installments.   The Servicers' method of applying late fees resulted in Borrowers' failure to pay subsequent installments on time, and in successive late payments and fees.  One of the Servicers was subject to the National Bank Act ("NBA"), and the other to the Home Owners' Loan Act ("HOLA").


Plaintiffs sued the Servicers for breach of contract, asserting that each loan implicitly incorporated the requirement in Section 10242.5 subdivision (b) of California's Real Estate Law, that a payment made within 10 days of the due date of an installment must be applied to that installment.   Plaintiffs thus alleged in part that Servicers breached the terms of the loans they serviced by applying payments made within 10 days of scheduled installments to past due installments.   Plaintiffs also asserted causes of action for unfair business practices under California's Unfair Competition Law, unjust enrichment, and declaratory relief. 


Servicers demurred.  The lower court sustained the demurrers and dismissed the putative class action lawsuits, reasoning that Servicers were exempted from the 10-day payment rule and that federal law preempted the breach of contract claims.  The lower court also ruled that the unfair business practices claims and requests for declaratory relief failed for the same reasons, and that relief for unjust enrichment was unavailable because of the express contracts.  Plaintiffs appealed, and the cases were consolidated.  The Appellate Court affirmed.


As you may recall, Article 7 of California's Real Estate Law governs loans made or negotiated by mortgage loan brokers.  See Cal. Bus. & Prof. Code § 10240 et seq. ("Article 7").  Among other things, Article 7 limits the charge of a late payment to 10% of the installment due, and provides for a 10-day grace period.  See Cal. Bus. & Prof. Code § 10248.3.  Moreover, a late payment fee may be charged only once for the same late installment, and a payment made within 10 days of a scheduled installment's due date must be applied to that installment.  Cal. Bus. & Prof.  Code § 10242.5 subd. (a), (b) ("Section 10242.5").  See also Cal. Bus. & Prof. Code § 10245 (providing that Section 10242.5's late fee limitation applies to broker-negotiated loans regardless of loan amount). 


In addition, although California law excludes certain entities, such as banks, savings associations, and servicers, from the definition of a mortgage loan broker, and therefore exempts them from certain requirements associated with mortgage loans, mortgage loan brokers are expressly prohibited from negotiating loans with late fees other than those specified in Section 10242.5.  See Cal. Bus. & Prof. Code §§ 10133.1, subdiv (a); 10245; 10248.1.


Moreover, under regulations now superseded, the Home Owners' Loan Act preempted state law by providing that "federal savings associations may extend credit as authorized under federal law . . . without regard to state law purporting to regulate or otherwise affect their credit activities. . . . . [including] state law purporting to impose requirements regarding . . . [l]oan-related fees, including  . . . late charges . . .," as well as the "processing, origination, servicing, sale or purchase of, or investment or participation in mortgages."  12 C.F.R. § 560.2(a),(b)(5)&(10). 


Under its so-called savings clause, HOLA expressly did not preempt state laws, such as contract law, "to the extent that they only incidentally affect the lending operations of Federal savings associations. .  . ."  12 C.F.R. § 560.2(c)(1).  See also 12 C.F.R. § 560.33 (late fee regulation providing in part: "A Federal savings association may not impose a late charge more than one time for late payment of the same installment, and any installment payment made by the borrower shall be applied to the longest outstanding installment due.")


Finally, the regulations promulgated under the NBA provided in part:  "Except where made applicable by Federal law, state laws that obstruct, impair or condition a national bank's ability to fully exercise its Federally authorized real estate lending powers do not apply to national banks.  Specifically, a national bank may make real estate loans . . . without regard to state law limitations concerning" such matters as the "[p]rocessing, origination, servicing, sale or purchase of, or investment or participation in, mortgages."  12 C.F.R. § 34.4(a)(10). 


Under the NBA's savings clause, state laws that "are not inconsistent with the real estate lending powers of national banks and apply to national banks to the extent that they only incidentally affect the exercise of national banks' real estate lending powers" are not preempted.  12 C.F.R. § 34.4(b)(1).


The Appellate Court began its analysis by noting that Servicers were assigned servicing rights to third-party loans originated under state law, including the right to charge late payment fees for Servicers' own benefit, and provided an historical overview of California's requirements regarding late fees.  In so doing, the Appellate Court rejected Servicers' argument that Article 7 was intended to apply to mortgage loan broker transactions involving only those lenders not exempt from Section 10242.5.   Based on its examination of the legislative history of statutes governing mortgage loan brokers, the Appellate Court ultimately ruled that the loans at issue in this case were subject to the late fee limitation of Section 10242.5, reasoning in part that, because the rights and remedies available to mortgage borrowers under Article 7 were not waivable and were established for a public purpose, the limitations on late fees in Section 10242.5 may not be waived by private agreement.  


Accordingly, rejecting Servicers' argument that express contract terms may not be varied by operation of law, the Appellate Court went on to conclude that Section 10242.5's payment application requirement was implied by operation of law into the loans, despite terms in the deeds of trust providing that "payments shall be applied to each Periodic Payment in the order in which it became due."  The Court thus concluded that Section 10242.5 applied to the loans regardless of whether the loan originators were exempt entities.


Next, addressing whether federal preemption barred Borrowers' breach of contract claims that were premised on the implied incorporation of Section 10242.5 into their home mortgage loans, the Appellate Court determined that the breach of contract claims were preempted under the NBA and HOLA.


In so ruling, the Court considered and rejected Borrower's various arguments, including the assertions that:  servicing third-party loans is not "lending"; preemption only applies when a servicer made the loans it services; by choosing to service state-originated loans, Servicers agreed to abide by all the express and implied terms of the loans; and, as assignees, Servicers were liable for state-law violations to the same extent as the original lenders.


First, examining state law on an "as applied" basis, the Appellate Court noted that the regulations' savings clauses focused broadly on the effect of state laws on the lending operations of federally regulated financial institutions, rather than narrowly on the extension of credit on a particular loan.  


Against this backdrop, the Appellate Court cited among other things increased participation in the secondary mortgage market as a basis for a uniform federal scheme of regulation, noting the increasing number of federal financial institutions servicing loans originated by other lenders.  See In re Ocwen Loan Servicing, LLC Mortg. Serv. Lit., 491 F.3d 638, 642, 645-46 (7th Cir. 2007)(finding a California late fee statute preempted as to a federal servicer); Molosky v. Washington Mutual, Inc., 664 F.3d 10 (6th Cir. 2011)(rejecting argument that preemption does not apply when a federal savings association services a loan it did not originate); Casey v FDIC, 583 F.3d 586, 593-94 (8th Cir 2009). 


The Appellate Court also analyzed the breach of contract claims from a "state-imposed requirement" perspective, noting the difference between state-imposed and voluntarily undertaken obligations.  In rejecting Borrowers' argument that Servicers agreed to abide by all express and implied loan terms simply by assuming the servicing of the loans, the Court also pointed out that the implied incorporation of California's substantive standard on late fees into Servicers' servicing obligations would limit Servicers' ability to service the loans according to their terms, to collect late fees to which they were entitled, and would expose them to liability under a variety of state laws regulating loan-related fees.


Thus, the Court reasoned in part that California's requirements regarding the application of late fees to loan payments was a substantive standard implicitly incorporated into each loan agreement by operation of law that impaired the servicers' lending powers, rather than a self-imposed obligation voluntarily undertaken.     


Accordingly, the Appellate Court affirmed the judgments dismissing the class action complaints as preempted by the NBA and HOLA.




Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
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