Claims by borrowers that a lender breached the loan contract by adjusting mortgage loan interest rates in a way that did not comply with the approved index were not preempted by the Home Owners’ Loan Act or implementing Office of Thrift Supervision regulations, the U.S. Court of Appeals for the Ninth Circuit has determined. However, the borrowers’ other breach of contract claims fell because the appropriate federal regulatory agencies had approved an index substitution, the court said (Campidoglio LLC v. Wells Fargo & Co., Sept. 12, 2017, Callahan, C.).
Interest rate indexes and mergers. The controversy arose because of various financial institution mergers and the effect those mergers had on the index defined by the adjustable rate mortgage loans. The three borrowers originally borrowed from World Savings Bank, with the ARMs calling for the interest rate to be based on the cost of savings index at World and its affiliates. As all of these institutions were subsidiaries of Golden West Financial Corporation, this was called the "Golden West COSI."
The loan notes said that if the defined index became unavailable, the lender had the discretion to substitute "a national or regional index or another type of index approved by the Lender’s primary regulator."
Golden West was acquired by Wachovia Corporation and renamed Wachovia Mortgage, FSB. Wachovia notified the OTS that it intended to change the index to the Wachovia COSI, and the OTS raised no objection.
Wells Fargo later acquired Wachovia. Wells Fargo Bank notified the OTS that it intended to substitute the Wells Fargo COSI as the index. It also notified its own regulator, the Office of the Comptroller of the Currency. Neither agency objected, and Wells Fargo implemented the change.
Borrowers’ claims. The borrowers eventually sued Wells Fargo over the interest rate index substitutions, raising seven separate claims under Washington state law. The U.S. district judge eventually dismissed three of the seven claims as preempted and granted summary judgment against the other four.
On appeal, the borrowers sought to revive two substantive claims. First, they argued that their claim that Wells Fargo used an index other than the approved index was not preempted. Second, they claimed that the lenders failed to secure their regulators’ approval of index substitutions. Both violated the loan contracts, they said.
Preemption. The preemption issue was analyzed under the old OTS regulations, which later were superseded when the OCC took over the supervision of federal savings associations. According to the appellate court, the regulation in question, 12 CFR §560.2, required a preemption analysis to follow a three-step process:
- Determine whether the state law in question was one of the laws specified in 12 CFR §560.2(b), which described state laws that are preempted, or was a law of the same type. If so, the law was preempted and no further analysis was needed.
- If the law was not included in 12 CFR §560.2(b), then determine whether it affected lending. If so, the law was presumed to be preempted.
- If the law was presumed to be preempted, then determine whether it was included within the exemptions from preemption described in 12 CFR §560.2(c). These exemptions were to be construed narrowly, the court said, and any doubt was to be resolved in favor of deciding the state law was preempted.
The borrowers’ claims were that Wells Fargo adjusted the interest rates on their loans using an index other than the Wells Fargo COSI that had been described to the OTS and OCC. This would have been a breach of contract, and the common law of contracts was not included in 12 CFR §560.2(b), they asserted.
The court conceded that 12 CFR §560.2(b) did include the terms of credit, and the breach of contract claims did relate to the terms of credit. However, no Washington law imposed any requirements that were related to the terms of credit of these loans. Those requirements came only from the loan notes, and the bank would not be excused from fulfilling its contractual obligations simply because those obligations had some relationship to the subject matter of 12 CFR §560.2(b).
Moving on to step two of the analysis, the common law of contracts did affect lending, the court said. However, under step three, the contract laws were exempt from preemption because they had only an incidental effect on federal savings association lending activities.
Thus, the borrowers’ claim that Wells Fargo used an interest rate index that was inconsistent with the approved index was not preempted.
Approval of indexes. The borrowers focused their lack of approval claim on Wachovia’s index substitution. They claimed that Wachovia did not secure the OTS’s approval when it switched from the Golden West COSI to the Wachovia COSI and that making the change without regulatory approval breached the loan contract.
The regulation then in effect, 12 CFR §560.35, required a lender that intended to change indexes to give written notice to the appropriate regulator, the court began. If the regulatory agency did not raise an objection, the lender could make the change. Affirmative consent was not required. (The current regulations are comparable.).
Wachovia followed the rules, the court said. The savings association sent a letter to the OTS that told the agency of the planned substitution, although the letter did note that implementation plans were not final. Since the OTS had approved the original use of the Golden West COSI, the regulation required Wachovia only to tell the agency how the new index was derived. The bank did not need to provide the OTS with any further information.
The undisputed facts showed that the OTS never objected to Wachovia’s planned substitution, the court said. That satisfied the regulation.
Attorneys: Benjamin Gould (Keller Rohrback L.L.P.) for Campidoglio LLC, Carmen LLC, and San Marco LLC. Robert Collings Little (Anglin Flewelling Rasmussen Campbell & Trytten LLP) for Wells Fargo Bank, NA.
Companies: Campidoglio LLC; Carmen LLC; San Marco LLC; Wells Fargo Bank, NA; Wells Fargo & Co.
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