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4000 - Advisory Opinions


"Most Favored Lender" Doctrine Applies to Insured State Banks

FDIC-81-3

February 3, 1981

Frank L. Skillern, Jr., General Counsel

I am writing to you in response to your inquiry as to whether the "most favored lender" doctrine is incorporated in section 27 of the Federal Deposit Insurance Act ("section 27" or the "subsection"), which was added to the Act by section 521 of Title V of the Depository Institutions Deregulation and Monetary Control Act of 1980. After reviewing the matter, it is the Legal Division's opinion that the literal construction of this subsection, its legislative history and case law interpretation of the like statutory language of 12 U.S.C. 85, all support the conclusion that most favored lender status is accorded to insured state banks under section 27. The following is our interpretation of the subsection.

Section 27(a) reads as follows:

SEC. 27(a) In order to prevent discrimination against state-chartered insured banks, including insured savings banks and insured mutual savings banks, or insured branches of foreign banks with respect to interest rates, if the applicable rate prescribed in this subsection exceeds the rate such state bank or insured branch of a foreign bank would be permitted to charge in the absence of this subsection, such state bank or such insured branch of a foreign bank may, notwithstanding any state constitution or statute which is hereby preempted for the purposes of this section, take, receive, reserve, and charge on any loan or discount made, or upon any note, bill of exchange, or other evidence of debt, interest at a rate of not more than 1 per centum in excess of the discount rate on ninety-day commercial paper in effect at the Federal Reserve bank in the Federal Reserve district where such state bank or such insured branch of a foreign bank is located or at the rate allowed by the laws of the state, territory, or district where the bank is located, whichever may be greater.

The first part of this subsection states that its purpose is to prevent discrimination, with respect to interest rates, against state-chartered insured banks or insured branches of foreign banks (hereinafter both referred to as "insured state banks"). The subsection then refers to "the applicable rate prescribed in this subsection". This rate is set forth in the latter part of the subsection. Two interest rates are described there: "a rate of not more than 1 per centum in excess of the discount rate on ninety-day commercial paper in effect at the Federal Reserve bank in the Federal Reserve district where such [insured state bank] is located" (hereinafter "1 percent over the discount rate") and "the rate allowed by the laws of the state, territory, or district where the bank is located" (hereinafter "rate allowed by state law"). Under the terms of this subsection, the applicable rate prescribed is "whichever may be greater" of the two rates described above.

Thus, section 27(a) specifies that if the greater of (a) 1 percent over the discount rate, or (b) the rate allowed by state law, exceeds the rate which would be permitted in the absence of section 27(a), the insured state bank may charge the greater of the two. The question then becomes, what is meant by "the rate allowed by state law" and "the rate which would be permitted in absence of this subsection"? By looking at the Congressional intent and the case law construction of like language, it appears obvious that Congress intended that "the rate allowed by state law" should be the highest rate allowed to any lender under state law, and "the rate permitted in the absence of the subsection" is the rate specifically prescribed for state banks, if any, under state law.

The Congressional intent, specifically stated in the first part of section 27(a), is to prevent discrimination against insured state banks with respect to interest rates. The legislative history supports this. The following comments were made during the House and Senate debates on H.R. 4986, the bill containing language which eventually became section 27(a). "Title V . . . contains a provision [section 521] which provides parity, or competitive equality, between national banks and state chartered depository institutions on lending limits." 126 Cong. Rec. § 3170 (daily ed. Mar. 27, 1980) (remarks of Sen. Proxmire). "[Insured state banks will now be permitted] to charge 1 percent over the Federal Reserve discount rate--or the rate permitted by state law if that is higher." Id. at § 3177 (remarks of Sen. Bumpers). "State chartered depository institutions are given the benefits of 12 U.S.C. 85." Id. at § 3170 (remarks of Sen. Proxmire).

Indeed, the language employed in section 27(a) is very similar to that of 12 U.S.C. 85 which governs the interest rates which national banks may charge. This comes as no surprise since the intent was to put national banks and insured state banks on equal footing. Section 85 reads in relevant part as follows:

Any association may take, receive, reserve, and charge on any loan or discount made, or upon any notes, bills of exchange, or other evidences of debt, interest at the rate allowed by the laws of the State, Territory, or District where the bank is located, or at a rate of 1 per centum in excess of the discount rate on ninety-day commercial paper in effect at the Federal Reserve bank in the Federal Reserve district where the bank is located, . . . whichever may be the greater, and no more, except that where by the laws of any state a different rate is limited for banks organized under state laws, the rate so limited shall be allowed for associations organized or existing in any such state under this chapter. [Emphasis added.]

This section was interpreted by the Supreme Court in Tiffany v. National Bank of Missouri, 18 Wall. 409 (1874). In this case the Court held that under what is now 12 U.S.C. 85, national banks were permitted to charge interest at the rate allowed by the laws of the state, which it interpreted to mean the "rate of interest fixed by state laws for lenders generally". Id. at 411.

Subsequent cases have held that, consistent with the reasoning in Tiffany, the "rate allowed by state law to lenders generally" means the rate allowed by state law to any lender, whether the law is one pertaining to a specific type of lender or a more encompassing law pertaining to lenders generally. Thus national banks are now permitted to charge the rate allowed to the most favored lender in the state. This concept is widely known as "the most favored lender doctrine". Northway Lanes v. Hackley Union National Bank & Trust Co., 464 F.2d 855 (6th Cir. 1972); Fisher v. First National Bank, 548 F.2d 255 (8th Cir. 1977).

The Comptroller of the Currency has issued an interpretation of 12 U.S.C. 85 which also makes it clear that a national bank can charge the highest rate allowed to any competing institution. In 12 C.F.R. § 7.7310(a) the Comptroller states that:

(a) A national bank may charge interest at the maximum rate permitted by state law to any competing state-chartered or licensed lending institution. If state law permits a higher interest rate on a specified class of loans, a national bank making such loans at such higher rate is subject only to the provisions of state law relating to such class of loans that are material to the determination of the interest rate. For example, a national bank may lawfully charge the highest rate permitted to be charged by a state-licensed small loan company or Morris Plan bank, without being so licensed.

This interpretation of 12 U.S.C. 85 is consistent with the reasoning in Tiffany as it safeguards against potentially unfriendly state legislation designed to give non-bank lenders advantages over national banks. The legislative history of 12 U.S.C. 85 likewise supports this interpretation. This was pointed out in Northway Lanes, in which the court stated that "[t]he reference in Section 30 [now Section 85] to the rate allowed by the laws of the State,' was not intended to be limited to a state's general usury rate but was meant to include any exceptions to that rate established for special transactions or special classes of lenders. See, Cong. Globe, 38th Cong., 1st Sess., pp. 2123-2126 (remarks of Sen. Grimes)." 464 F.2d at 862.

By employing the same terminology in constructing section 27(a) as was used in 12 U.S.C. 85, it is only logical to conclude that Congress intended those words to have the same meaning. In fact, this is the only interpretation consistent with the Congressional intent to provide parity for national and insured state banks. Since national banks have been accorded most favored lender status, the same must be accorded to insured state banks under section 27(a) in order to prevent discrimination with respect to interest rates.

Finally, having determined that "the rate allowed by state law" means the highest rate allowed to any lender under state law, we are left with a determination of the meaning of the phrase used in section 27(a), "the rate which would be permitted in the absence of this subsection." The Court in Tiffany held 12 U.S.C. 85 to authorize a national bank to charge 1 percent over the discount rate or the highest rate allowed under state law but no more, "except that if state banks of issue are allowed to reserve more, the same privilege is allowed to national banking associations." 18 Wall. at 411. Since it was the intent of Congress to provide competitive equality between national banks and insured state banks by giving the latter the benefits of 12 U.S.C. 85, the rate permitted in the absence of section 27(a) must refer to the rate prescribed for state banks, if any, under state law.

Since the legislative history of section 27(a) as well as the plain meaning of its terms mandates a finding that it was the Congressional intent to provide parity between insured state banks and national banks with respect to interest rates, and since the language employed in section 27(a) parallels that of 12 U.S.C. 85, which has accorded national banks most favored lender status, it is the Legal Division's position that section 27(a) incorporates the most favored lender doctrine. Therefore, under this subsection insured state banks may charge interest at 1 percent over the discount rate, the highest rate allowed to any lender under state law or the rate specifically prescribed for state banks under state law, whichever of the three is greatest.

I trust you will find this information sufficient, but should you have any further questions, please do not hesitate to contact me.


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