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4000 - Advisory Opinions


Does section 27 of the Federal Deposit Insurance Act preempt the Michigan Motor Vehicle Sales Finance Act

FDIC--02--06 December 19, 2002 Rodney D. Ray, Counsel

This responds to your request on behalf of the X Association for an opinion from the FDIC that section 27 of the Federal Deposit Insurance Act (FDI Act) (12 U.S.C. § 1831d) preempts the Michigan Motor Vehicle Sales Finance Act (Act) (M.C.L. §§ 492.101 et seq.), as interpreted by the Michigan Department of Consumer and Industry Services, Financial Institutions Bureau (Bureau), with regard to out-of-state banks originating loans through motor vehicle dealers located in Michigan. I have reviewed all of the information the X has provided, including a copy of the Bureau's declaratory ruling, and other information that I considered relevant to your request. In addition, for purposes of this opinion, I have assumed the Bureau would reach a similar conclusion if it were presented with the same facts based upon a request by an out-of-state federally insured state bank.

Background

An Ohio-based national bank requested a declaratory ruling from the Bureau, the Michigan agency responsible for administering the Act, regarding the applicability of the Act to a lending program the bank proposed to engage in with Michigan consumers for the purchase of motor vehicles through bank agents located in the State of Michigan. Under the proposed arrangement with the agents, the bank "would enter into an agreement with a motor vehicle dealer in Michigan under which the dealer would serve as [the bank's] limited agent for the purpose of soliciting loans to finance motor vehicles, taking applications for the vehicle loans, preparing loan documentation, and closing the loans by obtaining the buyer's signatures on all required documents." The bank would prescribe the loan terms, including the minimum interest rate, but the dealer could, within a range established by the bank, negotiate for a higher interest rate. The bank would pay the dealer a commission (a yield-spread differential of zero to six percentage points over the minimum interest rate established by the bank) on each loan closed, and the bank would have no recourse against the dealer to repurchase the loans, except for a cause of action for breach of agency responsibilities.

In response to the request, the Bureau determined that the proposed sales transactions constituted "installment sales" to Michigan residents through automobile dealers in Michigan acting as the bank's agents that were covered by the Act. Therefore, the Bureau determined that where an entity utilized an agent to facilitate the making of an installment sale, the agent was required to be licensed and to ensure that the transaction was conducted in full compliance with the terms of the Act.1 Additionally, the Bureau ruled that an agent who facilitated the making of an installment sale contract on behalf of an unlicensed entity, or, regardless of whether the entity was licensed, if the transaction did not comply with the Act, would be subject to an administrative enforcement action as well as any applicable criminal penalties.

After the Bureau's ruling was issued, two Ohio-based national banks asked the Office of the Comptroller of the Currency (OCC) for a determination that the Act, as interpreted and applied by the Bureau to out-of-state national banks and motor vehicle dealers originating motor vehicle loans at dealership locations as third-party agents for out-of-state national banks, was preempted by various provisions of the National Bank Act. The Chief Counsel of the OCC responded to the request, concluding that, to the extent the Bureau interpreted the Act to limit the banks' proposed vehicle financing arrangement, the Michigan statute would be preempted by 12 U.S.C. §§ 24(seventh), 85, 484, and OCC regulations. 66 Fed. Reg. 28593 (May 23, 2001).

The X submitted a similar request to the FDIC for a preemption determination under section 27 of the FDI Act.2

Discussion

Congress enacted section 27 of the Act as part of section 521 of the Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA), Pub. L. 96-221, 94 Stat. 132 (1980). The purpose of the amendment was to provide federally insured state banks authority to loan money to customers at rates that were competitive with those authorized for national banks under section 85 of the National Bank Act. The statute reads as follows:

(a)  Interest rates

In order to prevent discrimination against State-chartered insured depository institutions, including insured 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, which every may be greater.

(b)  Interest overcharge; forfeiture; interest payment recovery

If the rate prescribed in subsection (a) exceeds the rate such State bank or such insured branch of a foreign bank would be permitted to charge in the absence of this section, and such State fixed rate is thereby preempted by the rate described in subsection (a), the taking, receiving, reserving, or charging a greater rate of interest than is allowed by subsection (a), when knowingly done, shall be deemed a forfeiture of the entire interest which the note, bill, or other evidence of debt carries with it, or which has been agreed to be paid thereon. If such greater rate of interest has been paid, the person who paid it may recover in a civil action commenced in a court of appropriate jurisdiction to later than two years after the date of such payment, an amount equal to twice the amount of the interest paid from such State bank or such insured branch of a foreign bank taking, receiving, reserving, or charging such interest.

Several states, like Michigan, have enacted statutes regulating installment sales transactions, but the FDIC's Legal Division has not previously addressed the extent to which such laws may be preempted by section 27.

The United States supreme Court has employed three types of preemption analysis to determine when state law is preempted under the Supremacy Clause of the Constitution.3 First, explicit preemption can occur when Congress, in enacting a federal statute, has expressed a clear intent to preempt state law. Second, field preemption can be found when it is clear, even absent explicit preemptive language in a federal statute, that Congress intended, by legislating comprehensively, to occupy an entire field of regulation and has thereby "left no room for the States to supplement" federal law. Finally, conflict preemption can occur when compliance with both state and federal law is impossible, or when the state law "stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress." Capital Cities Cable, Inc. v. Crisp, 467 U.S. 691, 698--699 (1984); Hillsborough County, Florida v. Automated Medical Laboratories, Inc., 471 U.S. 707, 713 (1985); Barnett Bank of Marion County, N.A. v. Nelson, 517 U.S. 25, 31 (1996).

While section 27 contains an explicit preemption clause, unlike section 85, the Bureau's ruling appears to avoid its reach. That clause preempts state constitutional or statutory interest limitations if the interest rates authorized by section 27(a) exceed the rate that would be permissible in the absence of the subsection. The Bureau's opinion, however, is directed primarily toward determining whether the proposed financing transaction constitutes an "installment sale" under the Act and, if so, the obligations imposed by the Act on the Michigan agents. The opinion does not say that the interest rate out-of-state federally insured banks involved in such transactions can legally charge Michigan residents is subject to Michigan usury limits.4 Therefore, the Bureau's ruling appears to address issues that fall outside the coverage of the explicit preemption clause contained in section 27.

Even if explicit preemption does not exist, however, state law can be preempted where it stands as an obstacle to the accomplishment of the full purposes and objectives of Congress.5 This inquiry requires consideration of "the relationship between state and federal laws as they are interpreted and applied, not merely as they are written." Jones v. Rath Packing Co., 430 U.S. 519, 526 (1977).

In considering how the Michigan statute is interpreted and applied, the most significant aspect of the Bureau's ruling, for purposes of this analysis, is the following paragraph:

IT IS ALSO MY RULING that where an entity has engaged an agent to facilitate the making of an installment sale contract, the agent must not only be licensed under the Act, but must ensure the transaction is conducted in full compliance with the Act.6 Where such agent has either facilitated the making of an installment sale contract on behalf of an unlicensed entity, or, regardless of whether the entity is licensed, if the transaction does not comply with the Act, the agent will be subject to an administrative enforcement action as well as any applicable criminal sanction.7 (Emphasis added).

To appreciate the impact of this statement, a brief overview of some of the Act's provisions is helpful.

The Act became law in 1950. Its preamble describes it as defining and addressing numerous aspects of installment sales transactions, including the prescribing of conditions under which installment sales can be made and regulating the financing of such sales. It also is described as ". . . limiting charges in connection with [installment sale instruments] and fixing the maximum interest rates for delinquencies, extensions and loans . . .". Section 2 of the Act defines a "sales finance company" to include a financial institution that engages as principal in the business of financing installment sales contracts between other parties. This definition would presumably cover an out-of-state federally insured depository institution that opted to be covered by the Act.8 Section 3 of the Act requires installment sellers and sales finance companies to be licensed under the Act. As part of the licensing process, applicants are required to designate an authorized agent in Michigan for service of process or other legal notices and provide a bond conditioned upon compliance with all of the provisions of the Act and the Bureau's rules and regulations. Judgment creditors of a licensee who are aggrieved by the licensee's actions can maintain an action for payment from the bond, and the Bureau has authority to revoke or suspend an applicant's license if the license violates the provisions of the Act.

Section 15(a) of the Act, on which the Bureau significantly relied in reaching its decision, prohibits the sale of an installment sales contract to any person doing business in the State of Michigan without a license under the Act. Sections 18--20 specify that finance charges on the contracts, extensions or renewals by holders of the contracts, and default charges are limited by various provisions of the Act to the amount permitted by the Michigan Credit Reform Act. Those sections also specify how finance and default charges are to be calculated and collected, and section 31 prohibits charging amounts that are not authorized under the Act. If a seller or subsequent holder receives prohibited charges and costs under the contract, section 31 provides that all of the costs and charges in connection with a contract, other than insurance, are void and unenforceable and requires that any amounts paid by the buyer for such charges, other than insurance, must be applied on the principal of the contract. Finally, section 37(a) subjects any person, including an agent, to criminal penalties for wilfully or intentionally engaging in business as an installment seller or sales finance company without having obtained a license and subsection (b) subjects licensees, including agents, who willfully or intentionally violate any provision of the Act to criminal sanctions.

Thus, under the Bureau's interpretation of the Act, the ability of an out-of-state federally insured state bank to legally make motor vehicle loans to Michigan residents utilizing lender agents located in Michigan, would be conditioned upon the institution subjecting itself to the Michigan regulatory scheme. Under that regulatory scheme, the lender is required to charge and collect interest on the contracts as provided under Michigan law. In addition, by subjecting itself to the Michigan regulatory scheme, Michigan law dictates the remedies that would be applicable if such institution charges an amount not authorized under the Act.

Section 85 of the National Bank Act was enacted to protect national banks from discriminatory state legislation by specifying the interest that national banks could charge their customers. Following its enactment, the courts construed the statute to afford national banks authority to charge the highest rates authorized for any competing institution in the state where the national bank was located and to "export" those rates to borrowers residing in other states without regard to usury restrictions imposed by the borrower's state laws. As a result of the considerable interest rate flexibility provided by the statute, federally insured state banks, whose loans remained subject to lower state usury limitations, were placed at a competitive disadvantage with national banks. The high interest rate environment that existed in the United States in the 1970s highlighted this problem and members of Congress became concerned that the continued viability of the nation's dual banking system might be adversely effected because state-chartered banks in states with low interest rates, such as Arkansas, could not compete with national banks for loan customers and maintain their profitability.9 To address this situation and provide competitive lending equality to federally insured state banks, Congress enacted section 27 as part of the DIDMCA of 1980, which gave federally insured state banks virtually the same interest rate authority and usury remedies that national banks had enjoyed for more than a century.

To achieve its goal of providing federally insured state banks competitive lending equality, Congress modeled section 27 after sections 85 of the National Bank Act. Because section 27 borrowed key language10 and concepts from section 85, the FDIC and the courts have recognized that it should be construed in para materia with similar provisions under the National Bank Act. Thus, for example, the interest rate exportation authority the Supreme Court recognized in Marguette for national banks was also provided to federally insured state banks when section 27 was enacted. Greenwood Trust Co. v. Commonwealth of Mass., 971 F.2d 818, 826--828(1st Cir.), cert. denied, 506 U.S. 1052(1993).

In addition to giving federally insured state banks the same ability to export interest rates that national banks enjoyed under section 85, Congress borrowed and incorporated key language and concepts from section 86 of the National Bank Act into section 27(b) to fashion a corresponding usury remedy. As is true of section 85, Congress' incorporation of key language and concepts from section 86 into section 27(b) brought with it the judicial interpretations of the former section11 and, thus, section 27(b) is the exclusive remedy for usury violations against a federally insured state bank. Hill v. Chemical Bank, 799 F. Supp. 948 (D. Minn. 1992).12

This authority can not be exercised, however, under the Bureau's interpretation of the Act, because the agent is required to ensure that the transactions it engages in are in full compliance with the Act. To be in compliance with the Act, the out-of-state federally insured state bank would have to be licensed under the Act, otherwise the transaction would run afoul of the section 15(a) proscription against selling the contracts to anyone doing business in Michigan without being licensed under the Act. To be license under the Act, however, the out-of-state federally insured state bank would have to post a bond conditioned upon compliance with all of the provisions of the Act, which would include the Michigan interest limitation and the Michigan remedies for violation of the statute.

Thus, the Bureau's ruling appears to require that an out-of-state federally insured state bank must subject itself to compliance with all of the laws of the State of Michigan governing installment sales transactions, even though it has been granted authority to do otherwise with regard to certain provisions of the Michigan statute by federal law. Such an interpretation stands as an obstacle to the accomplishment and execution of Congress' full purpose and objective of providing federally insured state banks competitive lending equality with national banks and should be preempted. The potentially disproportionate negative impact of the Bureau's ruling on out-of-state federally insured state banks is also highlighted in this instance by the fact that the OCC has determined that the Act, as applied by the Bureau, with regard to out-of-state national banks and their agents in Michigan is preempted by section 85 to the extent the Bureau interprets the Act to subject national banks to Michigan interest limitations.

The Bureau might argue that its ruling does not improperly attempt to restrict the federal authority Congress has provided out-of-state federally insured state banks because its ruling is only directed to policing the actions of bank agents in Michigan and does not address the out-of-state banks themselves. The Bureau's ruling affects the lending authority of out-of-state banks by implication, however, because it specifically provides that the lender's status as a national bank does not mean that entities entering into agency engagements with the bank may do so without complying with the licensing requirements of the Act and imposes compliance obligations, coupled with the threat of potential administrative and criminal sanctions, on the Michigan agents. Therefore, although the involvement of an out-of-state national bank in the transaction was recognized, the ruling did not reconcile the Act's licensing and compliance requirements with the lending authority provided to the bank by federal law. I believe, particularly if the Bureau were confronted with the same situation involving an out-of-state federally insured state bank, that the better approach would be to interpret and apply the federal and state provisions in a way that gives meaning to the state law but also avoids frustrating the Congressional objective and purpose for the enactment of section 27.

Conclusion

Based upon the facts presented and the foregoing legal analysis, I believe that the Act as interpreted and applied by the Bureau is not preempted by section 27, except to the extent out-of-state federally insured state banks making loans to Michigan residents through Michigan agents would be required to comply, either directly or through their Michigan agents, with the Michigan interest limitations and remedies contained in the Act.

I apologize for the delay in responding to this request and appreciate X raising this matter with us. Please be aware, however, that the law regarding the use of agents by banks to make loans to out-of-state borrowers at interest rates allowed by the state where the bank is located is still being analyzed and developed by the courts. Therefore, this opinion is being provided for your information and only represents the views of the staff of the Legal Division based upon the facts stated in the opinion. It does not, however, constitute a binding decision by the FDIC or its Board of Directors on these issues.

1Although the Ohio-based national bank characterized the proposed arrangement as a "direct lending program," the Bureau found, based on a Michigan Court of Appeals opinion and information contained in the briefs filed by the parties therein, that the arrangement more closely resembled an "installment sales contract" transaction than a "direct loan" transaction, making it subject to the Act. For purposes of this opinion, it is assumed that the Bureau's determination that the arrangement at issue constituted an installment, sales contract transaction was correct. Otherwise, as indicated in the Bureau's ruling, if the arrangement constituted a direct loan transaction, it would not be subject to the Act. Go back to Text

2The X is a national trade association for market-funded providers of financial services to consumers and small businesses. X's request states that it is submitted on behalf of its members that own state-chartered federally insured banks and industrial loan and thrifts that rely on federal preemption under section 27 when making direct loans to residents of other states. Go back to Text

3U.S. Const. art. VI, cl. 2. Go back to Text

4In its opinion, the Bureau appears to agree with National City's observation that the Act "was enacted to limit the rate and terms under which a motor vehicle dealer could sell an automobile. . ." and indicates that looking through the form to the substance of the transaction "is important not only for uniform administration of the Act, but to further Michigan's public policy of encouraging the sale of retail goods on credit while placing strict usury limits on outright loans of money." Go back to Text

5As previously indicated, preemption can also be found where Congress legislates comprehensively to occupy an entire field of regulation or when compliance with both state and federal law is impossible. Neither of these bases for preemption are being addressed, however, because the Act, as interpreted and applied by the Bureau, stands as an obstacle to the accomplishment of the full purposes and objectives of Congress. Thus, it is unnecessary to address additional alternative bases for preemption. Go back to Text

6Citing sections 12--34 of the Act (M.C.L. §§ 492.112--492.134). Go back to Text

7Citing sections 9 and 37 of the Act (M.C.L. §§ 442.109, 492.137). Go back to Text

8Although not entirely free from doubt, this conclusion is based upon the fact that the Act also defines a "financial institution" as including a state or nationally chartered bank that elects to come under the provisions of the Act. In the past, the Michigan Attorney General has construed that language as giving national banks the option to elect coverage under the Act for purposes of obtaining installment sales contracts from licensed sellers. Op. Atty. Gen. No. 1516 (February 27, 1952). The Attorney General's Opinion does not, however, specifically address the application of the Act in the context of an out-of-state national bank and it was issued prior to the Supreme Court's ruling in Marguette Nat'l Bank of Minneapolis v. First of Omaha Service Corp., 439 U.S. 299 (1978) (national bank may charge out-of-state customers interest allowed by the state where the bank is located pursuant to section 85 of the National Bank Act). Go back to Text

9See, e.g., 125 Cong. Rec. S15684 (daily ed. November 1, 1979) (statements of Senators Pryor and Bumpers). Go back to Text

10For present purposes, it is important to note that section 27, like section 85, specifically allows the lender to charge interest "at the rate allowed by the laws of the State . . . where the bank is located." Go back to Text

11Prior to the enactment of section 27 it was recognized that section 86 of the National Bank Act provided the exclusive remedy for usury by a national bank. First National Bank of Mena v. Nowlin, 509 F.2d 872 (8th Cir. 1975). Go back to Text

12the Hill decision relied, in part, on the Eighth Circuit's decision in M. Nahas & Co. v. First Nat'l Bank of Hot Springs, 920 F.2d 608 (8th Cir. 1991) to hold that section 27 completely preempts the field of usury claims against federally insured state banks. Recently, in Anderson v. H & R Block, Inc., 287 F.3d 1038 (11th Cir. 2002), the United States Court of Appeals for the Eleventh Circuit disagreed with the Eight Circuit's decisions in Nahas and a subsequent case, Krispin v. May Department Stores Co., 218 F.3d 919 (8th Cir. 2000), on whether section 86 of the National Bank Act completely preempts state law usury claims. Each of these cases involved the removal of state court actions to federal courts, and the disagreement between the two circuits involves a question of whether a defense based upon section 86 is covered by the "complete preemption" doctrine, which provides an exception to the well-pleaded complaint rule. If the defense completely preempts state law, removal to the federal courts is appropriate, but if the remedy under the federal statute constitutes an "ordinary preemption" defense, it can be asserted in state courts and will not support removal of the action to the federal courts. While the two circuits disagree on whether section 86 completely preempts state law usury claims for purposes of federal court removal jurisdiction, the Eleventh Circuit does not appear to disagree with the Eight Circuit's conclusion that section 86 is the exclusive remedy for usury claims against a national bank. See, Anderson, 1046, n. Go back to Text


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