To Pre-Empt Or Not to Pre-Empt, That Is The Question

Like most other businesses, banks seek to maximize the return to their shareholders.

In this day and age of competition and economic issues, that often means that a bank will venture from its traditional pasture of consumer and commercial loans to enter into the greener grass of the other side of the fence that may be offered by less traditional products. In this case, Pacific Capital Bank, N.A. v. State of Connecticut, U.S. Ct. Ap. 2d, No. 06-4149 (September 12, 2008), Pacific Capital Bank sought to do just that in the arena of tax refund anticipation loans (“RALs”).

Pacific is a national bank that has its headquarters in California. Under the National Bank Act law, a national bank may export to other states a loan interest rate that is permitted by the laws of the state in which it is headquartered, in this case, California. The Pacific Capital court stated that California law places no limits on interest rates charged by banks.

Pacific has no branches in Connecticut, but it affiliated itself with certain tax preparers that were located there. The tax preparers would prepare the taxpayer’s tax return, and, if a refund was indicated and the taxpayer was inclined, the tax preparer would provide the taxpayer with a loan application form. The completed form would be forwarded by the tax preparer to Pacific Capital. Pacific Capital alone would decide whether to extend the RAL.

The RALs were typically short term loans. The average fee charged by Pacific Capital on a $3,000 RAL would be $100, and the average loan period was 11 days. If annualized, the interest rate on the loan, therefore, would be 115%, although the taxpayer only paid a total finance charge of 3.3% of the total loan amount.

Connecticut passed a general statute, 42-480, which, among other things, was intended to limit the interest rate payable on RALs. The statute by its terms applied to all “facilitators” of these loans. The statute then defined a “facilitator” as “a person who, individually, or in conjunction or cooperation with another person, makes a refund anticipation loan, processes, receives or accepts for delivery an application for a refund anticipation loan, issues a check in payment of refund anticipation loan proceeds, or in any other manner acts to allow the making of a refund anticipation loan,…” Conn. Gen. Stat. §42-480(a)(2). The statute goes on to expressly exclude banks from its application.

It did not, however, expressly indicate how agents of a national bank would be treated, and in short order, Pacific Capital was unable to make RALs in Connecticut unless it complied with the provisions of §42-480, which strictly limited the interest that could be charged on RALs.

Pacific Capital sued the State of Connecticut. The essence of its case was that §42-480 was pre-empted by the National Bank Act (“NBA”). The State contended that §42-480 by its own terms did not regulate national banks, and therefore the pre-emption argument should be unavailing. Pacific Capital’s argument was, essentially, that by regulating “facilitators” and without specifically exempting facilitators that work with national banks, §42-480 effectively regulated the national banks and, therefore, should be unconstitutional.

The court agreed with Pacific Capital. It stated that “[i]n determining whether a state statute is preempted by the NBA, the Supreme Court has observed that the proper focus is not on whether the state statute regulates national banks directly but rather on whether it significantly interferes with national bank’s authorized activity….” Since all of the parties agreed that RALs are typically offered by tax-preparers, it seemed clear that regulating the tax-preparers that operated as agents of the banks would, in effect, regulate the bank.

Since it was clear that §42-480 could not apply to facilitators working as agents of national banks, the court had one more question to resolve: Is §42-480 of the Connecticut General Statutes pre-empted by the National Bank Act? The court stated that where it is faced with a choice of interpreting a state statute in a way that avoids conflict with a federal statute and determining whether the state statute is pre-empted by the federal statute, the court should prefer to interpret the state statute to avoid constitutional problems.

As a result, the court declined to declare §42-480 unconstitutional, but instead sidestepped the question by interpreting the definition of “facilitator” in §42-480 to exclude facilitators that assisted national banks in making RALs.

Posted by: Kimberly K. Mauer

Categories: Bankruptcy & Banking Law