The principle of principal: mortgagee sues to pay faster

Jefferson v. Chase Home Finance, 2007 WL 4374410 (N.D. Cal.)

Jefferson refinanced his home in 2003. His promissory note gave him a right to prepay principal, provided he told the holder in writing that he was doing that (and provided that he was otherwise current); if not, the holder could apply his prepayment to accrued and unpaid interest on the prepayment amount. His deed had similar terms. Chase began servicing his loan, and provided him with a payment coupon at the bottom of each monthly statement that said “Please designate how you want to apply any additional funds. Undesignated funds first pay outstanding late charges and fees, then principal.”

In 2004, Jefferson called Chase to see how he could make occasional prepayments. There’s a dispute over what various customer service representatives (CSRs) told him, but apparently the first one told him any prepayment would be used to pay principal, and didn’t mention any special requirements. Jefferson therefore set up automatic $167 monthly payments with his bank, and also continued to pay regular monthly principal and interest.

When Jefferson received his monthly statement, he was surprised to find that his additional payment was not applied to principal, but had been placed in “suspense.” A CSR told him he needed to make a written request to apply his extra payment to principal. He therefore sent a letter stating: “... [I] formally request that Chase Bank apply each individual monthly payment of $167 to the principal of loan # [ ] beginning with the January 2005 payment. Each $167.00 payment will be made in addition to the standard monthly payment and should be applied to the principal of the loan immediately upon receipt.”

Chase responded with a letter stating “[w]e have received your request to apply the amount of $167.00 each month to the principal balance of your loan. Your account has been noted.” Nonetheless, Chase failed to apply the prepayments to the loan principal. After a lot of back-and-forth, Chase credited most of the payments to principal, but not all on the date they were received, and each new payment gets routed to “suspense.”

Chase maintained that it told Jefferson early on that he couldn’t use his automatic bill payment feature to prepay, because the check sent by the bank doesn’t state how it needs to be applied. Chase claimed that its practice is to apply additional payments to principal only if they’re specifically designated as principal payments, because many borrowers send in multiple undesignated partial payments each month to add up to a regular monthly payment. If Chase processed such payments as prepayments, those borrowers would end up with insufficient funds for the next monthly payment.

Jefferson sued for violation of California’s Consumer Legal Remedies Act, False Advertising Law, and Unfair Competition Law. He argued that his claims were based on Chase’s misrepresentations about how it would credit payments: “[u]ndesignated funds first pay outstanding late charges and fees, then principal,” and so on.

Chase argued that Jefferson’s claims were preempted by the National Bank Act and OCC regulations, which provide that national banks can make real estate loans notwithstanding various state law limits, including repayment schedules and loan servicing. The court rejected this preemption argument.

OCC regulations state that a national bank may make real estate loans without regard to state law limitations regarding, among other things, “Disclosure and advertising, including laws requiring specific statements, information, or other content to be included in ... billing statements ... or other credit-related documents,” and also generally preempt state regulations that conflict with the federal scheme. There is a savings clause for regulations “to the extent that they only incidentally affect the exercise of national banks’ real estate lending powers.” There is no presumption against preemption, because of the history of significant federal presence in the banking field, and regulations can preempt as well as federal legislation can.

But Jefferson argued only that Chase misrepresented how it would apply prepayments, in violation of state law. Such laws of general application merely require all businesses, including banks, to refrain from misrepresentation and abide by their contracts. They do not impair a bank’s ability to lend, and their effects on banks are only incidental. A long line of California cases holds that consumer protection laws of general application are not preempted by federal banking law. The bank can choose how to operate, but it can’t mislead consumers about how it does so. Thus, Chase can service or process loans, and write its repayment coupons, without specific state regulation – but it can’t misrepresent its terms. Cases finding preemption were distinguishable, because they were ultimately based on state laws specifically regulating banking (predatory lending, deposit-taking, etc.).

In dicta, the court commented that a general claim that a lending practice is “unfair” – that it’s unethical, harms consumers, and the harm outweighs its utility, under California law – “may well be preempted,” because it requires an individual analysis of the lender’s acts untethered to any rule of general application. But that wasn’t Jefferson’s claim – he argued that Chase acted unlawfully (deceptively) and unfairly (in systematically breaching its contracts). Such obligations apply to all businesses.

Specifically, Jefferson’s CLRA claim alleged that Chase represented its services had characteristics or benefits they lacked; advertised services with intent not to sell them as advertised; and represented that a transaction conferred or involved rights, remedies or obligations which it did not have, all violating specific provisions of law.

Chase argued that none of its statements were likely to deceive. Though its practice is to put separate undesignated payments in suspense, Chase claimed that its payment coupons’ statement that “[u]ndesignated funds first pay outstanding late charges and fees then principal” was accurate because the phrase “obviously” applies only “to payments made with the coupon” itself, and/or when borrowers “are including additional funds with their single monthly mortgage payment check.” The court disagreed; the language was not so limited, and was consistent with Jefferson’s deed of trust, which was also unqualified about the order of payment.

Chase then argued that Jefferson didn’t allege reliance and couldn’t have been deceived, because the note itself clearly stated that he needed to designate his payments (“When I make a prepayment, I will tell the Note Holder in writing that I am doing so”), and because CSRs repeatedly told him that he would have to designate his payments as principal prepayments in writing, and could not use his bank to send the payments electronically.

The court found that Jefferson’s declaration did implicitly allege reliance. (He denies Chase told him that he couldn’t use the automatic payment function.) He declared that he continued to send in payments and was told he’d have to send a written request “despite” the payment coupon representation – that was enough to raise a triable issue of fact on reliance.

Jefferson’s false advertising law claims were easier, because he didn’t need to show actual deception, only likely deception. Chase argued that its monthly statements to existing customers weren’t ads or “statements to the public” covered by the law. The representations were made to consumers, in documents “likely to induce them to send their money to Chase,” and California courts have construed statements made to people about their loans as advertising within the scope of the false advertising law. This, and Jefferson’s unfair competition claims, survived summary judgment for now.

So did his conversion claim, because he alleged that Chase was bound by its representations to credit the prepayments to his principal balance immediately, and by keeping the funds in suspense, Chase interfered with his possession of the funds. Chase argued that Jefferson failed to inform Chase in writing that his payments should go to principal. But he did so; he just didn’t attach the writing to each check, but nothing in the note required attachment.