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State Preempts City

Cleveland predatory law struck down

November 27, 2006

WASHINGTON correspondent for MortgageDaily.com

Ohio's top state court has struck down the city of Cleveland's attempt to outlaw predatory lending.

In a 5-2 decision, the Supreme Court of Ohio ruled last week that three Cleveland city ordinances -- stricter than existing state laws on the controversial practice -- could not stand because the ordinances conflict with state law by prohibiting practices within the city that are permitted under state statutes.

The majority opinion, written by Justice Terrence O'Donnell, concluded that "any ordinances that seek to prohibit conduct that the state has authorized are in conflict with the state statutes and are therefore unconstitutional."

Cleveland-based attorney John Read told MortgageDaily.com the decision could be good news for both lenders and consumers. He said lenders who have been skittish about making loans in Ohio communities because of the "patchwork quilt of regulations" with which they had to comply could be encouraged by the decision to enter the Ohio market. Dayton, Toledo and Akron also have anti-predatory lending laws on the books.

Read, a partner with Vorys, Sater, Seymour and Pease, argued the case challenging Cleveland's law for the American Financial Services Association, a national trade organization representing consumer lending institutions.

Read also said the court's decision could positively affect the securitization of mortgages made in Ohio because it could eliminate investors' wariness over buying mortgages written in Cleveland or Toledo because they potentially could not be packaged with other mortgages written in Ohio because of a difference in the terms.

Although a lawsuit involving Toledo and its anti-predatory lending laws is pending in the state's Supreme Court, Read said he believes last week's decision invalidates anti-predatory lending laws passed by the other Ohio cities.

The lawsuit involved three ordinances adopted by Cleveland in 2002 that prohibited various predatory lending practices by consumer lenders doing business in the city. The city laws were much stricter than the state laws.

Shortly after the ordinances were adopted, the trade group challenged the laws in court. The organization argued that the ordinances were in conflict with legislation enacted earlier that year by the Ohio General Assembly that set up guidelines for all residential mortgage lenders doing business in Ohio.

Ohio's high court rebuffed the city's attempt to regulate in the area.

"The Cleveland ordinance purports to regulate loans with interest rates three and a half percentage points below those that the state regulates" wrote Justice O'Donnell. "In addition to a lower threshold for regulation, the municipal ordinance imposes stricter standards and additional requirements on lenders through mandatory loan counseling for the borrower ... The ordinance also prohibits any direct payments to home-improvement contractors of the proceeds of any residential loan having an interest rate within the specified ranges, and provides criminal penalties for certain violations of the ordinance. Thus Cleveland has undertaken to regulate the making of a loan authorized by the General Assembly. This is directly contradictory to [existing case law] because these ordinances seek to forbid what the statutes allow. Accordingly, the loan regulations of the ordinances are unconstitutional."

The city said it had the authority to put the ordinances into place under Ohio's home rule law, which allows cities and villages to govern themselves.

The majority decision had its detractors. Justice Maureen O'Connor concurred in the judgment only and wrote a separate opinion explaining her belief that the court should have placed more emphasis on the issue of preemption as opposed to the conflict analysis between the city and state law reflected in the majority opinion.

Justice O'Connor suggested that clear judicial recognition by Ohio courts of the state's authority to preempt local regulation in matters of statewide concern, which she found applicable in this case, would reduce litigation over alleged conflicts between state and local regulations and speed the resolution of conflicts that do arise. "State dominance in this area is not only a historical reality but a present day necessity," she wrote.

Justices Alice Robie Resnick and Paul E. Pfeifer wrote separate dissenting opinions. Both rejected the majority's holding that a state statute prohibiting interest rates and loan charges above a certain percentage as "predatory" should be read as implicitly permitting lending institutions to impose any rate or charge lower than the prohibited state limit.

"I would hold that the regulation of mortgage rates is more appropriately dealt with at the local level," Pfeifer wrote.

In making the decision, the top court reversed an appellate decision and agreed to hear arguments in the case to resolve a conflict among the state's appellate districts.

But Ohio's cities aren't the only ones grappling with how best to fight predatory lending.

Earlier this year, the Montgomery County council in Rockville, Md., passed a predatory lending ordinance that was temporarily halted at the last minute by the Montgomery County Circuit Court. The court held a final hearing on July 6. It has not yet issued a final ruling on that hearing.

And Ohio isn't the only state Supreme Court that has ruled that regulatory authority for mortgage lending lies at the state level. The California Supreme Court reached the same conclusion in 2004.

Lisa D. Burden is a legal analyst for MortgageDaily.com and holds a law degree from the University of Maryland. She is currently a freelance journalist who previously wrote for Institutional Investor publications and the Baltimore Daily Record.

e-mail Lisa at: [email protected]

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