Clark resolves the question of whether the three percent (3%) limitation on permissible points and fees under Section 4.1a of the Illinois Interest Act (815 ILCS 205/4.1a(f)) (the "Act") has been preempted by the federal Depository Institutions Deregulation and Monetary Control Act of 1980 ("DIDMCA") (12 U.S.C. §1735f-7a (2000)). On September 22, 2005, the Illinois Supreme Court justices unanimously ruled that DIDMCA did, in fact, preempt the 3% cap on points and fees where the nominal interest rate of a mortgage loan in Illinois exceeds 8%. The Court also held that an amendment to Section 4 of the Act in 1981 implicitly repealed Section 4.1a in 1981.

From 1995 to March, 2004, lenders originating mortgage loans in Illinois operated under the authoritative opinions of courts, the Illinois Attorney General and the Illinois Office of Banks and Real Estate, which concluded that DIDMCA preempted the 3% cap under the Act. However, the March, 2004 decision of the Illinois Appellate Court (First District) in Clark effectively reversed this prevailing opinion by concluding that Illinois had "opted out" of DIDMCA in 1992 when the Act was modified. Click here to read our June, 2004 article on the Appellate Court decision in Clark and the audit Document Systems, Inc. ("DSI") implemented in response.

The Clark case arose out of separate foreclosure actions brought by the plaintiff creditors. These creditors filed for foreclosure against a number of homeowners who were in arrears with their mortgage payments. The defendant homeowners filed counterclaims and affirmative defenses that included allegations that the creditors had violated the Act by imposing fees in excess of 3% on loans with interest rates greater than 8%. The trial court dismissed those counterclaims, ruling that the homeowners' claims under the Act were preempted by DIDMCA and, in some cases, by the federal Alternative Mortgage Transaction Parity Act of 1982 ("Parity Act") (12 U.S.C. §3803(c) (2000)). The cases were later consolidated, and the homeowners filed an appeal.

The appellate court reversed the trial court decision, relying, in part, on its prior decision in Fidelity Financial Services, Inc. v. Hicks, 214 Ill. App. 3d 398 (1991). The Hicks court held, among other things, that the 3% fee cap in Section 4.1a of the Act was not implicitly repealed when the Illinois legislature amended Section 4 of the Act, by allowing any rate or amount of interest or compensation for loans secured by a real estate mortgage. In addition, the appellate court in Clark declined to follow conflicting federal authority in Currie v. Diamond Mortgage Corp. of Illinois, 859 F.2d 1538 (7th Cir. 1988), which held that Section 501 of DIDMCA preempted Section 4.1a. Instead, the appellate court in Clark held that 1992 amendments to Section 4.1a of the Act and its reenactment reflected the Illinois legislature's intent to "opt out" of DIMCA.

To resolve the issue of whether DIDMCA preempted Section 4.1a and whether Section 4.1a was implicitly repealed by amendments to Section 4, the Illinois Supreme Court accepted the Clark lenders' appeal of the appellate court's decision.

DIDMCA is federal legislation that preempts every existing state limitation on the rate or amount of interest, discount points, finance charges, or other charges (collectively, "points and fees") which may be charged, taken, received, or reserved on any loan, mortgage, credit sale, or advance which is secured by a first lien on residential real property made after March 31, 1980 and described in Section 527(b) of the National Housing Act unless a State "opted out" of the federal preemption. A State could "opt out" in one of two ways. Under one method, a State must have, by April 1, 1983, adopted a law or certified that its voters have voted in favor of any provision, constitutional or otherwise, which states explicitly and by its terms that such State does not want the preemption provisions of DIDMCA to apply. Another method of opting out is for the State, at any time after March 31, 1980, to adopt a statute that places limitations on points and fees on any loan, mortgage, credit sale, or advance described in DIDMCA.

Section 4.1a Implicitly Repealed by 1981 and 1982 Amendments to Section 4 of Act

The creditors in Clark claimed that amendments made to Section 4 of the Act implicitly repealed Section 4.1a of the Act. In 1981, the Illinois legislature had amended Section 4 to enable lenders to "charge, contract for, and receive any rate or amount of interest or compensation with respect to" loans "secured by a mortgage on residential real estate." In 1982, Section 4 was again amended to remove the word "residential" from the foregoing provision, enabling lenders to receive any rate or amount of interest or compensation on any real estate mortgage. By permitting any rate or amount of interest or compensation to be charged on any real estate mortgage, the creditors in Clark contended that the legislature's amendments to Section 4 in 1981 and 1982 implicitly repealed Section 4.1a's 3% cap on mortgage loans bearing interest rates above 8%.

Finding "no functional distinction between the noninterest 'compensation' in Section 4 and the noninterest 'charges' in Section 4.1a of the Act, the Illinois Supreme Court concluded that Section 4 and Section 4.1 were "irreconcilably inconsistent." (citations omitted.) The Supreme Court expressly overruled the reasoning reached in Hicks and ruled that the 1981 amendments to Section 4 implicitly repealed Section 4.1a's limitation on noninterest charges (points and fees) that lenders may impose on residential mortgage loans.

DIDMCA Preempted 3% Cap in Section 4.1a

In reaching its decision that Illinois did not "opt out" of DIDMCA and, therefore, DIDMCA preempted the 3% cap in Section 4.1a, the Supreme Court determined that DIDMCA applied not only to first-lien purchase money loans, but to first-lien, non-purchase money loans (e.g., refinancings) as well. The Court determined that the State of Illinois did not "opt out" of DIDMCA by adopting a law or certifying that its voters voted in favor of a provision which stated explicitly and by its terms that the State did not want DIDMCA to apply.

-- 1992 Amendment to Section 4.1a Was Not an "Opt Out" from DIDMCA

Since the Supreme Court found that Illinois had not expressly "opted out" of DIDMCA by statute or vote, the Court explored the possibility that Illinois may have "opted out" of DIDMCA in 1992 under the alternative method of opting out -- adopting a law after March 31, 1980, that placed limitations on discount points or such other charges on any loan, mortgage, credit sale or advance. In 1992, two fee categories in Section 4.1a, which were unrelated to points and fees, were removed from the types of charges governed by that Section. These amendments allowed lenders to charge fees for dishonored checks and late payments and established that these fees would not be considered lender charges as consideration for the loan (i.e., points and fees) referred to in Section 4.1a.

The homeowners contended that if the relevant portion of Section 4.1a was implicitly repealed in 1981 by the amendment to Section 4 of the Act, the 1992 amendment constituted its "readoption" and reflected the legislature's intent to revive the preempted points and fees limitation. The creditors, on the other hand, argued that the 1991 amendment could not be considered new opt-out legislation. Secondly, the creditors maintained that the amendment did not limit points as required by one of the "opt-out" provisions of DIDMCA, because the 1992 amendment amended a portion of Section 4.1a that is unrelated to the points and fees limitations.

Relying on a prior Illinois Supreme Court decision which held that the legislature "must expressly reenact a statute which has been repealed by implication to render it valid and enforceable again," the Supreme Court declined to follow the homeowners' line of argument that Section 4.1a was readopted or reenacted. The Court found that the text of the amendment or its legislative history did not reflect the legislature's "express" intent to "reenact" the 3% cap on lender charges. Accordingly, the Supreme Court determined that Illinois had not "opted out" of DIDMCA by adopting a law that placed limitations on points and fees.

By reversing the appellate court's decision in Clark, the Illinois Supreme Court has ended approximately 20 years of uncertainty and litigation about whether "points and fees" are limited to a 3% cap under Illinois law and whether DIDMCA has preempted Section 4.1a of the Act.

Melanie A. Feliciano is Assistant General Counsel of Document Systems, Inc. ad a member of its Compliance Department.