by Aaron B. Millar
The latest statistics show that although the Utah foreclosure rate has decreased, Utah foreclosures are still quite high relative to the nation. In Q3 2011, one in 145 Utah homes was in foreclosure, sixth highest in the nation. See http://knowledgebase.findlaw.com/kb/2011/Dec/504952.html. Consumers often turn to consumer protection statutes, such as the federal Truth in Lending Act (“TILA”), for protection against foreclosing lenders.
Imagine this scenario: Hours before the foreclosure sale, the mortgage lender receives a fax from the defaulting borrower’s lawyer stating that the borrower rescinds the loan and that the lender is obligated to reconvey its deed of trust because the finance charge in the loan disclosures was understated by $36. The borrower further demands that the lender return all of the fees and interest payments the borrower made on the loan. Possible? Yes. Many lenders have been unprepared to confront a rescission demand under TILA. Given the tight statutory time frame and the risks involved, the lender must proceed expeditiously and with caution when responding to a rescission demand.
TILA is a strict liability statute that requires lenders to provide certain notices and disclosures to consumers so that the consumer can shop interest rates. Failure to provide accurate disclosures subjects lenders to TILA’s damages and rescission remedies. If a consumer elects to rescind the loan transaction, a lender can lose its security interest in the property and be required to pay back all fees, costs, and interest payments that it received from the borrower. Just as daunting, the lender has a mere twenty days to rescind upon receipt of the borrower’s rescission notice. After the lender fulfills its obligations, the borrower must tender the loan proceeds. The lender’s failure to rescind can result in severe penalties. In one case outside of Utah, for example, the court held that because the lender failed to accept the borrower’s valid rescission notice, the borrower did not have to tender and was able to keep the loan proceeds. See Family Fin. Servs v. Spencer, 677 A.2d 479 (Conn. App. Ct. 1995).
Notwithstanding the potentially draconian nature of rescission, the narrow drafting of TILA and the equities taken by federal courts in Utah have limited its application. Thus, a proper TILA analysis will often show that the loan at issue affords no right of rescission. The following is an issue checklist for lenders to consider upon receiving a rescission notice:
Has the statute of limitations run on the TILA rescission claim?
The TILA rescission remedy is popular among consumers because it expires three years after the loan consummation if “right of rescission” or accurate material disclosures are not given to the borrower. (In contrast, a TILA claim for damages has a short, one-year statute of limitations.) The U.S. Supreme Court has held that even if the rescission claim is brought as a defense to a foreclosure proceeding, or is in the nature of “recoupment,” the three-year period is not extended. See Beach v. Ocwen Fed. Bank, 523 U.S. 410, 416 (1998). If the borrower files for bankruptcy protection before the three-year period has run, however, the statute of limitation is extended two years.
Is the subject transaction a refinancing or a purchase money transaction?
Only refinance transactions secured by the consumer’s principal dwelling have a rescission right under TILA, not loans for the purchase or construction of that property. Even if only a portion of the loan proceeds is used to construct or purchase the dwelling, the consumer may not rescind the loan.
What was the consumer’s purpose in obtaining the allegedly offending loan?
Only loans obtained for personal, family, or household purposes are covered by TILA. The security for the loan is not determinative of the loan’s “purpose.” For example, if the borrower gives a trust deed on his home as security for a loan to further his business, the loan is not protected by TILA. To determine whether the purpose of the loan is for consumer purposes, the majority of courts look at the purpose of the original loan, not the subsequent purpose for which that loan was later refinanced.
Has the borrower alleged his ability to tender the amount of the loan?
Under TILA, the borrower need only tender the loan proceeds after the lender rescinds the loan. The majority of courts, however, have exercised their equitable powers to condition rescission on the borrower’s tender. Although the Tenth Circuit has not considered this issue, Judge Kimball followed the Circuit majority and twice held that unless the plaintiff alleges the ability to repay the loan in the borrower’s rescission notice and subsequent complaint, the TILA rescission claim may be dismissed on a motion to dismiss. See Black v. First Choice Fin., LLC, 2011 U.S. Dist. LEXIS 133317, at **5-6 (D. Utah Nov. 18, 2011) (quoting Sanders v. Ethington, 2010 U.S. Dist. LEXIS 133996 (D. Utah Dec. 16, 2010)).
This view is not unanimous in Utah. Judge Campbell, for example, held that a failure to allege repayment ability is not a proper consideration on a motion to dismiss because alleging the ability to tender is not required by TILA. See McGinnis v. GMAC Mortg. Corp., 2010 U.S. Dist. LEXIS 90286, at *14 (D. Utah Aug. 27, 2010). Judge Campbell also noted that generally the borrower must demonstrate an ability to tender the loan proceeds to survive a summary judgment motion. See id. at *13.
The minority of courts have denied conditional rescission, holding that the lender’s obligation to rescind is not dependent on the borrower’s ability to tender the loan amount.
Is the alleged TILA violation a material disclosure violation or a technical violation?
If only a technical violation is alleged, rescission is unavailable – only TILA damages may be available, though subject to the one-year statute of limitations. See id. at *11.
Two copies of the notice of the right to rescind must be given to each person who both (1) lives in the dwelling; and (2) has an ownership interest in the dwelling, even though that person may have no personal obligation for the debt.
With respect to other required disclosures, the failure to accurately disclose any of the following will be considered a material violation subject to a three-year right of rescission: (1) annual percentage rate or “APR,” (2) finance charge,1 (3) the amount financed, (4) the sum of the amount financed and the finance charge (termed the “total of payments”), and (5) the number, amount and due dates of payments to repay the total of payments.
Has the home been sold?
The right of rescission expires once the home is sold or title is transferred.
Has the original lender assigned the loan?
As it relates to TILA rescission, any consumer who has the right to rescind a transaction against the lender may rescind the transaction as against any assignee of the lender.
Is the subject transaction a refinancing (with no new advances) of an existing extension of credit by the same lender?
In some cases, consumers with equity in their homes have refinanced their home mortgage with the same lender multiple times in order to obtain a better interest rate. Such a consumer may be unable to rescind this refinancing transaction. A federal district court in Utah recently declined to rescind a refinanced loan obtained from the same lender that had originated the original loan. See Wright v. Residential Acceptance Network, 2011 U.S. Dist. LEXIS 104305 (D. Utah Sept. 14, 2011). The Wright court’s rationale: TILA affords no rescission right for “a transaction which constitutes a refinancing or consolidation (with no new advances) of the principal balance then due and any accrued and unpaid finance charges of an existing extension of credit by the same creditor secured by an interest in the same property.” 15 U.S.C. § 1635(e)(2).
Has the borrower already refinanced the allegedly offending loan?
Some courts disallow rescission of a loan subsequent to refinancing since refinancing eliminates any security interest (and rescission results in the removal of a security interest). Thus, these courts have concluded that refinancing “supersedes” the deed of trust (security interest) underlying the original loan.
Other jurisdictions have allowed rescission of a refinanced loan, noting that TILA and applicable regulations refer to a right to rescind the transaction, not just a right to rescind the security interest, and rescission would also entitle mortgagors to finance and other charges.
Federal district courts in Utah have not determined whether a loan can be rescinded after it has been refinanced.
A lender must act decisively when faced with a notice of rescission. If the creditor determines that the subject loan transaction may not be rescinded under TILA, then the lender should promptly petition the court for a declaration of its rights.
If the lender determines that the loan is subject to rescission, then the lender should immediately petition the court for an order allowing the lender to condition the reconveyance of its security interest on the tender of the loan proceeds the borrower received. Without such an order, after the lender reconveys its deed of trust, the borrower could sell or encumber the real property. The borrower could use the funds to pay off other debts that are non-dischargeable in bankruptcy. When the lender sues the borrower for failure to return the loan proceeds, the borrower could wait until the bankruptcy preference period had run, then file Chapter 7 bankruptcy to discharge the borrower’s duty to tender the loan proceeds to the lender, leaving the lender with a total loss on its loan. Faced with this possibility, many courts order that the deed of trust will not have to be reconveyed until the borrower tenders back the loan proceeds.
Regardless of the approach taken, the lender should take deliberate action to preserve its rights.
1. If the creditor has not yet instituted foreclosure proceedings when the borrower rescinds, the creditor’s finance charge disclosure must come within one-half of one percent of the total amount of the loan to be within the permissible range of accuracy. If the creditor has initiated foreclosure, the disclosure of the finance charge will be regarded as accurate “if the amount disclosed…does not vary from the actual finance charge by more than $ 35 or is greater than the amount required to be disclosed.” 15 U.S.C. § 1635(i)(2).