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From Banking and Finance Law Daily, May 30, 2014

Borrowers’ right to rescind mortgage not a guarantee of ability to do so

By Richard A. Roth, J.D.

Mortgage loan borrowers who had a three-year right to rescind their mortgage loans due to inadequate Truth in Lending Act disclosures were not entitled to rescission procedures that would assure their practical ability to implement the right, the U.S. Court of Appeals for the Seventh Circuit has decided. Rescission is an equitable remedy, the court said, and TILA gives courts the authority to structure the process in a manner that is fair to both borrowers and creditors. In the circumstances of this case, it was fair to require the borrowers to tender the amount they owed before the creditors released their security interests, reject the borrowers’ proposed installment payment plan, and give the borrowers only 90 days to produce the required funds (Iroanyah v. Bank of America, May 28, 2014, Cudahy, Circuit Judge).

TILA and Reg. Z—Truth in Lending (12 CFR Part 1026) give a mortgage loan borrower the right to rescind a mortgage loan transaction within three days of closing, and they extend that right to three years if necessary TILA disclosures are not properly given (see 15 U.S.C. §1635 and 12 CFR §1026.23). While the right of rescission is unilateral, it does not apply to some transactions, such as purchase-money mortgages.

Rescission suit. Taylor Bean & Whitaker Mortgage Corporation made two loans to the borrowers that were secured by their home and thus covered by the right to rescind. The borrowers eventually became unable to make the required payments and, when TBW and the loan assignees moved to foreclose, the borrowers sent rescission notices. The federal district court judge determined that the TILA disclosures given to the borrowers at closing were deficient, which afforded the borrowers the three-year rescission term.

After deciding the loan transactions could be rescinded and calculating the amount the borrowers were obligated to repay, the judge exercised his authority under 15 U.S.C. §1635 to specify the rescission process to be followed. First, he reversed the standard procedures and specified instead that the borrowers were required to repay the creditors before the creditors were obligated to release their security. Second, he rejected the borrowers’ suggestion that they should be permitted to repay that amount by making interest-free installment payments over the terms of the original loans. Third, he specified that the borrowers were required to tender the full amount they owed within 90 days; otherwise, he intended to rule in favor of the creditors on the rescission issue.

The borrowers were unable to pay what they owed the creditors, and the judge subsequently dismissed their rescission claim. The borrowers appealed.

Tender before release of security. According to the appellate court, the borrowers offered “two mutually incongruous propositions” to support their claim that the judge improperly required them to repay the creditors before the mortgages were released. First, they claimed that the security interest was voided automatically as soon as they exercised their right to rescind. This meant rescission could not be conditioned on repayment.

On the other hand, the borrowers conceded that the judge could require them to repay the creditors first but argued that they were entitled to the reduction in what they owed, by subtracting the amount of interest and fees they had already paid, regardless of whether they were able to repay the creditors. In other words, they were entitled to a reduction in what they owed regardless of whether they were able to repay the creditors and secure a release of the security interests.

These positions arose from the borrowers’ incorrectly interpreting TILA and Reg. Z to create a fully unconditional right of rescission, the court said in rejecting their arguments. There are two sides and a number of steps to a rescission, and the borrowers’ obligation to tender what they owe the creditors “is inherently part of rescission.” If a borrower is unable to pay the creditor what is owed, rescission may be impossible, the court observed.

Rescission is an equitable process that is intended to unwind the entire transaction, the court said. If any part of the transaction will survive, whether it is the security interest or the repayment obligation, rescission cannot take place.

Installment payments. The borrowers’ repayment plan would have created a 26-year-long, interest-free installment plan, according to the appellate court. The district court judge was right to decide this would be inequitable.

To begin with, the original lender that was responsible for the deficient disclosures was closed. The remaining creditors had liability under TILA, but for the errors of another company. The deficiencies were “hyper-technical disclosure deficiencies” the borrowers conceded had caused no harm. Also, by the time of the decision, the borrowers had been living in the home without making any payments for several years, which was a substantial benefit. Turning the original transaction into an interest-free loan would create “a wholly unreasonable installment plan,” the appellate court said.

A court does have the power under TILA to create an installment plan, the appellate court noted. However, the district court judge had no obligation to create an installment plan after rejecting what the borrowers proposed.

Repayment deadline. The borrowers complained that the 90 days allowed by the judge was not long enough to allow them to repay what they owed the creditors. However, the borrowers were entitled to an equitable plan, the appellate court said, which would not necessarily be a plan that actually would work under all of the circumstances. Rescission was a powerful right, but there was no guarantee that the borrowers would be able to satisfy equitable rescission terms, according to the court.

The appellate court noted that the borrowers in fact made no effort to secure the financing they needed and that they gave the district court judge no evidence that securing financing within 90 days would have been impossible.

The case is No. 13-1382.

Attorneys: Lloyd J. Brooks (Brooks Law Firm) for Wilson Iroanyah. James D. Adducci (Adducci, Dorf, Lehner, Mitchell & Blankenship) for Bank of America, NA, and Green Tree Servicing, LLC. Douglas R. Sargent (Locke Lord LLP) for Taylor, Bean & Whitaker Mortgage Corp.

Companies: Bank of America, NA; Bank of New York Mellon; Green Tree Servicing, LLC; Mortgage Electronic Registration Systems, Inc.; Taylor Bean & Whitaker Mortgage Corporation.

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