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From Banking and Finance Law Daily, July 12, 2013

Right to rescind mortgage loan must be exercised by filing suit, not just giving notice

By Richard A. Roth, J.D.

Consumers who wanted to rescind their home mortgage refinancing loans based on claims of faulty disclosures were required to file suit within three years of the loan transaction closing, the U.S. Court of Appeals for the Eighth Circuit has determined. Simply sending a written notice within the three-year term was insufficient, the court declared (Keiran v. Home Capital, Inc., July 12, 2013, Beam, Circuit Judge).

When a consumer borrows money and gives an interest in his home as security, the Truth in Lending Act gives the consumer an unconditional three-day right of rescission (unless the loan is to finance the purchase of the home). If the lender fails to give the consumer the notices required by TILA and Reg. Z—Truth in Lending (12 CFR 1026), the right to rescind is extended to three years. In the two cases that were consolidated by the court, the consumers made the same claims—that they were not given the required disclosures because they received only one copy of the notice of their right to rescind, rather than the required two copies apiece, and that they had exercised their right to rescind by sending a written notice to their creditors within three years of the loan closings.

The trial courts in both cases rejected the consumers’ claims. Both judges determined that if the consumers wished to rescind their loans they were not only required to notify the creditors but, if the creditors refused to agree to a rescission, they were required to file suit within the three-year term.

Law and regulation. The right to rescind is created by 15 U.S.C. §1635. The three-year time limit is set by paragraph (f), which says the right “shall expire three years after the date of consummation of the transaction” . . . As applicable to the two suits, Reg. Z, at 12 C.F.R. §1026.23, says “To exercise the right to rescind, the consumer shall notify the creditor by mail . . . Notice is considered given when mailed . . .”

The precise issue before the Eighth Circuit was whether giving written notice within the three-year term would preserve the right to rescind so that it could be asserted in a suit filed more than three years after the loan was closed.

Conflict among the circuits. That issue has been considered and decided by four other U.S. appellate courts. However, those four circuits are evenly divided on the question. Two have taken the consumer-friendly path, deciding that a written notice to the consumer would preserve the right to rescind—the Fourth Circuit in Gilbert v. Residential Funding LLC and the Third Circuit in Scherzer v. Homestar Mortgage Services. These courts found that nothing in TILA or Reg. Z mentioned a need to file a suit and that the duty should not be imposed on consumers given that TILA was intended to be a consumer protection law.

On the other hand, two circuits have sided with creditors—the Tenth Circuit in Rosenfield v. HSBC Bank USA and the Ninth Circuit in McOmie-Gray v. Bank of America Home Loans. These courts expressed concern over the practical difficulties that would face creditors if a consumer could preserve a right to rescind indefinitely simply by sending a letter. Moreover, the justification for rescission is “remedial economy,” which would not be furthered by allowing a rescission claim to live on after unwinding a transaction became difficult, these courts said.

These circuits also pointed to a U.S. Supreme Court decision as support for their interpretation of the three-year limit. In Beach v. Ocwen Federal Bank, consumers who had made no previous effort to rescind their loan attempted to use the right of rescission as a defense in a collection suit filed outside of the three-year term. The Supreme Court said that the right to rescind ended after three years.

Court’s decision. The Eighth Circuit said it was persuaded by the factors that prevailed in Rosenfield and that the consumers were required to file suit within the three-year term if they wished to preserve their rescission rights. The nature of rescission and the practical problems that would face creditors were “compelling reasons,” the court said, and the Supreme Court precedent in Beach supported the decision.

Reg. Z did say that a consumer needed to give the creditor a written notice to rescind a loan, but it did not say that was the only thing the consumer needed to do, the court reasoned. While neither the law nor the regulation said anything about filing suit, litigation would be needed to accomplish a rescission in most situations.

The court also rejected the theory put forward by the Consumer Financial Protection Bureau, as amicus curiae, that the creditor, not the consumer, should have to file a suit once the rescission notice was delivered. This would allow a consumer unilaterally to put a cloud on the creditor’s title, the court worried.

Damages for refusing to rescind. The consumers were briefly given hope for relief through a different avenue—a claim for damages arising from their creditors’ failures to rescind after the rescission notice was given. A refusal to rescind based on a proper demand would violate TILA, the court said, and that claim would accrue not at the loan closing but when the consumers’ demand for rescission was denied. The consumers’ damages claims had been filed within the applicable one-year statute of limitations, the court also said.

However, the consumers had not sued the proper creditors. In both cases, the consumers had demanded a rescission and damages from creditors that had received assignments of the loans from the original lenders. An assignee can be sued for the original lender’s TILA violations only if the violations were apparent from the face of the transaction documents, the court pointed out. Since both pairs of consumers had signed statements at their loan closings acknowledging their receipt of the proper number of right-to-rescind notices, any possible violation could not have been apparent from the loan documents, the court concluded.

Dissent. A dissenting opinion categorically rejected the majority’s logic. The ruling was contrary to the plain language of TILA, to the intent of the law, and to the interpretation of the CFPB, which was charged with enforcing the law, the dissenter argued. According to the dissenting opinion, the majority had interpreted a law that was to be construed in favor of consumers in a way that was “broadly in favor of lenders.”

The law never required that consumers file suit to exercise their right to rescind, according to the dissent. These consumers had done precisely what TILA and Reg. Z required.

The dissenting judge also asserted that Beach was irrelevant. The consumers in Beach had done nothing to exercise their right to rescind until five years after the loan closed. The only lesson from Beach is that the right to rescind had to be exercised within three years, the dissent said; the Supreme Court had said nothing about how the right was to be exercised.

Moreover, a creditor would not have to worry about the validity of its mortgage if a right to rescind could be exercised simply by the consumer’s notice. Once a notice was delivered, “the lender may choose to negotiate or it may choose to litigate, but it can never be subject to an indefinitely clouded title without its own tacit consent,” according to the dissent.

The consolidated cases are No. 11-3878 and No. 12-1053.

Attorneys: Jeramie Steinert (The Advisory & Intermediary Group LLC) for Alan G. Kieran. Aaron Daniel Van Oort (Faegre & Baker) for Home Capital, Inc. and BAC Home Loans Servicing, L.P.

Companies: BAC Home Loans Servicing, L.P.; Bank of New York Mellon; Countrywide Home Loans Servicing, LP; Home Capital, Inc.; Mortgage Electronic Registration Systems, Inc.

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