Reversing the ruling of the lower court, the U.S. Court of Appeals for the Third Circuit recently held that a borrower need only send a written notice of rescission within three years of a loan transaction to exercise his rescission right under TILA, concluding that a borrower is not additionally required to file a law suit within that period to rescind the loan transaction.
In so ruling, however, the Court also noted in part that: (1) beyond the initial absolute three-day right-to-cancel period, "notice-only" rescission is effective only if a borrower has a "valid" TILA claim for rescission, but a lender may file suit to resolve any uncertainty in that regard; and (2) consistent with section 1635's purpose to restore parties to their pre-loan positions, in order to protect the creditor after rescission, a court may condition the release of the lender's security interest on the borrower's tender of any loan proceeds.
A copy of the opinion is available at: http://www.ca3.uscourts.gov/opinarch/114254p.pdf.
Plaintiffs-borrowers ("Borrowers") obtained two separate loans that were secured by mortgages on their residence. Within three years of the loan closing, Borrowers notified the original lender and the current loan owner (collectively, "Lenders") that they were exercising their right to rescind the loan agreements under the federal Truth in Lending Act ("TILA"), asserting that the original lender failed to provide all the disclosures required under TILA.
The loan owner agreed to rescind the smaller of the two loans, but refused to allow rescission as to the other loan, claiming that the original lender had not materially violated TILA's disclosure requirements.
Borrowers then filed suit against Lenders over three years after their loan closing date, seeking among other things damages and a declaration of rescission. In response, Lenders filed a motion for judgment on the pleadings, arguing that suits for rescission filed more than three years after a loan's closing were time-barred, even if the borrower had sent notice of rescission within that three-year period.
Borrowers argued that they had already exercised their right to rescind by mailing Lenders a written notice and that they were not required to also file suit within the three-year rescission period. The lower court agreed with Lenders, granted the motion on the pleadings, and dismissed the case. Borrowers appealed.
The Third Circuit reversed, reasoning in part that written notice alone is sufficient to exercise the right of rescission, and that in the Court's view nothing in TILA suggests that a lawsuit must be filed within three years of a loan transaction in order to preserve the right to rescind.
As you may recall, section 1635 of TILA provides in part: "the obligor shall have the right to rescind the transaction . . . by notifying the creditor, in accordance with regulations . . . of his intention to do so." 15 U.S.C. § 1635(a). TILA's implementing regulation, Regulation Z, in turn, provides that such notice must be sent "by mail, telegram, or other means of written communication." 12 C.F.R. §§ 1026.15(a)(2), 1026.23(a)(2).
In addition, TILA further provides that: (1) after the borrower "exercises his right to rescind," the lender must return within 20 days of receiving notice of rescission any money or property that it received as earnest money or downpayment, "and shall take any action necessary . . . to reflect the termination of any security interest created under the transaction" ; and (2) the obligor becomes obliged to tender any property he has received from the lender "[u]pon the performance of the creditor's obligations." 15 U.S.C. § 1635(b).
Finally, TILA's Section 1635(f) provides that [a]n obligor's right of rescission shall expire three years after the date of [the loan] transaction or upon the sale of the property, whichever occurs first . . . ." 15 U.S.C. § 1635(f).
Disagreeing with Lender's position that a borrower must file a complaint within three years of a loan closing in order to rescind, the Third Circuit relied on what it viewed as TILA's plain language in concluding that Borrowers exercised their right to rescind when they sent the rescission notice to the lender.
In so doing, the Court rejected the reasoning adopted by numerous other courts, opining that Lenders' reliance on the U.S. Supreme Court's opinion in Beach v. Ocwen was misplaced, given that the Supreme Court did not address specifically whether a borrower must send both written notice and file suit within three years of the closing date. See Beach v. Ocwen Fed. Bank, 523 U.S. 410, 411-13 (1998)(addressing question whether borrowers who failed to provide notice of rescission within the three-year period may later assert rescission as an affirmative defense in foreclosure proceedings). See also, e.g., Rosenfield v. HSBC Bank, USA, 681 F.3d 1172, 1188 (10th Cir. 2012)(rejecting notice-only view); Yamamoto v. Bank of New York, 329 F.3d 1167, 1172 (9th Cir. 2003); Large v. Conseco Fin. Servicing Corp., 292 F.3d 49, 54-55 (1st Cir. 2002). But see Williams v. Homestake Mortgage Co., 968 F.2d 1137, 1139-40 (11th Cir. 1992)(rescission occurs automatically upon notice); Gilbert v. Residential Funding LLC, 678 F.3d 271, 277-78 (4th Cir. 2012)(ruling that notice within three years of the closing is sufficient for rescission).
Noting among other things the absence of any specific references in section 1635 to "causes of action" or "commencement of suits" and agreeing with the position of the Consumer Financial Protection Bureau, which filed an amicus brief in this case, that mere written notice suffices to accomplish rescission, the Court explained that any subsequent legal action would be limited to an examination of whether a valid rescission had occurred and, if so, enforcement of the parties' respective obligations post-rescission.
Further finding support for its interpretation, the Court noted that section 1635(b) provides that the creditor must return money or property to the borrower "'[w]ithin 20 days after receipt of a notice of rescission' – not within twenty days of a court order stating that the obligor is entitled to rescind."
Moreover, stressing TILA's remedial nature, and thus liberally construing its provisions, the Third Circuit addressed Lenders' various concerns, including Lenders' assertion that it would be "problematic" for a court to conclude that rescission occurred after the three-year period because there would be no "right to rescission" to enforce at the time of the lawsuit. In so doing, the Court noted that "while the obligor no longer has the right to rescission after the three-year period has passed, he does have the right to the return of his property and to clear title – the rights flowing from rescission – and it is these rights that permit him to bring suit." Thus, comparing the operation of the three-year period to the three-day absolute right of rescission, the Court explained that borrowers who "have exercised" their right to rescind may file suit after the three-year period has passed.
The Third Circuit also gave only passing attention to Lenders' assertions that the court's "notice-only" interpretation: (1) allowed borrowers to unilaterally and instantly void a lender's security interest, even in instances where the borrower has received all required disclosures; (2) increased uncertainty with respect to title to collateral, particularly in foreclosure situations; and (3) would increase costs for both consumers and lenders generally. In doing so, the court stressed that its interpretation hinged on obligors having only "valid" TILA claims against lenders for disclosure violations.
Pointing out that the uncertainty as to the status of a security interest in a foreclosure situation is limited to those loans for which borrowers sent a notice of rescission within the three-year period, the Court stated that lenders could either sue to confirm the validity or non-validity of a purported rescission or do nothing, and thus assume the risk that a court might rule that the rescission was valid.
With respect to Lenders' argument that their security interest "becomes void" as of the moment of delivery of a demand for rescission, the Third Circuit pointed out that when a borrower fails to tender any loan proceeds disbursed to him, "courts are not required to treat the lender as an unsecured creditor" but may condition the release of a security interest on the return of the loan proceeds.
While thus recognizing that its interpretation would likely raise costs for consumers in the long run, the Third Circuit stated that, because TILA says nothing about filing a suit within the three-year period, the "most natural reading" of the statute merely requires a borrower to send valid written notice of rescission before the end of the three-year period.
Accordingly, the Court reversed and remanded.
Ralph T. Wutscher
McGinnis Wutscher LLP
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