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A costly lesson: the Truth in Lending Act gives borrowers a three-day period after closing to bail out of a mortgage transaction. However, failure to provide the right notices at closing extends that period to three years. Here's some valuable advice on how to avoid the nightmare of rescission claims.

OVER THE PAST COUPLE OF YEARS, INTEREST RATES HAVE BEEN AT their lowest level in roughly 30 years, and many residential mortgage lenders have enjoyed explosive growth. Homeowners have jumped at the chance to cash out the equity in their homes and/or consolidate debt. Yet, as is always the case, there are some borrowers who will encounter financial difficulties and start to fall behind on payments. [??] For these borrowers some options have become less appealing in recent times. Interest rates have started to rise, so the option of refinancing is much less attractive. Unfortunately, some borrowers unable to meet their obligations will look for ways to hold on to their homes by any means possible. [??] With increasing frequency, one claim borrowers are making is that the lender allegedly failed to provide borrowers the required notice of right to cancel (NOR) at closing. Under the federal Truth in Lending Act (TILA), failure to provide proper notices allows the borrower to rescind the loan up to three years after the time of the mortgage loan closing. (If given proper notices, the borrower has three business days in which to rescind under TILA.)

Rescission within three days of a mortgage loan closing is a straightforward process. Rescission up to three years after the closing is far more complicated and costly.

We're seeing more of these "stale rescission claims" in recent years. This article sets out an action plan for lenders to deal with such claims. With some proactive strategies, lenders can avoid what can otherwise be a costly legal trap.

TILA background

Before getting into the prescriptions, here's a brief refresher on the Truth in Lending Act and rescission under TILA. TILA was passed in 1968. Courts regularly characterize it as a consumer-rights statute. One provision of TILA is a "cooling-off period" for borrowers after consummation of certain loan transactions.

In mortgage refinancing transactions, borrowers must normally be given a minimum of three days from the date of the closing to rescind their loans. TILA also requires that lenders give each borrower two copies of the NOR (one to retain and one to send in if the borrower wishes to rescind, or a single electronic copy each) outlining the appropriate time period to rescind, the meaning of rescission and the proper procedure for rescission. If the lender fails to provide the NOR at the closing or provides a defective NOR, the rescission period can be extended for up to three years.

Courts have generally been quite strict when determining if an NOR is defective. For example, courts have found an NOR to be defective where the lender provided a single copy, rather than two copies for each borrower. Similarly, NORs have been found to be defective when the NORs explain how to calculate the number of days a borrower has to rescind, but do not expressly identify the specific date by which he or she must rescind.

Further, evidence that the borrowers actually knew of their rescission rights all along may not be a defense to a claim based on a defective NOR. A court, for example, has awarded rescission where the lender provided a defective NOR even when the borrowers were real estate agents and admitted that they knew of their rights under TILA regardless of defective NORs.

The lender's first line of defense against stale rescission claims

TILA's rules as to delivery of the NOR are counterintuitive. Every borrower must get two copies of the completed NOR. The copies must be completely and correctly filled out. A husband and wife who are co-signing must receive two copies each.

It must be emphasized to whomever performs closings that these formal requirements exist and that the cost for not conforming to them can be substantial.

When business is booming, in particular, it might be wise not just to train those who perform closings, but also to train loan officers and assistants and remind them periodically of these TILA requirements. Because turnover can be high, ongoing training programs are a critical line of defense. A comprehensive training program merely cuts down on meritorious NOR claims, of course, rather than preventing or deterring false claims. A strong training program nevertheless can be powerful evidence in the event the issue is litigated, and can make the difference at the summary judgment stage of a lawsuit (see the fifth line of defense in this article).

The second line of defense

No one is perfect. Notwithstanding a lender's best training efforts, there may be times when a loan officer or closing agent slips up. It can be as simple as leaving the office in a hurry for a closing at a borrower's home before making the appropriate number of photocopies. In other words, there may be cases when quick internal fact-finding will establish that a particular borrower's NOR claim is, in fact, valid.

If information can be collected quickly and a finding made, there is a fleeting chance to resolve the situation quickly and with minimal cost. TILA provides for attorneys' fees for the prevailing plaintiff. Sometimes a lender only gets to the heart of the matter after the plaintiff's lawyer has incurred substantial fees, taking depositions, written discovery, motion practice and so on. Then, one can encounter a true quagmire scenario--i.e., a sense that you, the lender, are facing bad facts, but the plaintiff's lawyer's demand for attorneys' fees is so high that an uphill battle over the merits of the case starts looking good compared with the high alter-native cost of settlement.

A lender that can determine the facts quickly, before attorneys' fees are incurred, can settle a case that, if protracted, might evolve into a costly experience.

The lender's third line of defense

Many lenders hire title companies or other third parties to perform their closings. If the lender is not the one tasked with providing the required disclosures, the lender should not be the one to bear the costs for allegedly improper or nonexistent disclosures.

We have seen such indemnification agreements, and the lender that has entered into them has avoided the stale NOR pitfall from the start. Some lenders provide for arbitration clauses in their loan agreements. These do not eliminate the risk of stale rescission claims but they may expedite the efficient resolution of such claims. Also, because they may diminish their value to plaintiffs' counsel, they also may diminish the risk of such claims being brought.

The fourth line of defense

Rescission, literally, is the restoration of the parties' positions prior to the loan closing. Thus, in a rescission the lender should get back the loan principal amount and relinquish the security interest in the borrowers' property that secured the loan. The borrowers should get back their closing costs and payments made on the loan (along with the statutory penalty of not more than $2,000 and attorneys' fees, as noted earlier).

Of course, many borrowers are not in a position to give back the remaining principal on the loan when they seek rescission. Some courts have held that rescission may be conditioned on repayment of the amount advanced by the lender. The courts, it should be noted, allow for "wiggle room," saying that this repayment requirement is discretionary. Nevertheless, it should be explored, especially in cases where the merits are strong for the lender.

For example, consider the situation where a borrower admits knowledge of the right to cancel and admits a conscious decision not to exercise the rescission right in the three days or a week after a closing. However, this same borrower nonetheless seeks rescission based on his or her not having received two copies of the NOR. Given these facts, a court might be particularly amenable to conditioning the borrower's rescission rights on his or her advanced tender to the lender, which can be the death knell for the borrower's claim.

The fifth line of defense

Sometimes the truth is unclear; no one is likely to remember the details of a specific closing a year or two later. Often the option of requiring the borrower to tender his or her share of the loan principal as a prerequisite to rescission may be unavailable or simply unrealistic. In these circumstances, lenders will have to measure the uncertain costs and outcome of litigation with the costs of settlement. The costs and benefits of litigation will vary case by case and will be based on the particular facts, the forum, and the knowledge and expertise of counsel.

Winning in court short of trial should be a high priority, and it may be within reach. When creating TILA, Congress recognized that lenders could be unfairly subject to self-serving claims that the borrower did not get his or her NOR. After all, in the normal course, borrowers leave the closing with their NORs. How is the lender to disprove the borrowers' claims, a year or two later, that the borrowers never got their NORs?

Lenders (or their agents) normally leave the closing with a "lender's copy" of the NOR, signed by the borrower. TILA expressly provides for a "presumption" that the borrowers received the NOR if the lender can provide a copy of this signed acknowledgment. This, in turn, can present the opportunity for summary judgment--victory for the lender before trial.

While the lender's copy of the signed notice of right to cancel is good proof that the borrower received his or her copies, Congress recognized, on the other hand, that signing a document saying one has received a given disclosure does not prove receipt. Congress therefore made the presumed receipt "rebuttable." Unfortunately, TILA does not explain what evidence a borrower must offer to rebut this presumption.

Courts are inconsistent. However, the majority of courts recognize both the fallibility of memory and the unfortunate fact of dishonesty, particularly in the face of circumstances such as the threat of losing one's home. They therefore compel borrowers, if confronted with their own signed acknowledgment of receipt of the NOR, to rebut that fact with "clear and convincing" evidence. This standard has been described as that measure or degree of proof that will produce in the mind of the trier of facts "a firm belief or conviction" as to the allegations sought to be established.

On behalf of lenders, we have had recent success arguing that borrowers failed to offer "clear and convincing evidence" of nonreceipt of the NOR and that they, therefore, lost their case on summary judgment.

Such an argument is supported by evidence of a good training program by the lender regarding delivery of the proper disclosures. It is supported by testimony of the loan officer or others involved at the settlement as to standard operating procedures and their best recollection of the facts of the present case. Finally, the lender's summary judgment argument often involves deposition testimony of the borrowers themselves, who often cannot account for inconsistencies, cannot show that they have retained all materials received related to their loan or can only provide sketchy testimony.

It is important to note, however, that not all courts are inclined to impose the "clear and convincing evidence" burden of proof on borrowers. In fact, some treat this TILA presumption as a "bursting bubble," meaning borrowers can rebut the statutory presumption merely with their sworn testimony that they never got the NOR.

Before plunging into this summary judgment strategy, therefore, lenders should 1) make sure to evaluate the latest developments in a given jurisdiction to see whether such an argument is worth making and 2) carefully evaluate whether the facts of a given case are sufficiently strong to try to advance courts in this direction.

Some cases involve unsympathetic courts and sympathetic borrowers. Such cases would be poor candidates for encouraging that the court read TILA in a way that raises the bar for plaintiffs. Lenders should therefore pick their battles with care to encourage the law's positive development.

The mechanics of rescission

Despite their best efforts, lenders will still from time to time face the task of rescinding a loan up to three years after the loan has funded. Rescission, in the law, is an "equitable remedy," meaning it is resolved by the judge, not a jury. In practice, this means the courts have some flexibility in how they craft a rescission, rather than being tightly bound by the text of TILA or Regulation Z (the federal regulations promulgated under TILA).

At least in theory, rescission means putting the lender and borrower back to where they were before they consummated their agreement and funded the loan. But reality often gets in the way of this clean-cut theoretical resolution.

Federal regulations provide that "when a consumer rescinds a transaction, the security interest giving rise to the right of rescission becomes void, and the consumer shall not be liable for any amount, including any finance charge." Upon rightful rescission, the lender must "return any money or property that has been given to anyone in connection with the transaction, and take any action necessary to reflect the termination of the security interest."

On its face, this would suggest that the lender is not only stripped of any interest payments for the period during which the borrower has been living in the residence before his or her notice of rescission. The lender also loses its security interest for the loan's principal amount before the borrower tenders that amount to the lender. As mentioned earlier, courts regularly avoid such extreme and harsh results, and the federal regulations expressly recognize the court's authority to craft a fair arrangement when rescission is required or agreed to.

In truth, there is no way to travel back in time, and there is no clear way to rescind a loan that funded long before. These transactions involve a previous loan--perhaps from a different lender--which was of course paid off, and the loan proceeds, having been distributed far and wide.

In our experience, how these cases are resolved--if they get this far--is through the negotiation of a new secured loan between the borrowers and the lender. The principal amount is the same as the original rescinded loan, less 1) the closing costs from the left side of the HUD-1 settlement statement (except tax and insurance amounts escrowed on the borrower's behalf); 2) statutory damages ($200 to $2,000); and 3) attorneys' fees. The term and rates of the new loan are negotiated. Negotiations on these details can take time and be costly.

Fortunately, however, by heeding the precautions and strategies outlined in this article, the vast majority of cases can be avoided, defeated or resolved before they ever get this far.

Seth Leventhal is an attorney at Dorsey & Whitney LLC in Minneapolis. He can be reached at


ONE OF THE MOST NOTORIOUS "NOR cases"--Truth in Lending Act (TILA) claims based on the failure to receive proper copies of the notice of right to cancel (NOR)--is the case of Weeden v. Auto Workers Credit Union, a case decided by the U.S. Court of Appeals for the Sixth Circuit in 1999.

In the Weeden case, the borrowers, a married couple, sought a refinance transaction. The loan application was not straightforward. The lender had to work for this loan. The problems were ironed out, however (or so the lender thought), and the loan was funded on June 17, 1993.

The Weedens, however, were fairly sophisticated borrowers. Mrs. Weeden was, in fact, a real estate agent. So the Weedens went through their closing papers with care, apparently. They "vociferously protested" certain charges and had a $450 fee waived to address the borrowers' objections. This change required amended disclosures, which were subsequently mailed to the Weedens. Because the timing of the accurate disclosures triggers the three-day period of the notice of right to cancel, the time for the Weedens to rescind was extended.

In the days and weeks after the Weedens' closing, interest rates dropped by a full point. As mentioned, the record in the case suggests the Weedens knew the rules and knew how to use them to their best advantage. Under the circumstances, one can see why the Weedens may have wanted to rescind.

It is unclear in the record as to when the Weedens were sent and received their notice of right to cancel following receipt of their corrected HUD-1. However, the issue in the case was not just whether the borrowers received the full advantage of a three-day period (it appears they did, though)--the issue was also about the number of notices they received.

TILA requires that each borrower of record receive two copies each; that is, a married couple that receives a loan subject to TILA requirements must receive four completed copies. Some in the industry do not know of this requirement much less understand the rationale for it. (The borrower is supposed to be able to retain one copy for his or her records and send another back to the lender in the event the borrower elects to exercise rescission rights.) It is the law, however, and the Court of Appeals vacated a judgment for the lender and ordered judgment for the plaintiffs in Weeden.

How much the lender had to pay out at the end of the Weeden case is anyone's guess, but TILA includes an attorney fee-shifting provision, so the payout, presumably, included the plaintiffs' lawyers' fees through trial and appeal.

Wholly aside from the misfortune that befell this particular lender in this case, however, one should not lose sight of an important (and, for lenders, maddening) holding in the case: Even if borrowers know they have a right to cancel, failure to provide them with two copies each of the NOR allows them to demand rescission at any time three years from closing. If refused, TILA allows them to recover attorneys' fees in their effort to enforce their TILA rescission rights.

The cautionary tale of the Weedens arose when interest rates were falling, of course, and the sought-after rescission was shortly after the closing (even if not within the standard three-day period or the seven-day period that many lenders allow for). The case was not a "stale rescission claim" up to three years after the closing. We're currently seeing these stale claims in an atmosphere of rising interest rates, where rescission appears to be an effort to renegotiate an obligation that a borrower is having trouble meeting, rather than to take advantage of a better available rate.

Nevertheless, the Weeden case still offers a valuable lesson: TILA, and specifically all the steps involved in giving borrowers the required notice of their rights to cancel or rescind, will often be applied rigidly and favorably to plaintiffs.


THE TRUTH IN LENDING ACT (TILA) IS NOT A new statute, and the required notice of right to cancel (NOR) has been the law for about 35 years. The number of reported cases in this area, however, has risen sharply in recent years--from no reported cases in 1995, for example, to 42 reported cases over the past three years.

Admittedly, tracking reported cases is an imperfect measure of the actual incidence of these cases in the real world, but the increasing rate of reported cases is unmistakable and is consistent with anecdotal information.

There is an uneven geographical distribution of reported cases nationwide, with concentrations in Illinois and Pennsylvania. This might be a function of a particularly active plaintiffs' bar in these areas, particularly plaintiff-favorable forums or statistical anomalies. Most likely, it is due to some combination of these factors, and perhaps others as well.

Many of the cases are being brought in the context of a bankruptcy, in an adversary proceeding. This may be the worst forum for lenders--with borrowers' difficult circumstances playing on the fact-finders' sympathies, with relatively short deadlines (relative to civil litigation outside of bankruptcy) and with the lender's security interest in play when the borrowers' limited assets are a foregone conclusion.

The rise in the number of cases is troubling enough, but in June 2004 there was a decision in federal district court in Massachusetts of perhaps still greater concern. In Rodrigues v. Members Mortgage Co., the court granted a motion to certify a class-action lawsuit involving the notice of right to cancel.

Class actions raise the stakes of cases by factors of 10, hundreds or even thousands. At their essence, class actions require that individual cases are sufficiently homogeneous to warrant treating them as a group (i.e., a class) rather than addressing each case individually. In NOR cases (cases brought under TILA in which claims are based on the failure to receive a notice of a right to cancel or rescind), class treatment is particularly inappropriate. This is so because every case, it seems, must turn on the particular circumstances of a specific transaction (including the specific disclosures--both the timing and the content--and the mechanics of the remedy of rescission).

The Rodrigues case, however, involved an incident where the closing agent allegedly caused borrowers to sign copies of their NORs and also required them to sign, at the closing, a document entitled, "Confirmation of Non-Exercise of Right to Cancel," which was postdated--that is, dated after the rescission period would have terminated, but signed the moment it began.

There are disputed issues of fact as to whether borrowers in the proposed class in Rodrigues were all provided with this "Confirmation of Non-Exercise of Right to Cancel" at their closings and whether they were all required to execute it at the closing as a condition of entering into the loan. The court, in granting the motion for class certification, reasoned that how these questions were answered would determine whether, ultimately, the case could be decided on a class-wide basis.

By certifying the class in the face of this uncertainty, the court essentially shifted the burden to the lenders that would have to move for the court to decertify the class.

The Rodrigues case involves a factual scenario that may be avoided by proper training and procedures. Perhaps most important, though, the court in Rodrigues noted the divergence among U.S. federal district courts as to whether class resolution is an appropriate procedure for claims seeking a declaration of a right to rescind under TILA, and cavalierly dismissed what it called the lenders' "sturm und drang about the catastrophic effects of a declaration of a right to rescind on a class-wide basis."

The court answered these concerns by speculating that,"[F]ew borrowers are apt to request rescission because of the hassle and likely higher interest rate involved in refinancing." Lenders should hope the court got it right.

The court's reasoning, however, fails to distinguish between the incentives of class members and class counsel. The recent uptick in NOR cases and the Rodrigues case may herald new challenges for some mortgage lenders.
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Author:Leventhal, Seth
Publication:Mortgage Banking
Geographic Code:1USA
Date:Dec 1, 2005
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