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Restoring equity to rescissions.

In an 11th U.S. Circuit Court of Appeals decision last year, a modicum of equity was restored to the relationship between a lender and a rescinding borrower. The facts were as follows:

After discovering that their Regulation Z disclosures failed to properly disclose the effects of rescission, the correct finance charge and the extent of the securitv interest taken as collateral for their loan, the plaintiffs in Williams v. Homestake Mortgage Company, rescinded their loan a full year after consummation. While the defendant mortgage company did not contest the Regulation Z violations, the mortgage company refused to void its security interest in the plaintiffs' home until the plaintiffs returned the outstanding principal balance on the loan.

Naturally, the plaintiffs sued, citing the Truth-in-Lending Act's (TILA) rescission provisions. These provisions provide that the sequence of events under rescission is that a lender first cancels the lien and then the borrower returns the outstanding principal balance.

The court, seeing the inherent inequity in such an arrangement, relied on Regulation Z's grant of authority to a court to modifv this sequence of events if the court deems such action necessary and equitable. The court stated that "a court may impose conditions that run with the voiding of a creditor's security interest upon terms that would be equitable and just to the parties in view of all surrounding circumstances" and agreed that the rescission should be contingent on the return of the loan principal.

Lenders may take comfort in the Eleventh Circuit's analysis of the inequities of truth-in-lending's rescission language. Lenders facing a rescission request may want to seek injunctive relief immediately from their local court to obtain a result, as Homestake Mortgage did.

This is not the first instance in which a court has conditioned a consumer's right to rescind on the consumer's repayment of the principal balance due on the loan. In FDIC v. Hughes Development Co., Inc., a 1991 8th U.S. Circuit Court of Appeals decision, that circuit court concluded that TILA gives courts discretion to devise alternative procedures to enforce TILA's rescission provisions, "including conditioning rescission upon the debtor's return of principal." The U.S. District Court for the District of Maine reached the same conclusion in its 1991 New Maine National Bank v. Gendron decision. That decision noted that both Congress and Regulation Z contemplated that "equitable principles" would be applied to the right of rescission. These three cases reference other judicial decisions supporting this analysis and treatment of creditors.

Most creditors would agree that no consumer compliance story can have a totally happy ending, especially when considering that one of the most, if not the most common uses of rescission is in consumer bankruptcy. In such cases, a consumer will rescind the loan just before or upon filing for bankruptcy protection. Assuming the rescission is based on a valid disclosure violation and the loan is, in fact, truly rescindable, the bankruptcy court may, and frequently has, forced the creditor to return all interest and fees already collected (including those paid to third parties) or to credit that amount against the rescinded loan's principal balance due. Then the creditor is left with an unsecured claim for the new principal balance. In some cases, courts, both bankruptcy and non-bankruptcy, have allowed consumers to pay out the remaining debt over time, essentially converting it in an interest-free loan, despite TILA's requirement that the entire principal balance be repaid upon rescission. Depending on the individual bankruptcy case, the creditor then has between a reasonable and remote chance of realizing repayment on that unsecured claim.

While Homestake and the other cases are helpful and afford lenders a certain level of comfort and defense to rescission and its associated losses, creditors are well advised to continue to carefully comply with TILA's disclosure requirements and other consumer compliance laws and regulations.

Paul H. Schieber is co-chairman of the Consumer Financial Services Group of the Philadelphia-based law firm of Blank, Rome, Comisky & McCauley.
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Title Annotation:Executive Essay
Author:Schieber, Paul H.
Publication:Mortgage Banking
Article Type:Column
Date:Mar 1, 1993
Words:659
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