On January 13, 2015, the U.S. Supreme Court settled a circuit court split regarding how and when a mortgage borrower may exercise the right of rescission under the Truth-in-Lending-Act (“TILA”) and the CFPB’s implementing Regulation Z. Specifically, the Court considered the question whether the exercise of the rescission right by a borrower was effective simply by providing a written notice to the lender or whether the borrower must also file a lawsuit to exercise the rescission right. The decision settles a split between circuit courts, with the First, Sixth, Eighth, Ninth and Tenth circuits requiring borrowers to file a lawsuit before the three-year deadline and the Third, Fourth and Eleventh circuits requiring only written notice before the expiration of the three-year deadline.
Unfortunately for the mortgage industry, the Court, in a unanimous decision, found that only written notice is required. The case, Jesinoski v. Countrywide Home Loans, Inc., 2015 WL 144681 (Jan. 13, 2015), involved borrowers that sent a letter purporting to rescind a loan refinancing their mortgage exactly three years after the loan closing, but did not file suit seeking a declaration of rescission until a year later. A copy of the decision is available here.
The rescission language in TILA, 15 U.S.C. § 1635, provides borrowers with an unconditional right to rescind certain non-purchase money mortgage loan transactions within three days of the date the borrower is provided: (a) a notice detailing the right of rescission (and how to exercise it); and (b) certain “material” TILA disclosures. Under Section 1635(f), if a lender has failed to provide to the borrower either the notice of rescission or accurate material disclosures, an extended right of rescission is provided that expires three years after the transaction consummation date or upon the sale of the property, whichever occurs first.
Prior to the Supreme Court’s ruling, the U.S. Court of Appeals for the Eighth Circuit had affirmed a district court decision holding that the Jesinoskis were required to file a lawsuit within the three-year period provided by Section 1635(f) of TILA rather than merely provide the lender with written notice of their rescission. The Supreme Court reversed, finding the language of Section 1635 “le[ft] no doubt that rescission is effected when the borrower notifies the lender of his intention to rescind,” and that “so long as [a] borrower notifies [the lender] within three years after the transaction is consummated,” the rescission is timely. The Supreme Court noted that “[n]othing in [TILA] suggests that a borrower need also file a lawsuit within th[e] three year period.”
The Supreme Court rejected the argument—strongly promoted by the mortgage industry — that written notice of rescission does not suffice if the lender disputes the adequacy of the disclosures — finding Section 1635 of TILA draws no distinction “between disputed and undisputed rescissions.”
As an important corollary to its principal determination, the Supreme Court also noted that TILA expressly rejects the common law rule that a rescinding party must return what he/she received before rescission can be effective—which in the case of a mortgage loan is the money lent. The Supreme Court noted that Section 1635(b) of TILA was a statutory right that did not adopt common law equitable requirements, thereby potentially weakening several remedies frequently employed by creditors following the receipt of rescission notices. It now appears that a borrower’s written notice of the intent to rescind is complete and effective solely upon the proper delivery of a rescission notice.
Depending upon the federal circuit in which a mortgage loan is located, numerous legal issues relating to rescission may now be re-opened:
Viability of Current Federal Circuit Opinions and Guidance.
It may be possible for complaining plaintiffs to challenge many formerly-applicable judicial interpretations of TILA’s rescission obligations following the Jesinoski decision. Moreover, because appellate court decisions interpreting Jesinoski may take upwards of two years to be decided, it is likely that lenders will be presented with the challenge of having to defend the propriety of their responses to particular rescission notices in the lower courts following this latest U.S. Supreme Court decision.
In many jurisdictions, lenders have been able to insist that a rescinding borrower must repay the loan proceeds before the lender is required to release its mortgage. Many of the technical requirements of Section 1635 of TILA and Regulation Z could then be resolved as part of a negotiation with the borrower, who generally could not repay the loan proceeds without a new mortgage loan (which could not be obtained without the release of the existing mortgage).
Several of these technical requirements may now have to be revisited. For example, both as to the rescinding borrower and the lender, the applicable statute of limitations as to available remedies will have to be analyzed. It is not clear whether a borrower must bring an action to remove a recorded lien within TILA’s general one-year statute of limitations or whether a lender must comply with any TILA time limitations to return (or offset) funds paid by a borrower that has sent a notice of rescission.
Of particular concern is a timing requirement contained in Section 1023(d) of Regulation Z that requires that a creditor return to the borrower all funds paid to it, including all finance charges paid, within 20 days of receipt of a notice of rescission. The language of this provision of Regulation Z (which formerly was subsumed as part of an overall settlement with a rescinding borrower), indicates that the borrower may be relieved of its obligation to repay loan proceeds if it “would be impracticable or inequitable . . . .”
State Real Property Laws.
Although the Jesinoski decision is based upon federal law, it may also affect judicial and non-judicial foreclosure laws in many states. An effective recession may affect the status of a previously recorded mortgage lien.
For example, prior to this decision, many courts had invoked their equitable powers to require borrowers to tender or demonstrate an ability to tender back to the lender the money that originally was lent before requiring a lender to release its mortgage lien. The Jesinoski decision can be read to imply that a rescission notice itself has an effect on an existing mortgage lien. (While it is clear that a lender would retain the right to sue on the promissory note, the potential loss of the real property security may make recoveries of loan proceeds more problematical.)
The determination of lien status may be a particularly sensitive issue in jurisdictions such as California, where lenders are subject to limitations on judicial and non-judicial foreclosure based upon versions of the “one form of action rule.” The failure to comply with those types of requirements could expose lenders not only to remedies in regard to a mortgage lien, but could also jeopardize the underlying debt.
In any event, based upon the state law rules that govern mortgages and foreclosures, one result of the Jesinoski decision may be to shift the burden of filing suit to lenders if they believe a borrower’s rescission is improper or invalid.
Bankruptcy by the Borrower.
It is perhaps in the bankruptcy context that the Jesinoski decision presents the greatest potential loss to lenders, because of the possibility that a bankruptcy court could not only affirm the validity of a rescission, but invalidate a lender’s mortgage lien as a result (which would benefit unsecured lenders). Moreover, a very real threat is presented to the extent that bankruptcy courts in the first instance interpret (most likely in a manner favorable to debtors) the effect of the Jesinoski decision on mortgage liens in each state.
In light of these potential knock-on effects, lenders need to consider commencing litigation with respect to the effectiveness of rescission notices promptly after receipt of a notice the lender intends to dispute.
Mortgage Lending Compliance.
From a compliance perspective, heightened care in the post-closing quality control process to verify compliance with TILA’s disclosure requests will likely be necessary. Also, lenders may consider adopting closing procedures whereby a borrower “acknowledges” receipt of correct rescission notices, as well as the expiration of the three-day rescission period.
The Jesinoski decision will have different effects in different states and federal circuits depending upon the degree to which it changes prior law and how lenders have come to respond to a rescission notice. It will likely take years for the ramifications of the Jesinoski decision to be completely clear.