On February 5, 2013, the Third Circuit Court of Appeals sided with the Fourth Circuit in holding that under the Truth-in-Lending Act an obligor exercises her right of rescission solely by sending the creditor valid written notice of rescission and need not also file suit within the three year statutory period.  Sherzer v. Homestar Mortgage Servs. et al, No 11-4254, 2013 U.S. App. Lexis 2486 (3d. Cir. Feb. 5, 2013). The issue, which would seemingly arise rarely, has drawn Court of Appeals opinions from the 9th, 10th, 4th, and 3rd Circuits within the past 12 months. (See McOmie-Gray v. Bank of Am. Home Loans, 667 F.3d 1325 (9th Cir. 2012); Rosenfield v. HSBC Bank, USA, 681 F.3d 1172 (10th Cir. 2012); Gilbert v. Residential Funding, LLC, 678 F.3d 271 (4th Cir. 2012); Sherzer, 2013 U.S. App. Lexis 2486)  As the issue has gathered steam, the CFPB, the American Bankers Association, the Consumer Bankers Association, and the Consumer Mortgage Coalition all entered the fray, with the CFPB filing an amicus brief in support of the borrowers and the lenders associations filing amici briefs on the side of the lenders.  

The question creating so much hubbub is seemingly simple: does an obligor sufficiently exercise her right to rescind a loan subject to TILA simply by notifying the creditor in writing of her intention, or must the obligor also file suit to enforce her rights before the three-year statutory period expires? The answer, of course, is as clear as mud. 

In relevant part, TILA, codified at 15 U.S.C. §1635, allows obligors a “no questions asked” right to rescind certain consumer credit transactions within a proscribed time period. Where a lender has provided an obligor with proper disclosure of credit terms, the obligor “shall have the right to rescind the transaction until midnight of the third business day.” (Id.) Obligors may exercise this right “by notifying the creditor, in accordance with regulations of the Bureau, of his intention to do so.” (Id.)  Where an obligor has not received proper disclosures, an obligor’s right of rescission continues past the three-day period, but “shall expire three years after the date of consummation of the transaction or upon the sale of the property, whichever occurs first." (Id.) The fundamental question – one left largely unanswered by TILA – is HOW does a party exercise their right to rescind. Is the unilateral sending of written notice to a lender an effective act of rescission? Does rescission require judicial action? Is the sending of a written notice merely alerting the lender that a borrower will seek its right of rescission through a lawsuit sufficient? Maybe the answer comes down to something more fundamental than even the statutory language itself. Maybe the answer comes from how we see the role of the judiciary in the rescission process. Is the judiciary’s role to enforce a rescission right already exercised or is the judiciary’s role part and partial of the rescission process, such that the two are necessarily one and the same.   Regardless, what is beyond debate is that TILA is silent as to judicial action in the context of rescission. 

In Sherzer, borrowers obtained two loans from lender Homestar Mortgage Services (“Homestar”) in August 2004 secured by mortgages on their principal dwelling.  (Sherzer, 2013 U.S. App. Lexis 2486, at *1-4) Homestar later sold or assigned its interest in the loans to HSBC Bank (“HSBC”). In May 2007, borrowers’ counsel sent a letter to Homestar and HSBC (collectively, “Lenders”) asserting that Homestar failed to provide all necessary disclosures required by TILA. As such, the borrowers claimed to exercise their right to rescind their loan agreements under 15 U.S.C. §1635.  Lenders denied that rescission of the larger of the two loans was appropriate and claimed that Homestar had not violated TILA. The borrowers brought suit in November 2007 – more than three years after the loan closed – seeking a declaration of rescission, remedies for rescission, and damages.  Lenders moved for a judgment on the pleadings, arguing the borrowers’ right to rescission was time-barred under 15 U.S.C. §1635(f). The district court ruled in favor of HSBC, finding TILA requires borrowers to both send written notice of intent to rescind AND file a rescission action within three years. In so holding, the district court found that because the borrowers did not file suit within three years, the right of rescission became extinguished. Such a holding was in keeping with recent 9th and 10th Circuit opinions.

While admitting the answer was “not pellucid,” the Third Circuit reversed the district court and sided with the borrowers and the CFPB. (Id. at *17) In essence, the court agreed with the CFPB that §1635 “establishes a private, non-judicial mechanism for consumers to rescind mortgage loans by providing notice to their lenders.” (Id. at *5) The Third Circuit based its ruling largely on TILA’s lack of specific language requiring borrowers to file suit. “Neither §1635 (a) nor Regulation Z states that the obligor must also file suit; both refer exclusively to written notification as the means by which an obligor exercises his right of rescission.”  (Id. at * 10) Moreover, §1635(f) establishes a three-year limitation for “an obligor’s right of rescission,” but “makes no mention of filing a suit or bringing a claim.” (Id. at *12) The court argued that siding  with the Lenders  would require the court “to infer that the statute contains additional, unwritten requirements with which obligors must comply – an inference that seems particularly inappropriate in light of the fact that TILA is a remedial statute that we must construe liberally.” (Id. at *17) 

Although the Lenders failed to sway the Third Circuit, they made two strong arguments. First, Lenders argued that the issue is impliedly governed by the Supreme Court’s holding in Beach v. Ocwen Federal Bank, 523 U.S. 410 (1998). In Beach, the Court held that obligors who failed to exercise their right of rescission within the three-year statutory period could not assert rescission as an affirmative defense to a foreclosure action filed more than three years after the loan’s origination. (Id. at 411-13) In finding that the three-year period was a statute of repose, the Court held that it was “Congress’s manifest intent . . . that the Act permit[] no federal right to rescind, defensively or otherwise, after the 3-year period of §1635(f) has run.”  (Id. at 419) Lenders argue that obligors’ rights are completely extinguished after three years. Therefore, any suit filed after the three-year period should be dismissed because obligors retain no rights for a court to enforce.  The Third Circuit rejected the applicability of  Beach. The court found that Beach merely stands for the proposition that “an obligor must exercise his right of rescission within three years of the commencement of the loan; the right is extinguished once that period has passed.” (Sherzer, 2013 U.S. App. Lexis 2486, at *23)  Importantly, the court found Beach neither dispositive nor instructive on the question of HOW an obligor must exercise his right of rescission within that three-year period. (Id.)

Lenders’ further arguments invoked practical and logistical concerns. Namely, if obligors can unilaterally rescind via written notice, can the borrowers bring an enforcement suit at any time in the future? This issue could potentially create increased uncertainty with respect to title and result in increased costs for both lenders and consumers.  In short, would the contract be voided immediately upon receipt of written notice? If so, what if the notice was invalid? The Third Circuit dismisses many of the Lenders  concerns out of hand. The  court contends  the Lenders’ concerns  are  misplaced because “rescission of the loan agreement occurs when an obligor with a valid TILA claim provides the lender with written notice.” (Id. at *30)  Moreover, “if a borrower fails to exercise a valid right to rescission, then the lender maintains its security interest.” (Id.)  Of course,  determining  whether  a rescission claim is valid would necessarily require the use of judicial system. Therefore, the Third Circuit does not necessarily address the Lenders’ underlying argument head-on. Under the Lenders’ interpretation, a borrower claiming a right to rescind, whether valid or invalid, could only cloud title for up to three years following origination. On the other hand, under the new Third Circuit ruling, a borrower claiming a right to rescind, whether valid or invalid, could theoretically cloud title for longer than three years. 

The Third Circuit tries to assuage Lenders’ fears that a borrower’s cause of action will live on in perpetuity, haunting the title like a ghastly apparition. The CFPB posits that §1640’s one-year statute of  limitations would apply following written notice. (Id. at n.8) The Third Circuit, through the use of analogous statutes of limitations, posits that borrowers’ right of action would expire ten years after the closing date. (Id. at *32-4) Regardless, at least lenders will know the borrowers’ ability to exercise rescission will expire at some point (though we know not when).

Finally, the Third Circuit admits that its ruling may well increase costs for lenders and consumers.  However, the court notes that as with many remedial statutes, 

the fact that this approach may be more costly is not, in and of itself, a reason to disregard the text of the statute. Many TILA regulations increase costs for lenders (and, in turn consumers), and it is for Congress – not the courts – to determine whether those increases are warranted. 

(Id. at *36) 

The take away is that in the 3rd and 4th Circuits, borrowers who failed to receive material disclosures and wish to exercise their rescission rights under TILA must send written notice to their lender within three years of the closing date. In the 9th and 10th Circuits, those same borrowers must also bring suit to enforce their rights within three years following the closing date of their loan.  Whether this issue will be decided finally by the Supreme Court, or if it will be left to Congress, remains to be seen. Moreover, as the cases do not seem to have been decided on ideological lines, it is hard to determine which way the pendulum will swing for courts in circuits where the issue has not been decided. What is certain is that both borrowers and lenders in undecided circuits will likely be in for a long and bumpy judicial ride.