Imagine this scenario: The day before the foreclosure sale, the
creditor receives a fax from the lawyer for the defaulting borrower, stating
that the borrower rescinds the loan and that the creditor is obligated to
release its deed of trust with no payment, because the finance charge in the loan
disclosures was understated by $36. Not only is the
creditor asked to release its security, but the borrower demands that the creditor
return all of the payments the borrower has made on the loan. Impossible?
Many creditors have gone into shock when confronted with a demand under
15 U.S.C. Section 1635.
The creditor must proceed most carefully when confronted with such a situation.
The Truth in Lending law (TILA)
provides a draconian remedy to borrowers who do not receive accurate disclosures
with respect to their loan, the right to rescind the loan and release the
lender's real property security interest. Even seemingly minor failures to supply proper TILA disclosures,
such as understating the finance charge by more than $35,
or a mistake in the right to rescission forms, have been held to support rescission of the loan.
If the creditor who receives such a demand acts quickly, the worst potentials present in this
legislation can be avoided.
Exempt Transactions: Only transactions subject to TILA may be rescinded
under this rule. Business purpose loans and loans to organizations are
examples of transactions exempt from TILA. The exemptions are
discussed in more detail in the Article on Predatory
Lending Law. Besides the exemptions from TILA, the following
transactions are exempt from the rescission rules:
(1) a residential mortgage transaction as defined in
section 103(w) [15 USCS § 1602(w)];
(2) a transaction which constitutes a refinancing or
consolidation (with no new advances) of the principal balance then due and any
accrued and unpaid finance charges of an existing extension of credit by the
same creditor secured by an interest in the same property;
(3) a transaction in which an agency of a State is the
(4) advances under a preexisting open end credit plan if
a security interest has already been retained or acquired and such advances are
in accordance with a previously established credit limit for such plan.
Grounds for Rescission: Obligors of consumer loans secured by a
principal dwelling have the right to rescind the loan transaction until midnight
of the third business day following the last of three events: 1) the consummation of the transaction;
delivery of rescission forms and 3) the delivery of all material disclosures required by TILA
( material disclosures are the annual percentage rate, the finance charge, the
amount financed, the total payments, the payment schedule, and, if applicable, the
predatory lending disclosures
and limitations referred to in 12 CFR § 226.32 (c) and (d).)
Proper Notice of Rescission: The creditor must
deliver two copies of the notice of the right to rescind to each consumer which
describe the security interest, the right to rescind, how to exercise the right
to rescind, the effects of rescission, and the date the rescission period
Defective Disclosure: If the disclosures or the rescission forms are
not delivered, or are not completely accurate, the obligor has until three days
after accurate disclosures and forms are delivered to rescind the loan, or if
accurate forms and disclosures are not delivered, until three years after the
date of consummation of the transaction, the date the
obligor disposes of all interest in the property or upon the sale of the
property, whichever occurs first.
Exercise of Right of Rescission :
The statute states that to exercise the right to rescind, the
consumer notifies the creditor by written communication. When a consumer rescinds a
transaction, the security interest giving rise to the right of rescission
becomes void and the consumer is not liable for any amount. Within 20 days
after receiving the rescission notice, the creditor is required to return all
money or property the borrower has given in connection with the transaction
and to terminate the creditor's security interest. The borrower is
allowed to retain any money or property it has received, such as the loan
proceeds, until after the lender has
released its security agreement. When the creditor has complied, the
borrower is required to tender the consideration given by the creditor.
Significantly, the statute allows these procedures to be modified by court
What can be done? If the lender immediately
files suit asking for an order allowing the creditor to condition its release
of its security interest on the tender of the consideration the borrower
received, i.e., the loan proceeds, courts may grant and have granted that order under the terms of the statute.
The creditor's counsel may be able to obtain an extension of time from
Debtor's counsel to negotiate a settlement, when faced with an ex parte
application for such an order. Many courts will make such an order to prevent an injustice.
Under the terms of the statute, without such an order, after the creditor
releases its deed of trust, the borrower could sell or encumber the real
property security. The borrower could use the funds
to pay off other debts, such as tax liens which may not be dischargeable in
bankruptcy. When the creditor sues the borrower for failure to return
the loan proceeds, the borrower could wait until the bankruptcy preference
period had run, then the file Chapter 7 bankruptcy, to discharge the
borrower's duty to tender the loan proceeds to the creditor, leaving the
creditor with a total loss on its loan. Faced with this potential, many
courts will issue the order changing the statutory order of the remedies
provided in Section 1635, so that the deed of trust will not have to be
released until the borrower tenders back the loan proceeds, and demonstrates
the vitality of the rescission claim.