The federal Truth In Lending Act (TILA) is a consumer protection statute designed to protect borrowers from unfair lending practices. When a consumer loan is secured by the borrower’s residence, the TILA gives the borrower the right to rescind the transaction. If the lender makes required disclosures to the borrower, including advising the borrower of the right to rescind, the borrower must exercise the right to rescind within three days after the loan closes. If the lender does not make the required disclosures, the period in which the borrower can rescind the transaction is three years.
When the borrower exercises the right to rescind the transaction, the TILA provides that “Within 20 days after receipt of a notice of rescission,” the lender “shall take any action necessary or appropriate to reflect the termination of any security interest created under the transaction.” The TILA provides that “Upon the performance of the [lender]’s obligations under this section, the [borrower] shall tender the property [i.e., the loan proceeds] to the [lender].”
Because the TILA only requires that the borrower return the loan proceeds to the lender “upon” the performance of the lender’s obligation to release its security interest, in a number of bankruptcy cases, courts have held that when a debtor has exercised its right of rescission, the lender’s security interest becomes unenforceable twenty days after the lender received the notice of rescission and that the lender then has only a general unsecured claim for return of the loan proceeds which shares pro rata in whatever distributions, if any, are made to the holders of general unsecured claims in the bankruptcy case.
At least in bankruptcy courts in the Fourth Circuit, lenders no longer face the prospect of having to give up their liens without getting back the money that they lent. In a July 14 opinion in Lavis v. Reverse Mortgage Solutions, Inc., the United States Court of Appeals for the Fourth Circuit held that no “provision of TILA allows a borrower to avoid tendering the loan proceeds as part of rescission.”
The borrower in Lavis had obtained a reverse mortgage loan from Reverse Mortgage Solutions. Some of the loan proceeds were used to pay off a loan secured by an existing lien on her residence. Most were disbursed to the borrower in cash. RMS did not make the disclosures required by the TILA. Within three years after the loan closing, the borrower sent RMS a notice of rescission. RMS did not release its lien on her residence. The borrower then sued RMS.
In the trial court, RMS argued that the ability of the borrower to tender the loan proceeds back to RMS had to be considered in determining whether she could rescind the loan transaction. The trial court disagreed. The trial court concluded that RMS had violated the TILA both by failing to make the required disclosures and by failing to release its lien on the borrower’s residence within twenty days after receipt of the notice of rescission. Moreover, the trial court held that the lender’s failure to release its lien excused the borrower from the obligation to return the loan proceeds.
The Fourth Circuit reversed. The Court found the absence of an express provision in the TILA excusing the borrower from the obligation to return the loan proceeds if the lender violates the TILA to be significant. The Court said:
The absence of a provision identifying the relief Lavis seeks is significant. By any measure, such relief would be remarkable. It would mean that failure to provide a required disclosure results in a lender losing—lock, stock and barrel—the moneys it loaned. And the borrower would get to keep, with no repayment obligation, those same funds. Such relief, in some cases, would redistribute tens of thousands of dollars; in other cases, hundreds of thousands. It is hard to imagine that such extraordinary relief, if allowed under TILA, would not be specified.
Moreover, the Court said that excusing the borrower from returning the borrowed funds was contrary to the concept of rescission. The Court said:
The equitable goal of rescission under TILA is to restore the parties to the ‘status quo ante.’ [citations omitted]. Yet Lavis’ argument would do the opposite. It would grant Lavis a windfall of the amounts RMS advanced to Lavis in cash, as well as those paid to satisfy Lavis’ prior lien on the property and the insurance obligation. And it would also impose a penalty on RMS in the same amount.
“Tender,” the Fourth Circuit said, “is a critical part of rescission.”
Notably, the Fourth Circuit cited decisions of only two other Circuit Courts of Appeal, the Sixth Circuit and the Tenth Circuit, in support of its decision. In most Circuits, lenders who violate the TILA still face the risk that they will be required to give up their liens without getting the money that they lent back. At least in the Fourth Circuit, borrowers can’t rescind a loan transaction and keep the loan proceeds.