it's all about the principal preserving consumers right of rescission under the truth in lending act

8/9/2019 It's All About the Principal Preserving Consumers Right of Rescission Under the Truth in Lending Act

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DRAFT VERSION 1.0 Email comments to [email protected]

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Its All About the Principal: Preserving Consumers' Right ofRescission Under the Truth in Lending Act

89 NORTH CAROLINALAW REVIEW __ (forthcoming 2010)

Lea Krivinskas Shepard

ABSTRACT

This Article explores a significant market-based threat to the Truth in Lending Actsright of rescission, a remedy that attempts to deter lender overreaching and fraud during one of themost complex financial transactions of a borrowers lifetime. The depressed housing market hassubstantially impaired many borrowers ability to fulfill their responsibilities in rescissionsunwinding process: restoring the lender to the status quo ante by repaying the net loan proceeds ofthe mortgage transaction.

When a consumer is unable to finance her tender obligation, non-bankruptcy judgesoverwhelming response has been to protect the lender and deny rescission to the borrower. This Article argues that these courts, to fulfill TILAs consumer-protective function, must take a

different approach. Non-bankruptcy courts, which handle the vast majority of TILA rescissionactions, should use their equitable authority under TILA to modify borrowers repaymentobligations by allowing borrowers to tender in installments, over a period of years, and at reasonableinterest rates. This approach both averts foreclosures that harm borrowers, lenders, andneighborhoods and ensures that TILAs consumer-protective mandate will remain viable even in adepressed housing market.

This Article also considers an important aspect of TILA's rescission remedy that, whiletacitly acknowledged by courts and commentators, has been insufficiently explored in the academicliterature. There exists an uneasy tension between the goal of the Truth in Lending Actinforming consumers of the financial consequences of their mortgage loan transactionsandborrowers frequent use of TILA rescission: defending their homes from foreclosure actions that thelenders disclosure violation may or may not have precipitated. The Article concludes that TILArescission actions, albeit a blunt instrument in the consumer protection setting, must be preserved,particularly during periods of economic calamity, since it remains a singular source of borrowerleverage in a legal and economic climate that remains generally inhospitable to homeowners.


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Its All About the Principal: Preserving Consumers' Right ofRescission Under the Truth in Lending Act

89 NORTH CAROLINALAW REVIEW __ (forthcoming 2010)

Lea Krivinskas Shepard*

I. Introduction: Underwater and Drowning........................................................ ........ 3

II. The Truth in Lending Act: A Powerful and Controversial Disclosure Statute......12A. Why Congress Passed the Truth in Lending Act..........................................................................12B. TILAs Right of Rescission: A Crucial Tool in Deterring Lender Overreaching .........................16

1. Comparing TILA Rescission and Common Law Rescission ........................................162. Conditional Rescission: A Reversion to the Common Law Rescission Sequence ....20

a. Background ........................................... .................................................. ....................................... 20b. Courts Rationale for Ordering Conditional Rescission ........................................... .............. 22

III. When Consumers Cannot Afford to Tender: Choosing Between a Return to theStatus Quo Ante and Meaningful Rescission-Based Protection................................ 24A. Yamamoto and its Progeny: Judicial Nullification of a Crucial Remedy..................... 27B. Other Circuits: Complete Adjudication, But Relief for Underwater BorrowersRemains Elusive ........................................................................................................................32

1. Background ........................................... .................................................. ....................................... 322. Illustrative Cases.......... .................................................. .................................................. .............. 33

C. Alternative Approaches: Tendering in Installments ......................................................361. Non-Bankruptcy Courts .............................................. .................................................. .............. 362. Bankruptcy Courts ................................................ .................................................. ...................... 39

a. The Significance of Conditional Rescission in Bankruptcy Cases....................................39

b. Instructive Chapter 13 cases .......................................... .................................................. ...... 42IV. Why Installment Payments Make Sense .............................................................. 45

A. Weighing the Equities ........................................................................................................45B. A Gradual Return to the Status Quo Ante........................................................................49C. Preserving Rescission as a Significance Source of Borrower Leverage.....................49

V. Conclusion............................... .............................................................. ................. 53

* Assistant Professor, Loyola University Chicago School of Law. J.D., Harvard LawSchool; A.B., Duke University. I am deeply indebted to John Breen, John Bronsteen,Brett Frischmann, Cynthia Ho, Dan Krivinskas, Donna Krivinskas, David Leibowitz,Daniel Lindsey, Margaret Moses, Daniel Mulligan, Katherine Porter, Elizabeth Renuart,

ArnoldRosenberg, Pamela Simmons, Jeff Sovern, Diane Thompson, Jason Veloso,Spencer Weber Waller, Neil Williams, Mike Zimmer, and all attendees of the TeachingConsumer Law Conference and Loyola Half-Baked Workshop for their invaluablecomments and suggestions. Patricia Scott, Julia Wentz, Eric Shukis, and Aileen Che, andYvette Le provided very helpful research assistance. I thank Spencer Shepard IV,Gezinus Hidding, Crisarla Houston, Cynthia Lepow, Aldona Krivinskas, MichaelKrivinskas, and Jolita Kavaliunas for their kindness and support.


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89 NORTH CAROLINA LAWREVIEW__ (forthcoming 2010)


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I. Introduction: Underwater and Drowning

The Paxtins were in trouble. They knew it, and their creditors knew it. Two

months behind on their mortgage payments and credit card bills, the couple, tired ofdunning calls from debt collectors, cringed every time the phone rang, which seemedlike every hour. They knew they might lose their home.

In the real estate section at the local Barnes & Noble, the couple learnedabout various foreclosure defense strategies.1 Bankruptcy could help the couplereduce their credit card debt,2 but didnt provide a long-term solution for theirmortgage debt, which had grown out of control.3 Under the Truth in Lending Act(TILA),4 however, an expansive federal credit price disclosure statute,5 if their lendermade a material error6 in the paperwork it provided the couple two and a half yearsago when they refinanced their 30-year, 8 percent variable interest rate loan, the

1 See generallyRalph R. Roberts & Lois Maljak, FORECLOSURE SELF-DEFENSE FORDUMMIES (Wiley Publishing ed. 2008).

2 In either Chapter 7 or Chapter 13 bankruptcy, a consumer may discharge a sizeableportion of her unsecured debt. See11 U.S.C. 727(b); 1328(a); see, e.g., Scott F. Norberg,Consumer Bankruptcy's New Clothes: An Empirical Study of Discharge and Debt Collection inChapter 13, 7 Am. Bankr. Inst. L. Rev. 415, 430 (1999) (demonstrating in a late 1990ssample that unsecured creditors received only 15.2 percent of their claims in Chapter 13plans); Dalie Jimenez, The Distribution of Assets in Consumer Chapter 7 Bankruptcy Cases, 83AM.BANKR.L.J. 795, 805-06 (2009) (in study of 2,500 Chapter 7 cases filed between2007 and 2009, only 11 percent of all general unsecured claims received any distributionwhatsoever; of these, the average median distribution was eight percent).

3 Consumers may modify various debts in Chapter 13 bankruptcy by reducing interest

rates, extending loan terms, changing amortization schedules, and limiting secured claimsto the value of the collateral. See11 U.S.C. 1322(b)(2); see, e.g.,Adam Levitin, Resolvingthe Foreclosure Crisis: Modification of Mortgages in Bankruptcy, 2009 WIS.L.REV.565, 571(explaining that the bankruptcy system is generally unable to help reduce the damagefrom the current foreclosure crisis because of the protection it provides to most lenderswho hold residential mortgage claims). The Bankruptcy Code, however, preventsborrowers from modifying mortgage loans secured only by the debtor's principalresidence. Instead, borrowers must cure defaults on residential loans and pay off theloans according to their original terms; otherwise, the bankruptcy court will lift the stayon collection actions and allow the mortgagee to foreclose on the property. See11 U.S.C. 1322(b)(5); 362(d)(1); seeLevitin, supranote 3, at 582.

4 15 U.S.C. 1601 et seq.5 See generallyDEE PRIDGEN &RICHARD M.ALDERMAN,CONSUMERCREDIT AND THE

LAW, 14:17 (2008-09 ed.) [hereinafter PRIDGEN &ALDERMAN,CONSUMERCREDIT].6 TILA defines material disclosures as the annual percentage rate, the method of

determining the finance charge and the balance upon which a finance charge will beimposed, the amount of the finance charge, the amount to be financed, the total ofpayments, the number and amount of payments, and the due dates or periods ofpayments scheduled to repay the indebtedness. 15 U.S.C. 1602(u).


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couple might find a way out of the morass. If, for example, their lender misstated theannual percentage rate (APR)7 or finance charge,8 or failed to inform the couple oftheir right to back out of the loan at no cost within the first three days after closing,9

the Paxtins might be able to rescindor cancelthe loan.10Alternatively, if the couple had a good attorney, they might be able to reach a

settlement with the lender (or the lenders assignee11 ). If confronted with a solid TILA rescission claim, the lender, concerned about the possibility of protractedlitigation, might agree to modify the couples loan by reducing the interest rate or the

7 See15 U.S.C. 1606. The APR provides a unitary shopping instrument by convertingthe finance charge into a percentage rate based on an annual term. Elizabeth Renuart &Diane E. Thompson, The Truth, the Whole Truth, and Nothing But the Truth: Fulfilling thePromise of Truth in Lending, 25 YALEJ.ON REG. 181, 188 (2008).

8 TILA defines the finance charge, as the sum of all charges, payable directly or indirectly

by the person to whom the credit is extended, and imposed directly or indirectly by thecreditor as an incident to the extension of credit. 15 U.S.C. 1605. The finance chargeincludes, for example, interest, service charges, loan fees, credit report fees, and insurancecharges. Id.

9 Under TILA, each borrower having a right to rescind must receive two copies of thenotice of right to rescind, which must clearly 1) disclose that the creditor is retaining oracquiring a security interest in the consumer's principal dwelling, 2) disclose that theconsumer has a right to rescind the transaction, 3) describe how the consumer canexercise the right to rescind, 4) describe the effects of rescission, and 5) provide the datethe rescission period expires. 12 C.F.R. 226.15(b), 226.23(b). The Federal ReserveBoard has published model disclosure forms, including a model notice of right torescind, to assist creditors in complying with the disclosure requirements. See, e.g., 12

C.F.R. 226, Appendix H, Form H-8 (to be used in a refinancing with a new lender);Form H-9 (to be used in a refinancing with the same creditor that issued the originalloan). The requirement that each obligor receive two copies of the notice of right torescind is not a mere technicality, as [e]ffective exercise of the right to rescindobviously depends upon the delivery of one copy of the rescission form to the creditorand the retention by the obligor of the other copy. Moreover, each person whosehome ownership interest may be compromised by a credit transaction must be informedof his or her rescission rights. Stone v. Mehlberg, 728 F. Supp. 1341, 1353 (W.D. Mich.1989).

10 15 U.S.C. 1635(a).11 Although this Article generally refers to those who oppose TILA rescission claims as

lenders, or creditors, any rescission action can also be brought against assignees, 15U.S.C. 1641(c), even though assignees are not creditors under TILA, 12 C.F.R. 226.2(a)(17) (a creditor must be the person to whom the obligation is initially payable).See also FDIC v. Hughes Dev. Co., 684 F. Supp. 616 (D. Minn. 1988) (holding that when theFDIC purchases assets secured by mortgages on consumers principal dwellings, theFDIC remains subject to the consumers rescission rights); ELIZABETH RENUART &KATHLEEN KEEST,NAT'L CONSUMERLAWCENTER,TRUTH IN LENDING 2.3.5.2 (6thed. 2007).


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principal, or both. In the best-case scenario, the foreclosure action would bedismissed and the Paxtins could keep their home. The couple wasnt sure if thelender had made any errors substantial enough to trigger their rescission rights, but

they had noticed that they were paying for credit insurance that they didn't rememberlearning about. As they dug out their mortgage paperwork from a filing cabinet, theynoticed that they had received four copies of a Notice of Right to Cancel,12 butthe date field had been left blank.

TILA errors seemed surprisingly common: although mortgage companies'compliance departments are supposed to scrutinize mortgage loan documents formistakes and omissions,13 lenders commit TILA errors more often than they violateany other consumer protection regulation.14 Some companies in the business ofidentifying actionable mistakes in borrowers' disclosure documents claim that majorTruth in Lending Act or related violations might be spotted in as many as 80 percentof loans.15

If, however, the lender was unwilling to settle, a court would have todetermine whether or not the couple was entitled to rescind. If the court identifieda material error, the lender and the Paxtins would, through rescission, unwind thetransaction, returning the parties to the status quo ante their pre-mortgagetransaction positions.16 The lender would have to return to the Paxtins their closingcosts17 and two and a half years worth of finance charges, including interest.18 In

12 See supranote 9.13 See, e.g., Andrew L. Sandler & Benjamin B. Klubes, Compliance Risk Management in

Subprime Lending: The New Fair Lending Challenge, 53 CONSUMERFIN.L.Q.REP.113(1999).

14

See Metavante Regulatory Services Compliance Manual, Summary of Regulations(2009).15 Gretchen Morgenson, The Silence of the Lenders, NEWYORKTIMES, July 13, 2008, at B1(quoting statements of president of forensic loan audit company that TILA, RESPA, andother errors were found in at least 80 percent of mortgages recently reviewed); LewSichelman, Document Review Could Save Home, CHICAGOTRIBUNE, Oct. 3, 2008, at 8(quoting forensic loan auditors' statement that 80 percent of recent mortgages auditedhad errors relating to TILA, RESPA, predatory lending, and fraud); Linda Stern, StepCarefully When You Enter the Mortgage Market: The Problems Abound, BOSTON GLOBE,July30, 2009, at B10 (Almost every mortgage made during the big bubble has missingpaperwork or other mistakes that violate the Truth in Lending Act.) Estimates of thefrequency of actionable TILA errors, however, vary widely.

16 See15 U.S.C. 1635; see, e.g.,McKenna v. First Horizon Home Loan Corp., 475 F.3d 418, 421(1st Cir. 2007) (Rescission essentially restores the status quo ante; the creditor terminatesits security interest and returns any monies paid by the debtor in exchange for the latter'sreturn of all disbursed funds or property interests.); Sosa v. Fite, 498 F.2d 114, 119 (5thCir. 1974) ([S]ection 1635(b) is clearly designed to restore the parties as much as possibleto the status quo ante.)

17 For example, the lender must return all broker fees, application and commitment fees,and title search and appraisal fees. 12 C.F.R. pt. 226, supp. I, 226.15(d)(2) cmt. 1;


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turn, the Paxtins would be required to return the present balance on the mortgagethe loan principal.19 The net sum they would have to return to the lender (thecurrent balance minus the closing costs and finance charges the lender would be

forced to return)20the couples tender obligation or the net loan proceeds was several thousand dollars less than the principal balance on the couplesmortgage.21 Rescission is so costly for and intimidating to creditors precisely becausesuccessful rescission plaintiffs receive the equivalent of an interest-free, fee-freemortgage for the period between the loan closing and the exercise of their rescissionrights.

The only problem was that the Paxtins werent sure how they were going tofulfill their end of the rescission bargain, or tender22 the net loan proceeds to thelender. In a more normal housing market, to unwind a mortgage through rescission,the Paxtins could either finance the tender obligation by refinancing their mortgageor by selling their home, using the proceeds of either the refinancing or the sale to

pay off the mortgage written by TILA-violating lender.23

If the couple successfullyrefinanced their mortgage, generating sufficient proceeds to pay the tenderobligation, the couple could avert foreclosure and remain in their home. Even if thePaxtins were insufficiently creditworthy to refinance the loan, they could financetheir tender obligation by selling the home, allowing the couple to satisfy a major

226.23(d)(2) cmt. 1.18 12 C.F.R. 226.15(d)(2), 226.23(d)(2); 12 C.F.R. pt. 226, supp. I, 226.15(d)(2) cmts. 1

& 2; 226.23(d)(2) cmts. 1 & 2.19 See12 C.F.R. 226.15(d)(3), 226.23(d)(3).20 To prevent an inefficient and perfunctory exchange of funds, courts routinely allow the

creditor to offset the interest and fees it must return to the borrower against the loanprincipal the borrower must tender to the lender. See Harris v. Tower Loan of Mississippi,Inc., 609 F.2d 120, 123 (Fifth Cir. 1980); In re Piercy, 18 B.R. 1004, 1008 (Bankr. W.D. Ky.1982).

21 See In re Stuart, 367 B.R. 541, 552 n.12 (Bankr. E.D. Pa. 2007) (providing detaileddescription of how a successful rescission reduces the borrower's overall liability to herlender).

22 In the contracts setting, the phrase tender of performance refers to an obligorsdemonstration of readiness, willingness, and ability to perform the obligation. SeeBLACKS LAWDICTIONARY(7th ed. 1999). Under this definition, a borrower seeking torescind a loan transaction would tender by offering to return the net loan proceeds tothe lender and, at the time of the offer, be capable of performing. See id. In the Truth inLending Act context, however, courts use the word tender very loosely. Courtssometimes refer to a borrowers tender of performance, and, at other times, courtsdescribe tender as the borrowers actual performanceof the obligation (i.e., the rescindingborrowers actual payment of the net loan proceeds to the lender). This confusion ispartially attributable to courts diverse approaches to structuring the parties obligationsin the unwinding process. See infraSection III.

23 RENUART &KEEST, supranote 11, 6.8.2, at 465.


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debt burden and move on to a more affordable apartment or smaller home. The Paxtins couldnt refinance their mortgage or sell their home because

they, like nearly a quarter of American homeowners,24 were underwater, or upside

down, on their mortgage: they owed more on their mortgage than their homethecollateral securing their mortgage loanwas worth.25 In a depressed or unstablehousing market, no private lender would be likely to refinance a loan with more thana 100 percent loan-to-value ratio,26 since, in the event the borrower defaulted on themortgage, and the lender forced a sale of the home, the lender would be left with alarge deficiency.27 Likewise, if the couple attempted to finance their tenderobligation by selling their home, they would be left short: a sale of the home in thecurrent depressed housing market would yield far less than the couple owed on themortgage. Thus, a sale could not generate enough proceeds to fully repay the netloan proceeds.

Things seemed bleak for the Paxtins. After the couple notified their lender

that they intended to rescind the mortgage transaction, the lender initially ignoredthe rescission notice.28 A few weeks later, it sent the couple a letter denying any

24 Ruth Simon & James R. Hagerty, One in Four Borrowers is Underwater,WALL ST.J., Nov. 24,2009, at A1. By the end of 2010, nearly 42 percent of Americans may be underwater.Dawn Kopecki and Theo Francis, U.S. May Retool Loan Program for Underwater Borrowers,BLOOMBERG.COM, Jan. 27, 2010.

25 Various terms describe the condition of a borrower, her mortgage, and the owner of themortgage note (either the original lender or an assignee) when the borrower's mortgageexceeds her home's value. Such a borrower may be underwater or upside down onher mortgage. She has negative equity (the amount by which the mortgage debtexceeds the home's value) in her home. A creditor holding such a mortgage is referred to

as undersecured. Such mortgages have a loan-to-value ratio greater than 100%.26 The loan-to-value ratio, a key factor in lenders financing decisions, is calculated bydividing the outstanding principal by the current value of the property subject to thelenders security interest. JACKP.FRIEDMAN &JACKC.HARRIS,KEYS TO MORTGAGEFINANCING AND REFINANCING 8 (2001).

27 DIANETHOMPSON &ELIZABETH RENUART,NAT'L CONSUMERLAWCTR.,TRUTH INLENDING 6.8.2 (6th ed. Supp. 2009) (Planning for tender may be more complicated . .. when the borrower owes more than the home is worth. This may, for example, makerefinancing impossible unless the excess debt is reduced through other claims.);Congressional Oversight Panel, Foreclosure Crisis: Working Toward a Solution34 (Mar. 2009),available at http://cop.senate.gov/documents/cop-030609-report.pdf. If a borrower isunder water, a private lender is unlikely to refinance the loan because the borrower'srepayment incentives are diminished and the homeowner may abandon the property dueto the negative equity overhang. Id. For example, a borrower who experiencessubstantial financial distress, desires to relocate to a new job in a distant location, orwants to downsize to a smaller home may conclude that the simplest course of action iswalk away from a home with significant negative equity that is impossible to sell. Id.

28 It is common for creditors to ignore borrowers' rescission notices. See, e.g., Prince v. U.S.Bank Nat. Ass'n, 2009 WL 2998141, at *1 (S.D. Ala. 2009).


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TILA violations. Shortly after the parties brought the matter to court, the lenderfiled a motion to dismiss, claiming that, even if the lender had failed to disclosematerial information under TILA, thereby entitling the borrowers to rescission,

continuing with the case would be futile. According to the lender, since theborrowers were underwater, they were unable to tender and, thus, unable to fulfilltheir end of the rescission bargain.

Without examining the merits of the borrowers' claim, the court gave thePaxtins an ultimatum: unless they tendered within 60 days, it would dismiss theirrescission claim.29 Because the couple was underwater, no lender would agree to arefinancing, and a sale of the home couldnt cover the entire tender obligation.Because the couple could not tender, the court dismissed the action with prejudice.Out of options, the couple vacated the property. Marked by a bank-ownedplacard in the yard, the home stands dormant on a quiet street.

***

The Truth in Lending Act has a laudable goalclearly and conspicuouslydisclosing to consumers the cost of various credit transactions, thereby protectingconsumers from unfair and deceptive acts and practices and increasing competitionamong banks and financial institutions.30 Consistent with this goal, under TILA, aconsumer who has taken out a non-purchase-money mortgage31through a homerefinancing, home equity loan, or home improvement credit sale32has an absoluteright to rescind the loan within three business days following the loan closing.33 Thisthree-day cooling off34 or buyers remorse35 period can extend to up to threeyears, however, if the lender omits or incorrectly discloses certain material

information

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in the documents the borrowers received during a non-purchase-money mortgage loan transaction.

29 For a description of cases in which courts routinely dismiss inability-to-tender actionsbefore adjudicating borrowers rescission claims, see infraSection III.A.

30 15 U.S.C. 1601.31 A non-purchase-money mortgage is a mortgage other than one used to finance the initial

initial construction or acquisition of a property. Cf. 15 U.S.C. 1602(w) (definition ofresidential mortgage transaction). Only non-purchase-money mortgages are eligiblefor rescission. See15 U.S.C. 1635(e)(1) (excepting from TILAs rescission provisionsresidential mortgage transactions, or purchase-money mortgages). Congresspresumably was not concerned with providing borrowers a right of rescission in thepurchase-money context, since, in such cases, it would likely be apparent to the borrowerthat the home would be encumbered by the new mortgage.

32 SeePRIDGEN &ALDERMAN,CONSUMERCREDIT, supranote 5, 14:18, at 1024.33 15 U.S.C. 1635(a).34 PRIDGEN &ALDERMAN,CONSUMERCREDIT, supranote 5, 14:17, at 1022.35 Semar v. Platte Valley Fed. Sav. & Loan Ass'n, 791 F.2d 699, 701 (9th Cir. 1986).36 See supranote 5.


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Lenders pay dearly for these errors: as part of the unwinding process,lenders must return to borrowers all closing costs, finance charges (includinginterest), and all payments that the borrower has made to the lender between the

loan closing and the exercise of her rescission rights. In turn, the borrower mustreturn to the lender the original loan proceeds.

The results of a successful rescission action can be dramatic. The net sumthe borrower must return to the lender to terminate the parties relationship can bethousands of dollarsup to three years worth of fees and interestless than theborrowers current mortgage obligation. Through bringing a rescission action,borrowers can routinely reduce their principal balance by 10 to 20 percent, a resultfar more advantageous to the borrower than that achievable through any private orgovernment-sponsored loan modification. In anticipation of protracted litigationand this costly result, lenders frequently settle with borrowers who bring strongrescission claims. In these settlements, lenders might agree to modify a borrowers

mortgage loan by reducing the current balance by roughly the same amount thelender would have to return to the borrower in a rescission: a figure equal to the feesand interest that have accumulated since the loan closing.

Through either a completed rescission or a loan modification, the borrower,in the best case scenario, can come out ahead. A borrower previously behind on hermortgage payments might be able to avert foreclosure, remain in her home, andresume payments on a smaller mortgage loan.

TILA's rescission remedy, exercisable by borrowers on a strict liability basis,37serves a significant role in preventing lender overreaching during one the mostcomplex and important financial transactions in the life of a borrower. TILArescission actions, likewise, provide one of the few sources of borrower leverage in

negotiations with lenders for home mortgage modifications.

38

As illustrated by the Paxtins story,39 however, TILAs rescission remedy iscurrently out of reach for a sizable group of consumers in certain areas of thecountry where home values have dropped considerably between the time theborrowers entered into these mortgage transactions with TILA-violating lenders andthe point at which the borrowers seek rescission.40 In more normal housing markets,a borrower who is eligible for rescission may be able to tender even if the value ofher home is slightly less than the principal balance of her mortgageif she is only

37 See, e.g., In re McElvany, 98 B.R. 237, 240 (Bankr. W.D. Pa. 1989) (It is a system of strictliability if the required disclosures are not made according to provisions of RegulationZ; It is strict liability in the sense that absolute compliance is required and eventechnical violations will form the basis for liability) (internal citations omitted);RENUART &KEEST, supranote 11, 1.4.2.3.2 (Except where Congress has explicitlyrelieved lenders of liability for noncompliance, it is a strict liability statute.).

38 See infraSection IV.C.39 See supraSection I.40 Simon & Hagerty, supranote 19, at A1; Kopecki and Theo Francis, supranote 19.


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minimally underwater,41 since the borrowers obligation is reduced by allorigination fees and finance charges paid between the loan closing and the time ofthe loans cancellation.42 In the current housing market, however, while a rescinding

borrower must tender only the loan principal minus all finance charges and closingcosts reaped by the TILA-violating lender,43 as a result of recent dramatic decreasesin home values in certain areas of the country, many borrowers net tenderobligations are still likely to exceed the value of their homes.44 Thus, an underwater TILA plaintiff typically cannot refinance her mortgage,45 and a sale of her homeusually cannot generate sufficient proceeds to fully finance the borrowers tenderobligation.

When a consumer is unable to finance her tender obligation, non-bankruptcyjudges' overwhelming response is to use their equitable authority under TILA toprotect the lender. Concerned that an underwater TILA plaintiff will be unable tofulfill her end of the rescission bargain, judges frequently dismiss the plaintiffs

rescission action altogether. As a result, TILAs rescission remedy, a powerful meansof reducing lender overreaching, is at risk of becoming dormant and underutilized inthe current depressed housing market. In the words of two practicing lawyers,TILA, at least in the rescission context, is a statute without a remedy.46 As a result,many lawyers in communities most hard-hit by depressed real estate prices areturning away clients with valid TILA rescission claims, regardless of the strength ofthe lawsuit.47

Non-bankruptcy courts dominant approach in inability-to-tender cases istoo rigid. By requiring consumers to repay their tender obligations in full andimmediately or risk dismissal of their claims, courts are, in effect, limiting rescissionto a decreasing pool of privileged homeowners: those who can afford to tender

from available funds or those with sufficient equity in their homes to finance theirtender obligations. Given the recent widespread collapse in home values, thisapproach is impracticable and inequitable.

There is a better way. This Article argues that these courts, to fulfill TILAsconsumer-protective function, should take a different approach. Non-bankruptcy

41 See supranote 25 (definition of underwater).42 15 U.S.C. 1635(b). For example, if a borrower is only a few thousand dollars

underwater, this negative equity might be canceled out by the interest and fees thelender must return to the borrower as part of the rescission process. See id.

43 See15 U.S.C. 1635(b); 12 C.F.R. 226.23(d).44 Simon & Hagerty, supranote 19, at A1; Kopecki and Theo Francis, supranote 19.45 See supranote 21.46 Telephone interview with Dan Mulligan, Principal, Jenkins Mulligan & Gabriel L.L.P.,

(Jan. 25, 2010); Telephone interview with Pamela Simmons, Partner, Law Office ofSimmons & Purdy (Feb. 9, 2010).

47 Id.


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courts, which handle the vast majority of TILA rescission actions,48 should use theirequitable authority under TILA to modify borrowers repayment obligations byallowing borrowers to tender in installments, over a period of years, and at

reasonable interest rates. There are significant benefits for all stakeholdersborrowers, lenders, and communities alikeassociated with modifying repaymentobligations. Considering the difficulty many governmental-sponsored and private-party loan modification programs have had in gaining traction to avert furtherdegradation of the housing market,49 rescission-based modifications of repaymentobligations can help mitigate the damage from the current housing crisis. Thisapproach both reduces foreclosures that harm borrowers, lenders, and communities50and ensures that TILAs consumer-protective mandate will remain viable even in adepressed housing market.51

Part II of this Article describes the origins of the Truth in Lending Act anddescribes how courts, through the practice of conditional rescission, have used their

equitable authority under TILA and Regulation Z to protect lenders interests. PartIII describes how the depressed housing market prevents many rescission plaintiffsfrom restoring creditors to the status quo ante in full and immediately, and exploresseveral non-bankruptcy and bankruptcy court cases in which courts have confrontedinability-to-tender problems. Part IV critiques courts' variegated but predominantpractice of denying rescission reliefand TILAs protectionsto borrowers whocannot afford to immediately tender in full. This Part suggests that these courtsshould instead allow borrowers to tender in installments, an approach that is moreconsistent with TILA's consumer-protective mandate and is crucial in preserving

48 Telephone Interview with David P. Leibowitz, Managing Member and Partner, Lakelaw

(Jan. 29, 2010). Most TILA rescission actions appear to be brought in state court inresponse to foreclosure actions. Id. Most bankruptcy attorneys, moreover, are unfamiliarwith the Truth in Lending Act and rarely bring actions under consumer statutes likeTILA. Id.

49 See, e.g., U.S. Govt Accountability Office, Troubled Asset Relief Program: Treasury ActionsNeeded to Make the Home Affordable Modification Program More Transparent and Accountable,GAO-09-837 (July 2009); Peter S. Goodman, Treasury Weighs Fixes to Foreclosures Program,N.Y.TIMES, Jan. 21, 2010.

50 Congressional Oversight Panel, supranote 21, at 8-10 (describing how foreclosuresimpose significant stress and losses on households, communities, state and localgovernments, and investors). One study estimated that each foreclosure on averageimposes $60,000 in direct costs on lenders; another study estimated that one foreclosurecan depress the property values of the eighty closest homes by nearly $5,000. See id.(citations omitted).

51 Whether or not disclosure of the cost of credit is the most effective means of protectingconsumers is a fundamental question, but one beyond the scope of this Article. At themoment, consumer credit regulation is dominated by disclosure laws. Manycommentators, however, have expressed doubt that disclosure-based regulation caneffectively inform consumers and, accordingly, affect behavior.


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borrowers leverage in a predominantly inhospitable legal and economic climate.Part V concludes.

Whether or not disclosure-based regulations are the most effective means of

protecting consumers in the marketplace is a fundamental question, but one beyondthe scope of this Article. Important perspectives on this topic have been amplifiedelsewhere.52 This Article, in contrast, takes a pragmatic view of how courts andregulators can right now fashion the contours of TILAs rescission remedy in a waymost consistent with TILAs consumer-protective origins and functions, and to anextent that can help alleviate insidious problems in the housing market. Whilemeaningful, substantive reform of the consumer protection landscape is critical,change remains elusive. This Article emphasizes that courts currently have theabilitythrough use of their equitable authorityto alleviate homeowner sufferingand to ensure that TILAs goals are realized to the extent possible given currentpolitical and economic realities.

II. The Truth in Lending Act: A Powerful and Controversial DisclosureStatute

A. Why Congress Passed the Truth in Lending Act

A product of President Lyndon Johnsons Great Society initiatives,53 theTruth in Lending Act's enactment in 1968 marked the birth of modern consumerlegislative activism.54 Its complex disclosures and frequent use by consumers havelong unnerved the credit industry,55 and the statute remains the most intricate and

52 See, e.g., Jonathan M. Landers & Ralph J. Rohner,A Functional Analysis of Truth in Lending,26UCLAL.REV.711, 715 (1978-79) (Behavioral scientists, public opinion research,consumer research, and our own common sense tell us the same thing: consumerbehavior in a particular transaction is almost certainly not going to be affected by a[Truth in Lending] disclosure statement, notwithstanding the quality of that statement.);Oren Bar-Gill & Elizabeth Warren,Making Credit Safer, 157 U.PA.L.REV.1 (2008);Patricia A. McCoy, Rethinking Disclosure in a World of Risk-Based Pricing, 44 HARVJ. ONLEGIS. 123 (2007); Jeff Sovern, Preventing Future Economic Crises Through Consumer ProtectionLaw,Working Paper (2010), available athttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=%201531781.

53 SeeLyndon Johnson, Remarks at the University of Michigan Graduation Ceremonies,1963-64 PUB.PAPERS pt. 1, at 704 (May 22, 1964) (discussing poverty, urban decay, theerosion of community bonds, environmental dangers, inadequate education); ROBERTDALLEK,LYNDON B.JOHNSON:PORTRAIT OF A PRESIDENT (2005); Peter B. Edelman,Toward a Comprehensive Antipoverty Strategy: Getting Beyond the Silver Bullet, 81 GEORGETOWNL.J. 1697, 1710-18 (1993)

54 RENUART &KEEST, supranote 11, 1.2.1.55 Id.


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controversial mandatory disclosure law ever enacted.56 When Congress passedTILA, the consumer protection landscape was vastly different from its current state. TILA's passage, for example, preceded a protracted period of deregulation and

federal preemption of state consumer laws.57 While the statute remains a powerfulenforcement tool, the consumer-centric sentiments that saturate the Truth inLending Act are vestige of a more consumer-protective and paternalistic legal andeconomic culture.

Congress passed TILA primarily to address ubiquitous defects in creditors'cost-of-credit disclosures.58 Before TILA, consumers found it difficult to impossibleto comparison shop for credit, since creditors had no uniform way of calculatinginterest or determining what additional charges would be included in the interestrate.59 To remedy this problem, TILA requires lenders to disclose to prospectiveconsumer borrowers specific, standardized information about open-60 and closed-end61 credit transactions in an attempt to both 1) increase transparency and

competition in the credit markets and 2) promote the informed use of credit.62

56 JOHNA.SPANOGLE,RALPHJ.ROHNER,DEE PRIDGEN &JEFF SOVERN,CONSUMERLAW: CASES &MATERIALS 125 (3d ed. 2007).

57 Interest rate deregulation, for example, arrived in the late 1970s and early 1980s, triggeredby inflationary pressure that reduced lenders' profits, raising concerns that usury laws-caps on interest rateswould result in decreased lending. ELIZABETH RENUART &KATHLEEN E.KEEST,THE COST OF CREDIT:REGULATION,PREEMPTION, ANDINDUSTRYABUSES 42 (3d ed. 2005).

58 Jonathan M. Landers & Ralph J. Rohner,A Functional Analysis of Truth in Lending, 26UCLAL.REV.711, 713 (1978-79) (The basic premises of TILA were that consumersneeded certain information to make essential decisions in consumer credit transactions

and that the information then available as part of the contracting process, or provided asa result of state law requirements, was inadequate.).59 RENUART &KEEST, supranote 11, 1.1.1. For example, lenders calculated interest in a

variety of ways, including the add-on rate, the discount rate, and a simple interest rate,making it very difficult for a consumer to choose the cheapest form of credit. Id. See alsoChristopher L. Peterson, Truth, Understanding, and High-Cost Consumer Credit: The HistoricalContext of the Truth in Lending Act, 55 Fla. L. Rev. 807, 875-76 (2003).

60 An open-end credit transaction is one in which 1) the creditor reasonably contemplatesrepeated transactions, 2) the creditor may impose a finance charge on an outstandingunpaid balance, and 3) the amount of credit that is extended to the consumer up to aparticular limit is generally made available to the extent that the consumer repays theoutstanding balance. 12 C.F.R. 226.2(a)(20). Examples of open-end credit arrangementsinclude credit card loans and home equity loans. See generallyPRIDGEN &ALDERMAN,supranote 5, 8:2; see12 C.F.R. 226.5-226.16 (disclosure regulations for open-endcredit transactions).

61 Regulation Z defines closed-end credit negatively: as consumer credit other than open-end credit. 12 C.F.R. 226.2(a)(10); see12 C.F.R. 226.17-226.24 (disclosure regulationsfor closed-end credit transactions).

62 15 U.S.C. 1601(a).


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TILA provides a standardized definition of two key measurements of the cost ofcredit: the finance charge63 and the annual percentage rate.64

TILAs application is broadranging from open-end65 credit transactions

like credit card and home equity loans to closed-end66 transactions like car loans andmortgages. The statute applies whenever a creditor67 offers or extends credit to aconsumer68 primarily for personal, family, or household purposes,69 and when thecredit is subject to a finance charge70 or is payable by a written agreement in morethan four installments.71 Congress delegated broad authority to the Federal ReserveBoard to implement TILA,72 and the Board has exercised this authority by issuingRegulation Z73 and an Official Staff Commentary on Regulation Z.74 The Fedsinterpretations of TILA and Regulation Z are given great deference by courts.75

For certain TILA violations, a creditor is liable for actual damages, statutorydamages, costs, and reasonable attorneys fees.76 If, however, lenders commit materialdisclosure violations in non-purchase-money77 home equity credit transactions,

63 See15 U.S.C. 1605. Regulation Z describes the finance charge as the cost ofconsumer credit as a dollar amount. 12 C.F.R. 226.4(a). It includes charges payabledirectly or indirectly by the consumer and imposed directly or indirectly by the creditor asan incident to or a condition of the extension of credit. Id. The finance charge includes,for example, interest, service charges, loan fees, credit report fees, and insurance charges.Id.

64 See15 U.S.C. 1606; Renuart & Thompson, supranote 7, at 188.65 See supranote 60.66 See supranote 61.67 Regulation Z defines a creditor as a person 1) who regularly extends consumer credit

that is subject to a finance charge or is payable by written agreement in more than 4installments, and 2) to whom the obligation is initially payable. 12 C.F.R. 226.2(a)(17),n.3. Any person who originates two or more mortgages over the course of a year or whooriginates one or more mortgages through a mortgage broker is considered a creditorsubject to TILA's rescission provisions. Id.;15 U.S.C. 1602(f). Although assignees arenot creditors under TILA, assignees nonetheless are subject to rescission. See15 U.S.C. 1641(c); see, e.g., FDIC v. Hughes Dev. Co., 684 F. Supp. 616 (D. Minn. 1988)

68 12 C.F.R. 226.2(a)(11) (definition of consumer).69 12 C.F.R. 226.2(a)(12) (definition of consumer credit).70 12 C.F.R. 226.4(a) (definition of finance charge).71 12 C.F.R. 226.1(c)(1) (describing TILA's coverage).72 15 U.S.C. 1604(a).73 12 C.F.R. 226 et seq.74 12 C.F.R. 226, Supplement I.75 SeeFord Motor Credit Co. v. Milhollin, 444 U.S. 555, 565 (1980) (holding that Federal Reserve

Board staff opinions interpreting TILA and Regulation Z are dispositive [u]nessdemonstrably irrational).

76 See15 U.S.C. 1640.77 For a description of non-purchase-money mortgages, seesources cited supranote 31.


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borrowers can also pursue a more dramatic remedy.78 If, as part of the transaction,the creditor acquired or retained a non-purchase-money security interest in theconsumers principal dwelling, the consumer can rescind the transaction until

midnight of the third business day following the loan closing.79 During this three-daycooling off period, a consumer is to reflect on the wisdom and desirability of thecontract and on the risk of possible loss of the home.80 Congress believed that byimposing a mandatory period for reflection and evaluation, consumers would beless susceptible to high-pressure or fraudulent creditor practices [that] resulted in anencumbrance on and possible loss of the homestead.81 The consumers three-dayrescission right extends to three years82 if the creditor fails to provide the consumerwith a notice describing the rescission right or with material information about theloan, including the annual percentage rate (APR), finance charge, amount financed,total of payments, and payment schedule.83

TILA has undergone several substantial revisions during its 30-year history.

In response to criticism from creditors that compliance with the earliest version ofthe statute had become too difficult, TILA was amended in 1980 in the Truth inLending Simplification and Reform Act.84 In 1994, in response to the predatorylending crisis,85 Congress passed the Home Ownership and Equity Protection Act(HOEPA) as an amendment to TILA. HOEPA established enhanced disclosurerules for high cost home mortgages exceeding certain price threshold triggers. 86 In1995, in response to Rodash v. AIB Mortgage Company,87 a controversial class action in

78 RENUART &KEEST, supranote 11, 1.1.2, at 3.79 15 U.S.C. 1635(a); 12 C.F.R. 226.23(a)(1), (a)(3). Only non-purchase-money

mortgages are eligible for rescission. See15 U.S.C. 1635(e)(1) (excepting from TILAs

rescission provisions residential mortgage transactions, defined in 15 U.S.C. 1602(w) asfinancing agreements arising from the acquisition or initial construction of a home).80 RALPHJ.ROHNER&FRED H.MILLER,TRUTH IN LENDING 598 (Robert A. Cook et al.

Eds., 2000).81 Id.82 15 U.S.C. 1635(f).83 See15 U.S.C. 1602(u).84 Pub. L. No. 96-221, 94 Stat. 168 (1980) (codified in scattered sections of 15 U.S.C.A.)85 ROBERTJ.HOBBS &STEPHEN GARDNER,NAT'L CONSUMERLAWCTR.,THE PRACTICE

OF CONSUMERLAW: SEEKING ECONOMICJUSTICE, 10.5.2 (2d ed. 2006).86 HOEPA attempted to address problems of reverse redlining: the targeting of

individuals for credit on unfair terms based on their income, race, or ethnicity. Williamsv. Gelt Fin. Corp., 237 B.R. 590, 598-99 (E.D. Pa. 1999) (citing S. Rep. No. 103-169, at 21(1993)); Pub. L. No. 103-325, 151, 108 Stat. 2190 (1994); Peterson, Truth, Understanding,and High-Cost Consumer Credit, supranote 59, at 811 n.18. Failure to make certainadvance-look disclosures constitute a failure to make material disclosures underTILA, which triggers a borrowers right of rescission. RENUART &KEEST, supranote 11, 9.3.10 (citing 15 U.S.C. 1602; Reg. Z 226.23, n.48).

87 16 F.3d 1142.


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which the Eleventh Circuit identified relatively minor disclosure errors as TILA violations triggering rescission, Congress clarified what charges needed to beincorporated in the finance charge and broadened TILAs definition of an

accurate finance charge.88 In July 2008, in response to the subprime mortgagecrisis, the Federal Reserve Board added a new category of higher-priced mortgageloans to Regulation Z.89 Lenders who issue these higher-priced loans are subjectto heightened disclosure requirements and are required to more carefully scrutinizethe borrowers ability to repay the loan.90

B. TILAs Right of Rescission: A Crucial Tool in Deterring LenderOverreaching

1. Comparing TILA Rescission and Common Law Rescission

TILAs rescission provisions shift significant leverage to consumers byenhancing the protections provided to consumers under common law causes ofaction and remedies,91 the oldest and most basic forms of consumer protection.92For example, under the common law, a borrower seeking to rescind her mortgageloan as a result of the lender's fraudulent misrepresentation must establish thefollowing elements: 1) a representation, 2) its falsity, 3) its materiality, 4) thedefendant's knowledge of the representations falsity or ignorance of its truth(scienter), and 5) the plaintiff's justifiable reliance on the representation.93 Theplaintiff may have to plead fraud with particularity and prove each element by clearand convincing evidence.94

A plaintiff able to establish these elements must bring a common law

rescission action within a short time after the transaction.

95

Traditionally, moreover,88 1605(a), (d), (e), (f); Pub. L. No. 104-12, 109 Stat. 161; Pub. L. No. 104-29, 109 Stat.

271; see generallyJo Carrillo & Paul Cofoed, The Sound of Silence: The Continuing Legal DebateOver Class Action Rescission Under TILA, 6 HASTINGS BUS.L.J. 1 (2010)

89 See12 C.F.R. 226.35.90 See12 C.F.R. 226.35. A higher priced mortgage loan that contains a prepayment penalty

in violation of 226.35(b)(2) is subject to TILAs extended right of rescission.THOMPSON &RENUART,supranote 27, 6.4.2.4A, at 269.

91 See supraSection II.B.2.92 DEE PRIDGEN &RICHARD M.ALDERMAN,CONSUMERPROTECTION AND THE LAW

2:1 (2008-09 ed.).93 W.PAGE KEETON et al.,PROSSER&KEETON ON THE LAW OFTORTS 728 (5th ed.

1984). Courts, however, list anywhere from four to nine elements of the common lawfraudulent misrepresentation claim. DAN B.DOBBS,THE LAW OFTORTS 1345 (2000).

94 DOBBS, supranote 77, at 1345. Rescission does not require that the plaintiff establishproof of damage.

95 See, e.g.,JAMES M.FISCHER,UNDERSTANDING REMEDIES(1999) (explaining that therescission remedy is subject to abuse because the plaintiff may seek to unwind a


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the borrower needed to take the first steps in restoring the lender to the status quoante: the borrower had to return the loan proceeds to the lender before the courtwould require the lender to terminate its security interest in the borrowers home and

return accrued interest and fees.96 TILA substantially liberalizes these requirements. TILA rescission claims

need not be pleaded with particularity.97 TILA violations are measured by a strictliability standard.98 Consequently, creditors will be liable even for technical orminor violations.99 As under the common law, 100 a plaintiff seeking rescission underTILA need not prove that the lenders disclosure violation caused actual damage.101

TILA, moreover, allows borrowers who have suffered a material disclosure violation to unwind the loan transaction up to three years following the loanclosing.102 It is unlikely that a borrower seeking to rescind under the common lawcould bring a rescission action one, two, or three years following the loan transaction,as TILA's rescission provisions permit. TILA's lengthy extended rescission period

can complicate attempts to return the parties to their pre-transaction positions in

transaction not due to an objective injury referable to the bargain or sale, but rather asa result of 'buyer's remorse'); see, e.g., Warner v. Denis, 84 Haw. 338, 344 (Haw. Ct. App.1997) (holding that a right of rescission must be exercised within a reasonable time andemphasizing that [e]quity will not permit one party, in whose favor a right of rescissionhas arisen, to delay unreasonably the exercise of the right and thus speculate on the riseor fall in the value of the land.).

96 See, e.g.,Williams v. Homestake Mortg. Co., 968 F.2d 1137, 1140 (11th Cir. 1992); Wells FargoBank, N.A. v. Jaaskelainen, 407 B.R. 449, 455 (D. Mass. 2009); see also Williston onContracts 68:24 ([R]escission is not allowable . . . unless the party seeking to rescindcan and does first restore or offer to restore anything of value it has received under the

contract. Action must be taken within a reasonable time, and must be communicated tothe other party.). In modern equitable rescission cases, however, courts need not requireplaintiffs to tender or offer restoration in [her] complaint, or show an ability to makerestoration, since the court has the ability to condition relief on the plaintiffsrestoration of the defendant to the status quo ante. DAN B.DOBBS,LAW OF REMEDIES:DAMAGESEQUITYRESTITUTION 463 (rev. 2d ed. Supp. 1993).

97 RENUART &KEEST, supranote 11, 7.6.6, at 552.98 Smith v. Fidelity Consumer Discount Co., 898 F.2d 896, 898 (3d Cir. 1990) (citing 15 U.S.C.

1640(a)) ([A] creditor who fails to comply with TILA in any respect is liable to theconsumer ... regardless of the nature of the violation or the creditor's intent.) (citationand internal quotation marks omitted)).

99 Semar v. Platte Valley Federal Sav. & Loan Ass'n, 791 F.2d 699, 704 (9th Cir. 1986)100 SeeDOBBS, supranote 96, at 463.101 See, e.g., Griggs v. Provident Consumer Discount Co., 680 F.2d 927, 932 (3d Cir. 1999), vacated on

other grounds, 459 U.S. 56, 103 S.Ct. 400, 74 L.Ed.2d 225 (1982) (The Act allows recoveryeven when the complainant was not deceived by misdisclosure.); Bilal v. Household Fin.Corp. (In re Bilal), 296 B.R. 828, 833 (Bankr. D. Kan. 2003) (citingHerrera v. First NorthernSavings and Loan Ass'n, 805 F.2d 896, 900 (10th Cir. 1986)).

102 12 C.F.R. 226.15(a)(3).


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cases in which the value of the property has depreciated substantially (and theborrower therefore is unable to finance her tender obligation by selling her home orrefinancing the mortgage).103 This long limitations period, however, provides

significant protection to consumers who detect a defect in the loan disclosures onlyafter other related or unrelated complications with the loan arise.

In addition, TILA reverses the order of events necessary to restore theparties to the status quo ante. Section 1635(b) and its implementing regulation, 12C.F.R. 226.23(d), set forth the procedures governing rescission. Traditionally,under the common law, the borrower had to tender before the court would requirethe lender to terminate its security interest in the borrower's home and return allinterest and closing costs,104 TILA places the onus on the offending lender.105 UnderTILA, after the borrower notifies the lender or its assignee of her intent to rescind,section 1635(b) and its implementing regulation require the lender to cancel itssecurity interest in the borrowers home.106 Only after the creditor complies with its

obligations under the statute must the consumer return the net loan proceeds (theloan principal minus all costs and finance charges paid by the consumer over the loanterm) to the creditor.107

The rescission process set forth in the statute in many ways resembles ahostage exchange: each captor (the borrower or creditor) is reluctant to give up herhostage (the tender obligation or security interest, respectively) before the other partycomplies, since unrequited release risks a near-complete loss of leverage. If theborrower tenders to a creditor who refuses to release its security interest in theborrowers home, the borrower, having relinquished a large lump sum of cash and allof her bargaining power,108 must resort to expensive legal process to force the lenderto comply with its end of the bargain. Conversely, if the lender releases its security

interest before the borrower tenders,

109

the lender is rendered a vulnerable, unsecuredcreditor, whose collateral is subject to attachment by lien creditors.110 Courts haveconcluded that TILAs rescission sequence imposes too substantial a burden on

103 See supraSection III.104 Seetext accompanying note 80, supra.105 See Palmer v. Wilson, 502 F.2d 860, 862 (9th Cir. 1974) (Although tender of consideration

received is an equitable prerequisite to rescission, the requirement was abolished by theTruth in Lending Act.).

106 15 U.S.C. 1635(b); 12 C.F.R. 226.15(d)(3).107 15 U.S.C. 1635(b); 12 C.F.R. 226.15(d)(3).108 Nat'l Consumer Law Center, Proposed Revisions to Regulations B, E, M, Z, DD and The

Official Staff Commentaries (Jan. 30, 2004), available athttp://www.consumerlaw.org/intiatives/test_and_comm/content/frb_jan04_content.html.

109 For a description of courts use of the word tender in the Truth in Lending Actcontext, see supranote 22.110 See infratext accompanying notes 128-130.


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creditors; as a result, courts in most cases revert to the common law unwindingprocess, requiring the borrower to restore the lender to the status quo antebefore thelender must cancel its security interest in the borrowers home.111

Rescission can have a dramatic impact on the consumers ultimate financialobligation to the offending lender because a valid rescission relieves the consumerof any liability for payment of finance or other charges incurred in connection withthe rescinded transaction.112 In a normal housing market, the amount the borrowermust return to the lender to cancel the loanthe consumer's tender obligationislikely to be significantly less than the borrower's principal mortgage obligation,particularly if the borrower sought rescission toward the end of the three-yearextended rescission period.113 When a consumer validly exercises her right ofrescission, she is not responsible for any finance charges or closing costs. 114 Thus, ineffect, all cash payments the consumer made between the loan closing and the pointat which the borrower exercised her rescission rights are applied to the loan

principal.115

In contrast, the majority of the payments a non-rescinding borrowermakes in the early years of a loan are applied to the interest, which continues toaccrue on a slowly declining principal balance.116

TILA's legislative history provides little guidance as to the precise reasonsCongress created a rescission remedy. It is clear that Congress intended to protecthomeowners from abuse from dishonest home improvement contractors who madequestionable home improvements financed by loans secured by borrowers'homes.117 Beyond this articulated concern, however, courts and the Federal ReserveBoard have little information about rescissions precise origins.

In spite of significant gaps in the legislative history of rescission specifically,courts agree that, as a whole, TILA, a remedial statute, must be liberally construed

in favor of borrowers.

118

TILA is designed to protect borrowers who, relative to111 See infraSection II.B.2.112 In re Stuart, 367 B.R. 541, 552 n.12 (Bankr. E.D. Pa. 2007)113 See id.114 Id.;15 U.S.C. 1635(b).115 Stuart, 367 B.R. at 552 n.12.116 Id.117 U.S. Rep. No. 368, 96th Cong., 2d Sess. 28, reprinted in1980 U.S.C.C.A.N. 236, 264 (This

provision was enacted to give the consumer the opportunity to reconsider any transactionwhich would have the serious consequence of encumbering the title to his home.); SeeZakarian v. Option One Mortg. Corp., 642 F. Supp. 2d 1206, 1213-14 (D. Hawaii 2009)(noting that Congress created the statutory rescission right to protect homeowners fromcertain sharp practices of home improvement contractors . . . by creating a rescissionright for home improvement loans that were secured by residential mortgages on existingdwellings) (citation omitted)).

118 See, e.g., Smith v. Fidelity Consumer Discount Co., 898 F.2d 896, 898 (3d Cir. 1990) (TILA, asa remedial statute which is designed to balance the scales thought to be weighed in favorof lenders, is to be liberally construed in favor of borrowers. (Bizier v. Globe Financial


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lenders, are unsophisticated actors who possess less leverage in loan negotiations. 119This disparity in bargaining power renders borrowers vulnerable to overreaching andfraud by lenders. Thus, consistent with the statute's overall consumer-protective

purpose, Congress in TILA's rescission provisions shifts significant leverage fromlenders to borrowers in setting forth a strict liability remedy that substantiallyliberalizes the steps needed to unwind a mortgage transaction under the commonlaw.120

By reordering the common law rescission sequence and forcing the lender tocancel its security interest first, TILA gives consumers extra leverage in the hostagenegotiation: the borrower need not sacrifice a large sum of cash to a creditor whomight drag its feet or refuse to honor its end of the bargain.121 Likewise, by forcingthe lender to act first by releasing its security interest, TILA gives the borrower sometime to seek financing for her tender obligation.122 If the borrower were required totender while the security interest remained in place, a borrower would have difficulty

funding her tender obligation by refinancing the current mortgage loan, since title toher home would be clouded.123 Because rescission is such a painless remedy fromthe consumer's perspective and plac[es] all burdens on the creditor, it serves as animportant deterrent in urging creditors, under pain of an expensive unwindingprocess, to comply with TILAs disclosure requirements.124

2. Conditional Rescission: A Reversion to the Common Law RescissionSequence

a. Background

Although TILA allows consumers to initiate the rescission process without acourts intervention merely by sending a cancellation notice125 to the holder of thenote,126 creditors routinely ignore the rescission notice127 or respond by denying that

Services, 654 F.2d 1, 3 (1st Cir. 1981) (citation omitted)); seeLynn Drysdale & Kathleen E.Keest, The Two-Tiered Consumer Finance Services Marketplace: The Fringe Banking System and ItsChallenge to Current Thinking About the Role of Usury Laws in Todays Society, 51 S.C. L. REV.589, 638 (2000).

119 RENUART &KEEST, supranote 11, 1.4.2.3.1, at 12.120 See supraSection II.B.1.121 See Nat'l Consumer Law Center, supranote 83.122 See id.123 See id.124 See id(citingWilliams v. Homestake Mortgage Co., 968 F.2d 1137, 1140 (11th Cir. 1992)).125 For a description of a creditors obligation to provide each borrower entitled to rescind

with two copies of a Notice of Right to Cancel, see supranote 9.126 See15 U.S.C. 1635(b).127 See, e.g., In re Schweizer, 354 B.R. 272, 278 (Bankr. D. Idaho 2006); Bookhart v. Mid-Penn


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they have violated the statute.128 As a result, even though rescission under TILA is anon-judicial remedy, courts frequently are forced to decide whether or not thelender has committed a violation triggering a borrower's right of rescission. For the

most part, by intervening in the rescission process, courts have interpreted TILA'srescission provisions in ways that have reduced consumers' leverage under thestatute.129

The most notable and longstanding example of this reapportionment ofbargaining power is a practice known as conditional rescission or judicialpreconditioning.130 Although courts have ordered conditional rescission for nearlyfour decades,131 the practice, due to a dramatic decline in housing values, has onlyrecently substantially complicated matters for many plaintiffs in inability-to-tendercases. This section describes courts' rationale for ordering conditional rescission,illustrating that courts have not hesitated to modify the plain language of the statutefor the benefit of lenders.

This Article does not critique the practice of conditional rescission itself: inmost cases, conditional rescission properly protects creditors from the risk offorfeiture.132 The Article takes a more nuanced view of the practice: because TILA isa remedial statute with a consumer-protective function,133 courts that have orderedconditional rescission to protect lenders from forfeiture likewise must not hesitate touse their equitable authority to preserve rescission in inability-to-tender cases. As aresult of courts application of conditional rescission in inability-to-tender cases,consumers who are substantially underwater on their mortgagesa sizeablepercentage of borrowers nationallyare, in effect, denied TILAs rescission-basedprotection, risking validation of instances of lender overreaching and fraud.

Consumer Discount Co., 559 F. Supp. 208, 209 (E.D. Pa. 1983).128 See, e.g., Wells Fargo Bank, N.A. v. Jaaskelainen, 407 B.R. 449, 453 (D. Mass. 2009)129 For a description of how courts generally deny relief to borrowers who are unable to

tender in full and immediately, see infraSections IIIA-B.130 This Article uses the term conditional rescission. Some courts, however, use neither

term and generically describe this process, for example, as conditioning relief on theborrowers fulfillment of her tender obligation.

131 See, e.g., Palmer v. Wilson, 502 F.2d 860, 862 (9th Cir. 1974) (an early conditional rescissioncase).

132Seetext accompanying notes 136-138, supra.133 See, e.g., Smith v. Fidelity Consumer Discount Co., 898 F.2d 896, 898 (3d Cir. 1990) (TILA, as

a remedial statute which is designed to balance the scales thought to be weighed in favorof lenders, is to be liberally construed in favor of borrowers. (Bizier v. Globe FinancialServices, 654 F.2d 1, 3 (1st Cir. 1981) (citation omitted)); seeLynn Drysdale & Kathleen E.Keest, The Two-Tiered Consumer Finance Services Marketplace: The Fringe Banking System and ItsChallenge to Current Thinking About the Role of Usury Laws in Todays Society, 51 S.C. L. REV.589, 638 (2000).


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b. Courts Rationale for Ordering Conditional Rescission

At the request of lenders defending rescission actions, courts routinely use

their equitable discretion to reverse the order of events set forth in the statute,effectively reinstating the common law sequence of events necessary to effectuate arescission. Through this process of conditional rescission, courts require theborrower to tender before the creditor invalidates its security interest in theborrowers home.134 In the words of one court, conditional rescission, an equitablemodification of TILA's rescission process, ensure[s] that plaintiffs make good ontheir repayment obligations if rescission is awarded.135

Lenders have successfully persuaded courts that following the original orderof events set forth in the statuteforcing lenders to invalidate their security interestsbefore borrowers tendercreates an undue burden on and risk to lenders.136 If, aftera lender has taken steps to reflect the cancellation of its security interest in the

borrowers home, a borrower defaults on her tender obligation, the lender, strippedof its secured status, must pursue the watered-down collection remedies of anunsecured creditor. To collect the outstanding debtthe borrowers tenderobligationa lender might have to ask the court to reinstate the lenders securityinterest. Alternatively, the lender might be required to sue the borrower and,judgment in hand, attempt to levy on the debtors unencumbered property.

As a newly unsecured creditor, the lender would not be guaranteed a fullrecovery of the net loan proceeds. The newly unencumbered home might bepartially or fully exempt under state homestead exemption statutes.137 Another

134 See, e.g., Palmer v. Wilson, 502 F.2d 860, 862 (9th Cir. 1974); Williams v. Homestake Mortg.

Co., 968 F.2d 1137, 1142 (11th Cir. 1992); FDIC v. Hughes Development Co., 938 F.2d 889,890 (8th Cir. 1991); Rudisell v. Fifth Third Bank, 622 F.2d 243, 254 (6th Cir. 1980); La Gronev. Johnson, 534 F.2d 1360, 1362 (9th Cir. 1976); Powers v. Sims and Levin, 542 F.2d 1216,1221-22 (4th Cir. 1976); Bustamante v. First Federal Savings & Loan Association, 619 F.2d 360,365 (5th Cir. 1980); but see, e.g., In re Celona, 90 B.R. 104 (Bankr. E.D. Pa. 1998); In re Piercy,18 B.R. 1004 (Bankr. W.D. Ky. 1982).

135 Williams v. Saxon at *3.136 See, e.g., Palmer v. Wilson, 502 F.2d 860, 862 (9th Cir. 1974) (describing the combination of

rescission and statutory damages as an unduly harsh penalty if the creditor is reducedto the status of an unsecured creditor, and the debtors are judgment proof.); Stanley v.Household Fin. Corp. III (In re Stanley), 315 B.R. 602, 615-16 (Bankr. D. Kan. 2004)(The concept that a debtor is entitled to a free home or financial windfall because acreditor failed to check a box on a notice of right to rescind form is an irrational resultthat fails to recognize the full scope and policy behind the TILA's rescissionframework.).

137 Dawson v. Thomas (In re Dawson), 411 B.R. 1, 14 (Bankr. D.D.C. 2008) (ordering conditionalrescission in part because, if the lender's security interest were immediately canceled, theplaintiff would be able to avail herself of homestead exemption, which would force thenewly unsecured lender to seek repayment by levying on the debtor's unencumbered,


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unsecured creditor might beat the lender in the race of the diligent and perfect itsinterest in the borrower's unencumbered, non-exempt assets before the lender does.Moreover, the debtor might seek bankruptcy protection while simultaneously

exercising her rescission rights under TILA, potentially allowing the debtor to satisfyher tender obligation for pennies on the dollar.138

Courts explain that their decision whether or not to change the default orderset out in the statute depends on the equities of the each case.139 For example,courts appear more willing to order conditional rescission when the lenders TILA violations are not egregious (e.g., when the disclosure errors do not appearintentional).140 Likewise, when the borrower has engaged in some kind ofreprehensible behavior (e.g., the borrower has misrepresented facts on her loanapplication), courts are far more willing to condition invalidation of the securityinterest on the borrower's tender.

Some commentators have criticized conditional rescission as an unwarranted

deviation from the plain language of a remedial, consumer-protective statute.141

Arguably, a consumer who must tender before the lender cancels its security interestin her home is no better off than she would be without TILAs protection, sinceTILAs rescission provisions shift leverage to borrowers by reversing the order ofthe common law rescission sequence.142 By forcing TILA-violating lenders to cancel

non-exempt property). For examples of homestead exemption statutes, see D.C. Code 15-501(a)(14) (unlimited); Tex. Prop. Code 41.001-41.002, Tex. Const. Art. 16, 51(unlimited); Ohio Rev. Code 2329.66(A)(1)(b) (caps exemption at $20,200 per debtor).

138 If the court classifies the debtor's tender obligation as an unsecured claim, the debtormay discharge a sizeable portion of the tender amount in either Chapter 7 or Chapter 13

bankruptcy, through which a consumer may discharge a sizeable portion of herunsecured debt. See11 U.S.C. 727(b); 1328(a); seesources cited supranote 2.139 See, e.g., Zakarian v. Option One Mortg. Corp., 642 F. Supp. 2d 1206, 1215-16 (D. Hawaii

2009) (citingPalmer v. Wilson, 502 F.2d 860, 862 (9th Cir.1974)) (refusing to orderconditional rescission when plaintiff alleged that lender had failed to provide anyrequired TILA disclosures); Williams v. Homestake Mortg. Co., 968 F.2d 1137, 1142 (11thCir. 1992) (explaining that in determining whether or not to order conditional rescission,a court should consider traditional equitable notions, including such factors as theseverity of [the lender's] TILA violations and whether [the borrower] has the ability torepay the principal amount).

140 See, e.g., Kratz v. Countrywide Bank, 2009 WL 3063077, at *6 (C.D. Cal. 2009) (Where thealleged TILA violations are not egregious, courts not only may, but should, conditionrescission on repayment of the amounts advanced by the lender.) (citingLaGrone v.

Johnson, 534 F.2d 1360, 1362 (9th Cir.1976)).141 See generallyRobert Murken, Comment, Cant Get No Satisfaction? Revising How Courts

Rescind Home Equity Loans Under the Truth in Lending Act, 77TEMP.L.REV.457 (2004);Note, Truth-in-Lending: Judicial Modification of the Right of Rescission, 1974 DUKE L.J. 1227(1974).

142 PRIDGEN &ALDERMAN,CONSUMERCREDIT, supranote 5, 14:27, at 1054; Williams v.


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their security interests first, Congress increased TILAs deterrent role,143 encouragedconsumers to act as private attorneys general in bringing rescission actions, andgave consumers significant leverage in negotiating a possible settlement with the

lender. These policy goals are undermined if consumers must tender first. The controversy around conditional rescission itself has largely subsided,

however, because Congress in the Truth in Lending Simplification and Reform Act144added a provision sanctioning the longstanding practice.145 In this amendment,Congress sought to clarify that the courts, at any time during the rescission process,may impose equitable conditions to insure that the consumer meets his obligationsafter the creditor has performed his obligations as required under the act.146Although courts routinely revert to the common law rescission sequence by orderingconditional rescission, the practice has laid the groundwork for a troublesomepractice in rescission cases that has deprived substantially underwater borrowers ofTILAs rescission protections: requiring consumers to tender in full immediately or

within a short period of time or risk the dismissal of their rescission claims.

III. When Consumers Cannot Afford to Tender: Choosing Between a Returnto the Status Quo Ante and Meaningful Rescission-Based Protection Todays depressed housing market has substantially exacerbated a

complication present when some plaintiffs seek rescission during TILAs three-yearextended rescission period. Generally, a borrower seeking to rescind eitherrefinances her mortgage or sells her home, using the proceeds of one of thesetransactions to pay off the mortgage written by the offending lender.

As a result of a recent dramatic drop in home values across the country,

however, an increasing number of rescission-eligible borrowers cannot afford toimmediately tender. If the value of the borrowers home has decreased considerablybetween the time the borrower refinances her mortgage and when she seeks torescind the transaction, neither a sale of the home nor a mortgage refinancing cangenerate 100 percent of the borrowers tender obligation. Thus, as a result of a

Homestake Mortg. Co., 968 F.2d 1137, 1140 (11th Cir. 1992).143 Williams v. Homestake Mortg. Co., 968 F.2d 1137, 1140 (11th Cir. 1992) ([B]ecause rescission

is such a painless remedy under the statute (placing all burdens on the creditor), it acts asan important enforcement tool, insuring creditor compliance with TILA's disclosurerequirements.)

144 See supranote 84 and accompanying text.145 TILAs rescission provisions now provide that [t]he procedures prescribed by this

subsection shall apply except when otherwise ordered to by a court. Pub. L. 96-221, 94Stat. 175 (TILA 125(b) (codified as amended at 15 U.S.C. 1635(b)). See also 12 C.F.R. 226.23(d)(4); PRIDGEN &ALDERMAN,CONSUMERCREDIT, supranote 5, 14:27, at1054-55.

146 S. Rep. No. 368, 96th Cong., 2d Sess. 29 (1980), reprinted in1980 U.S.C.C.A.N. 236, 265.


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collapse in home values and a borrowers resulting inability to finance the tenderobligation, an intractable tension develops between two goals of TILAs rescissionremedy: returning the parties to their pre-transaction positions (the status quo ante)147

and providing consumers with meaningful, strict liability-based relief throughrescission when lenders commit a material disclosure error.148 Although courts havethe equitable authority to modify consumers' tender obligations by allowingconsumers to repay the net loan proceeds in installments, most courts have treatedconsumers' repayment troubles in an all-or-nothing fashion: consumers are requiredto tender in full immediately or within a short time, or their rescission claims areeventually dismissed.

As this Section explains, courts following the Ninth Circuits holding inYamamoto v. Bank of New York149 generally dismiss underwater borrowers rescissionactions before adjudicating the rescission claim (i.e., determining whether or not thelender has committed a material disclosure violation, thereby entitling the borrower

to rescind). Courts followingYamamoto reason that dismissing such claims is a logicalacceleration of the outcome in cases in which courts apply conditional rescission: ifa court orders conditional rescission, a lender may retain its security interest until therescinding borrower fulfills her tender obligation. If the borrower is unable totender, the unwinding process will be suspended, perhaps indefinitely. Given theapparent inevitable consequence of a borrower's inability to tender, Yamamoto courtsroutinely eviscerate TILAs protections by dismissing the rescission claims ofborrowers who cannot afford to tender in full immediately or within a short periodof time.

Courts that depart from the Yamamoto approach generally adjudicateunderwater borrowers rescission claims, but subsequently order conditional

rescission. These courts application of conditional rescission has the net effect ofdenying an underwater borrower rescission-based relief, since the borrower mustrestore the lender to the status quo antebefore the court will order the lender to cancelits security interest in her home and return interest and fees.

Courts approaches' in inability-to-tender cases can be grouped into severalcategories:

147 See, e.g.,McKenna v. First Horizon Home Loan Corp., 475 F.3d 418, 421 (1st Cir. 2007); Sosa v.Fite, 498 F.2d 114, 119 (5th Cir. 1974); Williams v. Homestake Mortgage Co., 968 F.2d 1137,1142 (11th Cir. Fla. 1992);Am. Mortg. Network, Inc. v. Shelton, 486 F.3d 815, 820 (4th Cir.

N.C. 2007).148 Williams v. Saxon Mortg. Co., 2008 WL 45739, at *4 (S.D. Ala. 2008) ((describing restoring

the parties to the status quo ante and maintain[ing] the vitality of rescission as anenforcement tool as the twin aims of TILA's rescission process) (citingWilliams v.Homestake Mortg. Co., 968 F.2d 1137, 1140, 1142 (11th Cir. 1992)).

149 329 F.3d 1167 (9th Cir. 2003).


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Yamamoto and its Progeny: Judicial Nullification of a Crucial RemedyA number of courts (primarily those in the Ninth Circuit) allow the

lender to retain its security interest until the borrower tenders, butfrequently dismiss cases at the pleading stage if 1) borrowersaffirmatively acknowledge an inability to tender,150 2) the facts suggestthat the borrower is unable to tender (e.g., the borrower has defaultedon her mortgage or has substantial negative equity),151 or 3) theborrower has merely failed to plead in her complaint that she has theability to tender.152

Other Circuits: Complete Adjudication, But Relieffor Underwater Borrowers Remains Elusive

The majority of courts allow the lender to retain its security interestuntil the borrower tenders, but, unlike courts in the Ninth Circuit,generally choose not to dismiss the case at the pleading stage, even ifthe facts suggest that the plaintiff will be unable to tender.Borrowers in these cases have their day in court (i.e., courts fullyadjudicate their rescission claims), thereby increasing the likelihoodthat the lenders will be willing to settle the case by modifying theloans. If lenders refuse to settle, however, because courts routinelyorder conditional rescission, borrowers will be denied rescissionrelief unless and until they tender.

Alternative Approaches: Tendering in Installments

In limited cases in both the non-bankruptcy and bankruptcy settings,courts have been willing to allow borrowers to repay their tenderobligations in installments, over a period of years, and at reasonableinterest rates. In these cases, the judge may or may not orderconditional rescission.

The following sections describe each of these general approaches, explaining theextent to which each sustains or undercuts TILA's consumer-protective functions.

150 See, e.g., Yamamoto v. Bank of New York, 329 F.3d 1167 (9th Cir. 2003).151 See, e.g., Carlos v. Ocwen Loan Servicing, LLC, 2009 WL 1295873 (E.D. Cal. 2009).152 See, e.g., Rogers v. Cal State Mortg. Co. Inc., 2010 WL 144861, 10 (E.D. Cal. 2010).


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deciding whether the defendants committed a material disclosure error.160 The plaintiffs in Yamamoto had affirmatively acknowledged in their depositions

that, even if allowed to rescind their loan, they could not afford to tender. After

giving the plaintiffs an opportunity to tender, the district court dismissed therescission action. In reliance on Yamamoto, however, recently several courts in theNinth Circuit have gone further. These courts have dismissed rescission actions atthe pleading stage if the facts merelysuggested that the plaintiffs would be unable totender (for example, if the plaintiffs had defaulted on the mortgage) or if theplaintiffs had failed to allege in their complaint that they could, in fact, afford totender (for example, by describing how they intended to finance the tenderobligation).161 This approach is imprudent not only because it undercuts underwaterborrowers rescission-based protections, but also, as some courts have pointed out,these courts expansion of Yamamoto generally violates courts obligation under Rule12(b)(6) to interpret the allegations and facts in the light most favorable to the

plaintiffs.162

In Carlos v. Ocwen Loan Servicing, LLC,163 for example, the plaintiffs, who

sought rescission in an apparent attempt to forestall foreclosure of their Californiahome, offered in their co

it's all about the principal preserving consumers right of rescission under the truth in lending act

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