The Truth in Lending Act requires a borrower who wants to rescind a loan to return the loan’s unpaid principal to the lender. This usually does not present a problem if the borrower exercises his Truth in Lending rescission rights during the three day cancellation period immediately after a transaction closes. However, some borrowers seek to rescind months and sometime years after the closing. That is because the TILA provides that, if there is some deficiency in the loan’s legally mandated disclosures, the availability of the rescission remedy is extended to three years. This can create a problem for lenders as some borrowers will not have the ability to immediately return loan proceeds because the loan money has been used to either refinance their home or for a home equity loan that has long been drawn down and spent.
The right of rescission is a right to void a loan. When a loan is rescinded, then the parties are returned to their original position, as if the loan was never made. The lender loses its security interest and must return to the borrower fees and interest. Under TILA, once the lender has released its security and returned fees and interest, the borrower must return the unpaid principal of the loan.
Let’s take a typical rescission case. TILA requires that borrowers be provided with two copies of a Notice of Right to Cancel their loan transactions within three days of closing. Frequently borrowers contend that they received only one copy of the Right to Cancel Notice and, for that reason, have a right to rescind their mortgage. This is where a borrower’s ability to tender the loan proceeds becomes critical. Some courts require a borrower to allege that he is ready, willing and able to tender the loan to the bank to state a rescission claim. If he cannot, his case will be dismissed. Other courts do not require a borrower to make such a claim. Without even alleging that he can meet his end of the bargain, a borrower can make the lender bear the expense of discovery and case defense, thereby gaining a great deal of leverage in negotiating a workout of his loan.
The Federal District Court for the Northern District of Illinois acknowledged the unfairness of having a lender return interest and fees and release its security interest before requiring the borrower to show that he can live up to his rescission obligations. It stated:
Though the statute is clear on its face, the scheme created thereby is arguably inequitable, and it is tempting at first blush to assume that this cannot really have been what Congress intended. If the point of rescission is to return the parties to where they would have been had the transaction never occurred, it is questionable whether it makes sense to require the creditor to give up its security interest without requiring the consumer to at least simultaneously tender the money or property she acquired in the transaction. A scheme that requires the creditor to act first by canceling its security interest without assurance that the consumer will do her part risks leaving the creditor high and dry, an unsecured creditor forced to rely on the consumer’s good graces and ability to tender.
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But when read in the context of the statute as a whole, the purpose of which is to protect the consumer, 15 U.S.C. § 1601(a), it is clear that this is exactly what Congress intended. The point of giving the consumer an absolute right to rescind is to “‘place[ ] the consumer in a much stronger bargaining position than he enjoys under the traditional rules of rescission,’” and to “insure[ ] creditor compliance with TILA’s disclosure requirements.”
Velazquez v. HomeAmerican Credit, Inc., here.
Courts address this unfairness in a variety of ways. The Ninth Circuit district courts demonstrate the two common approaches used at the pleading stage. In its seminal case, Yamamoto v. Bank of New York, here, the Ninth Circuit held that a trial court “may” require a borrower seeking rescission of a mortgage transaction under the Truth in Lending Act to demonstrate an ability to tender the loan proceeds but did not have to.
As a result of Yamamoto, a number of district courts within the Ninth Circuit have concluded that failure to plead an ability to tender is not fatal to a TILA rescission claim. Others have ruled that rescission claims can and should be dismissed at the pleading stage based upon the plaintiff’s failure to allege an ability to return loan proceeds. “It makes little sense to let [a] rescission claim proceed absent some indication that the claim will not simply be dismissed at the summary judgment stage after needless depletion of the parties’ and the Court’s resources.” Kakogui v. American Broker's Conduit, 2010 U.S. Dist. LEXIS 44593 (N.D. Calif. 2010) (collecting cases on both sides of the argument). Until we get either a legislative fix or a Supreme Court decision, the court rulings on this issue will continue to be in conflict. In the meantime, litigants should carefully study these two approaches and adopt the one that best supports their position in litigation.