The federal Truth in Lending Act (TILA) is a consumer protection law designed to protect borrowers from unfair lending practices. When a consumer loan is secured by the borrower’s residence, TILA gives the borrower the right to cancel the transaction. If the Lender makes the required disclosures to the Borrower, including advising it of its right to rescind, the Borrower must exercise its right to rescind within three days of loan closing. If the lender does not make the required disclosures, the period during which the borrower can cancel the transaction is three years.
Where the borrower exercises the right to rescind the transaction, TILA provides that “within 20 days of receipt of notice of termination”, the lender “shall take any action necessary or appropriate to reflect the termination of any security created as part of the transaction”. .” TILA provides that “when executing the [lender]obligations under this article, the [borrower] will offer the property [i.e., the loan proceeds] to [lender].”
Because TILA only requires the borrower to return loan proceeds to the lender “upon” the performance of the lender’s obligation to release its security, in a number of bankruptcy cases, courts have held that when ‘a debtor has exercised its right of rescission, the lender’s security shall become unenforceable twenty days after the lender has received the notice of rescission and the lender then has only a general unsecured claim for repayment of the proceeds of the loan which shares pro rata distributions, if any, made to holders of general unsecured claims in the event of bankruptcy.
At least in the Fourth Circuit bankruptcy courts, lenders no longer face the prospect of having to give up their privileges without getting back the money they lent. In a notice dated July 14 to Wash c. 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 presenting loan proceeds in a cancellation”.
The borrower in The opinion had obtained a reverse mortgage from Reverse Mortgage Solutions. A portion of the loan proceeds was used to repay a loan secured by an existing lien on his residence. Most were paid to the borrower in cash. RMS has failed to make the disclosures required by TILA. Within three years of closing the loan, the borrower sent RMS a notice of termination. RMS did not waive his lien on his residence. The borrower then sued RMS.
In the trial court, RMS argued that the ability of the borrower to return the loan proceeds to RMS should be considered in determining whether it could cancel the loan transaction. The trial court disagreed. The trial court found that RMS violated the TILA both by failing to make required disclosures and by failing to release its lien on the borrower’s residence within twenty days of receiving notice of cancelation. Additionally, the trial court held that the lender’s failure to release its lien exempted the borrower from the obligation to return the loan proceeds.
The fourth inverted circuit. The Court found that the absence of an express provision in the TILA exempting the borrower from the obligation to return the proceeds of the loan if the lender violates the TILA was significant. The Court said:
The absence of a provision identifying the remedy sought by Lavis is significant. By any measure, such a relief would be remarkable. This would mean that failure to provide required disclosure would result in the lender losing — key, stock and barrel — the money it loaned. And the borrower would keep these same funds, with no obligation to repay. 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 authorized by TILA, would not be specified.
Further, the Court held that exempting the borrower from returning the borrowed funds was contrary to the concept of termination. The Court said:
The equitable objective of annulment under TILA is to restore the parties to the “status quo ante”. [citations omitted]. Yet Lavis’ argument would do the opposite. This would grant Lavis a windfall of amounts advanced by RMS to Lavis in cash, as well as those paid to satisfy Lavis’ prior lien on the property and insurance obligation. And it would also impose a penalty on RMS of the same amount.
“The bidding,” the Fourth Circuit said, “is an essential part of the termination.”
Notably, the Fourth Circuit cited the decisions of only two other Circuit Courts of Appeals, the Sixth Circuit and the Tenth Circuit, in support of its decision. In most circuits, lenders who violate TILA still run the risk that they will be required to relinquish their privileges without getting back the money they lent. At least in the Fourth Circuit, borrowers cannot cancel a loan transaction and keep the loan proceeds.