Lenders that refinance home equity loans by replacing the old mortgage with a new one for an increased amount should be concerned about a recent decision of the 3rd U.S. Circuit Court of Appeals holding that neither of the Federal Reserve Board's model rescission forms provides adequate disclosure of a borrower's rescission rights in certain refinancings.
The ruling implies that most lenders must change their rescission notices. said John L. Culhane, a senior associate in the law firm of Wolf, Block, Schoor & Solis-Cohen in Philadelphia.
"Lenders that refinance their existing loans by replacing the old mortgage with a new one for an increased amount should review their rescission notices to determine whether the form accurately reflects how the refinancing is structured," advised lawyers at Blank, Rome, Comisky & McCauley in Philadelphia. A nonstandard hybrid form should be perhaps be considered to comply with the ruling, they said.
In Porter vs. Mid-Penn Consumer Discount Co., the appellate court upheld a federal district court ruling that the transaction refinancing plaintiff Rosetta Porter's loan was a partially exempt "refinancing" and therefore, Fed Form H-8 was "an inadequate notice because it inaccurately suggested that Porter had the right to rescind the whole loan."
"While it only applies in the 3rd Circuit, it means that probably all refinancings lenders have done will be rescindable for three years following closing because lenders gave the wrong rescission notice," Culhane said. "The case could be followed by other circuits, and lenders in other circuits will want to examine their procedure and take proactive action to avoid similar liability. It is a sleeper and a really technical issue, but it has major implications for mortgage lenders nationwide."
Culhane speculates that the consumer-borrower will wind up having her mortgage debt converted into an unsecured debt likely to be discharged in bankruptcy, "leaving her home free and clear, which was the objective of the suit."
Joseph Lynyak, a partner in the Los Angeles law firm of Tisdale & Lynyak. said the case should cause mortgage lenders to review the nature of the transactions they are entering and to determine precisely what their loan staffs are doing.
The case arose from the bankruptcy of Rosetta Porter, whose lawyers argued that the lender, a consumer discount company, failed to honor her request to rescind a 1987 loan that was secured by a mortgage on her home.
The case was based on a Truth In Lending Act, Regulation Z, provision, that normally allows borrowers three days to rescind, but requires lenders to provide a clear and conspicuous disclosure of rescission rights. If the lender's disclosures are insufficient, the borrower's right to rescind is extended to three years under the law.
Porter's lawyers claimed that Consumer failed to disclose clearly the effects of rescission, and, therefore, her 1990 request for rescission was timely, and should have been honored under the law. In addition to rescission, she sought actual and statutory damages under the law.
Porter's claim was that the 1987 transaction was a "refinancing" that was partially exempt from rescission because her mortgage was replaced by a new mortgage from the same lender for an increased amount. It marked the third time over a three-year period where a loan was used to pay off the existing loan and provide additional money to the borrower. Mid-Penn recorded a new mortgage for each transaction to replace the prior one.
However, in the 1987 transaction, Mid-Penn waited until several days after the expiration of the three-day rescission period, to execute a "satisfaction" document in the records for the 1986 loan. As a result, the lender held two mortgages on Porter's home for a brief period.
But in the notice that Consumer gave the plaintiff, it did not advise her that two mortgages would be temporarily held simultaneously, nor did it in any other way mention the 1986 loan or the effect of the 1986 loan on Porter's rescission rights.
The same thing happened in 1988 when a company affiliated with Consumer refinanced the loan, with Porter getting the standard H-8 right of rescission notice. Both the old and the new mortgages were on file for several days after the right of rescission period.
Porter's request to rescind came after three days following the transaction, but before three years had expired the court said.
"It was therefore timely only if Consumer's notice was deficient. Porter agrees that she received the material disclosures and two copies of the cancellation notice. She also concedes that the notice properly told her when and now to rescind.
"Her claim is only that Consumer did not clearly notify her how her rescission rights were limited, and therefore did not clearly indicate what the effects would be if she rescinded," the court said.
The court explained that when a "refinancing" does not involve new money, no disclosure of the nonexistent right to rescind is necessary, but where a "refinancing" does involve new money, "lenders must still clearly notify borrowers of their [limited] rescission rights.
"Because rescission rights in ~refinancing' situations differ from those applicable in new-loan situations the [Fed] promulgated, in addition to the H-8, a model rescission form H-9 for partially exempt ~refinancings'" the court said. The H-9 crucially differs from the H-8 in that it spells out that the borrower has the right to cancel the new transactions to the extent of the increase in the amount of credit, but that such cancellation will not affect the amount that the borrower already owes or the lender's existing security interest."
The court said that, "We acknowledge that Consumer's violation of TILA was probably unintentional, and that Consumer may have relied upon the bankruptcy court's earlier decisions that similarly structured transactions were not ~refinancings' so that the H-8 was an acceptable notice for those transactions.
"Moreover, Porter herself, like most borrowers, may never have read or been confused by Consumer's cancellation notice," the court said. "Nevertheless, TILA achieves its remedial goals by a system of strict liability in favor of the consumers when mandated disclosures have not been made. A creditor who fails to comply with TILA in any respect is liable to the consumer under the statute regardless of the nature of the violation or the creditor's intent.
"(O)nce the court finds a violation, no matter how technical, it has no discretion with respect to liability," the panel held. "Our decision thus cannot turn on whether or not Consumer is blameworthy in an abstract sense, or on whether or not Porter has suffered an injustice."
The court added, "Furthermore, we are confident that this decision will promote TILA's goal of informed decisionmaking by consumer borrowers. Congress created the statutory right of rescission and required clear disclosure of that right because it thought that borrowers who take out consumer loans should have the chance to rethink those transactions if the titles to their homes will be put at risk.
"As a result of our holding here, future lenders in Consumer's position will know that if neither the H-8 nor H-9 fits a transaction, they must prepare their own notice forms that do clearly explain their borrowers' statutory rescission rights." the panel said. "As a result of that improved disclosure, future borrowers in Porter's position will be more likely to understand their statutory rescission rights.'