WASHINGTON Strange as it might sound, a recent high court decision allowing borrowers to skip courts when filing rescission actions may lead to more lawsuits, not fewer.
Although the decision makes it easier for borrowers to avoid litigation, it still allows banks to challenge an attempt through litigation. And because rescission attempts are expected to increase due to the lower bar to begin the process, lawyers said banks will increasingly turn more to the courts.
"The Supreme Court's decision is going to shift the burden on lenders to initiate a lawsuit," said Robert Lotstein, managing attorney of LotsteinLegal PLLC.
Before the decision, federal courts in many sections of the country expected homeowners to initiate a lawsuit to seek rescission. Under the Truth in Lending Act, consumers have three days after a refinancing or home equity line of credit closing to rescind and stop the transaction for any reason. There is another three-year window to rescind if the lender's mortgage disclosures are deemed inadequate.
But in the Jan. 13 decision in Jesinoski v. Countrywide Home Loans, the high court said borrowers can simply notify a lender by letter to exercise their rescission rights during the three-year period. The justices unanimously rejected the premise that borrowers must file a lawsuit.
Observers said the outcome of the case will result in more rescission attempts. Lotstein said the ruling will enable borrowers to slow down the foreclosure process. He noted that even the invalid notices, which banks can challenge before a judge, can be costly because servicers still might have to increase their reserves to cover the risk of a rescission.
"It may prompt borrowers to send letters whenever they have problems in making their payments," Lotstein said. He added that the potential for more legal disputes calls for intervention of federal regulators to write rules on rescission rights to provide more clarity. In 2010, the Federal Reserve Board was working on a proposal to clarify the handling of rescission claims in court proceedings. But the Fed dropped that initiative when jurisdiction over TILA regulations was transferred to the Consumer Financial Protection Bureau.
"The bureau has the authority to revisit this issue," Lotstein said.
Simon Fleischmann, a partner in Locke Lord in Chicago, expects to see an increase in "frivolous" rescission notices. Before the decision, he said, the costs associated with a borrower filing a lawsuit limited rescission bids, but that is no longer a restraint.
"When a lawsuit is required, there is a filing fee and there is an obligation by the borrower to certify that they are making a pleading in good faith and upon a reasonable investigation. That tends to weed out a lot of truly frivolous claims," Fleischmann said. "Without that mechanism in place, anyone can send a letter and assert a rescission demand. I think more people will do that."
When a rescission is ordered by the courts, there is an unwinding of the loan transaction. The lender or servicer must reimburse the borrower for all the interest payments made on the loan. Typically, the borrower then pays off the outstanding principal balance by refinancing.
The Jesinoski case arose after a couple, Larry and Cheryle Jesinoski, sent a rescission letter to Countrywide which had been acquired by Bank of America on the third anniversary of their closing. The borrowers sued a year later after B of A had refused to recognize their rescission as valid.
The 8th Circuit Court of Appeals ruled in favor of the bank on the grounds that TILA required the Jesinoskis to file a lawsuit and that a written notice was not sufficient. But the Supreme Court overturned that decision. "The language leaves no doubt that rescission is effected when the borrower notifies the creditor of his intention to rescind," Justice Antonio Scalia wrote in the opinion. "The statute does not also require him to sue within three years."
If a rescission request is before a judge, TILA allows homeowners to litigate their case on the merits before it is determined if they can meet their share of the financial responsibility to unwind the contract, such as repaying principal. Before the decision, many U.S. district courts had interpreted rescission rights through common law or established precedent rather than a strict reading of TILA.
As a result, "the banks have been quite successful in arguing that no one should waste their time in court if the consumer cannot come up with the money first," said Nina Simon, a consumer attorney who previously worked for AARP and the Center for Responsible lending.
But in writing the Jesinoski opinion, Scalia stressed that statutory law modifies common law and the courts should follow the TILA statute.
"What Scalia said is very helpful," Simon said. "I hope we will see judges rethinking that."
Yet others worry that borrowers will now use the rescission process simply to escape foreclosure, or gain leverage in seeking a loan modification or other form of loss mitigation.
Steven Kaplan, an attorney at K&L Gates, said lenders will need to be more proactive when they receive a rescission notice, including investigating whether rescission is warranted and assessing the potential risk. "Do they need to refund money in accordance with TILA and effect a rescission or do nothing if it is a frivolous notice?" he said.
But overall, Kaplan said he expects lenders and servicers will file more lawsuits against borrowers to stop rescission attempts. "It will force a lot more declaratory judgment actions," he said.