WASHINGTON The Supreme Court is slated to hear arguments Tuesday in a case that could determine when and how borrowers are allowed to cancel their mortgages.
The case, Jesinoski v. Countrywide, centers on how consumers can exercise their statutory rights to request a rescission of their mortgage, which is allowed if the finance charge was understated by at least $36.
Banks and other mortgage lenders are anxiously awaiting the outcome of the case, as some lawyers for troubled borrowers have attempted to invoke rescission in an effort to delay foreclosures.
"This is a very important case," said Robert Lotstein, managing attorney at LotsteinLegal in Washington. "The plaintiffs' bar uses the right of rescission as a weapon to slow down or stop foreclosures. It can be an incredibly lengthy process. People have been able to stay in their homes for long periods of time while not paying their mortgage."
Under the Truth in Lending Act, a consumer has three business days after the closing of a refinancing or home equity line of credit to rescind the transaction.
That right of rescission is extended for up to three years if the mortgage disclosures are found to be inaccurate or the lender fails to provide the borrower with the proper disclosures. The statute requires borrowers to notify the lender in writing that they are exercising their right to rescind the loan.
But there have been several conflicting court cases that center around exactly how the borrower must inform the lender. The chief question is whether a borrower can simply send a notice or if they have to file a lawsuit to receive a rescission.
Several U.S. appeals courts have ruled the borrower must file a lawsuit to exercise the extended right of rescission but other circuit courts have stuck to the literal language of the statute, resulting in a split among the courts.
Bankers are hoping the Supreme Court will finally put the issue to rest.
"As a consumer protection statute that has penalties and class action ramifications, it merits that there be order in the way it is applied," said Rod Alba, senior regulatory counsel for the American Bankers Association.
At issue is a ruling by the Eighth Circuit Court of Appeals in the Jesinoski case, which found that borrowers must file a lawsuit within three years of a closing to preserve their right to rescission and unwind the mortgage transaction.
This case is "attracting a lot of interest because it is such a heavily litigated area where the plaintiffs bar and consumer advocates want this right of rescission expanded as much as possible," said one industry attorney who spoke on condition of anonymity because a client is Bank of America, which acquired Countrywide in 2008.
Consumer advocates argue that the Eighth Circuit erred in its ruling, and that borrowers only need to file a written notice with the lender, not file a lawsuit, to exercise their right of rescission.
"It is untenable to require the borrower to sue within three years to exercise that right," according to a brief filed by the National Consumer Law Center, Center for Responsible Lending, the National Association of Consumer Advocates and other consumer groups.
The groups also contend that Congress understood that the "primary goal" of rescission is to save homes from foreclosure.
In a separate brief, the Consumer Financial Protection Bureau which now oversees implementation of the Truth-in-Lending Act agreed that consumers should not be required to file a lawsuit to seek rescission. The agency urged the high court to overturn the Eighth Circuit ruling.
Once a borrower files a notice of rescission, the lender "can immediately resolve any uncertainty about the status of the underlying transaction by filing a lawsuit to declare the notice invalid," CFPB says in its brief.
At the same time, the CFPB suggests that if the court decides a lawsuit is required to exercise the right of rescission, then the three-year time frame expressed in the law doesn't apply. The Truth-in-Lending Act specifies that consumers file a notice within three years; it doesn't mention a timeframe for lawsuits.
"TILA does not impose a specific deadline" by which the borrower "must sue when a creditor fails to honor a notice of rescission," the CFPB brief says.
So the Supreme Court "can borrow a limitations period for such suits from an analogous source of law."
The banking industry, meanwhile, is hoping the Supreme Court will affirm the earlier court ruling, ensuring the extended right of rescission ends after three years so lenders are no longer at risk.
"It would provide some security and finality for lenders," said Alba of the ABA, which filed a brief in the case along with five other industry groups.
Lenders dislike rescission because it can be very expensive, particularly because the borrower may not be making monthly payments on the loan while a case is being resolved.
Ultimately, many lenders see rescission as a stalling tactic by borrowers who are hoping to delay foreclosure. In many cases, the borrower does not have the financial wherewithal to complete a rescission, which would require that the borrower refund all monies they received from refinancing the loan. A recession can't be completed if the borrower can't repay the lender.
"The judge is not going to let the borrower walk away with a free house," said the attorney.
However, the rescission process allows the borrower to remain in the home without making any mortgage payments.
"If they can't make their [mortgage] payments now, how are they going to come up with the money to pay off the debt they owe? It's a delaying tactic," the attorney said.
Lenders also argue that the three-year time period is open to gamesmanship, because some borrowers, including Jesinoski, file their notice on the last possible day before the three-year time frame expires.
Even if a borrower files a notice with the lender instead of directly seeking a lawsuit, the case usually ends up in court. In filing a rescission notice, the borrower generally claims they never received required disclosures or the form for filing for a rescission.
"That shifts the burden of proof to the lender," Alba said, requiring the lender to prove that the borrower received accurate and timely disclosures.
Industry officials are confident, however, that the Supreme Court will affirm the Eighth Circuit court's ruling, which should reduce rescission claims.
"The filing of a lawsuit helps weed out the borrowers who know that they have a frivolous claim," Lotstein said. "Regardless of the outcome, industry should understand that borrowers will continue to use TILA in an effort to place a roadblock to losing a home."
In 2010, the Federal Reserve Board proposed to clarify rescission claims in court proceedings along with other TILA changes.
"The Board does not believe that Congress intended for the creditor to lose its status as a secured creditor if the borrower does not return the loan balance," according to a proposal issued that year.
Therefore, the creditor should not release its "security interest until the consumer tenders the principal balance less interest and fees, and any damages and costs, as determined by the court."
The Fed added that most courts adhere to that standard to ensure the lender is not left in an unsecured position.
"The Fed's proposal was designed to reduce litigation regarding the right to rescind by setting forth clear rules when a consumer asserted the right to rescind after the traditional three-business day period," said Richard Andreano, a partner at Ballard Spahr in Washington. "The rules would cover both when the parties were in litigation and when the parties were not in litigation."
Despite the support from industry groups for the plan, the Fed never finalized the proposal and transferred jurisdiction over TILA regulations to the CFPB in February 2011. The CFPB has not acted on the Fed's proposal.