Mortgage Banking and Consumer Credit Alert
February 2007
Authors:
R. Bruce Allensworth
+1.617.261.3119
bruce.allensworth@klgates.com
www.klgates.com
Class or No Class?
Loan Rescission under TILA and
Class Actions: The Debate Continues
Brian M. Forbes
+1.617.261.3152
brian.forbes@klgates.com
Irene C. Freidel
+1.617.951.9154
irene.freidel@klgates.com
Steven M. Kaplan
+1.202.778.9204
steven.kaplan@klgates.com
Jonathan D. Jaffe
+1.415.249.1023
jonathan.jaffe@klgates.com
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Loan rescission is a drastic remedy that is available for certain violations of the federal
Truth in Lending Act (“TILA”). When a debtor elects to rescind under TILA, the creditor
must terminate its security interest in the loan and return any money paid by the debtor.
Thus, when faced with litigants seeking TILA rescission claims on a class-wide basis,
creditors and assignees take notice.
Courts have long been divided on whether it is proper to certify a class of borrowers for the
purpose enforcing or declaring loan rescission rights under TILA. While TILA expressly
permits class actions for civil damages claims, the statute is silent concerning class actions
in a rescission setting. Not surprisingly, there is a split among courts regarding whether
rescission class claims can be resolved through the class action mechanism provided by
Rule 23 of the Federal Rules of Civil Procedure or whether rescission claims are inherently
individual in nature and can be addressed only on a case-by-case basis. Adding to this
debate is a recent decision from the First Circuit Court of Appeals, McKenna v. First
Horizon Home Loan Corp., which held, among other things, that class resolution is not
appropriate for TILA rescission claims, regardless of whether the class claims directly seek
rescission or a declaration of the right to rescind.1
TILA and the Right to Rescind—An Election with Consequences
No one will debate that the effect of rescission on the creditor or assignee is significant.
Under TILA, a consumer may rescind a loan for up to three years after consummation of
the transaction if the lender failed to provide the borrower with a notice of right to cancel,
as well as all “material disclosures.”2 The term “material disclosures” for closed-end loans
is defined by TILA’s implementing regulation, Federal Reserve Board Regulation Z, as
“the required disclosures of the annual percentage rate, the finance charge, the amount
financed, the total payments, the payment schedule,” and certain disclosures and limitations
applicable to loans subject to the Home Ownership and Equity Protection Act.3 “Material
disclosures” for open-end loans are defined as “the information that must be provided to
satisfy the requirements of section 226.6 [of Regulation Z pertaining to the initial disclosure
statement] with regard to the method of determining the finance charge and the balance
upon which a finance charge will be imposed, the annual percentage rate, the amount or
method of determining the amount of any membership or participation fee that may be
imposed as part of the plan” and certain disclosures for home-equity plans.4
Rescission is a remedy that must be sought by each borrower through the detailed process
set forth in TILA. When a consumer exercises the right to rescind, the lender’s security
interest in the real property becomes void and the consumer will not be liable for most, if
not all charges, including any finance charge.5 Within 20 days after the borrower’s notice
of intent to rescind, the creditor must return any money or property given to anyone in
connection with the transaction and must reflect the termination of the security interest.6
When the creditor has complied with these obligations, the consumer must repay the loan
proceeds to the creditor.7 “Rescission essentially restores the status quo ante.”8 Significantly,
Mortgage Banking and Consumer Credit Alert
a consumer can rescind a loan held by an assignee to
the same extent the consumer can rescind against an
original creditor.9 Thus, rescission claims, if permitted
to be brought on a class basis, would have a significant
financial consequence on all those involved. As aptly
stated by the McKenna court, “[i]t is nose-on-theface plain that unrestricted class action availability
for rescission claims would open the door for vast
recoveries.”10
McKenna v. First Horizon Home
Loan Corp.: The Case Against Class
Treatment of Rescission
In McKenna, a case originally brought in the United
States District Court for the District of Massachusetts,
the plaintiffs, individually and on behalf of a class
of Massachusetts consumers, alleged that First
Horizon, a mortgage lender, had inaccurately
disclosed information pertaining to rescission rights
and failed to appropriately respond to the named
plaintiffs’ request for rescission in violation of the
Massachusetts version of TILA.11 Plaintiffs moved
for class certification seeking a declaration that any
class member who elected to do so could rescind his
or her credit transaction with First Horizon during
TILA’s extended three-year rescission period. After
the federal district court granted plaintiffs’ motion
for class certification and certified a class declaring
the right of class members to rescind their mortgage
loans, the First Circuit Court of Appeals agreed to
review the lower court decision given the “important
and unsettled legal issues involved and the substantial
financial impact that the order portended.”12
Upon review, the First Circuit disagreed with the
lower court’s decision and held that there were at
least two primary reasons for denying class treatment
of rescission claims: (1) “Congress’s manifest intent
to shield residential lenders from crushing liability”
and (2) “the highly personal nature of the rescission
remedy.”13 Employing principles of statutory
construction to divine the intent of Congress, the First
Circuit noted that TILA’s civil liability provisions
at Section 1640 specifically address class actions,
and Congress “painstakingly established [a cap] for
damages class actions.”14 At the same time, Section
1635, which governs rescission claims, does not
expressly provide for (or even mention) class claims
and does not have a cap on recovery. Thus, the First
Circuit determined that inclusion of the class action
provision in one section of TILA and the exclusion
of a class action provision in the rescission section
of TILA was deliberate, and “strongly suggests that
Congress did not intend to include a class-action
mechanism within the compass of section 1635.”15
Recognizing that the exclusion of any mention of
class actions from the rescission provision could be
viewed alternatively as Congressional intent to not
limit rescission class actions, the court opined that
“the notion that Congress would limit liability to
$500,000 with respect to one remedy [damages class
actions] while allowing the sky to be the limit with
respect to another remedy for the same violation
strains credulity.”16
In addition to what it determined was Congress’s intent
with respect to class action rescission suits, the First
Circuit also concluded that the “personal nature of the
rescission remedy” made such claims inappropriate for
class treatment. “The highly individualized character
of this process and the range of variations that may
occur render rescission largely incompatible with a
sensible deployment of the class-action mechanism.”17
Similar reasoning was employed by the Fifth Circuit
Court of Appeals in James v. Home Construction Co.
of Mobile, Inc., the only other reported decision from
a federal appellate court addressing the issue:
The language of Section 1635(b),
it seems clear, gives the creditor
ten [now twenty] days in each case
in which to go through the steps of
rescission before the matter can be
brought to court. This is a right which
the creditor has with each individual
obligor.... Thus, the notion of a class
action in this sort of context would
contradict what would seem to be the
Congressional intent about the nature
of this action.18
While plaintiffs, like those in McKenna (and
elsewhere), may attempt to avoid the inherent
problems with certifying a rescission class by seeking a
declaration that each class member is entitled to rescind
his or her loan, the First Circuit rejected this approach
as merely “elevat[ing] form over substance.”19 “Both
of the primary reasons for denying class treatment to
actual rescission claims—Congress’s manifest intent
February 2007 | 2
Mortgage Banking and Consumer Credit Alert
to shield residential lenders from crushing liability and
the highly personal nature of the rescission remedy—
apply with equal force to the proposed formation of
declaratory rescission classes.”20
The Andrews court held, among other things, that
class resolution is appropriate for claims seeking a
declaration of the right of class members to rescind
under TILA.25
For these reasons, the First Circuit reversed the district
court’s decision and determined that the lower court
“lacked the authority to certify a class of residential
borrowers who might potentially be eligible for
recessionary relief.”21
In Andrews, the plaintiffs alleged that the material
disclosures the lender delivered to the consumer
contained numerous violations, including violations
of TILA’s disclosure requirements relating to payment
period, the annual percentage rate, and the variable
rate feature. Any violation of a material obligation
could give rise to an extended rescission claim, i.e., a
rescission claim that extends for three years rather than
three days from consummation or closing. The court,
sometimes relying on tortured logic and analysis, found
a number of violations existed, including material
disclosure violations. Thus, the court also held that the
borrowers had extended rescission rights.
While the First Circuit and Fifth Circuit (in James)
appear to be the only other federal Courts of Appeal
to have addressed the issue of class-wide TILA
rescission, several other federal district courts have
also determined that the class action mechanism is
not an appropriate method for addressing rescission
claims of individual borrowers.22 A common theme in
many of these decisions is the potential for “enormous
penalties on the lender …out of all proportion to any
alleged harm done….”23 In reaching its conclusion to
deny class certification of rescission claims, one court
considered that:
subsequent assignments of the loan
from the original lender to others: a
court acting in equity would certainly
pause before unwinding a loan if it
had been transferred to subsequent
assignees who took without knowledge
of the alleged TILA violations.24
While not always the case in the context of other
consumer finance litigation, it is clear that the potential
significant exposure facing creditors and assignees in
the case of class-wide rescission claims has found
purchase with many courts reviewing the issue.
Andrews v. Chevy Chase Bank,
FSB: A Case Employing Class
Treatment of Rescission Claims
The First Circuit and Fifth Circuit decisions are
not binding on courts in other circuits. While some
courts have determined that TILA rescission claims
are not appropriate for class treatment, not all courts
agree. The recent decision from the United States
District Court for the Eastern District of Wisconsin,
Andrews v. Chevy Chase Bank, FSB, issued less than
two weeks before the First Circuit decision in First
Horizon, illustrates the disagreement between courts
on the issue of class treatment of rescission claims.
The Andrews court then considered whether it would
be appropriate to certify a class seeking a declaration of
the right to rescind loans for the same TILA violations
alleged by the named plaintiffs.26 Quoting other
courts that have certified TILA rescission classes, the
Andrews court stated that:
there is nothing in the language of
TILA which precludes the use of the
class action mechanisms provided by
Rule 23 to obtain a judicial declaration
whether an infirmity in the documents,
common to all members of the class,
entitles each member of the class
individually to seek rescission. 27
The Andrews court also rejected the commonly
articulated defense to rescission class actions—that
Congress did not intend to permit rescission claims
to be treated on a class basis. The Andrews court
determined that the statutory distinctions—the cap on
damages class actions compared with the absence of a
cap on rescission—were insignificant and concluded
that “[i]t is just as likely that Congress did not intend
to limit rescission claims in any way.”28 To bolster its
holding (but without citing any authority), the court
also declared that “public policy strongly favors
allowing class actions in cases like the present one.”29
With its combined findings for liability on plaintiffs’
underlying TILA claims and the court’s decision to
apply declaratory relief for rescission claims on a class
basis, the Andrews decision may have a significant
February 2007 | 3
Mortgage Banking and Consumer Credit Alert
impact on the lending industry. Given the recent First
Circuit decision in McKenna (which is not controlling
on the Wisconsin court), however, it is likely that the
Andrews case will be appealed.
The certification of a rescission class is not an anomaly.
While there do not appear to be any reported decisions
from federal appeals courts holding that TILA
rescission classes are permissible, federal district
court decisions in Illinois and Pennsylvania have
concluded that TILA rescission claims are appropriate
for class resolution.30 These cases illustrate the high
stakes lenders and investors face when confronted
with consumer class actions alleging TILA disclosure
violations and requests for class-wide relief. Until
additional federal appellate courts weighin on the
issue, the debate as to whether TILA rescission claims
can be adjudicated on a class basis will likely remain
unresolved.
The Rescission Duration Limitation
By including a three-year rescission period as set
forth in section 1635(f) of TILA, Congress imposed
a significant duration limitation on a borrower’s right
to rescind his or her loan. Section 1635(f) is not a
statute of limitations.31 Rather, Section 1635 states
that any borrower’s rescission right “shall expire”
three years after the loan closes or upon the sale of
the secured property, whichever occurs first.32 As the
U.S. Supreme Court held in Beach v. Ocwen Federal
Bank, the statute “talks not of a suit’s commencement
but of a right’s duration, which it addresses in terms so
straightforward as to render any limitation on the time
for seeking a remedy superfluous.”33 Thus, “§ 1635(f)
completely extinguishes the right of rescission at the
end of the 3-year period.”34 “We respect Congress’s
manifest intent by concluding that the Act permits
no federal right to rescind, defensively or otherwise,
after the 3-year period of § 1635(f) has run.”35 Even
if a court were to certify a TILA rescission class and
ultimately declare a class right to rescind, Beach
should foreclose any class member from thereafter
rescinding if his or her loan was closed more than
three years prior to such rescission.36
Implications of these Decisions for
the Consumer Credit Industry
While TILA provides a maximum liability cap of
$500,000 on statutory damages in a class action, there
is no corollary limitation on amounts recoverable by
rescission, in which each individual case may require
refunding to each borrower interest and certain
costs paid by the borrower, as well as terminating
the creditor’s security interest. The First Horizon
decision is an important piece to the TILA rescission
and class certification debate. At the same time, the
Andrews decision, as well as those of other courts
that have permitted loan rescission to be conducted
on a class basis, illustrates the significant financial
consequences for the consumer credit industry.
While not all courts agree that rescission claims
can be handled on a class basis, the uncertainty of
the situation underscores the need to ensure that
proper TILA disclosures are provided and continued
vigilance with TILA compliance. New cases asserting
TILA rescission class claims must be viewed with
caution. Please let us know if you would like to discuss
our capabilities and experience with respect to class
action defense and TILA compliance to assist creditors
and assignees through the legal and regulatory thicket
posed by these issues. For a sample of the types of
class actions defended by K&L Gates lawyers in the
specialized area of mortgage lending and consumer
credit, the courts in which we have defended them
and our lawyers who concentrate in class action
defense, please visit our practice page at http://www.
klgates.com/practices/ServiceDetail.aspx?service=6
and view our class action representative matters at
http://www.klgates.com/files/upload/Class_Action_
concumerfinanceRepmatters_FINAL.pdf.
Endnotes
1
McKenna v. First Horizon Home Loan Corp.,
No. 06-8018, __ F.3d __, 2007 WL 210850 (1st Cir. Jan. 29,
2007). It should be noted that the First Circuit decision in
First Horizon is not binding on lower courts outside of the
Circuit.
2
15 U.S.C. § 1635(a); 12 C.F.R. § 226.23(a)(3). Not
all types of loan transactions are rescindable under TILA.
Rescission is a remedy only available for consumer credit
transactions in which a security interest will be acquired
or retained in the consumer’s principal dwelling. 12 C.F.R.
§ 226.23(a)(1). The right to rescind does not apply to
residential mortgage transactions (purchase money loans)
or a refinancing by the original creditor with no new money.
12 C.F.R. § 226.23(f).
February 2007 | 4
Mortgage Banking and Consumer Credit Alert
3
12 C.F.R. § 226.23(a)(3) fn. 48.
individual, action.”).
4
12 C.F.R. § 226.15(a)(3) fn. 36.
5
15 U.S.C. § 1635(b); 12 C.F.R. § 226(d)(1).
19
McKenna, 2007 WL 210850, at *7 (citing Gibbons
v. Interbank Funding Group, 208 F.R.D. 278, 285 (N.D.
Cal. 2002)).
6
Id. § 226.23(d)(2).
7
Id. § 226.23(d)(3).
8
McKenna, 2007 WL 210850, at *2.
9
15 U.S.C. § 1641(c).
10
McKenna, 2007 WL 210850, at *5.
11
Based on these same allegations, plaintiffs also
alleged that First Horizon violated the Massachusetts Cost
Consumer Credit Disclosure Act (“MCCCDA”), Mass.
Gen. Laws ch. 140D. Because “the MCCCDA mirrors its
federal counterpart [TILA],” the First Circuit construed
the MCCCDA in accordance with TILA and looked only
to TILA to “suppl[y] the applicable rules of decision.”
McKenna, 2007 WL 210850, at *3. It should be noted that
one significant difference between TILA and the MCCCDA
is the limitation period on the right to rescind. Under TILA,
the borrower’s rescission right expires three years after
the loan closes or upon the sale of the secured property,
whichever occurs first. 15 U.S.C. § 1635(f). Under the
MCCCDA, the right expires after four years. Mass. Gen.
Laws ch. 140D, § 10(f).
12
McKenna, 2007 WL 210850, at *2.
13
Id., at *7.
14
McKenna, 2007 WL 210850, at *5.
15
McKenna, 2007 WL 210850, at *4.
20
McKenna, 2007 WL 210850, at *7. See also Jefferson
161 F.R.D. at 69 (“A declaratory judgment permitting
classwide rescission…would turn Section 1635(b) into a
penal provision, a result certainly never explicitly authorized
by Congress.”).
21
McKenna, 2007 WL 210850, at * 1.
22
See, e.g., Murry v. America’s Mortgage Banc, Inc., Civ.
No. 03 C 5811, 2005 WL 1323364, at * 10-11 (N.D. Ill.
May 5, 2005); Gibbons, 208 F.R.D. at 285-86; Jefferson v.
Security Pac. Fin. Servs., Inc., 162 F.R.D. 123, 126 (N.D.
Ill. 1995) (“Jefferson II”); Jefferson I, 161 F.R.D. at 70; see
also In re Cmty. Bank of N. Va., Civ. No. 02-1201, 2006 WL
3308425, at *13 n.11 (W.D. Pa. Oct. 9, 2006) (commenting
that “there is a persuasive line of cases that hold that
Congress did not intend that TILA/HOEPA claims for
rescission, as opposed to damages, be maintained in a class
action”). The California Court of Appeals, Fourth Appellate
District, also recently weighed in on the issue and affirmed
the decision of a trial court denying the borrowers leave
to amend their complaint to add a class action rescission
claim. LaLiberte v. Pac. Mercantile Bank, _ Cal. Rptr. 3d _,
No. G036235, 2007 WL 188882 (Cal. Ct. App. Jan. 25,
2007) (citing cases at footnote 4) (“We agree with those
courts that hold rescission under TILA is a personal remedy
not suitable for class action treatment”).
23
16
Id. at *5. In reaching its conclusion as to the intent of
Congress with respect to class action rescission claims, the
First Circuit also found persuasive the legislative history of
TILA and the moratorium on class actions Congress had
once imposed when it amended TILA in 1995 to “provide
for higher tolerance levels for what it viewed as honest
mistakes in carrying out disclosure obligations.” McKenna,
2007 WL 210850, at *5-6.
17
18
McKenna, 2007 WL 210850, at *6.
James v. Home Constr. Co. of Mobile, Inc., 621 F.2d 727,
731 (5th Cir. 1980); see also Jefferson v. Security Pac. Fin.
Servs., Inc., 161 F.R.D. 63, 69 (D. Ill. 1995) (Jefferson I)
(“Under Section 1635, individuals must choose to assert the
right to rescind, on an individual basis and within individual
time frames, before filing suit. The individual issues with
respect to the court’s jurisdiction over each class member’s
entitlement to rescission, alone, preclude a finding that this
case can be managed better as a class, rather than as an
See, e.g., Jefferson I, 161 F.R.D. at 70; accord Murry,
2005 WL 1323364, at *11.
24
Murry, 2005 WL 1323364, at *11.
25
Andrews v. Chevy Chase Bank, FSB, Civ. No. 05
C 0454, __ F.R.D. __, 2007 WL 112568 (E.D. Wis. Jan. 16,
2007).
26
Even though the court determined that the defendant’s
disclosures were in violation of §§ 1632 and 1638(b), the
court recognized statutory damages for such violations were
not available under § 1640(a). Andrews, 2007 WL 112568,
at *7-8.
27
Andrews, 2007 WL 112568, at *8 (quoting Rodrigues v.
Members Mortgage Co., Inc., 226 F.R.D. 147, 153 (D. Mass.
2005) and Williams v. Empire Funding Corp., 183 F.R.D.
428, 436 (E.D. Pa. 1998)). Notably, given the First Circuit
decision in First Horizon, the Rodriques opinion (a decision
by the federal district court for the district of Massachusetts
and under the jurisdiction of the First Circuit) quoted by the
Andrews court, is of questionable precedent.
February 2007 | 5
Mortgage Banking and Consumer Credit Alert
28
Andrews, 2007 WL 112568, at *9.
29
Id.
31
Crown, Cork & Seal Co., Inc. v. Parker, 462 U.S.
345, 353-54 (1983); Am. Pipe & Constr. Co. v. Utah, 414
U.S. 538, 552-53 (1974).
30
See, e.g., Latham v. Residential Loan Ctrs. Of Am.,
Inc., Civ. No. 03 C 7094, 2004 WL 1093315, at *3 (N.D.
Ill. May 6, 2004); Williams, 183 F.R.D. at 435-36. In light
of McKenna, reported decisions from the federal district
court for the District of Massachusetts that had previously
determined that class claims could be adjudicated on a class
basis are now called into question, including Rodrigues
v. Members Mortgage Co., Inc., 226 F.R.D. 147, 153
(D. Mass. 2005) and McIntosh v. Irwin Union Bank & Trust
Co., 215 F.R.D. 26 (D. Mass. 2003).
32
15 U.S.C. § 1635(f).
33
Beach v. Ocwen Fed. Bank, 523 U.S. 410, 417 (1998).
34
Id. at 412.
35
Id. at 419.
36
See discussion of Beach v. Ocwen Fed. Bank in In re
Cmty. Bank of N. Va, 2006 WL 3308425, at *11-13.
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