Mortgage Banking & Consumer Credit Alert
September 2008
www.klgates.com
Authors:
Class or No Class? The Waning Debate
R. Bruce Allensworth
+1.617.261.3119
bruce.allensworth@klgates.com
Part II: The Seventh Circuit Court of Appeals Rejects Classwide
Rescission Under TILA
Irene C. Freidel
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irene.freidel@klgates.com
Brian M. Forbes
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brian.m.forbes@klgates.com
Gregory N. Blase
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gregory.blase@klgates.com
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In its recent decision in Andrews v. Chevy Chase Bank,1 the Seventh Circuit Court of
Appeals joined the First2 and Fifth3 Circuits and the California Court of Appeals4 in
rejecting plaintiffs’ attempts to obtain classwide rescission under Section 1635 of the Truth
in Lending Act, 15 U.S.C. §§ 1601, et seq. (“TILA”).5 In the Client Alert we issued in
February 2007,6 we took note of the trial court’s decision in Andrews certifying a TILA
rescission class -- a decision that flamed the debate as to whether classwide loan rescission
is compatible with class actions under Rule 23 of the Federal Rules of Civil Procedure
(and other state analogs to Rule 23). That debate appears to have subsided to some degree
with the Seventh Circuit’s clear instruction that “as a matter of law … a class action for
the rescission remedy under TILA may not be maintained.”7 To that end, the Andrews
decision is expected to have an immediate impact on pending cases seeking classwide
TILA rescission against creditors and loan assignees both in the Seventh Circuit and in
other jurisdictions, including California where more than forty TILA Option ARM class
actions are pending.
In Andrews, the plaintiffs obtained an option ARM loan from defendant.8 Under the terms
of the loan, plaintiffs had the option of making a low, interest-only payment for the first
five years of the loan.9 Plaintiffs alleged that they were misled by the defendants’ TILA
disclosures claiming that they believed that the interest rate on their mortgage loan would
remain fixed during the initial five-year period.10 In fact, the interest rate was variable
after the first payment, and over time, the rate increased such that the low payment was
not enough to cover even interest, resulting in a negatively amortized loan.11 Plaintiffs
sought rescission under TILA on behalf of a class of all persons who received similar
TILA disclosures.12 The United States District Court for the Eastern District of Wisconsin
certified a rescission class, and the defendant sought interlocutory appellate review of that
decision.
In its opinion, the Seventh Circuit first noted that rescission requires a complete “unwinding
[of] the transaction in its entirety and thus requires returning the borrowers to the position
they occupied prior to the loan agreement.”13 When a consumer exercises the right to
rescind, the lender’s security interest in the real property becomes void and the lender
is obligated to take steps within 20 days after receipt of notice to reflect termination
of the security interest.14 The consumer will not be liable for, among other charges,
finance charges; thus the creditor must return any money or property given to anyone in
connection with the transaction.15 When the creditor has complied with these obligations,
the consumer must then repay the loan proceeds to the creditor. Thus, the court concluded
that this “purely personal” and “highly individualized remedy” involves a “transactional
unwinding” process that makes it “an extremely poor fit for the class-action mechanism.”16
Accordingly, the Court observed, a rescission class would be unworkable because, among
other reasons, the district court would have to hold numerous mini-trials to address
borrowers’ individualized issues along with the lender’s equitable right to challenge
rescission on a case-by-case basis.17
Mortgage Banking & Consumer Credit Alert
The Court also rejected the commonly-offered
argument that TILA’s silence on the issue of class
treatment of rescission claims is tantamount to
Congressional approval of classwide rescission relief.
The Court reasoned that because Congress explicitly
authorized class recovery for statutory damages under
Section 1640 of TILA, the exclusion of any provision
for class recovery under Section 1635 (the rescission
remedy section) requires an assumption that Congress
intentionally excluded the availability of class relief in
rescission claims.18 This is a particularly compelling
argument where Congress capped recovery for
classwide statutory damages claims at $500,000,19 but
rescission-related liability from the certification of the
rescission class in Andrews was estimated to be around
$210 million. The Court agreed with the First Circuit
in concluding that “[t]he notion that Congress would
limit liability to $500,000 with respect to one remedy
while allowing the sky to be the limit with respect to
another for the same violation strains credulity.”20
Finally, the Court went on to hold that, as a matter of
law, a TILA rescission class cannot be certified under
Rule 23(b) of the Federal Rules of Civil Procedure.
Specifically, the Court held that a certification order
under Fed. R. Civ. P. 23(b)(2), where parties seek a
declaration of their right to rescind, would merely
signal a right on the part of the class members to
initiate rescission and that this could not be the type
of “final” declaratory relief contemplated by the Rule.
As to certification under Rule 23(b)(3), where parties
seek classwide monetary relief, the Court held that
no TILA rescission class could satisfy the superiority
or predominance elements of the Rule, where class
treatment would require the Court to hold hundreds, if
not thousands, of mini-trials for each borrower seeking
to “unwind” his loan through rescission.21
The decision in Andrews is significant because the
Seventh Circuit is now the third federal appeals court
to reject classwide rescission as a recovery, making it
more likely that courts in other jurisdictions will adopt
this position.22 Further, the Court conclusively ruled
that as a matter of law, a rescission class cannot be
certified in accordance with the requirements of Rule
23(b). While the Andrews decision does not resolve
the classwide rescission issue conclusively for all other
jurisdictions, the debate is over in at least the First,
Fifth, and Seventh Circuits, and it is likely to have
an impact on the numerous TILA Option ARM class
actions currently pending in California.
Endnotes
1 --- F.3d ----, 2008 WL 4330761 (7th Cir. Sept. 24, 2008).
2
S ee McKenna v. First Horizon Home Loan Corp., 475 F.3d 418
(1st Cir. 2007)
3
S ee James v. Home Constr. Co. of Mobile, Inc., 627 F.2d 727
(5th Cir. 1980).
4
S ee LaLiberte v. Pacific Mercantile Bank, 53 Cal. Rptr. 3d 745 (Cal. Ct.
App. 2007), cert. denied, 128 S. Ct. 393 (2007).
5
or a detailed discussion of McKenna and the issue of classwide TILA
F
rescission generally see Class or No Class? Loan Rescission under TILA
and Class Actions: The Debate Continues, K&L Gates Mortgage Banking
and Consumer Credit Alert, R. B. Allensworth, Brian M. Forbes, Irene C.
Freidel, Steven M. Kaplan, Jonathan D. Jaffe (February 2007). The client
alert can also be found on the web at http://www.klgates.com/newsstand/
Detail.aspx?publication=3598.
6
Id.
7
Andrews, 2008 WL 4330761, at *7.
8
Id., at *1.
9
Id.
10 Id.
11 Id., at *2.
12 U
nder 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.” 15 U.S.C. § 1635(a); 12 C.F.R. § 226.23(a)(3). 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. 12 C.F.R. § 226.23(a)(3)
fn. 48. “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. 12 C.F.R. § 226.15(a)(3) fn. 36.
13 Andrews, 2008 WL 4330761, at *3.
14 15 U.S.C. § 1635(b); 12 C.F.R. § 226(d)(2). 15 15 U.S.C. § 1635(b); 12 C.F.R. § 226(d)(3). 16 Andrews, 2008 WL 4330761, at *3.
17 Id., at *4.
18 Id., at *4-5.
19 15 U.S.C. § 1640(a)(2)(B).
20 Andrews, 2008 WL 4330761, at *5 (citing McKenna, 475 F.3d at 424).
21 Andrews, 2008 WL 4330761, at *6-7.
22 I n fact, the Andrews court noted that “creating a circuit split generally
requires quite solid justification.” Id. at *6.
September 2008 | 2
Mortgage Banking & Consumer Credit Alert
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September 2008 | 3
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