In a case of first impression, the U.S. Court of Appeals for the Third Circuit has ruled that a lendee who has not received all of the required disclosures from the lender exercises the right to rescind a loan under the federal Truth in Lending Act simply by notifying the lender in writing within three years of consummating the transaction. The lendee does not, however, need to file suit seeking declaration of rescission within that three-year time period, the court found.
A three-judge Third Circuit panel in Sherzer v. Homestar Mortgage Services reversed a ruling by U.S. District Court for the Eastern District of Pennsylvania Judge Mary A. McLaughlin that had held that suits for rescission filed more than three years after a loan’s closing date are time-barred under Section 1635(f) of the TILA, which states that an obligor’s right to rescind a loan "expire[s] three years after the date of consummation of the transaction or upon the sale of the property, whichever occurs first."
Judge Thomas M. Hardiman, writing for the Third Circuit, said that under the "most natural reading" of Section 1635(f), an obligor is required to send valid written notice of rescission within three years of consummation.
"Because the statute says nothing about filing a suit within that three-year period, we hold that the district court erred as a matter of law when it dismissed the Sherzers’ complaint as untimely," Hardman wrote.
Hardiman was joined by Judges Marjorie O. Rendell and Dolores K. Sloviter.
In Sherzer, according to Hardiman, plaintiffs Daniel and Geraldine Sherzer closed on two mortgage loans from defendant Homestar Mortgage Services on August 26, 2004 — one for $705,000 and one for $171,000.
Homestar subsequently turned the loans over to defendant HSBC Bank and on May 11, 2007, less than three years after closing, the Sherzers’ attorney wrote a letter to Homestar and HSBC claiming that Homestar had failed to provide all the necessary disclosures under the TILA and informing the companies that the Sherzers were exercising their right to rescind the loans under Section 1635, Hardiman said.
HSBC agreed to rescind the $171,000 loan but denied rescission of the larger loan and the Sherzers filed suit in federal court, according to Hardiman.
McLaughlin sided with the lenders and, on appeal to the Third Circuit, the plaintiffs argued that under Section 1635, the right of rescission is exercised when an obligor who has not received the necessary disclosures provides written notice to a lender within three years of the close of the transaction, Hardiman said.
The lender is then required to return any money or property it received as a down payment, the plaintiffs argued, according to Hardiman.
The plaintiffs argued that if the lender refuses to rescind the loan, the obligor may file suit to determine whether a valid rescission occurred and to recover the down payment and quiet title, Hardiman said.
The defendants, meanwhile, argued on appeal that an obligor cannot unilaterally rescind a loan and that in situations where a dispute over rescission occurs, the obligors must, under Section 1635, file suit within three years of the close of the loan transaction, according to Hardiman.
But Hardiman said Section 1635 makes no mention of a requirement to file suit within that three-year period.
Hardiman also pointed to the language in Section 1635(b) that states, "20 days after receipt of a notice of rescission, the creditor shall return to the obligor any money or property given as earnest money."
Hardiman said this language "suggests that rescission occurs automatically when the obligor validly exercises his right to rescind."
"In sum, nothing in the text of the statute supports the view that ‘it is the filing of an action in a court … that is required to invoke the right limited by the TILA statute of repose,’" Hardiman said, citing language from the U.S. Court of Appeals for the Tenth Circuit’s 2012 opinion in Rosenfield v. HSBC Bank, USA, which held that obligors must file suits seeking a declaration of rescission within the three-year timeframe.
While the First and Ninth Circuits have reached conclusions similar to the Tenth Circuit, according to Hardiman, the Fourth Circuit held last year in Gilbert v. Residential Funding that written notice is all that’s required for rescission, according to Hardiman.
The lenders, meanwhile, argued that the U.S. Supreme Court’s 1998 ruling in Beach v. Ocwen Federal Bank definitively held that an obligor must send written notification and file suit to effect rescission, according to Hardiman.
But Hardiman disagreed, saying the question Beach actually addressed was whether obligors who fail to notify a lender of rescission within the three-year timeframe may still assert rescission as an affirmative defense in foreclosure proceedings.
"Critical to this appeal, nowhere in Beach does the court address how an obligor must exercise his right of rescission within that three-year period," Hardiman said. "This omission is unsurprising since the obligors in Beach did not claim to have taken any action to rescind their loan before the bank initiated foreclosure proceedings."
Hardiman instead likened the three-year right to rescission reserved by obligors who have not received all required material disclosures to the three-day absolute right to rescission all obligors are entitled to following the receipt of all necessary disclosures.
If an obligor exercises the right of rescission within that three-day period, the lender has 20 days to respond, according to Hardiman. If 20 days pass without a response, the obligor can file suit.
"After the three-day period has expired, the obligor no longer has a ‘right of rescission’ — but because he exercised that right in a timely manner, he now has a statutory right to his property and to clear title," Hardiman said. "The three-year right of rescission should be understood to work in the same way: it expires if it is not exercised in three years, but borrowers who have exercised the right can file suit after the three-year period has passed."
But Hardiman noted that the court’s holding in Sherzer does not mean an obligor can get out of a loan simply by claiming TILA violations.
"If the borrower fails to exercise a valid right to rescission, the lender maintains its security interest in the property and does not incur any obligations toward the borrower," Hardiman said. "A lender who believes an obligor’s notice of rescission is invalid may choose to file suit to resolve any uncertainty."
Hardiman also noted that, even in situations where an obligor does validly rescind a loan, lenders are protected from becoming unsecured creditors if the obligor is unable to return the loan proceeds.
In such situations, according to Hardiman, courts are permitted to rearrange parties’ loan obligations such as by conditioning the release of a lender’s security interest on the obligor’s repayment of the loan proceeds.
Counsel for the plaintiffs, Matthew Weisberg of Weisberg Law in Morton, Pa., called the ruling "well-reasoned, fundamental, and apropoe."
Weisberg writes a column for the Law Weekly.
Counsel for the defendants, Henry F. Reichner of Reed Smith in Philadelphia, declined to comment on the ruling.
(Copies of the 26-page opinion in Sherzer v. Homestar Mortgage Services, PICS No. 13-0370, are available from Pennsylvania Law Weekly. Please call the Pennsylvania Instant Case Service at 800-276-PICS to order or for information.) •