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Now You Have It, Now You Don’t: TILA Rescission Claims Brought by Chapter 13 Debtors
By Dennis R. Dow

An increasing number of debtors in bankruptcy are raising Truth in Lending Act (“TILA”) rescission issues in an attempt to avoid the security interest of their mortgage lenders. Recently, the Federal District Court for the District of Kansas weighed in on this issue. It held that a bankruptcy court may condition a borrower’s TILA rescission right on the return of the property the debtor received from the loan transaction. Quenzer v. Advanta Mortgage Corporation USA (In re Quenzer), 288 B.R. 884 (D. Kan. 2003). Currently, there is a split of authority among the bankruptcy courts as to whether the court has the authority, either statutory or equitable, to condition rescission in this manner. Compare Wepsic v. Josephson (In re Wepsic), 231 B.R. 768 (Bankr. S.D. Cal. 1998); Apaydin v. Citibank Federal Savings Bank (In re Apaydin), 201 B.R. 716 (Bankr. E.D. Pa. 1996); Thorp Loan and Thrift Co. v. Buckles (In re Buckles), 189 B.R. 752 (1995) (finding that equity required the debtor to tender loan proceeds as condition of rescission) with Williams v. BankOne National Association (In re Williams), 291 B.R. 636 (Bankr. E.D. Pa. 2003); Whitley v. Rhodes Financial Services Inc. (In re Whitley), 177 B.R. 142 (Bankr. D. Mass. 1995); Celona v. Equitable Nat’l Bank (In re Celona), 98 B.R. 705 (E.D. Pa. 1989)(finding that the court cannot condition the debtor’s rescission on tender of loan proceeds). However, in the non-bankruptcy context, it appears the majority of circuit courts have found there is authority to modify the TILA rescission procedures. See Williams v. Homestake Mortgage Co., 968 F.2d 1137 (11th Cir. 1992); FDIC v. Hughes Development Co., 938 F.2d 889 (8th Cir. 1991); and Brown v. National Permanent Savings and Loan Assn., 683 F.2d 444 (D.C.Cir. 1982)(lien avoidance could be conditioned on tender of loan proceeds by borrower). Contra Harris v. Tower of Loan of Mississippi, Inc., 609 F.2d 120 (5th Cir. 1980)(creditor’s duties are not conditioned on tender by the borrower).

In Quenzer, the chapter 13 debtors filed an adversary action in the bankruptcy court to rescind their mortgage loan based on the mortgage company’s failure to provide the proper notice of right to cancel as required under TILA. The mortgage company agreed that the oversight was a violation of TILA, which would allow the debtors to rescind the loan. The bankruptcy court found, pursuant to §1635(a) and (b) of TILA and the supporting Federal Reserve Board Regulations, the lender’s security interest was void as of the date the debtors gave notice of their right to rescind and that the bankruptcy court had no authority to provide an alternative remedy to the lender or condition the avoidance on the debtor’s return of the loan funds. In re Quenzer, 266 B.R. 760, 763-764 (Bankr. D. Kan. 2001).

In the bankruptcy context, if the security interest is avoided, the creditor loses its secured status and its right to be paid the value of the property. The chapter 13 debtor may then propose a plan that classifies the lender as an unsecured creditor. As a result, the lender may receive a significantly reduced amount for its claim as it is now only entitled to receive its pro-rata share of the debtor’s disposable income. The lender in Quenzer appealed the bankruptcy court’s decision to the district court based on equitable considerations and certain exceptions provided within the statute.

The district court held that the bankruptcy court has discretion to condition the voiding of the lender’s security interest upon equitable and just terms and further held that the debtors were required to return the property they received in connection with the mortgage transaction as part of the rescission process. The district court’s focus was on placing the parties in the same position they were in prior to the loan transaction. The district court looked to Rachbach v. Cogswell, 547 F.2d 502 (10th Cir. 1976), which held that there is inherent authority to do equity in relation to the TILA rescission procedures, and to the language of §1635(b) in support of its position. In Rachbach, the Court of Appeals held that the court could order the borrower to pay interest on the loan funds, even though §1635(b) specifically provides that the borrower is not liable for any finance charge upon rescission. The borrower had the benefit of using the loan proceeds, and thus, on an equitable basis, should be required to pay interest for the time period of use as a condition to the rescission.

Additionally, §1635(b) provides that, “[t]he procedures prescribed in this subsection shall apply except when otherwise ordered by the court.” This sentence was added in 1994, after the holding in the Rachbach case. The district court found that this sentence applied to the provisions of both subsections (a) and (b). Thus, the Quenzer court reasoned that there was authority, both inherent and actual, to condition the debtor’s TILA rescission on the return of the loan proceeds. The alternative to this equitable relief would be that the lender’s entire claim would be given unsecured status which, the district court believed, “would exact a penalty entirely disproportionate to its offense.”

In contrast to the Quenzer decision, courts that have held the avoidance of the mortgage may not be conditioned on the borrower’s tender of the loan proceeds, such as the recent Williams v. BankOne case from Pennsylvania mentioned above, generally argue that the §1635(b) provision that allows the court to modify the rescission procedures, does not apply to the §1635(a) provision for lien avoidance. They argue that the avoidance of the lien cannot be conditioned – it occurs automatically upon receipt of the notice of rescission. Additionally, these courts rely on §226.23(d) of Regulation Z, which provides further clarification by specifically stating that only the provisions regarding return of funds by the creditor and the consumer may be modified. The separate provision that avoids the creditor’s lien is specifically omitted from the court’s modification authority. If the result of the statute’s application in the bankruptcy context is not what Congress intended, these courts suggest that Congress, not the court system, should fashion a remedy.

Mr. Dow would like to acknowledge the assistance of Kristen Trainor in the preparation of this article.


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