Mortgage Crisis Requires Attention of Consumer Bankruptcy
Written by: David P. Leibowitz
Lakelaw-Leibowitz Law Center; Waukegan, Ill.
The typical consumer bankruptcy attorney is knowledgeable about bankruptcy law and property rights in general. Today, more than ever, mortgage foreclosure is the event which precipitates bankruptcy filings. Most of the mortgages that are now being foreclosed upon are subprime mortgages originated within the past three years. Many of these subprime mortgage transactions were refinancing transactions. The overwhelming majority of bankruptcy attorneys are unaware of the fact that refinancing transactions within three years prior to the bankruptcy case may be subject to substantial claims or defenses under the federal Truth in Lending Act (TILA) and Regulation Z. Trustees, as well as debtors, have the right to pursue TILA and TILA related claims. In re Smith, 640 F.2d 888, 890 (7th Cir. 1981) quite explicitly holds that the chapter 7 trustee has the sole standing to pursue a TILA claim for a debtor in chapter 7. To the same effect, see In re Polis, 217 F.3d 899 (7th Cir. 2000). The existence of a TILA claim or a pendent state law claim arising from the fraudulent or improper origination of a consumer mortgage, may be the difference between a debtor losing his house or keeping it pursuant to a chapter 13 plan, e.g In re Ramirez, 329 B.R. 727 (D. Kan. 2005).
Both TILA and related Regulation Z require disclosure of material terms of a consumer credit transaction in a highly specific manner. Claims can arise as a result of the lender’s failure to make proper disclosures, including failure to give the consumer a notice of right to rescind and from the lender’s failure to comply with a properly tendered rescission notice. In either circumstance, the consumer debtor may have an extended right to rescind, potentially up to three years from the date of the initiation of the consumer credit transaction.
In a successful TILA rescission claim, the consumer is entitled to a refund of all payments made under the mortgage as well as all finance charges paid incident to the closing. The mortgage lien is null and void. In cases of a lender’s failure to give proper TILA notices, which has a one year statute of limitations, the consumer is entitled to statutory damages of $2,000 and attorney fees. In cases of a lender’s failure to comply with a consumer’s valid notice of rescission, which has a three-year statute of limitations, a consumer is also entitled to statutory damages of $2,000 and attorney fees.
The right of the consumer to rescind is subject to the consumer's tender of the net of the original loan and damages to which the consumer is entitled. This amount is called the "TILA tender." In general, however, the TILA tender will result in all payments, whether principal, interest, late charges or original finance charges, becoming a reduction in principal.
The right to pursue the TILA claim is not limited to claims against the original lender, who may well also be in bankruptcy, such as Delta Funding or New Century Mortgage. Rather, the right to TILA damages extends to assignees. The debtor or trustee must provide notice of rescission to the servicer or the current holder of the mortgage. If the holder or servicer fails to act within 20 days of the date that the notice of rescission was sent, then the mortgage transaction is rescinded and becomes void, conditioned upon tender by the consumer of what she received at the closing.
After rescission, the bankruptcy court has jurisdiction to hear the ensuing adversary proceeding to determine damages against the lender, attorneys' fees, the TILA tender amount and the method by which the borrower must make tender. This is probably a noncore matter, related to a case pending under Title 11. The TILA tender can be conditioned and varied by the court. Some bankruptcy courts have held that TILA tender in a bankruptcy case is limited to the grant of an unsecured claim to the mortgagee. Whitley v. Rhodes (Case No. 93-19652-JNF, Adv. P. No. 94-1008 (Bankr. D. Mass Jan. 24, 1995). Other courts have required that the debtor refinance the property or sell the property. At minimum, the debtor can create substantial equity which otherwise was not available.
Consumer bankruptcy attorneys and creditors should also consider that mortgage rescue transactions, characterized by sales and leasebacks with options to buy, often can be recharacterized as equitable mortgages for purposes of TILA. Because these transactions are often initiated through brokers or other intermediaries, these transactions are subject to the Home Owners Equity Protection Act (HOEPA) provisions of the Truth in Lending Act. Absent proper disclosures, there is often a high likelihood that such transactions may be avoided for the benefit of the estate and even for the debtor. Moore v. Cycon Enterprises Inc., (Case No. 1:04-CV-800), 2006 US Dist. LEXIS 57452 (WD Mi. 2006).
An exhaustive discussion of TILA and HOEPA is well beyond the scope of this note. There is a steep learning curve for mortgage foreclosure defenses and claims under TILA. However, consideration of such claims can be highly rewarding to debtors and trustees administering their estates.