10/3/07

Kent Kluver Senior Attorney, Wolters Kluwer Financial Services

While it has been on the books for sometime, one topic that continues to generate questions here at ComplianceHeadquarters.com is the right of rescission under Truth-in-Lending. This article will provide an overview of the rules and discuss some of the more interesting twists and turns in applying the law to a lending transaction. For purposes of this article, we’ll limit ourselves to the closed-end credit rules.

When is a transaction rescindable?

When all of the following are true:

1. The credit is subject to Truth-in-Lending (credit to a consumer, for consumer purposes). A business-purpose loan is not rescindable, even if secured by the borrower’s principal dwelling, because the credit is not subject to Truth-in-Lending. Remember to distinguish the purpose of the credit from the purpose to which the collateral is put.
   
   
2. The credit is secured by the consumer’s principal dwelling. A consumer can only have one principal dwelling.
   
   
3. No exemption applies.

Here are the major exemptions:

• Residential mortgage transaction—basically, credit to acquire or construct the consumer’s principal dwelling.
  
  
• Refinancing by the same creditor of credit already secured by the consumer’s principal dwelling. If there’s “new money,” however, the new money portion of the transaction is rescindable.

What are the consequences of a transaction being rescindable?

1. The consumer has a limited time frame in which to “rescind”—that is, cancel—the transaction. If the consumer rescinds, both parties return to the position each was in prior to the transaction. In other words, all money and property collected from the consumer is returned and any security interest in the principal dwelling is released. The consumer must also return any property or money the consumer has received from the creditor.
   
   
2. The creditor must provide each consumer who has the right to rescind with two copies of a written notice explaining the right to rescind. The creditor must include on the notice a form the consumer can use to exercise the right. Regulation Z provides two model rescission notice forms for closed-end credit. One is for use when the entire transaction is rescindable. The other is for use when only the “new money” portion of a refinancing is rescindable. It is very important to use the right form.
   
   
3. The creditor must not distribute any proceeds of the credit until the rescission period has passed. It is debatable what the consequence should be if the lender violates this rule, but we’ve seen cases in which the rescission period was extended and the consumer was able to rescind long after the normal rescission time frame had passed.

What is the limited time frame in which the consumer can rescind?

The consumer can rescind at any time prior to midnight of the third business day following the latest of three occurrences:

1. “Consummation” of the transaction. “Consummation” of the transaction occurs when the consumer becomes contractually obligated on the transaction, which is generally when the consumer signs the promissory note or contract.
   
   
2. Consumer’s receipt of the notice of the right to rescind. Remember, each consumer with the right to rescind must receive two copies of the notice.
   
   
3. Consumer’s receipt of the “material” Truth-in-Lending disclosures. The “material” Truth-in-Lending disclosures are the APR, the finance charge, the amount financed, the total of payments, the payment schedule, and certain extra disclosures if the transaction is a “high-cost” mortgage. Ordinarily, you will provide the “material” disclosures when you provide the usual “fed box” disclosures.

Not until all three of these have occurred are you able to establish the end of the consumer’s rescission period. If any one or more of these events does not occur, the rescission period continues for three years.

What is a “business day?”

A “business day” for rescission purposes is every day other than Sunday and federal legal holidays. (For other purposes in Truth-in-Lending, “business day” is defined differently.)

If the three key events all occur on Tuesday, the rescission period closes at midnight of the third business day following Tuesday. The first day would be Wednesday, the second Thursday, and the third Friday, assuming no federal legal holidays during that time. So the rescission period would close at midnight on Friday.

Notice that for rescission purposes, Saturdays are business days. So if the three key events occur on a Friday, Saturday would be the first business day, Monday the second, and Tuesday the third, assuming no intervening federal holidays. Midnight Tuesday would be the close of the rescission period.

What if the consumer mails in the notice of rescission but we never receive it?

Regulation Z says that the consumer is treated as having fulfilled his notification duty when the consumer mails the notice, regardless whether you ever receive it.

This is called the “mailbox rule.” The consumer has effectively notified you when the consumer drops the notice in the mailbox as opposed to when you actually receive it.

What happens if we don’t have the consumer sign the “confirmation” statement on the notice of right of rescission?

Some lenders have a confirmation line on their rescission notice forms. This is a line that the consumer should sign after the rescission period has passed confirming that the rescission period has passed and that he or she has not rescinded.

Having the confirmation signed is helpful should the consumer ever claim that he or she did rescind. Remember that the mailbox rule discussed above creates the possibility that the consumer could effectively rescind without you leaning of it if the consumer’s notice does not reach you. The consumer cannot claim that such an incident has occurred if you have a signed confirmation that he or she has not rescinded.

While obtaining signatures to that confirmation is very useful, it is not mandatory. The confirmation provides a convenient way of proving that the consumer has not rescinded during the rescission period. But it is not a required part of the disclosure.

What is meant by “the same creditor” in the exemption for refinancing “by the same creditor?”

According to the Commentary, the exemption applies only to refinancing by the “original” creditor. The original creditor is the creditor to whom the written agreement was initially made payable.

If a loan secured by the consumer’s principal dwelling is sold, a refinancing by the creditor who bought and now holds the loan would not be within this exemption since it is not the “original” creditor.

What is “new money” in the exemption for refinancing by the same creditor?

You can think of “new money” as credit in excess of what is being refinanced from the old loan. To be more specific, the exemption is limited to the unpaid principal balance, plus any earned but unpaid finance charge, plus amounts attributed solely to the cost of the refinancing. If the new amount financed exceeds this total, the excess is “new money” and that portion of the loan is rescindable.

Remember that if there is new money, you need to use a different notice of right to rescind then you otherwise would.

What about insurance premiums in a refinancing? Would the premiums be “new money?”

No. Insurance premiums are included in amounts attributed solely to the cost of refinancing.

Who’s responsible for all this Truth-in-Lending and rescission stuff that we have to follow?

The person most responsible for the enactment of the Truth-in-Lending Act (TILA), of which the rescission rule is a part, is Senator Paul Douglas, a Democrat from Illinois. He first introduced consumer credit disclosure legislation in 1960, and reintroduced it in 1963, expending great energy over that time period in promoting the legislation. As it turned out, the TILA was not enacted until 1968. By that time, Senator Douglas was out of office, having lost a reelection bid in 1966. Senator William Proxmire, a Democrat from Wisconsin, championed the legislation after Douglas’ departure.

For a complete history of the TILA legislation, see “Legislative Methodology: Some Lessons from the Truth-in-Lending Act,” by Edward L. Rubin, 80 Georgetown Law Journal 233 (1991).