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Case Developments

Case Developments

By Matthew Vasconcellos, MPLP Law Clerk

Rescission Under the Truth in Lending Act
Remains Available After Refinancing
Under the Truth in Lending Act (TILA), when a loan made in a consumer credit transaction is secured by the borrower's principal dwelling, a borrower has the right to rescind the loan agreement up to three business days after the transaction, see 15 U.S.C. § 1635(a). However, when the lender "fails to deliver certain forms or to disclose important terms accurately" to the borrower, TILA extends the borrower's right to rescind the transaction to three years. When TILA permits borrowers to rescind the transaction, it permits them not only to remove the security interest on their home but also to recover certain fees incurred in the transaction.

            The borrowers in Barrett v. JP Morgan Chase Bank, N.A., 445 F.3d 874 (6th Cir, 2006), alleged that the Chase Bank had violated TILA's disclosure requirements and sought to rescind two lending transactions. At the time the borrowers sought to rescind the transaction, they had already refinanced the loan with another lender and Chase Bank had released the security interest on their home. The bank therefore argued that the transaction could not be rescinded because the loan had been refinanced and there was no security interest in the property. The district court held in favor of the Bank and dismissed the suit.

            The 6th Circuit reversed the district court’s decision because “the right to rescind a transaction under TILA not only gives consumers the right to release the security interest in their home but also gives them the right to recover certain fees incurred in the transaction.” The court held that the rescission, if granted (the district court did not determine if TILA was violated), would unwind the entire transaction and entitle the borrowers to a return of prepayment penalties, mortgage filing fees, loan transaction fees, appraisal fees, and closing costs. The court remanded the case to the district court to determine if TILA had been violated.

  Transferred Funds Used to Pay Household Expenses are Not “Fraudulent” Under the Federal Debt Collection Procedures Act (FDCPA)

The 6th Circuit Court of Appeals held that under the Federal Debt Collection Procedures Act (FDCPA)( 28 USC § 3304), funds transferred to a spouse and used to pay household expenses are not subject to collection from the recipient spouse, United States v. Goforth, 2006 WL 2818974. The defendant received a monthly allowance from her husband, who was later convicted of violating the False Claims Act for misuse of Medicare reimbursement funds. The United States recovered a $10 million judgment against the husband, another defendant, and their defunct home health care company, Century Health Services, Inc. (“Century”). Unable to collect on the judgment, the United States sought to collect from the wives of the convicted defendants.

Section 3304(a)(1)(A) states that “a transfer made or obligation incurred by a debtor is fraudulent as to a debt to the United States which arises before the transfer is made or the obligation is incurred if the debtor makes the transfer or incurs the obligation without receiving a reasonably equivalent value in exchange for the transfer or obligation.” The Court held that the monthly allowances she received from her husband that were used to pay living expenses such as food, clothing, utilities, gasoline, property taxes, and travel expenses constituted “reasonably equivalent value” and thus were not fraudulent transfers. 

The Fair Debt Collection Practices Act (FDCPA) § 1692e(10) Allows the Filing of a Lawsuit Absent Proof of the Debt

The 6th Circuit ruled in Harvey v. Great Seneca Fin. Corp. that the defendants’ filing of a lawsuit without the immediate means of proving the debt owed did not constitute a deceptive practice under the Fair Debt Collection Practices Act (FDCPA) § 1692e(10). Nor did the defendants violate § 1692d because “the filing of a debt-collection lawsuit without the immediate means of proving the debt does not have the natural consequence of harassing, abusing, or oppressing a debtor.” The plaintiff did not deny the existence of the debt or dispute the amount owed, only that the defendants did not have adequate proof of the debt before the lawsuit was filed.

Equitable Mortgage Doctrine Protects Homeowners Who Transfer Property Believing that the Transaction is a Refinancing

In Moore v. Cycon Enterprises, 2006 WL 2375477 (W.D.Mich.), the Moores purchased property, hired a builder and obtained a $174,500 loan to pay for construction. When the home was built, they refinanced the construction loan. Due to financial difficulties, the Moores fell behind on their mortgage payments, and the house was sold at a foreclosure sale. The Moores received a letter from defendant-Peltz stating he could obtain financing for them and prevent them from losing the house. The Moores agreed to refinance through Peltz. Peltz never represented to the Moores that the transaction would involve anything other than a refinancing of their current mortgage.

            Peltz thereafter sought out parties to invest in the Moores’ property. Having found an investor, Peltz had the Moores sign a residential purchase agreement in which they agreed to sell their property to the Cycon Corporation for $215,000 and Cycon agreed to lease the property back to the Moores with an option to repurchase the property. The Moores property had a fair market value of $307,900.  During the closing, Peltz continued to state that the transaction was a refinancing. Although Peltz did not tell the Moores that they were selling their property, he had them sign a warranty deed, which conveyed their property to Cycon's. In addition, Peltz had the Moores sign a lease-back of their property, with an option to repurchase it. At no time did the Moores believe these transactions to be anything more than a refinancing of their mortgage. Nor did they read the documents that Peltz asked them to sign.

            The Moores subsequently filed a Chapter 7 bankruptcy petition after they fell behind in their monthly payment of $2,515 to Cycon. After the bankruptcy trustee abandoned the claim, the Moores' attorney advised Cycon that the Moores were exercising their right under 15 U.S.C. § 1635(a) to rescind the transaction and demanded that Cycon terminate any security interest it had in the Moores' property. The Moores filed this action after Cycon refused to do so.

            Based on the Moores' financial situation at the time of the transaction, the parties' understanding of the transaction, and the inadequacy of the consideration paid to the Moores, the court applied the doctrine of equitable mortgage and set aside the sale of the property. “Proof of the grantor's adverse financial condition, along with inadequacy of the purchase price, is generally sufficient to establish that a deed absolute on its face is actually a mortgage.” The court went on to explain the purpose behind the equitable mortgage doctrine as follows (quoting the Michigan Supreme Court in Wilcox v Moore, 354 Mich 499 (1958)): 

  Suffice to say that its purpose is to protect the necessitous borrower from extortion. In the accomplishment of this purpose a court must look squarely at the real nature of the transaction, thus avoiding, so far as lies within its power, the betrayal of justice by the cloak of words, the contrivances of form, or the paper tigers of the crafty. We are interested not in form or color but in nature and substance.

The court also noted that, because equitable mortgage is an equitable doctrine, "traditional legal principles, such as the parole evidence rule, do not apply."

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