Even After Refinancing a Loan, A Borrower Can Rescind That Loan for TILA Violations

On April 27, 2006, the California Court of Appeal ruled that a borrower’s right to rescind the transaction for a Truth In Lending Act violation survives a refinancing of the offending loan.

In the case of Pacific Shore Funding v. Zoran Lozo, et al., the borrowers attempted to rescind their original loan transaction on the grounds that the lender had failed to comply with the disclosure requirements of the Truth In Lending Act.  Nearly three years had passed since the original loan transaction had occurred.

The Lozos had obtained a non purchase-money loan for $28,000 from Pacific Shore at a rate of 13.375 percent.  Pacific Shore charged origination, funding, processing and settlement fees in excess of $2,800, amounting to more than ten percent of the loan.  Accordingly, this “high-cost” loan was subject to the disclosure requirements of TILA and Regulation Z.  Two years after this loan, the Lozos obtained a second loan from Pacific Shore for $71,600, a portion of which paid off the first loan to Pacific Shore and the prepayment penalty.

After the refinance, the Lozos made a demand to Pacific Shore Funding to rescind their original loan.  Pacific Shore Funding refused and sued the borrowers for a declaration that the loan agreement was valid.  The borrowers cross-complained, alleging violation of TILA and seeking damages.

The borrowers’ claim for rescission rested on the grounds that 1) on the Notice of the Right to Rescind, Pacific Shore had failed to include a date or deadline for which a notice of rescission must be delivered by the borrower and 2) Pacific Shore had failed to provide two copies of the consumer disclosures of the interest rate, monthly payments, and borrowers’ right not to complete the transaction, along with a notice that borrowers risked losing their home if they failed to keep current with their loan.*

Pacific Shore did not dispute the TILA violations, instead admitting the violations had occurred but that as a matter of law, the borrowers had no loan to rescind.  At the lower court level, Pacific Shore was successful on a summary judgment motion with the court finding that since the Lozos had already refinanced their first loan, there was nothing left to rescind and following an earlier Ninth Circuit decision.  The matter went up on appeal, and the California Court of Appeal overturned the decision.

On appeal, the Court declined to follow an earlier Ninth Circuit decision that went in favor of the lender.  The earlier decision in King v. State of California (1986) was a situation where the borrowers had been in bankruptcy, thus creating a transfer of the residence to the Trustee, effectively cutting off the borrower’s ability to rescind under TILA.  However, in the present case, the Lozos still held title to the property and the plain language of Regulation Z states “[i]f the required notice or material disclosures are not delivered, the right to rescind shall expire 3 years after consumer, [1] upon transfer of  all of the consumer’s interest in the property, or [2] upon sale of the property, whichever occurs first.”

Once the Court interpreted that the language Regulation Z did not address a refinance situation, the Court also went on to point out that even with a re-finance, the borrower was entitled to rescind and demand the interest, fees, penalties and charges paid.

The twist was that while the borrowers had three years to rescind the loan, they had only one year to seek damages for TILA violations.  The Lozos had waited nearly three years and so could not seek damages under TILA.  However, the borrowers also cross-complained under Business & Professions Code 17200, the UCL.  This provision provides separate relief for any acts that fall within the meaning of unfair competition as defined by the Code, and has a four-year statue of limitations.  The Court pointed out that while the borrowers could not seek money damages under the UCL, the borrowers may be entitled to disgorgement of any fees and penalties wrongfully obtained by the lender.

Most importantly, the UCL provides for injunctive relief to halt the deceptive advertising or practice being engaged in by the defendant.  The Court noted that Pacific Shore did not provide any evidence that it was unlikely to repeat the deceptive advertising or practices, thus subjecting them to a claim for injunctive relief from the borrowers.

Ultimately, it did not matter whether or not the disclosures were intentionally left blank or intentionally withheld from borrowers.  Any violation of the disclosure requirements of TILA, even if the disclosure may have been substantially completed, was strictly construed against the lender and provided the borrower with a three year time frame to rescind the loan.  Furthermore, in conjunction with the relief sought under California’s Unfair Competition Law, the TILA violation gave rise to another claim for relief to the borrowers.

In reading the decision, it was evident that the Appellate Court looked at Pacific Shore Lending and found the surrounding circumstances between the lender and borrower inequitable, noting that TILA was designed to protect against “unscrupulous lenders with a means of laundering their TILA violations in the initial loan by refinancing it with a second loan, while forever preventing borrowers from recouping their wrongfully paid finance charges, downpayments and other fees.”  Clearly, no lender wants to be grouped in that category with Pacific Shore Lending.

The lesson to take away for lenders making high cost loans is that errors or omissions on disclosures can be costly.   A blank on the disclosure can be as fatal as not providing the disclosure at all.  In the close relationship between the broker and the lender and in some cases, the escrow officer, it may be tempting to pass the buck on whose responsibility it is to get the loan documents and disclosures to the borrowers.  However, there is no substitute for a thorough review.  Furthermore, if a demand for rescission is made by a borrower, that is not a time to play hardball with them.  Pull the files and engage an outside professional to comb through the documents for any possible omissions or defects in the documentation.  Compromising with the borrower prior to litigation is a far less costly solution.

* Actually, it is unclear from the case decision, but may be possible that Pacific Shore did actually supply the disclosures, but either neglected to supply two copies to the borrowers or neglected to supply the disclosures within the required three days prior to the execution of the loan documents.