In Baker v. Bank of America, N.A., No. 5:13-CV-92-F, 2014 U.S. Dist. LEXIS 9578 (E.D.N.C. Jan. 27, 2014), the United States District Court for the Eastern District of North Carolina held that even if a consumer timely exercises his or her right to rescind a loan transaction under the Truth in Lending Act (TILA), 15 U.S.C. § 1601, et. seq.i.e., during the three-day statutory “cooling-off” period — that exercise does not automatically cause the loan to be rescinded.  Rather, the court held, if a consumer’s notice of rescission is met with silence by the lender, the consumer must also file a lawsuit in order to complete the rescission before the statute of limitations expires (in this case, the statute of limitations was determined to be four years).   The Baker case provides a thorough interpretation of the effect of the statutory three-day “cooling-off” period, for which, it was noted in the decision, case law is “exceedingly sparse.”

In Baker, the consumer entered into a refinancing transaction knowing that the terms were less favorable than the consumer had been quoted.  Two days after closing the loan, the consumer mailed a signed rescission notice to the lender. The lender did not respond to the notice and funded the consumer loan.  The lender allegedly refused to rescind the transaction despite multiple requests from the consumer.  The consumer, unable to refinance on more favorable terms, eventually became delinquent on the loan and foreclosing procedures were initiated.  Personal bankruptcy proceedings resulted in a discharge of the personal obligations under the loan but the foreclosure proceedings continued on the basis of the lender’s security interest in the property.

This case arose when the consumer responded to the continued foreclosure proceedings by filing an action for rescission pursuant to the TILA, nearly six years after the original notice of rescission had been sent to the lender.  The defendants moved to dismiss the complaint for failure to state a claim upon which relief can be granted.  The consumer argued that the rescission automatically voided the security interest pursuant to Section 1635(b) of the TILA, which provides that “when an obligor exercises his right to rescind . . . he is not liable for any finance or other charge and any security interest given by the obligor . . . becomes void upon such a rescission” (emphasis added).  The consumer argued that this sentence provided for an automatic right of rescission that voided the transaction so long as the consumer sent notice of rescission within the three day statutory period.

The court disagreed.  Instead, the Court distinguished between the “exercise” of the right of rescission and “full rescission.”  The exercise of the right to rescind is accomplished by the giving of notice, whereas the full rescission is defined by a “full unwinding of the transaction and a return to the status quo.”  Because the security interest becomes void only upon rescission, the lender maintained a security interest that could be foreclosed upon until such time as the transaction was fully rescinded.

In reaching its conclusion, the Court declined to follow unpublished decisions from the United States Court of Appeals for the Ninth Circuit (which includes California) and the United States District Court for the Eastern District of Pennsylvania (within the Third Circuit), which had previously held that the notification made pursuant to the TILA automatically voided a security interest.  Rather, the Baker court held, where, as here, a lender fails to respond to a consumer’s exercise of his or her right to rescission within the three day statutory period, the consumer “must file a lawsuit to complete the rescission process in cases where the lender fails to respond to the notice or otherwise fails to recognize the borrower’s rescission rights.”

It is worth noting here that the Supreme Court granted certiorari on April 28, 2014 to a case which hinges on the question of whether or not the TILA right of rescission for the lender’s failure to furnish required disclosures must be invoked by filing a lawsuit or whether such rescission is automatic upon notice made within the three-year statutory period.  See Jesinoski v. Countrywide Home Loans, Inc., 729 F.3d 1092 (8th Cir. 2013) (per curiam), cert. granted, No. 13-684 (U.S. Apr. 24, 2014).

The Baker court also disagreed with the consumer that lawsuits seeking rescission pursuant to the TILA have an unlimited limitations period.  The court held that such a limitations period would cloud title to property to such an extent that Congress could not have intended that the right of rescission have an unlimited limitations period.  However, the court did not wade too deeply into the debate regarding which statute of limitations was appropriate.  Here, the right of rescission — that is, the right to sue for rescission — arose at the very latest when the lender failed to respond to the notice of rescission within the twenty day statutory period.  The suit in Baker was filed nearly six years later and therefore must have been untimely.  Although the court discussed the conflicting decisions of a number of other courts that placed the statute of limitations at the one-year and three-year mark, the court in Baker ultimately concluded that the relevant statute of limitation is “at most four years” and continues its analysis no further.

Given the uncertainties in the statute of limitations noted by the court, which identified decisions concluding the statute of limitations in these cases is as short as one-year, three-years or “at most four years,” the fate of individual rescission claims will remain varied.  In addition, a consumer may be required to assert a claim for rescission in order to effect the full rescission desired, but a lender that fails to take “any action necessary or appropriate to reflect the termination of any security interest” within twenty days after receiving notice of rescission remains liable for civil penalties.  Although such civil penalties are subject to a one-year statute of limitations, the TILA does provide for attorney’s fees in cases where the lender violates the TILA by failing to respond to a timely notice of rescission.  Thus a lender would still be wise to consider the risks and costs of litigation, civil penalties and attorney’s fees before ignoring a notice for rescission.