By Terris, Harry
American Banker , Vol. 172, No. 46
A pair of cases making their way through the court system could settle the question of whether federal provisions that protect mortgage borrowers can be applied to class actions.
The question, which has produced differing opinions in cases where it has arisen, has significant ramifications for lenders at a time when foreclosures are rising, a trend that lawyers say brings with it a corresponding increase in what are known as rescission lawsuits.
Such suits rely on a provision in the Truth-in-Lending Act that lets borrowers recover essentially all loan fees -- including interest payments for up to three years after taking out a refinancing or home equity loan -- if the loan documents are in violation of the law's disclosure requirements.
Some trial courts have allowed the provision to be applied to class actions -- an application that brings with it the potential for massive damages. But on Jan. 29 the U.S. Court of Appeals for the First Circuit in Boston ruled that rescission was not available as a class-action remedy.
A Wisconsin case involving the same issue is now being reviewed in the U.S. Court of Appeals for the Seventh Circuit in Chicago. That court's ruling, which could come this spring, may lend support to the First Circuit's ruling or restore a state of profound uncertainty.
The stakes are particularly high at a time when mortgage credit quality is deteriorating. According to Jeffrey P. Naimon, a partner with Buckley Kolar LLP in Washington, higher rates of foreclosure propel rescission suits.
Rescissions for Truth-in-Lending violations often occur because the borrower is in foreclosure "and they go to a lawyer, and the lawyer picks out, 'Oh, there's this Truth-in-Lending violation,' " he said.
Damages to creditors could balloon if rescission is applied to seasoned loans on a class basis. For example, a $150,000 mortgage at a 6% rate could generate $27,000 of interest payments over three years; if 1,000 borrowers in a class had such loans, the liability tally would be $27 million.
First Horizon National Corp., the defendant in the First Circuit case, estimated that it was exposed to a $200 million penalty, according to the court's ruling. (The Memphis company would not comment for this story.)
The ruling also described some district court decisions that emphasized the fact that "rescission class actions, if permitted, could easily render a creditor insolvent."
To date there have been no appellate decisions affirming rescission classes, according to a February review by Kirkpatrick & Lockhart Preston Gates Ellis LLP. Case law has been characterized by opinions that have come to contradictory conclusions and have been unclear on key issues.
A handful of recent district court rulings in favor of rescission classes have renewed the controversy. In the First Circuit decision, Judge Bruce Selya wrote that even though previous case law, including a 1980 appellate decision, addressed the issue, "the question is not free from doubt."
The First Circuit held that a cap on class-action damages under Truth-in-Lending -- set at $500,000 or 1% of the defendant's net worth -- and the legislation's silence on class actions with regard to rescission suggested that Congress intended to provide no rescission class-action mechanism at all.
"The notion that Congress would limit liability to $500,000 with respect to one remedy while allowing the sky to be the limit with respect to another remedy for the same violation strains credulity," Judge Selya wrote. …