Loan Rescission In Bankruptcy

Posted on October 17, 2008. Filed under: bankruptcy, Case Law, Truth in Lending Act | Tags: , , , |

In re Jaaskelainen, Case No. 07-12832-WCH (Bankr.Mass. 7/7/2008) (Bankr.Mass., 2008)

Upon the valid exercise of the right of rescission, the security interest becomes void and borrower is not liable for finance or any other charges or interest. Within twenty calendar days of the receipt of the NOR, the creditor shall return all money or property given in connection with the transaction and take any necessary action to terminate its security interest. Once this occurs, the borrower must tender the money or property loaned back to the creditor.

I previously held that rescission by an obligor is not conditioned by tender or payment in the context of a bankruptcy case.118 In Myers, I relied on the following passage by Judge Deitz explaining the difference between cases where the obligor is subject to a bankruptcy proceeding and those where the obligor is not:In a non-bankruptcy setting, the rights and duties of the parties upon TIL[A] rescission are clear and absolute. Each party must make the other as whole as he would have been had the contract never been entered into. In the absence of bankruptcy, there is no legal impediment to either party doing what is required to restore the status quo ante. Consequently, the creditor’s statutory duty to perform first merely establishes the order of performance; it does not alter the ultimate effect on the remedy.

Bankruptcy, however, relieves the debtor from his obligation to pay the creditor upon rescission. Conditioning rescission upon the debtor’s payment therefore imposes an obligation from which the debtor has been legally freed. Unlike the situation absent bankruptcy, there is a legitimate, legal impediment to the debtor’s reciprocal performance. It would be palpably unfair to deny the relief to which a consumer is entitled under TIL[A] because that consumer has also availed himself of bankruptcy relief. To do so would require that the consumer choose between bankruptcy and TIL[A], something neither form of statutory relief contemplates.

Essentially, when a borrower rescinds a transaction and the security interest is terminated as a matter of law, the creditor is left with an unsecured debt. Outside a bankruptcy proceeding, this characterization is of little consequence because unsecured debts must otherwise be paid in full, failing which, a creditor may take steps to reacquire a security interest. In a bankruptcy proceeding, however, unsecured debts are paid pro rata and may be discharged without payment. Requiring a Chapter 13 Debtor to tender the full amount of the loan on a creditor’s now unsecured claim would unfairly discriminate among unsecured claims in violation of 11 U.S.C. § 1322(a)(3).

In this case, Debtors sent a valid notice of rescission to the Defendants during the extended rescission period afforded them by the Defendants’ failure to provide each of them with two copies of the NOR.120 As such, the Defendants’ security interest is void and they hold nothing more than an unsecured claim which will receive the same dividend as other unsecured claims under the Debtors’ Chapter 13 plan. Moreover, the Debtors are only liable for the principal of the loan, minus the $16,143.32 which the parties stipulated was given by the Debtors in connection with the Refinancing, as they are no longer liable for any finance or other charges.121 While this circuit does not apply a hyper-technical standard of compliance to TILA, it nonetheless remains a strict liability statute.122 As such, I find the Defendants’ equitable arguments unpersuasive.

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