Sterten v. Option One Mortgage Corp.

Posted on January 9, 2009. Filed under: bankruptcy, Case Law, Mortgage Law, Truth in Lending Act | Tags: , , , , , , , |

A provision in the Truth in Lending Act that excuses minor inaccuracies on the part of lenders is not an “affirmative defense” that must be specifically raised by the defendant, but instead is a “general defense” that cannot be waived, the 3rd U.S. Circuit Court of Appeals has ruled.

The ruling in Sterten v. Option One Mortgage Corp. could prove to be a significant boon to banks by relaxing the rules for reaping the benefits of a TILA amendment that was designed to prevent creditors from being subject to “extraordinary liability” for small disclosure discrepancies.

The unanimous three-judge panel upheld a decision by U.S. District Judge Timothy J. Savage who had concluded that a bankruptcy judge had erred by first dismissing the debtor’s claims under TILA sua sponte due to the statute’s “tolerances for accuracy” provision, but later reversing himself on the grounds that Option One had waived that defense by failing to raise it.

Savage, in a March 2007 decision, held that “because the ‘tolerances for accuracy’ provision is not an affirmative defense,” the original verdict by Bankruptcy Judge Kevin J. Carey in favor of Option One “was correct and should not have been disturbed.”

Now the 3rd Circuit has agreed, finding that, under Rule 8(c) of the Federal Rules of Civil Procedure, the “tolerances for accuracy” provision should not be treated as an affirmative defense. Writing for the court, U.S. Circuit Judge Thomas L. Ambro found that Rule 8(c)’s key provision — that an affirmative defense will be deemed to be waived unless asserted — was designed to avoid “surprise and undue prejudice.”

In the case of the tolerances for accuracy defense, Ambro found, there is no risk that surprise would harm the plaintiff.

“The analysis a plaintiff must undertake to show any undisclosed finance charges under the Truth in Lending Act — that there were discrepancies between what was charged and what was disclosed in the Truth in Lending Disclosure Statement, and that those undisclosed fees fall within the Act’s definition of a ‘finance charge’ — is the same analysis required to show that the undisclosed charges exceeded [the tolerance for accuracy’s] range of error,” Ambro wrote.

As a result, Ambro said, “[W]e see no reason to think that Sterten suffered any ‘unfair surprise’ as a consequence of Option One’s failure to plead specifically the tolerances for accuracy defense.”

According to court papers, debtor Gaye L. Sterten took out a $132,000 loan from Option One in February 2001 to refinance a second mortgage on her home and to consolidate her medical and credit card bills. Nearly two years later, Sterten sent a letter to Option One contending that the closing of the loan failed to comply with the Truth in Lending Act and requesting a recision of the loan.

When Option One disputed her right to rescind, Sterten filed a Chapter 13 bankruptcy petition and Option One filed a proof of claim. Sterten responded by filing an adversary proceeding seeking recision of the loan.

The suit alleged that Sterten was never provided with either her Truth in Lending disclosure statement or her notice of right to cancel form; and that the finance charges were not accurately disclosed.

In its formal answer to the suit, Option One denied both allegations and said that it had “acted at all times relevant hereto in full compliance with all applicable laws and/or acts.”

After a bench trial, Carey found Sterten was less credible than the mortgage broker and therefore concluded that she had received the required forms.

On the issue of the finance charges, Carey found that only two — a $25 “mark up” in the appraisal fee and $32 charged for notary services — qualified as finance charges.

Carey then sua sponte applied TILA‘s tolerances for accuracy provision and concluded that, because the $57 in non-disclosed finance charges were within the tolerance range, Option One’s disclosure was “accurate as a matter of law.”

TILA’s tolerances for accuracy provision states that finance charges “shall be treated as being accurate” if they do not vary from the actual finance charge by more than $100, or, in a claim seeking recision of a loan, if the amount disclosed does not vary from the actual finance charge by more than half a percent of the loan total.

Sterten’s lawyer, David A. Scholl, urged Carey to reconsider, arguing that the court should not have applied the tolerances for accuracy provision because Option One had failed to raise it as an affirmative defense and had therefore waived it.

Carey agreed and vacated his judgment, declared a recision and awarded nearly $20,000 in attorney fees.

While Option One’s appeal to U.S. District Court was pending, Carey held a remedy hearing and concluded that Sterten had a repayment obligation of about $119,000, payable in 302 monthly installments. But Option One later prevailed in its appeal when Savage ruled that Carey’s original verdict should be reinstated because the tolerances for accuracy provision is not a waivable defense.

Now the 3rd Circuit has ruled that Savage correctly ordered that the original verdict in favor of Option One be reinstated.

Ambro, who was joined by Judges Maryanne Trump Barry and Leonard I. Garth, rejected the argument that Option One had waived the defense by failing to raise it at any stage of the litigation.

Instead, Ambro found that Sterten “cannot establish that she suffered any prejudice” as a result of Option One’s failure to raise the issue.

“We do not dispute that the most prudent course for Option One was to argue — in its answer or otherwise — that, if it made any disclosure errors, those errors fell within the tolerance range rather than relying on the Bankruptcy Court’s sua sponte application,” Ambro wrote.

“Still, Option One’s general denial that it committed any disclosure violations was sufficient to preserve the tolerance issue. Given that denial, and given the absence of any real prejudice suffered by Sterten, the Bankruptcy Court’s sua sponte application … was not improper.” Option One was represented in the appeal by attorney Donna M. Doblick of Reed Smith’s Pittsburgh office. Debtor’s attorney Scholl could not be reached for comment.

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