By Mara A. Baltabols, Esq. [1]
The Truth in Lending Act ("TILA") offers powerful tools that a consumer may use in bankruptcy. There are two types of TILA claims: (1) a claim for recoupment of damages for TILA violations; and (2) rescission of the mortgage based on a failure to provide material disclosures at closing. Recoupment is essentially a remedy under TILA for damages asserted to offset any amounts owed to a creditor. Recoupment is available for TILA disclosure violations on a loan used for family or household purposes and secured by real property owned by the debtor. Rescission, on the other hand, is generally only available for a refinance loan on the borrower's primary residence and it voids the creditor's lien on the property. Rescission is available up to three years from when the creditor fails to provide material disclosures for the loan. If successful, a rescission renders the secured credit unsecured and potentially dischargeable in bankruptcy.
It is important to utilize the remedies set forth in TILA when filing bankruptcy, especially if a debtor has grounds for rescission. The desired effect of rescission on a secured claim is to void the lien and render the debt unsecured in bankruptcy. In Chapter 13 bankruptcy cases, following rescission, the creditor becomes an unsecured creditor and treated as other unsecured creditors. In Chapter 7 bankruptcy cases, it is possible to void the lien and discharge the debt. However, discharge of the debt that becomes unsecured as a result of rescission is not a guarantee, as the bankruptcy court may modify TILA rescission based on considerations of equity.
In terms of rescission, a consumer may only rescind a loan that is a consumer loan, that secures a principal dwelling, and which is not for the construction or acquisition of property (e.g.. only available on a refinance). Prior to filing bankruptcy, the debtor should follow the applicable rescission procedures by sending a valid rescission notice within the three-year statute of limitations. The limitations period starts from the time of closing the subject loan - when the creditor failed to provide certain material disclosures. After sending the notice, if the creditor fails to honor rescission, the consumer has one year to enforce a creditor's failure to honor rescission and can do so as part of the bankruptcy.
A debtor must be careful to preserve standing to bring its TILA claim in bankruptcy. The debt that is "disputed" based on a TILA violation should be marked as such on the bankruptcy schedules. The potential TILA claim may also be listed as an asset and exempted where possible. It is important that the debtor exempt the disputed debt in a Chapter 7 bankruptcy in order to pursue the TILA claim. If the debtor fails to exempt the debt disputed under TILA, the debtor will lose standing to bring the claim unless the trustee abandons the claim.
On the other hand, in a Chapter 13 bankruptcy, a debtor has more control over the litigation as part of his continued possession of the property during the bankruptcy. A Chapter 13 consumer normally will have standing to pursue a pre-petition TILA claim as part of the bankruptcy without issue.
After marking the TILA claim on the appropriate schedules, a consumer's next step is to file an adversary proceeding by objecting to the creditor's proof of claim based on the existence of a TILA violation or rescission of the note and mortgage. However, procedural issues may arise where the creditor does not file a proof of claim. In that instance, a debtor may file a proof of claim on the creditor's behalf and list the TILA claim as a set-off.
A debtor may bring a TILA claim by recoupment beyond the one-year statute of limitations in a bankruptcy. TILA sets forth a strict one year limitations period for pursuing affirmative claims under TILA. However the Act allows a borrower to allege claims for an unlimited period in response to an action by way of recoupment. A debtor may pursue TILA damages in bankruptcy in order to off-set amounts that a creditor alleges as due.
Importantly, and in terms of recoupment, if a debtor wishes to assert a violation against an assignee of a loan, the debtor must be able to allege that the violations are apparent on the face of the disclosure documents. This rule does not apply to a rescission claim. On the other hand, rescission is enforceable against assignees of a loan so long as the other TILA requirements under are met, including the requirement that the debtor rescind the loan within the applicable three year limitations period.
In sum, the debtor may be able offset the amounts that he or she is liable for as part of the bankruptcy by asserting TILA violations where applicable. It is important for consumers and bankruptcy lawyers to consider TILA violations at the time of filing the petition and throughout bankruptcy proceedings. TILA imposes strict requirements on creditors that, where not followed, result in liability that can be pursued as part of a bankruptcy.
[1] Mara A. Baltabols is an associate attorney for Sulaiman Law Group, Ltd. She earned her J.D. from the University of South Carolina and her B.A. from the University of Colorado at Boulder.
