Written by: Evan Berquist
In a unanimous decision issued on January 13 of this year, the Supreme Court held that a borrower exercises its right to rescind a loan under Section 1635 of the Truth In Lending Act (“TILA”), simply by notifying its creditor of its intent to rescind within TILA’s three-year limitation period. See Jesinoski v. Countrywide Home Loans, Inc., No. 13-684, 574 U. S. ___, ___, (2015) (slip op., at 3). The Court reversed a decision by the Eighth Circuit, which held that a borrower could exercise its rights only if it filed a lawsuit within the three-year period. Before Jesinoski, courts were divided about what was required to exercise a borrower’s rights under the statute: five circuits held that a borrower must file a lawsuit, while only three circuit courts held that mere notice was sufficient. Jesinoski thus resolved an important circuit split decisively in favor of the borrowers.
Truth In Lending Act (“TILA”), 15 U. S. C. §§ 1601 et seq.
Congress first passed TILA in 1968, in order to help consumers “avoid the uninformed use of credit, and to protect the consumer against inaccurate and unfair credit billing.” 15 U. S. C. § 1601(a). Among other things, the Act and its implementing regulations require lenders to provide certain mandatory disclosures to consumers in mortgage loan transactions. TILA also grants borrowers the right to rescind loan transactions within given time periods. For up to three days following the closing of a loan transaction, borrowers can rescind the loan for any reason. If the lender failed to make the disclosures required by TILA, however, the borrower has three years to rescind the loan. See 15 U.S.C. § 1635(f). The question presented in this case was what the borrower has to do to exercise its rights of rescission within the 3-year period.
In 2007, the Jesinoskis closed a loan transaction with Countrywide Financial Services, Inc. (“Countrywide”). Exactly three years after closing the transaction, the borrowers mailed notice to Countrywide of their intention to rescind the loan. One year and one day after that—or four years and a day after the loan closing—the Jesinoskis filed suit against Countrywide, seeking to rescind the loan.
In federal district court, Countrywide moved for summary judgment, arguing that the borrowers had failed to satisfy the Act’s limitation period. The district court agreed, citing binding precedent in the Eighth Circuit that “a suit for rescission filed more than three years after consummation of an eligible transaction is barred by TILA’s statute of repose.” The Eighth Circuit affirmed.
The Supreme Court’s Opinion
In a unanimous opinion authored by Justice Scalia, the Supreme Court reversed. The Court resolved the case as a matter of simple statutory construction. In particular, the Court relied on 15 U.S.C. § 1635(a), which provides that a borrower “shall have the right to rescind . . . by notifying the creditor, in accordance with regulations of the Board, of his intention to do so.”* This language, the Court held, “leaves no doubt that rescission is effected when the borrower notifies the creditor of its intention to rescind.” The entire opinion went on for less than six pages, one of the shortest to be issued this Term.
In its opinion, the Court quickly rejected Countrywide’s arguments that rescission could result only from a lawsuit or judicial action. As Countrywide pointed out, under the common law doctrine of rescission, the borrower had to either tender the amount it had received to the lender (rescission at law) or receive a judicial decree of rescission (rescission at equity). The Court held that nothing in the Act, or in the Court’s jurisprudence, modifies “the clear import of 1635(a) . . . that a borrower need only provide written notice to a lender in order to exercise its right to rescind.”
Advocates for the financial services industry warn that the decision will harm consumers in the long run, by adding to clouds on title, incentivizing needless litigation, and injecting uncertainty into the mortgage market. As Countrywide argued in its brief, the circumstances presented in the Jesinowskis’ case—where a borrower sends notice of its intent to rescind but fails to bring a lawsuit within that time—already represented a “narrow, though frequently reprised, set of circumstances.” Following the Supreme Court’s decision, those circumstances are likely to become significantly more common. From now on, any bank that receives notice of a borrower’s intent to rescind a loan within three years of a loan closing should at least be prepared for the possibility of litigation.
* Following the events of this case, in 2010 Congress transferred rulemaking authority under the Act from the “Board” (Federal Reserve Board) to the Consumer Financial Protection Bureau. See Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, as amended.
Written by: Greg Johnson
The Bureau of Consumer Financial Protection (CFPB) recently issued proposed regulations that would amend Regulation E (12 CFR part 1005 et seq.) and Regulation Z (12 CFR part 1026 et seq.). The proposed regulations would adopt specific disclosure, periodic statement, limited liability, error resolution and other requirements for prepaid cards and accounts.
In its release of the proposed regulations, the CFPB noted that, among all non-cash payment forms (such as credit, debit, and check), usage of prepaid cards and accounts increased at the fastest rate from 2009 to 2012, reaching 9.2 billion transactions in 2012. The amount loaded to general purpose reloadable (GPR) cards grew from $1 billion in 2003 to $65 billion in 2012, and is projected to reach $98 billion in 2014. The CFPB also recited several positive attributes of prepaid cards and accounts, including their popularity among individuals who do not have traditional bank accounts.
As currently in effect, Regulation E applies to payroll cards, gift cards, and cards that accept government loads but does not apply to other prepaid cards or accounts. The CFPB stated that prior regulations did not address other types of prepaid cards or accounts due to the wide variety of types and usage. In an apparent response to the increased usage of prepaid cards and the perceived lack of consumer protection under Regulation E for other types of prepaid cards and accounts, the CFPB proposes to amend Regulation E so that it would generally apply to all prepaid cards and accounts on a consistent basis.
Prepaid Account. As proposed, Regulation E would generally apply to a Prepaid Account, which is defined as any card, code or other device that is established primarily for personal, family or household purposes and that satisfies each of the following criteria: (i) it is issued on a prepaid basis in a specific amount or is capable of being loaded with funds after issuance, (ii) it is redeemable upon presentation at multiple, unaffiliated merchants for goods or services, usable at ATMs or usable for person-to-person transfers, and (iii) it is a not a gift card or loyalty, award or promotional gift card that is marketed and labeled as such. Prepaid Accounts do not include HSAs, flexible spending accounts, medical savings accounts or health reimbursement arrangements.
Fee Disclosure Requirements. Issuers would generally be required to provide two fee disclosures before a consumer agrees to acquire a Prepaid Account. The first disclosure would highlight certain fees, such as periodic, per-purchase, and inactivity fees. The second disclosure would set forth all of the fees and the conditions under which the fees could be imposed.
Transaction Information. Issuers would generally be required to provide periodic statements or, in the alternative, make available the account balance through a readily available telephone line and at a terminal, an electronic history of account transactions that covers at least 18 months, and a written history of account transactions that covers at least 18 months upon request. Issuers would be required to disclose monthly and annual summary totals of fees imposed, as well as the total amount of loads to and debits from the prepaid account, when providing a periodic statement or account history.
Limitation of Liability/Error Resolution. Regulation E provides that a consumer may be liable for an unauthorized transfer only if the issuer has provided certain disclosures and other conditions are satisfied. Regulation E also limits the amount of liability that may be imposed on the consumer. With certain modifications, this regime would be extended to all Prepaid Accounts.
Credit Features. If overdraft services or other credit features are offered in connection with a Prepaid Account, the services would generally be subject to Regulation Z’s open end credit rules, including (i) obtaining the consumer’s consent to add such services and waiting at least 30 days until after card registration to add such services, (ii) obtaining the customer’s consent to an automatic repayment plan, (iii) under an authorized repayment plan, not deducting payments more frequently than once per calendar month, (iv) providing periodic statements at least 21 days in advance of the payment due date, and (v) complying with error resolution and limited liability provisions that are more consumer-protective than those under Regulation E.
The full version of the proposed regulations may be found at: http://www.consumerfinance.gov/regulations/#proposed
The CFPB invited public comments regarding the proposed regulations. Please contact your regular SLS lawyer if you have any questions regarding the proposed regulations or if you would like assistance in submitting comments to the CFPB.
PROPOSED TREASURY REGULATIONS ELIMINATE 36-MONTH TESTING PERIOD AS A TRIGGER FOR REPORTING COD INCOME
Removing the Non-Payment Testing Period Should Provide Clarity to Borrowers, Banks, Credit Unions and Other Financial Institutions
Written by: Mike W. Lochmann
Trust preferred securities (TRUPs), the hybrid security that counted as Tier 1 regulatory capital but generated tax deductible interest payments, were a favored source of capital for community banks. When the financial crisis hit, many bank holding companies (BHCs) with troubled bank subsidiaries exercised the right to defer interest payments on their outstanding TRUPs for up to five years. Interest continued to accrue during the deferral period, but the deferral was not a default and there was nothing that the TRUPs holder could do but wait. Many deferral periods that began late in 2009 and early 2010 are about to expire. TRUPs holders − long shackled by contractual stand still covenants – are about to be unleashed to exercise their creditor rights against the troubled BHCs that issues the TRUPs.
Deferred Interest Becomes Due and Payable In most cases, the five years of deferred interest on the TRUPs becomes due and payable in full when the deferral period ends. If the accrued interest is not paid, then the TRUPs holders may declare a default, accelerate the principal and demand immediate repayment of all principal and accrued interest on the TRUPs. The trustee for the unpaid TRUPs has all the rights of an unsecured creditor, may obtain a judgment against the BHC and can force the BHC (but not its subsidiary bank) into bankruptcy, which has already happened to at least three BHCs.
Dividends from Subsidiary Bank The obvious solution is for the BHC to pay all accrued interest on the TRUPs when the deferral period ends (after which a new five-year deferred period could begin). In many cases, however, the BHC may not have millions of dollars of liquid assets available to pay the accrued interest. The BHC may be dependent upon dividends from its subsidiary bank to make the interest payment due on the TRUPs. All of the accrued and unpaid interest may, in effect, be capital of the subsidiary bank (because during the deferral period, dividends were not paid by the bank to the BHC to pay the interest on the TRUPs). This retention of capital strengthened the subsidiary bank, helping it recover from the financial crisis. The subsidiary bank may no longer be in a troubled condition, but in many cases it will not have excess capital sufficient to pay an extraordinary dividend and remain well capitalized. The OCC and FDIC may be unwilling to approve an extraordinary dividend from the bank to the holding company. Also, the Federal Reserve may not permit a troubled BHC to pay the accrued interest due on the TRUPs.
Proceeds of Stock Offering Some BHCs may raise funds to repay TRUPs accrued interest by issuing new common stock. Convertible preferred stock is preferred by some private equity funds. A stock offering will usually dilute existing shareholders, but is generally preferable to a default on the TRUPs.
If the BHC and/or subsidiary bank are still in a troubled condition, regulators may prohibit the BHC from using the proceeds of a stock offering to pay the TRUPs interest. The Federal Reserve could direct a troubled BHC to retain such proceeds to be a source of strength to the subsidiary bank. In one instance, the Federal Reserve permitted a BHC to issue stock with proceeds placed in escrow and used by the escrow agent (not the BHC) to pay the TRUPs accrued interest. The Federal Reserve has indicated that structure may not be permitted in the future.
Merger with Acquiror Another alternative is for the BHC to sell by merging with a financially stronger BHC. In that case, TRUPs indentures generally require that the buyer assume all the obligations of the seller under the TRUPs. TRUPs holders have been unwilling in most cases to negotiate any discount with the buyer. The result is a lower price for the selling BHC’s shareholders. In most cases, the TRUPs indenture prohibits the BHC from selling or merging its subsidiary bank unless the acquiring bank and BHC assume all the seller’s TRUPs obligations.
Downsizing the Bank TRUPs indentures generally do not prohibit the subsidiary bank from selling its assets or branches. A bank may raise capital by selling deposits and branches, shrinking its balance sheet and increasing its regulatory capital ratios. If the downsized bank remains viable and well capitalized, banking regulators may approve a dividend of any resulting excess capital to the BHC.
Section 363 Sale in Bankruptcy If a BHC cannot receive dividends from its subsidiary bank, use proceeds from a stock offering or merge with another BHC, then the BHC must consider a holding company bankruptcy as a possible solution. If the subsidiary bank is viable, but the BHC is illiquid, then the debtor BHC may engage in a Section 363 sale (named after the bankruptcy code section authorizing such sales) of its subsidiary bank. Under bankruptcy court supervision, the BHC may sell the stock of its subsidiary bank free and clear of the BHC’s debts (including the TRUPs). Proceeds from the sale of the bank stock are then distributed according to the bankruptcy code:
- First, to any secured bank stock lender
- Second, to unsecured creditors, including TRUPs
- Third, to any preferred stockholders
- Fourth, any remainder to the common stockholders.
Holders of defaulted TRUPs may initiate an involuntary bankruptcy, but strategically, the BHC may want to file a voluntary bankruptcy. This is more likely to result in a favorable sales price for the subsidiary bank. The debtor BHC can pre-arrange for a stalking horse acquiror to submit a reasonable and competitive bid to purchase the stock of the subsidiary bank. Creditors, shareholders and third parties are then given a limited amount of time to top the stalking horse bid for the bank stock, usually in a bankruptcy court auction. The highest bidder purchases the stock of the bank, and receives a bankruptcy court order that it acquired the stock free and clear of all liens and claims of third parties (including the TRUPs).
Section 382 Recapitalization in Bankruptcy A BHC with significant net operating losses (NOLs) may pursue a Section 382 bankruptcy transaction. In this complex tax-driven transaction, the debtor BHC retains and recapitalizes its subsidiary bank, cleans the BHC balance sheet and preserves the economic value of its NOLs. Under bankruptcy court supervision, the BHC converts the TRUPs and other BHC debt into equity (in which the existing common shareholders are severely diluted or wiped out). The BHC then raises new equity from investors, which must constitute less than 50 percent of total equity. The reorganized and debt free BHC then operates the recapitalized subsidiary bank and uses its NOLs to shelter income and increase capital and value until the BHC and bank are subsequently sold.
Conclusion Troubled BHCs and healthy but illiquid BHCs that have TRUPs deferral periods about to expire face unique problems. There are various ways to address such problems, but careful advanced planning is required. BHCs that do not have a plan to deal with their maturing TRUPs may lose control to the TRUPs trustee and the bankruptcy court.
This article first appeared in Issue #18-November 2014 of the Western Independent Bankers CFO & Finance Digest linked here.
Join us for an open discussion with a panel of state/federal regulators and lawyers on the causes, effects and options for avoiding a repeat in the future. Each panel member will give their perspective on the lessons learned from the recent recession and how to avoid the problems in the future.
Discussions will also include:
- due diligence
- risk ratings
- the process of making and preserving loans
- lender liability
Our guest speakers include:
|Kevin Moore, Senior Vice President in charge of the Supervision and Risk Management Division of the Federal Reserve Bank of Kansas City|
|Stephen Gaddie, Assistant Regional Director at the FDIC|
|Ken Torgler, Director of Examinations, Kansas Office of the State Bank Commissioner|
Wednesday, Oct. 8 2:30 p.m. Registration 3-4:30 p.m. Seminar 4:30-6 p.m. Cocktail Reception
Stinson Leonard Street 1201 Walnut St. Suite 2900 Kansas City, MO 64106 29th Floor Conference Center
Please register by Monday, October 6
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The Financial Crimes Enforcement Network (FinCEN) recently proposed regulations under the Bank Secrecy Act (BSA) in an effort to combat illicit financial activity, including terrorist financing and money laundering. The proposed regulations impose additional requirements for bank’s customer due diligence programs.