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A lawsuit filed by a Wisconsin couple against
their mortgage lender could have major implications for banks should a U.S.
appeals court agree that borrowers can cancel their loans en masse when
their lenders violate a federal lending disclosure law.
The case began like hundreds of others filed since the U.S. housing boom
spawned a rise in sales of adjustable rate loans. Susan and Bryan Andrews of
Cedarburg, Wisconsin, claimed that lender Chevy Chase Bank FSB (CCX_pc.N:
Quote, Profile, Research) had hidden the true terms of what they believed
was a good deal on a low-interest loan.
In their 2005 lawsuit, the couple said the loan's interest rate had more
than doubled by their second monthly payment from the 1.95 percent rate they
thought was locked in for five years. The interest rate rose well above the
5.75 percent fixed-rate loan they had refinanced to pay their children's
college tuition.
The Andrews filed the case seeking class action status; and in early 2007,
U.S. District Judge Lynn Adelman ruled that the bank had violated the Truth
in Lending Act, or TILA, and that thousands of other Chevy Chase borrowers
could join them as plaintiffs.
The judge transformed the case from a run-of-the-mill class action to a
potential nightmare for the U.S. banking industry by also finding that the
borrowers could force the bank to cancel, or rescind, their loans. That
decision was stayed pending an appeal to the 7th U.S. Circuit Court of
Appeals, which is expected to rule any day.
The idea of canceling tainted loans to stem a tide of foreclosures has
caught hold in other quarters; a lawsuit filed last week by the Illinois
attorney general asks a court to rescind or reform Countrywide Financial
Corp (CFC.N: Quote, Profile, Research) mortgages originated under "unfair or
deceptive practices."
'MASSIVE CLASS SUITS'
The mortgage banking industry already faces pressure from state and federal
regulators, who have accused banks of lowering underwriting standards and
forcing some borrowers, through fraud, into costly adjustable loans that the
banks later bundled and sold as high-interest investment vehicles.
The loans have caused serious instability in the financial sector, as
mortgage interest rates adjusted upward and borrowers began defaulting at a
significant rate starting in 2007, drawing lawsuits from investors and
homeowners.
Federal appeals courts disagree over whether class-wide rescission under the
Truth in Lending Act is available, said attorney Christine Scheuneman, whose
firm represented Chevy Chase at the district court.
"If class treatment is found to be available for rescission ..., given the
current crisis not predicted in 2005, the result all over the country could
be massive class suits," said Scheuneman, a partner at Pillsbury Winthrop
Shaw Pittman LLP.
The Truth in Lending Act, a 1968 federal law designed to protect consumers
against lending fraud by requiring clear disclosure of loan terms and costs,
lets consumers seek rescission, or termination, of a loan and the return of
all interest and fees when a lender is found in violation.
Should the 7th U.S. Circuit Court of Appeals agree with Judge Adelman,
banking industry associations predict "confusion and market disruption" as
banks curtail lending further.
"Class certification of rescission claims would saddle the mortgage lending
industry and secondary market with billions of dollars of class action
exposure for supposed violations of TILA that do not give rise to any actual
damages," the financial services associations wrote in an amicus brief.
But the Andrews' attorney, Kevin Demet, said lenders want to scare the
judiciary into banning class action rescissions because they were unable to
convince Congress to do so in the 1990s.
"If (banks) get relief (from the appeals court), it's activist judges trying
to give them what they could not get legislatively," said Demet, of Demet &
Demet of Milwaukee, Wisconsin.
Consumer advocates said the banks would have "no more or no less" liability
for the tainted mortgages if the court found in favor of the Andrews
plaintiffs.
But an adverse ruling for borrowers would cut off an important remedy.
Borrowers would "lose the opportunity to use rescission to save their homes
from foreclosure or to rescind their mortgages and refinance into affordable
ones," the Center for Responsible Lending, the National Consumer Law Center,
Public Citizen and AARP Foundation Litigation wrote in an amicus brief filed
in the case.
Both sides said the case will likely be decided by the U.S. Supreme Court.
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