James A. Rudisell et al., Plaintiffs-appellants, v. the Fifth Third Bank, Defendant-appellee, 622 F.2d 243 (6th Cir. 1980)

Appellants, James and Jeanette Rudisell, sued appellee, Fifth Third Bank, for rescission of a home improvement contract for aluminum siding and accompanying promissory note and for statutory damages for violations of the Truth in Lending Act, 15 U.S.C. § 1601, et seq. (hereinafter, TILA). Appellee counterclaimed for judgment on the note. On cross-motions for summary judgment, the Magistrate made recommendations largely in favor of appellee, finding that appellee did violate TILA in one instance but that the damage claim was barred by the statute of limitations and appellants had no right to rescind. Both sides filed exceptions. The District Court found for appellee on all claims. The Rudisells appealed.

The Rudisells contracted for installation of aluminum siding by Aluminum Wholesale Distributors, Inc. (hereinafter, A.W.D.) on or about December 5, 1972.¹  A.W.D. suggested financing through its bank, but appellants preferred to use one of the banks they used locally. A.W.D. then went to Fifth Third Bank and on December 7, 1972, Fifth Third agreed to extend credit to the Rudisells. A.W.D. returned to the Rudisells with the documents a promissory note, which included the TILA disclosures, and a separate Notice of Right to Rescind.

Work commenced sometime in January 1973. Mr. Rudisell signed a completion certificate February 9, 1973, although appellants claim the work was not complete until February 12, 1973. A.W.D. assigned the promissory note to Fifth Third on February 9, 1973 and received payment from Fifth Third that same day. Later, appellants became dissatisfied with their siding. After unsuccessfully trying to contact A.W.D., they filed suit February 11, 1974. In August, 1974, they notified Fifth Third that they rescinded their contract. Upon motion by appellants, the District Court, by Order dated January 6, 1975, granted leave to appellants to amend the complaint to include a prayer for rescission.

Appellants claim multiple violations of TILA, viz.: failure to disclose the multiple creditors; failure to identify which creditor was responsible for each disclosure; failure to itemize each amount included in the finance charge; failure to describe the terms and amount of premiums of the credit life insurance; failure to disclose the cost of the credit report, the "unpaid balance of the cash price", the "unpaid balance", the method for calculating the amount due on default, and a definition of the "Rule of 78s"; failure to describe the security interest; and failure to make all disclosures on one side of one page. Because of these failures, appellants claim they are entitled to statutory damages and rescission of the contract.

Appellee claims no TILA violations occurred. Even if TILA was violated, they argue, appellants have no claim for relief because their right to damages is barred by the statutory limitations period and their right to rescission does not exist as no security interest was created in fact.

I. RIGHT TO DAMAGES.

TILA provides, 15 U.S.C. § 1640, for statutory penalties equal to twice the finance charge if the creditor fails to disclose any information required under TILA. However, that right is subject to a one year limitations period which starts running "from the date of the occurrence of the violation." 15 U.S.C. § 1640(e).

In Wachtel v. West, 476 F.2d 1062 (6th Cir.), cert. denied, 414 U.S. 874, 94 S. Ct. 161, 38 L. Ed. 2d 114 (1973), this Court was presented with a similar problem. There, plaintiffs borrowed money from the defendants, giving a second mortgage on their home as security. Plaintiffs later sued for damages and rescission, claiming TILA violations. Defendants moved for dismissal, asserting the one year limitations as a bar to plaintiffs' claim. The District Court granted the motion and this Court affirmed. The Act does not define "occurrence" of the violation, but TILA requires that disclosures be made "before the credit is extended". See 15 U.S.C. § 1639(b). Regulation Z, 12 C.F.R. § 226.1, et seq., promulgated by the Federal Reserve Board under the authority granted in 15 U.S.C. § 1604, gives further guidance. Section 226.8(a) provides that the disclosures "shall be made before the transaction is consummated," which occurs "at the time a contractual relationship is created between a creditor and a customer or a lessor and lessee irrespective of the time of performance of either party," 12 C.F.R. § 226.2(kk). Since the "purpose of disclosure is clearly to give the borrower an opportunity to do some comparative shopping for credit terms", 476 F.2d at 1064, this Court held:

a credit transaction which requires disclosures under the Act (TILA) is completed when the lender and borrower contract for the extension of credit. The disclosures must be made sometime before this event occurs. If the disclosures are not made, this violation of the Act occurs, at the latest, when the parties perform their contract.

476 F.2d at 1065. In Wachtel, the performance of the contract and the violation of the disclosure requirement took place the date the plaintiffs borrowed money and signed the second mortgage. See also Harvey v. Housing Development Corp. & Information Center, 451 F. Supp. 1198 (W.D. Mo. 1978).

In the present case, one could argue appellee performed on either of two dates: December 7, 1972, the date appellee agreed to extend credit, or February 9, 1973, the date appellee paid A.W.D. for the assignment of the Note. Although Fifth Third did not actually pay any money until February 9, 1973, it was December 7, 1972 that it obligated itself to pay A.W.D. when the work was completed. The credit transaction was completed when the Rudisells signed the promissory note. Thus, the disclosures should have been given at least by the time the Rudisells signed the promissory note. Although the actual date of signing this promissory note is not clear,²  it was signed sometime in December 1972. Thus, the statute ran in December 1973 and appellants' claim for damages, filed February 12, 1974, is barred by the statute of limitations. The District Court must be affirmed on this ground.³ 

II. RIGHT TO RESCISSION.

TILA provides a right to rescind a transaction involving a security interest on the residence of the debtor until midnight of the third business day following the consummation of the transaction or the delivery of the disclosures required regarding the right to rescind and all other material disclosures, whichever is later. 15 U.S.C. § 1635.⁴  If the disclosures are never made, the debtor has a continuing right to rescind. See Sosa v. Fite, 498 F.2d 114, 117-18 (5th Cir. 1974); Eby v. Reb Realty, Inc., 495 F.2d 646, 648 (9th Cir. 1974); Pedro v. Pacific Plan of California, 393 F. Supp. 315, 323 (N.D. Cal. 1975). The right to rescind is not dependent upon the one year statute of limitations period for a claim for damages. See Littlefield v. Walt Flanagan & Co., 498 F.2d 1133, 1136 (10th Cir. 1974).⁵  Thus, appellants may have a right to rescind even though their claim for damages is barred by the statute of limitations in 15 U.S.C. § 1640(e).

Appellants claim that as the contractor had a right to a mechanic's lien under Ohio law, which is a security interest arising by operation of law and which was never disclosed, they had a continuing right to rescind even though the three day period for rescission has passed. Appellee argues that appellants do not have the right to rescind because no security interest was created in fact. Even if appellants had a right to rescind, appellee argues that appellants forfeited that right by not acting within the three day period as appellee disclosed all it had to disclose. Finally, appellee argues rescission should be denied because rescission is an equitable remedy and the appellants should not be allowed to keep their aluminum siding without paying for it as the appellee has already paid the contractor.

A. Mechanic's Lien as a Security Interest.

The Magistrate recommended appellants be denied the right of rescission as TILA and Regulation Z gave such a right only when the situation involved a security interest in fact, not where a right to a security interest existed with only a mere possibility that the right would be asserted. Since no security interest was created by any of the financing agreements, appellants had no right to a security interest.

The District Court agreed with the Magistrate that the documents did not create a security interest. The court rejected appellants' argument that the contractor could have perfected a mechanic's lien and that this constituted a security interest. It held that the applicable regulation, 12 C.F.R. § 226.2(gg), which defined a security interest as including "other consensual or confessed liens whether or not recorded, mechanic's, materialmen's, artisan's, and other similar liens," implied a requirement that a mechanic's lien be recorded by the proximity of "whether or not recorded" to "consensual or confessed liens." The court also noted that under Ohio law a mechanic's lien was not effective prior to recording. Since the mechanic's lien was neither recorded nor created by the financing agreement, the District Court held it was not a security interest and thus appellants had no right to rescind.⁶ 

An unrecorded mechanic's lien is not outside the definition of a security interest solely because it was not created by the financing documents. The regulation includes in the definition of security interest "any lien on property arising by operation of law." See 12 C.F.R. § 226.2(gg).⁷  The statute grants a right of rescission in any consumer credit transaction where "a security interest, including any such interest arising by operation of law, is or will be retained or acquired" in the real property to be used as the residence of the debtor. See 15 U.S.C. § 1635(a).⁸ 

Nor should the mechanic's lien be outside the definition of a security interest solely because it was not recorded. Neither the language of the statute nor the regulation requires that liens which arise by operation of law be recorded. The clause "whether or not recorded" is intended to modify "consensual or confessed liens", as the District Court noted, but the absence of such a modifying phrase does not necessarily imply that liens which arise by operation of law must be recorded. Even if the liens did have to be recorded to be effective, the regulation cannot have contemplated a recording requirement: a lien like a mechanic's lien would not arise until the work was begun, but the work, by virtue of 12 C.F.R. § 226.9(c) (2), could not begin until the three day rescission period had passed that is, not until three days after all disclosures were required to have been made. Thus, implying a recording requirement would nullify the requirement of disclosing any mechanic's lien or other lien which would arise by operation of law after the performance began.⁹ 

There remains the question whether the mechanic's lien in this case is outside the definition of a security interest because no mechanic's lien was in fact recorded.

Under Ohio law at that time,¹⁰  any person who performed labor or furnished materials for the alteration or repair of a building had a lien at the time the work was started. See Page's Ohio Rev.Code § 1311.01, 1311.02 (1962). The contractor was required to give notice to the owner or lessee of the building of the name and address of every laborer who had not been paid in full, see Ohio Rev.Code § 1311.04, but his failure to do so did not affect the lien rights of his laborers. Id.; see J. G. Laird Lumber Co. v. Tietelbaum, 14 Ohio St.2d 115, 236 N.E.2d 531 (1968). A person who wished to assert a materialman's lien or a mechanic's lien was required to record an affidavit and the failure to do so constituted a waiver of the lien rights, but the laborer had sixty days from the last date of performance to do so. See Ohio Rev.Code § 1311.06. A mechanic's lien then is a significant encumbrance upon a person's home and a customer would certainly be better informed about available credit if he knew about the possible mechanic's lien before he signed the contract.

The Federal Reserve Board, in unofficial opinion letters, has decided that the contingency of a mechanic's lien, see FRB Letter No. 1236 (Sept. 2, 1977), (1974-1977 Transfer Binder) Cons. Cred. Guide (CCH) P 31,675, or the failure to later assert a lien arising by operation of state law, see F.T.C. Informal Staff Opinion Letter of August 5, 1969, (1969-1974 Transfer Binder) Cons. Cred. Guide (CCH) P 30,290, do not negate the customer's right to rescission.

The Board's letters, while not binding on the Court, represent an informed opinion by the agency charged with implementing the TILA and should be treated as persuasive authority. See Gennuso v. Commercial Bank & Trust Co., 566 F.2d 437, 442 n. 13 (3rd Cir. 1977); Ljepava v. M.L.S.C. Properties, Inc., 511 F.2d 935, 941 (9th Cir. 1975); Eby v. Reb Realty, Inc., 495 F.2d 646, 650 (9th Cir. 1974); Harvey v. Housing Development Corp. & Information Center, 451 F. Supp. 1198, 1206 (W.D. Mo. 1978); Sneed v. Beneficial Finance Co. of Hawaii, 410 F. Supp. 1135, 1140 n. 7 (D.Hawaii 1976). "(D)eference is especially appropriate in the process of interpreting the Truth in Lending Act and Regulation Z. Unless demonstrably irrational, Federal Reserve Board staff opinions construing the Act or Regulation should be dispositive . . . ." Ford Motor Credit Co. v. Milhollin, --- U.S. ----, 100 S. Ct. 790, 63 L. Ed. 2d 22 (1980).

Although the legislative history indicates mainly a concern with homeowners being tricked into signing secondary mortgages, see 114 Cong.Rec. 1610-11 (1968) (statement of Rep. Cahill), it also indicates concern with liens. See 114 Cong.Rec. 114388 (statement of Rep. Sullivan) ("Any credit transaction which involves a security interest in property must be clearly explained to the consumer as involving a mortgage or lien"). Earlier the same year, the Senate held hearings on the very problem with which the Congressmen were concerned that is, fraudulent practices used by home improvement contractors. See Hearings Before the Committee on Commerce, Senate, Serial 90-64, March 27, 28, 29, 1968 (Unfair Practices in the Home Improvement Industry & Amendments to the FTC Act). One of the problems mentioned during those hearings was where the homeowner paid the contractor, then discovered the subcontractor recorded a lien on the home, and had to pay twice. See id. at 42-43 (statement of Atty. Gen. John O'Connell), 75 (statement of Miss Furness); N.C. Freed Co., Inc. v. F.R.S., 473 F.2d 1210, 1215 (2d Cir.), cert. denied, 414 U.S. 827, 94 S. Ct. 48, 38 L. Ed. 2d 61 (1973); Gardner & North Roofing & Siding Corp. v. F.R.S., 464 F.2d 838, 841 (D.C. Cir. 1972).

Since the FRB letters are a reasonable interpretation of the statute in light of the legislative history, this Court adopts their reasoning and holds that a possibility of a mechanic's lien is a security interest which must be disclosed even though the mechanic's lien may never be actually taken. See Hobbs Lumber Co. v. Shidell, 42 Ohio Misc.2d 21, 326 N.E.2d 706, Cons. Cred. Guide (CCH) P 98,599 (Ohio Ct. Common Pleas 1974). Cf. Starks v. Orleans Motors, Inc., 372 F. Supp. 928 (E.D. La.), sum. affd., 500 F.2d 1182 (5th Cir. 1974) (vendor's privilege which arises by law when note is assigned from seller to bank is a security interest under TILA).

B. Disclosure of the Mechanic's Lien.

Thus, appellants had a right to rescind. However, they only have a right to rescind after the three day period has passed if the right to rescind was not disclosed or if other material disclosures were not made as required. The notice of right to rescind provided in this case copied what was required by the regulations. See 12 C.F.R. §§ 226.9(b) and (d). TILA, as amended in 1974, provides that a person cannot be held liable for a good faith compliance with the regulations. See 15 U.S.C. § 1640(f). Appellants must show a failure to make a material disclosure to be able to rescind.

Appellants claim appellee failed to disclose the mechanic's lien. TILA, 15 U.S.C. § 1638(a) (10), requires disclosure of "A description of any security interest held or to be retained or acquired by the creditor in connection with the extension of credit, and a clear identification of the property to which the security interest relates" (emphasis added). Regulation Z, 12 C.F.R. § 226.8(b) (5), requires a "description or identification of the type of any security interest held or to be retained or acquired by the creditor in connection with the extension of credit" be disclosed (emphasis added). The notice of the right to rescind merely states that the transaction "may result in a lien, mortgage, or other security interest on your home." The promissory note contains no reference to a security interest, although the contract for the aluminum siding states, "Seller is entitled to lien rights to the property shown as address of buyer unless otherwise specified." Nowhere do the papers hint that a mechanic's lien could arise by operation of law. Apart from a possible violation of the failure to make all material disclosures on the evidence of indebtedness or all on one side of one piece of paper, see 12 C.F.R. § 226.8(a), Gennuso v. Commercial Bank & Trust Co., 566 F.2d 437 (3rd Cir. 1977); Pedro v. Pacific Plan of California, 393 F. Supp. 315 (N.D. Cal. 1975), this Court finds that the disclosure was not adequate.¹¹  The creditor should at least disclose that a mechanic's lien may arise and cite the applicable provisions of the Ohio statutes.¹²  The failure to disclose the security interest is material. Signing papers without knowledge of a security interest on the debtor's home was the very problem the rescission remedy sought to prevent. In the present case, appellants have a right to rescind because the mechanic's lien was not adequately disclosed.¹³ 

Appellee argues, however, that it did not have the duty to disclose the mechanic's lien because such a security interest would not run in favor of it. Therefore, although appellants may be able to rescind their contract with A.W.D., it argues, they should not be allowed to rescind against appellee.

The statute does not determine the effect if the creditor does not give credit directly to the debtor. The regulations provide some guidance. Section 226.6(d) of Regulation Z, 12 C.F.R. § 226.6(d), states:

(d) Multiple creditors or lessors; joint disclosure. If there is more than one creditor or lessor in a transaction, each creditor or lessor shall be clearly identified and shall be responsible for making only those disclosures required by this Part which are within his knowledge and the purview of his relationship with the customer or lessee. If two or more creditors or lessors make a joint disclosure, each creditor or lessor shall be clearly identified. The disclosures required under paragraphs (b) and (c) of § 226.8 shall be made by the seller if he extends or arranges for the extension of credit. Otherwise disclosures shall be made as required under paragraphs (b) and (d) of § 226.8 or paragraph (b) of § 226.15.

Section 226.2(s) defines "creditor" as one who in the ordinary course of business regularly extends or arranges for the extension of consumer credit. "Arrange for the extension of credit" is defined in section 226.2(h):

(h) "Arrange for the extension of credit or for lease of personal property" means to provide or offer to provide consumer credit or a lease which is or will be extended by another person under a business or other relationship pursuant to which the person arranging such credit or lease

(1) Receives or will receive a fee, compensation, or other consideration for such service, or

(2) Has knowledge of the credit or lease terms and participates in the preparation of the contract documents required in connection with the extension of credit or the lease. It does not include honoring a credit card or similar device where no finance charge is imposed at the time of that transaction.

In the present case, appellants did not go to the bank at all A.W.D. helped them fill out their loan application, took the application to the bank, and brought back the Note for appellants to sign. Appellee did not loan its money to appellants in order that there be a cash sale by A.W.D.; A.W.D. contracted with appellants on condition that "Buyer agrees to execute a promissory note" and received payment from appellee when A.W.D. assigned the promissory note to appellee.

Had appellee loaned the money directly to appellants, and appellants then used the money for a cash sale from A.W.D., clearly A.W.D. would not have arranged or extended credit and would not have been a creditor. As Fifth Third Bank would have been the only creditor, a mechanic's lien, which would run in favor of A.W.D. and not Fifth Third, would not have run in favor of a creditor. There would have been no security interest in favor of a creditor to be disclosed and no right to rescind. See FRB Letter No. 1236, Sept. 2, 1977, (1974-1977 Transfer Binder) Cons. Cred. Guide (CCH) P 31,675; FC-0007, Official Staff Interpretation, Sept. 30, 1976 (12 C.F.R. Parts 20-299, at 595 (1979)); FRB Letter No. 178 (Nov. 18, 1969), (1969-1974 Transfer Binder) Cons. Cred. Guide (CCH) P 30,213; FRB Letter of July 16, 1969, (1969-1974 Transfer Binder) Cons. Cred. Guide (CCH) P 30,096.

However, this case does not involve a direct loan to a consumer. Here, A.W.D. signed a contract with appellants which clearly indicated appellants were deferring payment and were incurring a finance charge. Appellants agreed in this contract to execute a promissory note, which was later assigned to appellee. The Federal Reserve Board has distinguished this situation from the situation involving a direct loan to a consumer where the contractor arranges for the credit or extends credit and later assigns the note to a bank, both the contractor and the bank are creditors and a possible mechanic's lien on the residence of the debtor gives rise to the right of rescission. See FRB Letter No. 1236 (Sept. 2, 1977), (1974-1977 Transfer Binder) Cons. Cred. Guide (CCH) P 31,675; FRB Letter No. 388 (Aug. 4, 1970), (1969-1974 Transfer Binder) Cons. Cred. Guide (CCH) P 30,569; FRB Letter No. 178 (Nov. 18, 1969), (1969-1974 Transfer Binder) Cons. Cred. Guide (CCh) P 30,213.

Although merely helping the debtor fill out the forms may not be enough to make one an arranger of credit under TILA, see Gerasta v. Hibernia National Bank, 411 F. Supp. 176, 186 (E.D. La. 1976), aff'd in part, rev'd in part on other grounds, 575 F.2d 580 (5th Cir. 1978), A.W.D. did more. It agreed to allow appellants to defer payment. Thus, A.W.D. was a creditor and the mechanic's lien which would arise by operation of law is one in favor of a creditor. Cf. Mirabal v. General Motors Acceptance Corp., 537 F.2d 871, 874 n. 1 (7th Cir. 1976) (both dealer and GMAC are creditors where GMAC financed car and dealer was required to use GMAC's forms). Since the mechanic's lien is a security interest in debtor's home, TILA provides appellants with a right to rescind until three days after all material disclosures are made. Since the mechanic's lien was never disclosed, appellants presently have a right to rescind their transaction.

The provision of the regulations dealing with multiple creditor's disclosure obligations, 12 C.F.R. 226.6(d), does not help appellee. While appellee may not be liable for statutory penalties for failure to disclose the security interest, that being the obligation of the seller under this regulation, see Manning v. Princeton Consumer Discount Co., Inc., 533 F.2d 102, 105 (3rd Cir. 1976); Jennings v. Edwards, 454 F. Supp. 770, 773-76 (M.D.N.C. 1978), sum. aff'd, 598 F.2d 614 (4th Cir. 1979); FRB Letter No. 1236 (Sept. 2, 1977), (1974-1977 Transfer Binder) Cons. Cred. Guide (CCH) P 31,675; FRB Letter No. 388 (Aug. 4, 1970), (1969-1974 Transfer Binder) Cons. Cred. Guide (CCH) P 30,569, the appellants still have a right to rescind the transaction. Congress intended the rescission to absolutely void the transaction and return the debtor to the status quo existing before he started the transaction, even against third party purchasers. See 114 Cong.Rec. 14388 (1968) (statement of Rep. Sullivan).

C. Effect of Rescission.

The statute provides that if the debtor rescinds, the creditor is to return within ten days to the debtor any down payment or other monies it received from the debtor and to cancel its security interest. Upon doing that, the debtor is then to return to the creditor any property he received from the creditor. If the debtor tenders, but the creditor does not take possession of his property, the debtor is allowed to keep the property. 15 U.S.C. § 1635(b).¹⁴ 

In this case, appellants rescinded, but appellee did not do anything within ten days. The statute does not say what should happen if the creditor does not tender back the property within ten days as required under the statute due to a good faith belief that the debtor has no right to rescind.

Appellants argue that they should be allowed to rescind, receive back all monies paid to appellee, and keep the aluminum siding without paying for it, citing Sosa v. Fite, 498 F.2d 114 (5th Cir. 1974). However, that case is distinguishable. There, the debtor offered to tender the reasonable value of property received at the time of rescission.

The statute clearly does not require the debtor to tender first. See Ljepava v. M.L.S.C. Properties, Inc., 511 F.2d 935, 944 (9th Cir. 1975); Palmer v. Wilson, 502 F.2d 860, 861 (9th Cir. 1974). It contemplates the creditor tendering first. But upon the creditor fulfilling its obligations under the statute, the debtor then must tender. Gerasta v. Hibernia National Bank, 575 F.2d 580, 584 (5th Cir. 1978); Mitchell v. Security Investment Corp. of Palm Beaches, 464 F. Supp. 650 (S.D. Fla. 1979). Since rescission is an equitable remedy, the court may condition the return of monies to the debtor upon the return of property to the creditor. See Powers v. Sims & Levin, 542 F.2d 1216, 1220-22 (4th Cir. 1976); LaGrone v. Johnson, 534 F.2d 1360, 1361-62 (9th Cir. 1976); Palmer v. Wilson, 502 F.2d 860, 862 (9th Cir. 1974).

In the present case, appellants received aluminum siding. Appellee paid in full for this service, which appellants now claim is unsatisfactory. Appellee prepared all the disclosure forms, including the notice of the right to rescind. The loan application is clearly headed "Property Improvement Loan Application". Appellee should have been aware that a mechanic's lien might arise in appellants' home. Indeed, appellee furnished the notice of the right to rescind. Appellee thus could have disclosed the statutory lien on its form, but this was not done. Since Congress clearly intended to give a right to rescind to persons in appellants' situation, this Court feels it must grant them that right. However, since appellants have kept the aluminum siding, this Court feels that appellants should tender the reasonable value of the property they received since they cannot give back what they actually received, that is, the aluminum siding. The rescission and return of monies paid to appellee is thus conditioned upon the return to appellee by appellants the reasonable value of the property received. In this way, the Court will most nearly put the appellants in the position they were in before they entered the transaction.

The District Court is reversed on appellants' claim for rescission and the case is remanded to determine the reasonable value of the aluminum siding received.

The District Court on remand should order Fifth Third Bank to pay back to James and Jeanette Rudisell all monies received from them, such payment to be conditioned upon James and Jeanette Rudisell paying to, Fifth Third Bank the reasonable value of the aluminum siding received.

IT IS SO ORDERED.