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Compliance Corner: Fourth Quarter 2006

Consumer Damages and Remedies for Truth in Lending Act and Regulation Z Violations

This article reviews the types of damages a court can award to a consumer in a civil lawsuit for violating the Truth in Lending Act (TILA) or Regulation Z, TILA's implementing regulation. A future article will address a bank's potential liability with its federal regulator for such violations. These articles will educate creditors on their legal liability to both their customers and their regulators for violations of TILA and Regulation Z.

Congress enacted the Truth in Lending Act (TILA) in 1968 to inform consumers about the cost of credit so they can make informed credit decisions and to protect them against unfair credit practices.1 To fulfill its objectives, TILA requires that creditors disclose credit terms and costs at the various stages of open- and closed-end credit transactions (i.e., solicitation, advertising, account opening, consummation, and monthly statements).

Like many complex statutes, TILA is written in broad language. Congress directed the Board of Governors of the Federal Reserve System (the Board), responsible for administering TILA, to write an implementing regulation, and the Board subsequently enacted Regulation Z.2 Because the specific disclosure obligations for creditors are set forth in Regulation Z, many creditors focus their compliance efforts on the regulation instead of the statute. However, if a creditor wants to understand its potential legal exposure to its customers for violating TILA or Regulation Z, it must also examine TILA, because Regulation Z does not address civil liability.

Section 1640 External Link of TILA is the civil liability section. It states that creditors who violate any requirement imposed by TILA or Regulation Z are liable to the consumer for the total of all of the following damages that apply: 1) any actual damages a consumer sustained as a result of the violation; 2) statutory damages for violations of certain provisions of TILA, with a minimum amount of $100 or $200 (depending on the type of loan) and a maximum amount of $1,000 or $2,000; 3) court costs and attorney's fees; and 4) the sum of all fees and finance charges paid for high cost loans. These TILA damage provisions, along with the right of rescission, are discussed in more detail below.

Actual Damages
TILA allows consumers to recover the full amount of any actual damages they sustain from a TILA or Regulation Z violation. Because TILA is primarily a disclosure statute, the question arises: what are a consumer's "actual damages" if a creditor omits a required disclosure or makes an erroneous disclosure? One court decision relied on Black's Law Dictionary to define actual damages as "an amount awarded to a complainant to compensate for a proven injury or loss."3 In the context of a TILA or Regulation Z violation, this opinion required a plaintiff to establish that: 1) he read the TILA disclosure statement; 2) he understood the charges being disclosed; 3) had the disclosure statement been accurate, he would have sought a lower price; and 4) he would have obtained a lower price.

Many other federal appeals courts apply this high standard of proof.4 As a result, it is unlikely that many consumers will successfully present a valid claim for actual damages resulting from violations of TILA or Regulation Z. The recent bankruptcy case of In re: Boganski illustrates this difficulty.5 This case involved a lender who disclosed the annual percentage rate (APR) for a payday loan as 121.67 percent when the correct APR was actually 243.33 percent. Through his bankruptcy trustee, the consumer sought statutory and actual damages under TILA. While the court awarded statutory damages of $200, it denied the claim for actual damages because "there is no evidence [that the borrower] would have rejected that loan had he been advised of the actual APR." If a consumer could not recover damages in this circumstance, with a flagrant, significant violation, it is difficult to imagine a circumstance in which actual damages could be recovered.6

Statutory Damages
Because of the difficulty of proving actual damages, Congress also established statutory damages for violations of TILA's most important disclosures to ensure that consumers receive some compensation for violations, regardless of whether they actually suffered any harm, and also to deter creditors from violating TILA and Regulation Z. The measure of statutory damages is twice the amount of the consumer's finance charge, subject to minimum and maximum recoveries. For consumer leases and open- or closed-end loans not secured by residential real estate, the minimum and maximum amounts of statutory damages are $100 and $1,000, respectively. For closed-end loans secured by a consumer's real property or dwelling, the minimum and maximum amounts are $200 and $2,000, respectively.7

The sections of TILA to which statutory damages apply are:

  • Section 1635, the right of rescission
  • All eight subsections of section 1637(a), which includes disclosures involving the finance charge, the balance, periodic rates, other charges that can be imposed in a credit plan, security interests, consumer protections under 1666 and 1666i, creditor's responsibilities under sections 1666a and 1666i, and certain disclosures for open-end credit secured by a consumer's dwelling
  • Section 1637(b), for failing to provide any of the following required information in the customer's billing statement: 1) the amount of the finance charge; 2) for credit with more than one periodic rate, the range of balances to which the rates apply; 3) the annual percentage rate for the finance charge; 4) the balance on which the finance charge is computed; 5) the outstanding balance at the end of the account period; 6) the date by which payment must be made; and 7) the address used by the creditor for receiving billing inquires from the consumer
  • Section 1638(a), for failing to make any of these required closed-end disclosures: 1) the amount financed and the finance charge; 2) the finance charge expressed as an annual percentage rate using that term (unless the amount financed is less than $75 and the finance charge does not exceed $5, or if the amount financed exceeds $75 and the finance charge does not exceed $7.50); 3) the total paid (equaling the amount financed plus the finance charges); 4) the number, amount, and due dates for payments scheduled to repay the total of payments; and 5) a statement, for secured credit, that a security interest has been taken in the property purchased as part of the credit transaction or property not purchased as part of the credit transaction

Because statutory damages can be awarded for violating these sections of TILA, creditors should pay careful attention to them to ensure compliances.

High Cost Loans
The final category of damages is for high cost loans under section 1639 of TILA and section 32 of Regulation Z. The concept of a high cost loan derives from the Home Ownership and Equity Protection Act of 1994, which Congress enacted to address predatory lending practices. This law amended TILA and provides added protection for high cost loans.

The definition of a high cost loan is one in which either 1) the APR at consummation will exceed the yield on Treasury securities with comparable periods of maturity by more than eight percentage points for first lien loans, 2) the APR at consummation will exceed the yield on Treasury securities with comparable periods of maturity by more than 10 percentage points for second lien loans, or 3) the total fees and points payable by the consumer at or before closing exceed the larger of $528 or eight percent of the total loan amount.8 Credit insurance premiums for insurance written in connection with the credit transaction are counted as fees.

Loans qualifying as high cost are subject to many restrictions, including prohibitions against:

  • Balloon payments for loans with less than five-year terms, except for bridge loans of less than one year to buy or build a home
  • Negative amortization
  • The imposition of a higher interest rate if the borrower defaults
  • A repayment schedule that consolidates more than two periodic payments to be paid in advance from the proceeds of the loan
  • Prepayment penalties, including refunds of unearned interest calculated by any method less favorable than the actuarial method, except if the lender verifies that total monthly debt (including the mortgage) is 50 percent or less of the borrower's monthly gross income
  • Due-on-demand clause, except for consumer fraud or material misrepresentation in connection with the loan or if the consumer defaults, or the consumer adversely affects the creditor's security
  • Making loans based solely on the value of the collateral without regard to the borrower's ability to repay the loan
  • Refinancing a high cost loan into another high cost loan within the first 12 months of origination, unless the new loan is in the borrower's best interest
  • Wrongfully documenting a closed-end, high-cost loan as an open-end loan. For example, a high-cost mortgage cannot be structured as a home equity line of credit if the creditor has no reasonable expectation that repeat transactions will occur

If a creditor violates any of its obligations under section 1639 External Link of TILA or section 32 of Regulation Z, it is liable for the sum of all finance charges and fees paid by the consumer, unless the creditor demonstrates that the failure to comply is not material. The limits on statutory damages discussed above do not apply to high cost loans. In addition, if the mortgage contains a provision that section 1639 specifically prohibits, including the ones listed above, the loan can be rescinded, as discussed below.

The Right of Rescission
The right of rescission (rescission) is a special remedy under TILA that applies to consumer loans secured by a nonpurchase money mortgage on the consumer's principal dwelling. Rescission provides the borrower with a three-day period, after either consummation of the loan or delivery of the disclosures, whichever is later, to rescind the loan. If the borrower exercises this right, the creditor must refund all fees and charges paid and remove any security interest in the borrower's residence. Rescission does not apply to residential mortgage transactions to finance the acquisition or construction of a consumer's principal dwelling, but it does apply to a home equity line of credit, a home improvement loan, or the refinancing of an existing mortgage. If the refinancing is with the same creditor, and no new credit is extended, rescission does not apply.

Congress provided the right of rescission to allow a three-day "cooling off" period so consumers can reconsider the serious consequences of taking on debt and encumbering their primary residence, after full disclosure of the loan terms. However, if the creditor fails to deliver the notice of the right of rescission to the consumer, fails to make material disclosures, or makes computational errors in the material disclosures in excess of the tolerance for such errors, the rescission period is extended to three years from the date of consummation of the loan.9

The tolerance for errors for rescission purposes is the greater of $100 or 0.5 percent of the face amount of the note. However, if the loan is a refinance of an existing mortgage with a new creditor and no new advances, the tolerance is increased to the greater of $100 or 1 percent of the face amount of the note. In addition, the right of rescission is never triggered by an overstated finance charge-for example, if the creditor disclosed the APR as 15 percent when it was actually 11 percent.

In a foreclosure, special rescission rules apply. A consumer can rescind a loan in foreclosure if the mortgage broker fee is omitted from the finance charge and should have been included or if the creditor failed to provide a proper "notice of rescission" form. In addition, the tolerance for understating the finance charge disclosure is set at $35. Creditors should be especially careful in ensuring the accuracy of their finance charge disclosures because this low tolerance provides little room for error if a loan ends in foreclosure. The statute of limitations for use of the right of rescission in foreclosure is three years from the date of consummation of the loan.

If a loan is successfully rescinded, the consumer is entitled to a refund of all fees and charges, including finance charges, penalties, loan transaction fees, appraisal fees, closing costs, and, if a rescission lawsuit is filed, court costs and attorney's fees.

A rescission disclosure error or omission subject to the three-year statute of limitations can be very costly. For example, if a consumer with a $100,000 home improvement loan discovered errors in the TILA disclosures subject to rescission two and a half years after the loan consummated, the creditor would have to refund all finance charges paid on the loan. In addition, if a lawsuit is filed, the creditor is liable for statutory damages of twice the total finance charge, up to a maximum amount of $2,000, as well as costs and attorney's fees.

Other Sections of TILA Relevant to Damages
A brief discussion of other TILA sections relevant to civil damages is provided below.

Class action lawsuits. TILA has special rules for class actions. Section 1640(a)(2)(b) of TILA sets limits on a creditor's maximum liability to the lesser of one percent of its net worth or $500,000. This section also eliminates minimum recoveries for violations of the sections subject to statutory damages.

TILA's safe harbor and bona fide error provisions. Creditors can mitigate the risk of violating TILA and Regulation Z by taking advantage of TILA's safe harbor provision. Under section 1640(f) of TILA, if a creditor in good faith uses one of the Board's model forms or acts in conformity with Regulation Z, or the Board's official interpretations (such as the Official Staff Commentary) that were in effect at the time of the credit transaction, it cannot be held liable for a violation. However, use of a model form with incorrect numerical disclosures outside the tolerance for errors in these disclosures would not qualify.

In addition, under section 1640(c) of TILA, creditors cannot be held liable for violating TILA or Regulation Z if they can demonstrate that the violation resulted from a bona fide error, despite procedures adopted to avoid such errors. This includes clerical, calculation, computer malfunction, programming, and printing errors. However, it does not include an error in legal judgment. For example, a creditor cannot defend a TILA lawsuit on the basis that its lawyer provided incorrect legal advice.

Correction of errors. Under Section 1640(b), if a creditor discovers an error and notifies the consumer within 60 days after discovery, and makes appropriate adjustments so the consumer will not pay more than disclosed, the creditor has no liability to the consumer.

Costs and attorney's fees. Like most federal consumer protection statutes, TILA allows a consumer who prevails in a lawsuit to be awarded court costs and attorney's fees. In many cases, the attorney's fees can be the largest part of damages awarded because many TILA violations involve a relatively small amount of damages.

As is often the case with banking compliance, it is much less costly to comply with laws and regulations than to violate them. Creditors should be diligent in ensuring that their consumer credit operations comply with the requirements of both TILA and Regulation Z to avoid costly lawsuits and increased reputational risk.

  • 1  The full text of the Truth in Lending Act.External Link
  • 2  The full text of Regulation Z.External Link
  • 3  Peters v. Lupient Oldsmobile Co., 220 F.3d 915, 917 (8th Cir. 2000).
  • 4  See Turner v. Beneficial Corp., 242 F.3d 1023, 1026 (11th Cir.2001) (en banc); Perrone v. General Motors Acceptance Corp., 232 F.3d 433, 436-40 (5th Cir.2000); Stout v. J.D. Byrider, 228 F.3d 709, 718 (6th Cir.2000); In re Smith, 289 F.3d 1155, 1156-57 (9th Cir. 2002).
  • 5  322 BR 422 (9th Cir. BAP 2005).
  • 6  A consumer could still potentially recover for an understated APR under a different legal theory. If a creditor stated in the promissory note and TILA disclosure (using the facts of the Boganski case) that the APR was 121.67 percent, when it was actually 243.33 percent, the consumer could sue to enforce the interest rate that was contractually promised.
  • 7  Federal courts were divided on the issue of whether a 1995 amendment to TILA limited the $100 and $1,000 minimum and maximum statutory damages to lease transactions, thus permitting the refund of all finance charges paid for non-lease credit transactions. The Supreme Court resolved the conflict in Koons Buick Pontiac GMC, Inc. v. Nigh External Link case, 543 US 50 (2004), holding the minimum and maximum recoveries for statutory damages applied to all transactions, except for closed-end consumer loans secured by real property, for which the amendment increased the minimum and maximum recoveries to $200 and $2,000, respectively.
  • 8  The $528 figure is for 2006. The Board adjusts the amount annually, based on changes in the Consumer Price Index.
  • 9  Section 226.15(a)(3) of Regulation Z defines "material disclosures" as "the information that must be provided to satisfy the requirements in §226.6 with regard to the method of determining the finance charge and the balance upon which a finance charge will be imposed, the annual percentage rate, the amount or method of determining the amount of any membership or participation fee that may be imposed as part of the plan, and the payment information described in §226.5b(d)(5)(i) and (ii) that is required under §226.6(e)(2)."

The views expressed in this article are those of the author and are not necessarily those of this Reserve Bank or the Federal Reserve System.