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Friday, November 13, 2020

Living Trusts: Rescission

QUESTION
We have several loans involving living trusts. One of them came to our attention because the borrower wants to rescind the loan we made to a living trust that he set up for his nephew's benefit. We made this loan just two days ago for improvements of a large patio and other structures.

But this was a loan to our borrower, not the nephew.

So, may we refuse to rescind by claiming the loan was to a trust and, therefore, not a consumer loan?

ANSWER

This question's resolution may be found in Regulation Z, Comment 3(a)-10, which provides that credit extended for consumer purposes to certain trusts is considered to be credit extended to a natural person rather than credit extended to an organization.

Expressly noted in the section for Trusts for Tax or Estate Planning Purposes:

In some instances, a creditor may extend credit for consumer purposes to a trust that a consumer has created for tax or estate planning purposes (or both). Consumers sometimes place their assets in trust, with themselves or themselves and their families or other prospective heirs as beneficiaries, to obtain certain tax benefits and to facilitate the future administration of their estates.

During their lifetimes, however, such consumers may continue to use the assets and/or income of such trusts as their property. A creditor extending credit to finance the acquisition of, for example, a consumer’s dwelling that is held in such a trust, or to refinance existing debt secured by such a dwelling, may prepare the note, security instrument, and similar loan documents for execution by a trustee, rather than the beneficiaries of the trust.

Regardless of the capacity or capacities in which the loan documents are executed, assuming the transaction is primarily for personal, family, or household purposes, the transaction is subject to the regulation because in substance (if not form) consumer credit is being extended.

We don’t know categorically about a living trust, but it sounds as though it’s the sort of trust contemplated in Regulation Z, Comment 3(a)-10. I say this because the U.S. Court of Appeals for the 9th Circuit recently considered a similar situation.[i]

Here’s what happened.

As trustee of the Lou Ross Easter trust, Gilliam obtained a loan from Levine to finance repairs to a residential property that was the main asset of the trust. The property was the security for the loan. The borrower’s sister, Lou, had created the trust for the benefit of Lou’s daughter. After Lou died, Gilliam became the trustee. Gilliam obtained the loan to make repairs to the property, so her niece, as the sole beneficiary of the trust, could continue to reside there.

But Gilliam sued Levine for rescission and damages, alleging that Levine had violated TILA by failing to disclose the payment schedule accurately. Levine argued that the loan was not a consumer credit transaction because the trust property securing the loan was not the borrower’s primary residence, even though it was her niece's residence.

And here’s the decision, in brief: The district court dismissed the complaint, finding that the loan was not a consumer credit transaction. The district court mentioned the Regulation Z Commentary as the source for determining whether a transaction is for business purposes under RESPA, but did not mention Comment 3(a)-10.

Levine appealed, and, on appeal, Levine asserted that, as a general rule, a trust does not qualify as a natural person under TILA and cannot be a party to a consumer credit transaction, subject only to a limited exception when the loan is to finance the residence of the trustee.

Then, the 9th Circuit reversed. It held that Gilliam sufficiently alleged that the loan was obtained for a consumer purpose. It decided that Comment 3(a)-10 provides that a loan for “personal, family, or household purposes” of the beneficiary of this type of trust is a consumer credit transaction. The Comment explains that “[r]egardless of the capacity…in which the loan documents are executed,” trusts should be considered natural persons under TILA, so long as the transaction was obtained for a consumer purpose because “in substance (if not form) consumer credit is being extended.”

Thus, the lender’s argument attempted to draw an artificial distinction between a loan obtained for the benefit of the trustee alone and a loan obtained to benefit trust beneficiaries.

According to the 9th Circuit, the issue was one “of first impression under federal and state regulation of consumer credit transactions.” 

Worth mentioning is that, in addition to TILA, Gilliam included claims under California’s Rosenthal Act and RESPA. Finding the definitions of consumer credit transaction identical under TILA and the Rosenthal Act, and that RESPA’s definition required only that the transaction be for a consumer purpose, the 9th Circuit concluded that transactions such as this one should be regarded as consumer credit transactions under all three statutes. 

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director
Lenders Compliance Group

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[i] References: Gilliam v. Levine, 955 F.3d 1117 (9th Cir. Apr. 14, 2020)