Large v. Conseco Finance Servicing Corp.

• Decision Date: 06 June 2002
• Docket Number: No. 01-2136.,01-2136.
• Citation: 292 F.3d 49
• Parties: William E. LARGE and Diane A. Large, Plaintiffs, Appellants, v. CONSECO FINANCE SERVICING CORPORATION, Defendant, Appellee.
• Court: U.S. Court of Appeals — First Circuit

292 F.3d 49

William E. LARGE and Diane A. Large, Plaintiffs, Appellants, v. CONSECO FINANCE SERVICING CORPORATION, Defendant, Appellee.

No. 01-2136.

United States Court of Appeals, First Circuit.

Heard January 11, 2002.

Decided June 6, 2002.

Daniel A. Edelman, with whom Cathleen M. Combs, Tara L. Goodwin, Edelman, Combs & Latturner, Christopher M. Lefebvre, and Family and Consumer Law Center were on brief, for appellants.

Edward D. Rogers, with whom Richard L. Gemma, MacAdams & Wieck, Alan S. Kaplinsky, and Ballard Spahr Andrews & Ingersoll, LLP, were on brief, for appellee.

Before LYNCH, Circuit Judge, CAMPBELL, Senior Circuit Judge, and LIPEZ, Circuit Judge.

LIPEZ, Circuit Judge.

This case requires us to decide whether a borrower's assertion of the right to rescind a loan transaction subject to the Truth in Lending Act (TILA), 15 U.S.C. §§ 1601 et seq., has the effect of voiding the transaction without resort to the arbitration procedure called for by a provision in the loan agreement between the parties. Concluding that the mere assertion of the right of rescission does not undo the obligation to take the rescission claim to arbitration, we affirm the district court's grant of defendant-lender's motion to compel arbitration. We also conclude that plaintiffs' motion to conduct discovery on the question of the costs of arbitration is moot.

I. Background

The relevant facts are undisputed. William E. Large and Diane A. Large purchased a home in Johnston, Rhode Island, in September of 1998. On March 28, 2000, the Larges obtained a $20,000 mortgage loan from Conseco Finance Servicing Corp. at an annual percentage rate of 20.192%. A year later, on March 20, 2001, the Larges wrote to Conseco to give notice of their rescission of the transaction based on Conseco's alleged failure to make accurate rate material disclosures concerning the rate of interest, as required under the Truth in Lending Act, 15 U.S.C. §§ 1601 et seq.¹ The statute grants the borrower an unconditional right of rescission for the first three days following the consummation of the transaction. It also grants a right of rescission if the creditor fails to deliver certain forms and to disclose certain information. The statute provides, in pertinent part:

in the case of any consumer credit transaction... in which a security interest... is or will be retained or acquired in any property which is used as the principal dwelling of the person to whom credit is extended, the obligor shall have the right to rescind the transaction until midnight of the third business day following the consummation of the transaction or the delivery of the information and rescission forms required under this section together with a statement containing the material disclosures required under this subchapter, whichever is later, by notifying the creditor, in accordance with regulations of the Board, of his intention to do so.

15 U.S.C. § 1635(a). Section 1635(f) establishes a three-year time limit on the exercise of the conditional right of rescission. It is the conditional, three-year right of rescission that is at issue in this case. As noted, the Larges acted well within that time frame.

In their March 20, 2001, letter the Larges indicated to Conseco that because of its alleged violation of TILA's disclosure rules, it had "twenty days after receipt of this notice of rescission to return all monies paid and to take any action necessary and appropriate to reflect termination of [Conseco's] security interest" in the Larges' home, pursuant to 15 U.S.C. § 1635(b). Conseco replied nine days later, stating that it "fail[ed] to see any issues with regard to the disclosures made," and therefore would "not comply with this disputed rescission request."

Before receiving Conseco's letter, the Larges filed a complaint in federal district court on March 26, 2001, seeking to enforce their alleged rescission of the transaction. An amended complaint was filed on April 26. Conseco filed an answer on May 11, 2001, and moved to compel arbitration of the Larges' claims pursuant to the following arbitration clause in the loan agreement:

All disputes, claims, or controversies arising from or relating to this note or the relationships which result from this note, or the validity of this arbitration clause or the entire note, shall be resolved by binding arbitration by one arbitrator selected by [Conseco] with [the borrower's] consent.

The Larges opposed Conseco's motion to compel arbitration on the ground that the arbitration clause had been automatically rescinded, along with the remainder of the loan contract, when the Larges gave Conseco notice of rescission on March 20, 2001. The Larges also requested discovery on the question of the costs of arbitration. On June 18, 2001, Conseco wrote to the Larges offering "to pay all costs of arbitration" and to hold the arbitration in Rhode Island "as a convenience" to the Larges.

On July 26, 2001, the district court granted Conseco's motion to compel arbitration, denied the Larges' request for discovery, and dismissed the action. The district court rejected the Larges' "claim that their notice of rescission under the TILA invalidated all provisions of the mortgage contract, including the arbitration clause." The court explained that "absent an attack on the specific arbitration clause included within a contract, general rescission claims are resolvable by arbitration." The court also rejected the Larges' request for discovery on the costs of arbitration, noting that Conseco had offered to pay their costs and to hold the arbitration in Rhode Island, and that the TILA authorized the award of costs and attorney's fees if the Larges prevailed. See 15 U.S.C. § 1640(a)(3). The Larges filed a timely appeal.

II. The Motion to Compel Arbitration

The Federal Arbitration Act (FAA) "requires a federal court in which suit has been brought `upon any issue referable to arbitration under an agreement in writing for such arbitration' to stay the court action pending arbitration once it is satisfied that the issue is arbitrable under the agreement." Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 400, 87 S.Ct. 1801, 18 L.Ed.2d 1270 (1967) (quoting 9 U.S.C. § 3). The FAA establishes a "`liberal federal policy favoring arbitration agreements.'"² Green Tree Fin. Corp. v. Randolph, 531 U.S. 79, 91, 121 S.Ct. 513, 148 L.Ed.2d 373 (2000) (quoting Moses H. Cone Memorial Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 24, 103 S.Ct. 927, 74 L.Ed.2d 765 (1983)). However, "`arbitration is a matter of contract and a party cannot be required to submit to arbitration any dispute which he has not agreed so to submit.'" McCarthy v. Azure, 22 F.3d 351, 354 (1st Cir.1994) (quoting AT & T Techs., Inc. v. Communications Workers, 475 U.S. 643, 648, 106 S.Ct. 1415, 89 L.Ed.2d 648 (1986)). Although the Larges acknowledge having signed a loan agreement containing an arbitration clause, they take the position that rescission under the TILA is automatic, and that once they notified Conseco of their intention to rescind, the loan agreement ceased to exist, leaving them with no further obligation to Conseco. If the loan agreement ceased to exist, the Larges reason, so did the arbitration clause embedded in it.

The problem with this argument is that the right to rescind under the TILA does not extend beyond three days unless the lender fails to "deliver[] ... the information and rescission forms required under this section together with a statement containing the material disclosures required under this subchapter." 15 U.S.C. § 1635(a). Since the right to rescind after three days is conditioned on the lender failing to make certain disclosures required under the TILA, a borrower is not entitled to rescind after the initial three-day period has ended unless the required disclosures have in fact not been made. The question, then, is who should decide whether the statutory disclosure requirements have been met: the district court, or the arbitrator provided for in the loan agreement which the Larges claim to have rescinded?

The Supreme Court addressed this issue in Prima Paint, concluding that an arbitration clause is severable from the contract in which it is embedded. 388 U.S. at 402-07, 87 S.Ct. 1801. As we have explained, "`a broad arbitration clause will be held to encompass arbitration of the claim that the contract itself was induced by fraud.'" Unionmutual Stock Life Ins. Co. v. Beneficial Life Ins. Co., 774 F.2d 524, 528 (1st Cir.1985) (quoting Prima Paint, 388 U.S. at 402, 87 S.Ct. 1801). The severability doctrine applies unless "the claim is fraud in the inducement of the arbitration clause itself," in which case the arbitration clause does not govern a challenge to its own validity. Prima Paint, 388 U.S. at 403, 87 S.Ct. 1801. We have said that "[t]he basis of the underlying challenge to the contract does not alter the severability principle." Unionmutual, 774 F.2d at 529 ("[T]he fact that [the] attempt to rescind the entire agreement is based on the grounds of frustration of purpose rather than on fraud in the inducement does not change applicability of the severability doctrine."). In sum, "[t]he teaching of Prima Paint is that a federal court must not remove from the arbitrator[] consideration of a substantive challenge to a contract unless there has been an independent challenge to the making of the arbitration clause itself." Id.

The Larges do not allege that Conseco engaged in illegal conduct with respect to the arbitration clause itself. Prima Paint, therefore, would seem to support the district court's decision to grant Conseco's motion to compel arbitration. The Larges counter that the district court "overlooked the recent clarifications by the majority of circuits, which found that the [Prima Paint severability] doctrine does not apply to allegations of nonexistent contracts." However, the Larges cite cases involving allegations that the...