Large v. Conseco Finance Servicing Corp.

United States Court of Appeals
For the First Circuit

No. 01-2136

WILLIAM E. LARGE AND DIANE A. LARGE,

Plaintiffs, Appellants,

v.

CONSECO FINANCE SERVICING CORPORATION,

Defendant, Appellee.

APPEAL FROM THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF RHODE ISLAND

[Hon. Mary M. Lisi, U.S. District Judge]

Before

Lynch, Circuit Judge,
Campbell, Senior Circuit Judge,
and Lipez, Circuit Judge.

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.

June 6, 2002
 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 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

1
Because of the high interest rate, Conseco was required to
make special disclosures regarding the interest rate pursuant to 15
U.S.C. § 1639 and 12 C.F.R. § 226.32(c). The Larges alleged that
Conseco's disclosure understated the annual percentage rate for the
loan, and included an additional item, "Nominal Interest Rate,"
which the statute does not require, and which "contradicts and

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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

undermines the conspicuousness of the required annual percentage
rate disclosure."

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"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

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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 (1967) (quoting 9

U.S.C. § 3). The FAA establishes a "'liberal federal policy

favoring arbitration agreements.'"2 Green Tree Fin. Corp. v.

2
The core provision of the FAA is found in 9 U.S.C. § 2,
which provides:

A written provision in any maritime transaction or a
contract evidencing a transaction involving commerce to
settle by arbitration a controversy thereafter arising
out of such contract or transaction, or the refusal to
perform the whole or any part thereof, or an agreement in
writing to submit to arbitration an existing controversy
arising out of such a contract, transaction, or refusal,
shall be valid, irrevocable, and enforceable, save upon
such grounds as exist at law or in equity for the
revocation of any contract.

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Randolph, 531 U.S. 79, 91 (2000) (quoting Moses H. Cone Memorial

Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 24 (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 (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

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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. 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). 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. 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

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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 contract with the arbitration clause
never existed. The "clarification" of Prima Paint in these cases

does not bear on a dispute over a purported rescission of a

contract that is acknowledged to have once existed, but is alleged

to have been rescinded subsequently.

For example, in Three Valleys Municipal Water District v.

E.F. Hutton & Co., Inc., 925 F.2d 1136, 1137-42 (9th Cir. 1991),

the Ninth Circuit refused to compel arbitration where the
plaintiffs claimed that an agreement to arbitrate was void because

the individual who signed the agreement lacked the authority to

bind the plaintiffs. The court observed that the holding of Prima

Paint was "limited to challenges seeking to avoid or rescind a

contract," as the Larges are doing here, and was inapplicable to

"challenges going to the very existence of a contract that a party

claims never to have agreed to."3 Id. at 1140. Likewise, in

Sandvik AB v. Advent Int'l Corp., 220 F.3d 99, 100, 101 (3rd Cir.

2000), the Third Circuit refused to compel arbitration where the

party opposed to arbitration asserted that "the agent who signed

3
The court observed that "[a] contrary rule would lead to
untenable results. Party A could forge party B's name to a
contract and compel party B to arbitrate the question of the
genuineness of its signature." Three Valleys, 925 F.2d at 1140.

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the agreement on its behalf lacked authority to do so." The court

indicated that Prima Paint's "doctrine of severability [of the

arbitration clause from the challenged agreement] presumes an
underlying, existent[] agreement." Id. at 106. Although "[s]uch

an agreement exists, under the Prima Paint doctrine, even if one of

the parties seeks to rescind it on the basis of fraud in the
inducement," no such agreement can be said to exist if the parties

never entered into a contract in the first place. Id. Our

decision in McCarthy -- holding that an arbitration clause in a

contract signed by a corporate officer in his official capacity

could not be enforced in an action against the officer in his

individual capacity -- also turned on the fact that no contract had

ever existed between the plaintiff and the corporate officer in his
individual capacity.4 22 F.3d at 353, 357; see also Sphere Drake

Ins. Ltd., v. All Am. Ins. Co., 256 F.3d 587 (7th Cir. 2001);

Chastain v. Robinson-Humphrey Co., Inc., 957 F.2d 851, 855 (11th
Cir. 1992) ("Prima Paint has never been extended to require

arbitrators to adjudicate a party's contention, supported by

substantial evidence, that a contract never existed at all."

(emphasis in original)); I.S. Joseph Co., Inc. v. Mich. Sugar Co.,

4
The Larges cite Matterhorn, Inc. v. NCR Corp., 763 F.2d 866
(7th Cir. 1985), for the proposition that "[t]he fact that a
contract may have arguably once existed does not matter."
Matterhorn is easily distinguishable. The plaintiff there did not
challenge the validity of the contract containing the arbitration
clause, but instead argued that a subsequent transaction had
created a new contract that did not include an arbitration clause.
Id. at 871-72. The court upheld the jury's finding that the new
contract (which governed the dispute) did not include an
arbitration clause. Id. at 874-75.

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803 F.2d 396, 400 (8th Cir. 1986) (directing district court rather

than arbitrator to decide whether purported assignee could enforce

an arbitration clause in a contract to which it was not an original
party).

Here, it is undisputed that the loan agreement existed

between March 28, 2000, and March 20, 2001. The Larges contend,
however, that their letter of March 20, 2001, had the automatic and

immediate effect of voiding the entire transaction. In their view,

the letter did not simply demand rescission of the transaction, but

in fact rescinded the transaction the moment it was mailed. They

argue that the loan agreement (and with it the arbitration clause)

ceased to exist with the dispatch of the March 20, 2001, letter,

and therefore has no more force at this point than a contract that
never existed in the first place.

In support of their theory of automatic rescission, the

Larges point to 15 U.S.C. § 1635(b), which states that "[w]hen an
obligor exercises his right to rescind under [§ 1635(a)], he is not

liable for any finance or other charge, and any security interest

given by the obligor, including any such interest arising by

operation of law, becomes void upon such a rescission." In

addition, the TILA provides that, "[w]ithin 20 days after receipt

of a notice of rescission, the creditor shall return to the obligor

any money or property given as earnest money, downpayment, or

otherwise, and shall take any action necessary or appropriate to

reflect the termination of any security interest created under the

transaction." 15 U.S.C. § 1635(b). Likewise, Federal Reserve Board

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Regulation Z stipulates that "[w]hen a consumer rescinds a

transaction, the security interest giving rise to the right of

rescission becomes void and the consumer shall not be liable for
any amount, including any finance charge." 12 C.F.R. § 226.23

(d)(1).

The Larges misread these provisions. Neither the statute
nor the regulation establishes that a borrower's mere assertion of

the right of rescission has the automatic effect of voiding the

contract. Section 1635(b) states that, "[w]hen an obligor

exercises his right to rescind," the creditor's security interest

"becomes void." The natural reading of this language is that the

security interest becomes void when the obligor exercises a right

to rescind that is available in the particular case, either because
the creditor acknowledges that the right of rescission is

available, or because the appropriate decision maker has so

determined. If a lender disputes a borrower's purported right to
rescind, the designated decision maker -- here an arbitrator --

must decide whether the conditions for rescission have been met.

Until such decision is made, the Larges have only advanced a claim

seeking rescission. The agreement remains in force, and is subject

to the general rule 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." Unionmutual, 774 F.2d at 529. If the

TILA language on which the Larges rely created an exception to this

well-established rule of law, a borrower could rescind a

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transaction without any statutory justification simply by alleging

that the statutory requirements for rescission had been met. That

is an untenable proposition.
The Larges cite several cases from other jurisdictions in

an attempt to muster support for their claim that rescission under

the TILA is automatic upon the giving of notice, even if the lender
denies that the requirements for rescission have been met.

However, most of those cases are inapposite because the lender,

unlike Conseco here, had conceded that there had been a violation

of the TILA's disclosure rules. See In re Quenzer, 266 B.R. 760,

762 (Bankr. D. Kan. 2001) (the lender "concedes the notice given

violated the TILA"); In re Whitley, 177 B.R. 142, 144 (Bankr. D.

Mass. 1995) (defendant's counsel "conceded that a violation of
TILA . . . had occurred"). At issue in these cases was the power

of the court to impose additional conditions, beyond those

stipulated in the TILA, on the borrower's acknowledged right to
rescind. See Quenzer, 266 B.R. at 763 ("[the lender argues] that

the Court has the power to . . . condition the voiding of the

security interest on the debtors' repayment of the loan"); Whitley,

177 B.R. at 152 ("[t]his Court can conceive of circumstances where

the statutory right to rescind might be conditioned upon an

obligor's tender"). Thus, the language in these cases suggesting

that rescission under the TILA is automatic does not apply where

the lender disputes the borrower's claim that rescission is

warranted under the TILA in the first place.

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 The Eleventh Circuit has explained the meaning of

references to "automatic" rescission under the TILA. In Williams

v. Homestake Mortgage Co., 968 F.2d 1137, 1140 (11th Cir. 1992),
one of those cases where the creditor agreed that grounds for

rescission existed, the court noted that under the TILA, "all the

consumer need do is notify the creditor of his intent to rescind.
The agreement is then automatically rescinded and the creditor

must, ordinarily, tender first." In describing the TILA rescission

right as "automatic," the Williams court was contrasting TILA

rescission with common law rescission, where "the rescinding party

must first tender the property that he has received under the

agreement before the contract may be considered void." Id. at

1140. Rescission under the TILA is "automatic" in the sense that,
in contrast to common law rescission, the borrower need not first

return the loan proceeds received under the agreement to effect a

rescission.5 The purpose of the TILA's reordering of common law
rescission rules is to put the consumer in a stronger bargaining

position. Id. Contrary to what the Larges suggest, however, the

5
The procedure for effecting a rescission under the TILA is
as follows:

Within 20 days after receipt of a notice of rescission,
the creditor shall return to the obligor any money or
property given as earnest money, downpayment, or
otherwise, and shall take any action necessary or
appropriate to reflect the termination of any security
interest created under the transaction. If the creditor
has delivered any property to the obligor, the obligor
may retain possession of it. Upon the performance of the
creditor's obligations under this section, the obligor
shall tender the property to the creditor . . . .

15 U.S.C. § 1635(b).

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use of the word "automatic" in Williams presupposes that the

grounds for rescission have been established, either by agreement

or by an appropriate decision maker.
The one case the Larges cite that offers some support for

their position is Wilson v. Par Builders II, Inc., 879 F. Supp.

1187 (M.D. Fla. 1995).6 In Wilson, the borrowers sent the lender
notice of rescission pursuant to the TILA, and then filed an action

in federal district court seeking to enforce their statutory

rights. Id. at 1190. The district court denied the lender's

motion to compel arbitration, finding that the question of "the

effect, if any, of the [borrowers'] notice of rescission" was "an

issue for the district court." Id.

We find more compelling the holding of Dorsey v. H.C.P.

Sales, Inc., 46 F. Supp. 2d 804, 806 (N.D. Ill. 1999), where the

court, on essentially the same facts as in this case, rejected the

argument the Larges advance here. The outcome in Dorsey, unlike
that in Wilson, is consistent with Prima Paint and Unionmutual. We

therefore conclude that the district court was correct to grant the

motion to compel arbitration.

6
Franklin v. Hartland Mortgage Centers, Inc., No. 01 C 2041,
2001 WL 726986, at *2 (N.D. Ill. June 28, 2001), does not help the
Larges, as the arbitration clause in that case specifically
excluded disputes arising out of "the exercise of any self-help
remedies," and the court found that the debtor's exercise of the
TILA rescission right qualified as a self-help remedy. Nor do we
find persuasive the two Florida state court cases (not dealing with
TILA) which the Larges cite.

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 III. Discovery on the Costs of Arbitration

In Green Tree Fin. Corp. v. Randolph, 531 U.S. 79 (2000)

a TILA plaintiff argued that her "arbitration agreement's silence

with respect to costs and fees creates a risk that she will be

required to bear prohibitive arbitration costs if she pursues her

claims in an arbitral forum, and thereby forces her to forgo any

claims she may have." Id. at 90 (internal quotation marks

omitted). The Court rejected this argument on the ground that

"[t]he risk that [plaintiff] will be saddled with prohibitive costs

is too speculative to justify the invalidation of the arbitration
agreement." Id. at 91. The Court indicated that the outcome might

have been different if the plaintiff had demonstrated during
discovery a likelihood that she would in fact have incurred
prohibitive costs:

where . . . a party seeks to invalidate an
arbitration agreement on the ground that
arbitration would be prohibitively expensive,
that party bears the burden of showing the
likelihood of incurring such costs.
[Plaintiff] did not meet that burden. How
detailed the showing of prohibitive expense
must be before the party seeking arbitration
must come forward with contrary evidence is a
matter we need not discuss; for in this case
neither during discovery nor when the case was
presented on the merits was there any timely
showing at all on the point.
Id. at 92. Here, however, no such showing is possible because
Conseco has agreed to cover the costs of arbitration. Conseco's

offer to pay the costs of arbitration and to hold the arbitration
in the Larges' home state of Rhode Island mooted the issue of

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arbitration costs. The district court did not err in refusing to

permit the Larges to take discovery on the costs of arbitration.

We explained the controlling principle in Ortiz-Gonzalez

v. Fonovisa, 277 F.3d 59 (1st Cir. 2002). A party who had agreed

not to collect any award of attorney's fees nevertheless appealed

the district court's denial of its claim for attorney's fees, on
the ground that a "judgement for attorney's fees would be valuable

to deter other potential plaintiffs from filing frivolous claims."

Id. at 64. We held that, "[a]lthough possibly being of some value

in future situations, a judgment by the district court on the issue

of attorney's fees would be superfluous because of the agreement

[not to collect]." Id. at 65. We explained that "[c]ourts are not

required to go through the symbolic step of entering a judgment
which the beneficiary has already agreed not to collect" for no

other reason than to establish a precedent for use in future cases.

Id. Likewise here, the district court was not required to permit
discovery on an issue that no longer had any bearing on the outcome

of the dispute before it.
The Larges cite Perez v. Globe Airport Security Services,

Inc., 253 F.3d 1280 (11th Cir. 2001), for the proposition that an

arbitration agreement is invalid on its face if it limits the

judicial remedies available to the plaintiffs. The arbitration

agreement in Perez stipulated that all fees and costs would be

borne equally by the parties. Id. at 1282. The Eleventh Circuit

held that the agreement was illegal because it required the

plaintiff to waive her statutory right under Title VII to recover

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fees and costs if she prevailed. Id. at 1285. Perez is not on

point, however, because the arbitration clause here does not

deprive the Larges of any statutory rights in connection with the
costs of arbitration. The arbitration clause states: "The parties

agree and understand that the arbitrator shall have all powers

provided by law and the note. These powers shall include all legal
and equitable remedies, including, but not limited to, money

damages, declaratory relief, and injunctive relief." It does not

limit the power of the arbitrator to award statutory relief to the

Larges pursuant to 15 U.S.C. § 1640(a)(3) (authorizing award of

costs and attorney's fees to prevailing parties).

Affirmed.

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