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

10

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.
11

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?

12

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.

13

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 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.
14

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 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., 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).

15

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.
16

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 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).

17

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 transaction without any statutory justification simply
by alleging that the statutory requirements for rescission had been met. That is
an untenable proposition.

18

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.
19

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 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.

20

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.

21

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.
III. Discovery on the Costs of Arbitration
22

In Green Tree Fin. Corp. v. Randolph, 531 U.S. 79, 121 S.Ct. 513, 148 L.Ed.2d
373 (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, 121 S.Ct. 513
(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, 121 S.Ct. 513. 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:

23

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.

24

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 arbitration costs. The district court did not err in refusing to
permit the Larges to take discovery on the costs of arbitration.

25

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.
26

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 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).

27

Affirmed.

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

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.
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.

The Larges citeMatterhorn, 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.

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).

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.