A settlement agreement using the broad waiver of California Civil Code § 1542 failed to extinguish the home seller's rescission claim under California's Home Equity Sales Contract Act ("HESCA"). The Court held that the settlement agreement did not specifically advise the home seller of his right to rescind in conformance with that law. In re THOMAS LLOYD, Debtor. JEFFREY E. HOFFMAN, Plaintiff, vs. THOMAS R. LLOYD, an individual, EDWARD L. BLUM, an individual, and DOES 1 through 20, inclusive, Defendants. THOMAS LLOYD, Cross-Plaintiff, vs. JEFFREY E. HOFFMAN, dba H & B PROPERTIES; H & B PROPERTIES, LLC; J. EDWARDS INVESTMENT GROUP, INC., and NORCAL FINANCIAL, INC., Cross-Defendants, Case No. 04-32921 TEC, Chapter 11, Adv. Proc. No. 05-3328 TC of the UNITED STATES BANKRUPTCY COURT FOR THE NORTHERN DISTRICT OF CALIFORNIA 369 B.R. 549; 2007 Bankr. LEXIS 1619.

The California Home Equity Sales Contracts Act, Cal. Civ. Code § 1695 et seq., closely regulates the form of home equity sales contracts. The contract must contain two types of notices: (1) a notice of the seller's right to cancel; and (2) a notice that the buyer cannot ask the seller to sign any deed or other document until the right to cancel has expired. Cal. Civ. Code §§ 1695.3(h), 1695.5(a). The equity seller's right to cancel is the heart of the HESCA. The equity seller may cancel the contract until the earlier of midnight of the fifth business day after he or she signs a contract or 8:00 a.m. on the day scheduled for a foreclosure sale. Cal. Civ. Code § 1695.4(a). The written contract must contain two separate notices of the right to cancel. The first notice shall contain in immediate proximity to the space reserved for the equity seller's signature a conspicuous statement: "You may cancel this contract for the sale of your house without any penalty or obligation at any time before (date and time of day). See the attached notice of cancellation form for an explanation of this right." Cal. Civ. Code § 1695.5(a). The second notice is that the contract must be accompanied by a "notice of cancellation" on a separate page attached to the contract that states the deadline for cancellation, explains how the seller may cancel the contract, and contains a space in which the seller may indicate his or her intent to exercise the right to cancel. Cal. Civ. Code § 1695.5(b).

HESCA states expressly that the right to cancel does not expire before the seller has received the required notices. Cal. Civ. Code § 1695.5(d) states that until the equity purchaser has complied with the section governing notice of the right to cancel, the equity seller may cancel the contract. Cal. Civ. Code § 1695.4(a) provides that the five-day cancellation period begins when the equity seller signs a contract that complies with that chapter. To make the right to cancel more effective, the equity purchaser may not pay any consideration, accept a deed, record a deed, or transfer or encumber the property until the right to cancel has expired. Cal. Civ. Code § 1695.6(b). Thus, the Legislature contemplated that the equity seller would not have to return any consideration, or undo any other aspect of the contemplated sale, as a condition of canceling the sale contract. The statute also states that the seller's right to cancel is in addition to any other right of rescission. Cal. Civ. Code § 1694.5(a). The debtor, while facing foreclosure of his home, sold the home to a buyer. As part of the sale transaction, the debtor also signed a lease allowing him to stay in the property after the sale of the property. Lloyd, the debtor, soon fell behind in the rent payments due under the Lease. H&B Properties, the Buyer's entity, filed an unlawful detainer action on June 2, 2004. This action was settled before trial via an agreement executed on August 3, 2004 (the Settlement Agreement). The Settlement Agreement allowed Lloyd 90 days either: (a) to find a buyer for the Residence; or (b) to repurchase the Residence himself. If Lloyd failed to perform either alternative, the Option and Lease would be terminated and judgment would be entered against Lloyd for unpaid rent and attorneys fees. Shortly after the parties executed the Settlement Agreement, H&B Properties further encumbered the residence by obtaining a $110,000 loan from Norcal Financial, secured by a second deed of trust. Norcal Financial is another entity controlled by the buyer Hoffman. Of importance to this case is that the Settlement Agreement contained broad mutual releases. Those releases applied to claims unknown at the time of the release, because the parties expressly waived the protections of California Civil Code section 1452. The Settlement Agreement did not expressly address any rights under HESCA. Lloyd was unable to perform under the Settlement Agreement and filed a chapter 11 petition.

On October 18, 2004, Lloyd recorded a document entitled Notice of Rescission of Grant Deed Recorded Pursuant to Home Equity Sales Contract (the Notice of Rescission). In the Notice of Rescission, Lloyd asserted the right under HESCA to rescind both the grant deed to Hoffman and the Purchase-Sale Agreement. In light of California Civ. Code Section 1695.10, the general release would be enforceable, if at all, only if it represented a knowing and intelligent waiver of Lloyd's rights under HESCA. The court determined that the general release in the Settlement Agreement did not bar Lloyd from canceling the sale of the residence under HESCA. The court made the conclusion of law that the general release was not applicable to Lloyd's rights under HESCA if he was unaware of those rights at the time he executed that release. In so concluding, the Court found that the California Legislature expressly provided that rights under Section 1695 cannot be waived. Cal. Civ. Code § 1695.10. Although the Court did not believe that the Legislature meant to bar settlement of ripe claims arising under Section 1695, the anti-waiver provision suggests that any such settlement should be attended with adequate safeguards. Second, the Court also recognized that California courts have held that any waiver of an important statutory right must be knowing and intelligent. Cathay Bank v. Lee, 14 Cal.App. 4th 1533, 1539, 18 Cal. Rptr. 2d 420 (1993); accord In re Acosta, 182 B.R. 561, 566-67 (N.D.Cal. 1994). Third, the Court found that Section 1695 is an important consumer protection legislation, much like the Federal Truth-in-Lending Act and therefore found persuasive and pertinent that a decision in which a general release that did not specifically acknowledge the right to rescind under TILA was held not to bar the later exercise of that right. Mills v. Home Equity Group, Inc., 871 F.Supp. 1482, 1485-86 (D.D.C. 1994).

Counsel beware, draft your settlement agreements carefully and don't always rely on the broad scope of Section 1542.

Peter A. Kleinbrodt