Mortgage Servicers Beware of Possible Sanctions in Chapter 13 Bankruptcies

Residential mortgage servicers should take notice.  A recent case from the U.S. Bankruptcy Court for the District of Vermont handed down what may be the first instance of punitive sanctions under Federal Bankruptcy Rule of Procedure 3002.1.  The Court levied a $375,000 sanction to a mortgage servicer for its failure to comply with Rule 3002.1’s notice requirements despite the court’s repeated instructions to do so.  This rule could spur similar cases for violations of Rule 3002.1, especially for repeat offenders.

Chapter 13 of the Bankruptcy Code allows a debtor to pay debts over a period of time, but a debtor is not allowed to modify a mortgage on his or her principal residence.  Although a mortgage on a debtor’s principal residence cannot be modified, a mortgage default can be cured over the life of a chapter 13 plan.  These cure payments must be made in addition to the regular monthly mortgage payments.  In order for a debtor to bring a mortgage current, the debtor must know how much is owed, including any increases in the monthly payment as a result of interest rate adjustments and any additional fees and charges added to the loan balance.  This was difficult for many debtors because mortgage servicers often failed to notify debtors of such increase, fees and charges, either through inadvertence or because they worried that such communications could subject them to liability for violating the automatic stay.

Bankruptcy Rule 3002.1 was designed to fix this problem.  The Rule went into effect in 2011 and requires mortgage servicers on a debtor’s principal residence to provide the following information to the debtor, debtor’s counsel and the trustee throughout the bankruptcy case:

  • Provide notice of any change in the payment amount at least 21 days before the new amount comes due.
  • Provide notice of any post-petition fees, expenses or charges within 180 days after they are incurred.
  • Within 21 days after receiving the trustee’s notice of final cure payment, file a statement indicating whether the debtor has, in fact, cured the default and paid all other amounts as required.

Thus far, courts have been reluctant to impose sanctions for violations of this Rule, but that was not so in In re Gravel.  In Gravel, the court found that the mortgage servicer failed to comply with Bankruptcy Rule 3002.1 because it did not provide adequate notice to the debtor or the trustee of changes in the amount due under the terms of the mortgage.  This “warrant[ed] disallowance of all post-petition charges and an award of sanctions, under Rule 3002.1 (i) and § 105 [of the Bankruptcy Code].”  In re Gravel, 556 B.R. 561, 579 (Bankr. D. Vt. Sept. 12, 2016).

In issuing sanctions under Rule 3002.1, the court looked to the following three factors:

  • Whether the mortgage servicer had notice of the need to comply with Rule 3002.1;
  • Whether the mortgage servicer had previously failed to fulfill its duties under Rule 3002.1 and/or has previously been sanctioned for similar misconduct; and
  • Whether the mortgage servicer was given an opportunity to rectify processes leading to and/or causing the defalcations, and if so, whether it fulfilled its commitment to do so.  Id. at 571.

Though Rule 3002.1 is relatively new, creditors have had several years to create processes that comply with the new requirements.  Any creditor servicing a mortgage on a Chapter 13 debtor’s principal residence should have mechanisms in place to ensure that no post-petition fee, charge or change in billing of any kind accumulates against the debtor without proper notice to the debtor, debtor’s counsel and the trustee.

If you have any questions regarding this article, please contact its author, Andrew Robinson, at 414-727-6263 or arobinson@mzmilw.com.

AHR-crop