Mortgage Servicer Hit with $300,000 in Actual and Punitive Damages for Stay Violation

Because the Supreme Court has erected a higher standard for violations of the discharge injunction, the bankruptcy court was unable to find a mortgage servicer in contempt after discharge, although the servicer had continued exactly the same conduct putting the servicer in contempt of the automatic stay.

For what he called “reprehensible” conduct, Bankruptcy Judge Mike N. Nakagawa of Las Vegas slapped a mortgage servicer with some $300,000 in actual and punitive damages for violating the automatic stay 98 times over a period of 648 days during the debtors’ chapter 13 case.

The Facts

The husband and wife debtors filed a joint chapter 13 petition in March 2013. About six months later, the debtors secured an order stripping off a subordinate mortgage on their home, since the house was worth less than the first mortgage. In April 2014, the debtors won confirmation of their chapter 13 plan. The valuation of the home gave the holder of the subordinate mortgage nothing but an unsecured claim.

Given the debtors’ limited income, the mortgage servicer on the stripped-off mortgage received no payments under the three-year plan. The debtors made all their plan payments and received their discharges in September 2016.

More than two years after discharge, the debtors retained new counsel, reopened their bankruptcy case, and filed a motion to hold the subordinate mortgage servicer in contempt of the automatic stay and the discharge injunction.

Following eight months of pretrial discovery and motion practice, Judge Nakagawa held a two-day trial in September 2019. He handed down a 59-page opinion on February 25, holding the servicer in contempt of the automatic stay based on meticulous findings of fact buttressed by comprehensive references to the trial record.

In light of the Supreme Court’s higher standard for finding contempt of the discharge injunction, Judge Nakagawa absolved the servicer of liability for its attempts at collecting discharged debt after the entry of discharge. See Taggart v. Lorenzen, 139 S. Ct. 1795 (June 3, 2019). To read ABI’s report on Taggart, click here.

The Basis for Liability on Stay Violations

The debtors had made a problem for themselves initially. In their creditor matrix and other notices about their bankruptcy, the address for the mortgage servicer was incorrect.

After receiving repeated collection letters and telephone calls, the husband spoke with the mortgage servicer about six months after confirmation. Discovery uncovered a transcript of the phone call where the husband told the servicer that he and his wife were in chapter 13.

Judge Nakagawa explained in his opinion how the servicer had what he called an “unwritten policy or procedure” of ignoring any communications that were not made by the borrower. Because the wife alone was the borrower, the servicer ignored the husband’s call and did not confirm the debtors’ status in chapter 13.

The collection letters and calls continued.

The trial record included the servicer’s 115-page official manual describing how to deal with borrowers in bankruptcy. Contrary to the “unwritten policy,” the manual called for the servicer to “act promptly” after “notice of any nature, whether written or oral,” that a borrower is in bankruptcy. After confirming that the borrower is in bankruptcy, the formal policy called for the servicer to halt “any form of collection activity.”

Judge Nakagawa said that the policy “expressly acknowledges” that notice of bankruptcy can come in any form, “written or oral, and by telephone or in person.” To say that the husband was not authorized to give notice of bankruptcy by phone “is absurd at best,” the judge said.

Judge Nakagawa found that the servicer “adopted procedures to remain ignorant of a borrower’s resort to bankruptcy relief.” In other words, the phone call with the husband should have been enough to call off the dogs.

In the 21 months between the first collection attempt after the phone call and the entry of discharge, Judge Nakagawa found there were “no fewer than” 98 calls and letters violating the automatic stay. By a preponderance of the evidence, he found that the servicer had notice of the debtor’s bankruptcy and willfully violated the stay, entitling the debtors to the recovery of actual damages, including attorneys’ fees under Section 362(k). The statute allows punitive damages “in appropriate circumstances.”

The Discharge Violation

In the two years after discharge, Judge Nakagawa found that the servicer made 52 phone calls and sent 26 collection letters. However, the debtors were unable to convince the judge at trial that they had notified the servicer about the receipt of discharge.

At best, Judge Nakagawa said the debtors had informed the servicer about their discharges “at some point.” Absent “sufficient proof” of the date when the servicer received notice, the judge said there was a “fair ground of doubt” about the wrongfulness of the servicer’s post-discharge conduct.

Naturally, Judge Nakagawa recited the Taggart standard for holding a creditor in contempt for violating the discharge injunction. In short, a creditor cannot be in contempt of the discharge injunction if there was “an objectively reasonable basis for concluding that the creditor’s conduct might be lawful.” Taggart, 139 S. Ct. at 1801.

Judge Nakagawa said he was precluded by Taggart from awarding damages for violating the discharge injunction because the debtors failed to show by “clear and convincing evidence [that the servicer] was informed of the Chapter 13 discharge.”

Damages

Judge Nakagawa found that the husband had received 98 calls and letters attempting to collect the debt. By a preponderance of the evidence, he determined that the husband “suffered significant harm” and sustained $100,000 in damages for emotional distress.

The wife was unable to prove emotional distress damages, but Judge Nakagawa awarded $742 in actual damages for pecuniary loss.

With regard to punitive damages, Judge Nakagawa said the servicer’s employees were trained to do what they did and implemented the “unwritten policy” in violation of the formal bankruptcy policy manual. It was not, he said, a case of “rogue” employees who violated “established procedures.”

In light of the servicer’s “reprehensible” conduct, Judge Nakagawa assessed $200,000 in punitive damages. He suggested that punitive damages would have been larger had the servicer initiated foreclosure proceedings.

Judge Nakagawa said the $200,000 was “proportional to the amount of actual damages and, of course, limited to the amount necessary to deter future misconduct.”

Judge Nakagawa will hold a separate hearing to determine how much in attorneys’ fees to assess against the servicer, who has already appealed. It is doubtful whether the servicer is entitled to appeal until the court awards attorneys’ fees, if any.

This month, the debtors filed a motion to hold the servicer in contempt for failing to release its lien.

Observations

The case presents an interesting question: If a creditor is guilty of contempt for a knowing violation of the automatic stay, should Taggart insulate the creditor from liability for continuing the same conduct after discharge? Is a creditor with knowledge of bankruptcy insulated from liability for a discharge violation only after receiving actual knowledge of discharge?

Cases like this show how Taggart undercuts the efficacy of discharge and suggest that Congress should revisit the standards for holding a creditor in contempt of the discharge injunction.