Over a vigorous dissent, the Second Circuit overruled the bankruptcy court and in the process made two landmark rulings: (1) The Taggart standard for the imposition of contempt applies to all proceedings in bankruptcy court, not only for violating the discharge injunction; and (2) bankruptcy courts may not impose contempt sanctions for violations of Bankruptcy Rule 3002.1, which requires lenders to give notice within 180 days of fees or expenses being charged against a debtor.
According to the majority, sanctions even for repeated violations of Rule 3002.1 are limited to economic damages, which may be minimal.
The dissent concurred with the broad imposition of the Taggart standard but argued that contempt sanctions should be available under Rule 3002.1 or the bankruptcy court’s inherent powers.
Perhaps accurately, the dissenter said that the majority rendered “a bankruptcy court powerless to levy any sanction under the Rule [3002.1] against a serial violator of the Rule’s provisions over a substantial period of time where those violations . . . did not result in any actual economic harm to the multiple debtors who were the victims of the Rule violations.”
The Repeated, Flagrant Violations of Rule 3002.1
Bankruptcy Rule 3002.1 was added in 2011 to avoid situations where chapter 13 debtors would have received a discharge but face foreclosure on account of undisclosed post-petition charges from mortgage lenders.
In his majority opinion on August 2, Circuit Judge Dennis Jacobs said the rule was also designed to aid mortgage servicers in fear of allegedly violating the automatic stay by notifying chapter 13 debtors about defaults on mortgages.
Rule 3002.1(c) requires mortgage lenders to file notices of post-petition fees and charges within 180 days of when the charges were incurred.
For failure to file a notice, Rule 3002.1(i) allows the bankruptcy court to disallow the charges and “award other appropriate relief, including reasonable expenses and attorneys’ fees caused by the failure.” [Emphasis added.]
The opinion by the bankruptcy judge involved three debtors and a company advertising itself as one of the country’s 10 largest mortgage originators and servicers.
The servicer had been in trouble before for violating Rule 3002.1. The bankruptcy judge said that the servicer had been “chastised” by a bankruptcy judge in North Carolina for violating the rule. In one of the three cases in her court, the bankruptcy judge said that the servicer previously agreed to pay a $9,000 sanction for sending erroneous mortgage statements for three years.
In two of the three cases, the bankruptcy court had previously entered an order declaring that the debtors were current on all pre- and post-filing payments, fees and charges. Within a month after the so-called Debtor Current Orders, the servicer began billing the debtors for about $250 in fees allegedly incurred during the periods encompassed by the Debtor Current Orders. In those two cases, the servicer had not filed notices required by Rule 3002.1(c).
In the third case, there was no Debtor Current Order, but the servicer billed for expenses without filing the Rule 3002.1(c) notice.
For violating the rule, the bankruptcy judge imposed a total of $75,000 in sanctions under Rule 3002.1(i), representing $1,000 for each of the 25 months in which the servicer billed the three debtors without filing a notice.
In one of the cases where there was a Debtor Current Order, the bankruptcy judge imposed $100,000 in sanctions under Section 105. In the case with a Debtor Current Order where the lender had previously paid a $9,000 sanction for improper billing, she assessed a $200,000 sanction.
The bankruptcy court imposed Section 105 sanctions because she said that the record “categorically demonstrates” that the $9,000 sanction two years earlier had failed to achieve its intended remedial effect of deterring the servicer from sending out “inaccurate account statements.” Since she had given the servicer “an opportunity to bring its practices in line with the mandates of Rule 3002.1,” the bankruptcy judge felt that “the time has come for ‘the imposition of severe sanctions.’”
The bankruptcy judge admitted that the sanctions were not in the nature of coercive civil contempt sanctions because the servicer already had waived the post-filing fees. She based her action on the court’s “inherent authority” under Section 105 to impose punitive, non-contempt sanctions even when there had been belated compliance.
The sanctions totaled $375,000 and were to be paid to the state’s largest pro bono provider of legal services in bankruptcy cases. In re Gravel, 556 B.R. 561 (Bankr. D. Vt. Sept. 12, 2016). To read ABI’s report on the first bankruptcy court opinion, click here.
The servicer appealed. The district court reversed, ruling that $375,000 in sanctions exceeded the bankruptcy court’s statutory and inherent powers. Remanding, the district court said that the bankruptcy court could enforce its orders short of punitive sanctions.
After remand, the bankruptcy court adopted its previous findings and imposed the same $75,000 in sanctions for violating Rule 3001.2. The bankruptcy court reduced the other $300,000 in sanctions to $225,000. In re Gravel, 601 B.R. 873 (Bankr. D. Vt. June 27, 2019).
The servicer appealed. The Second Circuit accepted a direct appeal, overstepping an intermediate appeal to the district court.
Sanctions for the Debtor Current Orders
In his 33-page opinion, Judge Jacobs first reviewed the $225,000 in contempt sanctions for violation of the Debtor Current Orders.
Those orders declared that the debtors were current on their mortgages, including all monthly payments and any other charges. The orders prohibited the servicer “from disputing that the debtors are current (as set forth herein) in any other proceeding.”
Simply put, Judge Jacobs said that the servicer “did not, as a matter of law, violate” the Debtor Current Orders. The orders, he said, “did not enjoin the recording of expired fees on the statements” sent to the debtors.
Judge Jacobs applied the contempt standard established in Taggart v. Lorenzen, 139 S. Ct. 1795 (2019), where the Supreme Court held that there can be no sanctions for civil contempt of the discharge injunction if there was an “objectively reasonable basis for concluding that the creditor’s conduct might be lawful under the discharge order.” Id. at 1801. To read ABI’s discussion of Taggart, click here.
Under Taggart, Judge Jacobs said there can be contempt for violating an “injunction only ‘if there is no fair ground of doubt as to whether the order barred the creditor’s conduct.’” Id. at 1799. [Emphasis in original.]
“Without an express injunction” barring the servicer from sending out statements contrary to the Debtor Current Order, Judge Jacobs said there was a “fair ground of doubt as to whether the listed fees can form the basis for contempt.” He said that the bankruptcy court “could have crafted an order that would have forbidden the conduct.”
No Contempt for Violating Rule 3002.1
Judge Jacobs turned to the $75,000 in sanctions for violating Bankruptcy Rule 3002.1 by failing to file required notices.
Judge Jacobs began by noting how the sanctions were based on the number of incorrect mortgage statements, not the amount of incorrect charges that totaled $716. The bankruptcy court found authority for the sanction in Rule 3002.1’s authorization to “award other appropriate relief, including reasonable expenses and attorneys’ fees caused by the failure.”
Evidently minimizing the word “including” but focusing on “expenses and attorneys’ fees,” Judge Jacobs held that “other appropriate relief is limited to “nonpunitive sanctions.” He said that other provisions in the Bankruptcy Code, such as Section 362(k)(1), explicitly authorize punitive sanctions. Similarly, he said that Rule 3002.1 lacks a reference to “just orders,” like analogous Rule 37 of the Federal Rules of Civil procedure.
Given that the sanctions were not permitted by Rule 3002.1, Judge Jacobs deflected the argument that the $75,000 in sanctions were permissible under the court’s inherent powers. The circuit court, he said, could not consider the question because, in his view, the bankruptcy court had not adequately assessed whether the sanctions were authorized under inherent powers.
Judge Jacobs said it was “dubious” whether the bankruptcy court exercise its inherent powers because “there is no finding of bad faith.” In short, he held,
The sanction was imposed under Rule 3002.1(i), and our holding is that the sanction went beyond the relief authorized by that rule.
Despite the holding, Judge Jacobs left the door open for sanctions in future cases when the bankruptcy court uses a few magic words. He said that his opinion “does not limit a bankruptcy court’s inherent power to sanction offenders who act in bad faith. That is just not what the bankruptcy court did here; others might be free to do so if they were to make sufficient findings.”
Judge Jacobs reversed and vacated the bankruptcy court’s order. The majority did not remand and allow the bankruptcy judge to explain whether she had issued sanctions under the court’s inherent powers.
The Dissent
Circuit Judge Joseph F. Bianco wrote a 36-page dissent, three pages longer than the majority’s opinion. However, he agreed with the majority’s holding that the Debtor Current Orders “did not clearly and unambiguously prohibit” the servicer’s conduct. In other words, he appears to agree that Taggart applies to all potential contempt findings in bankruptcy court, including violations of the automatic stay.
Although he “respectfully” dissented, Judge Bianco vigorously disagreed with vacating the $75,000 in sanctions for violating Rule 3002.1. He believes that the “‘other appropriate relief’ language in [Rule 3002.1(i)(2)] conferred upon bankruptcy courts . . . a proper basis to impose the $75,000 punitive sanction against [the servicer] based upon its flagrant and repeated violations of the Rule.”
Judge Bianco saw his understanding of the Rule as being “not only consistent with the plain text of the Rule itself but is further supported by the purpose of the Rule and the fact that the Rule was modeled after Rule 37 of the Federal Rules of Civil Procedure, which allows for similar punitive sanctions.”
Even if Rule 3002.1 in itself did not permit the imposition of sanctions, Judge Bianco believes that the bankruptcy court has “independent authority under its inherent powers to impose this $75,000 sanction against [the servicer] for its egregious conduct in violation of the Rule.” The record, he said, was “more than sufficient” for upholding $75,000 in sanctions under a court’s inherent powers.
Judge Bianco went further. He read the “the plain text of Rule 3002.1 [as allowing] punitive, non-compensatory sanctions . . . consistent with the Rule’s purpose.”
On a practical level, Judge Bianco saw reason for punitive sanctions. He said that the “reimbursement of costs to a debtor for a Rule violation . . . does little to prevent future violations and therefore falls far short of safeguarding the Chapter 13 ‘fresh start’ process for all such debtors.”
Judge Bianco also disagreed with the majority failure to remand. He would have allowed the bankruptcy court on remand to expound on its “reasoning for the imposition of sanctions under its inherent powers.”
Observations
When Taggart came down, the question arose, “Does the same standard apply to contempt for violation of the automatic stay?”
The Second Circuit has now answered the question. In the Second Circuit, Taggart seems to apply not only to automatic stay violations but also to any circumstance when the bankruptcy court is inclined to impose contempt sanctions.
In this writer’s view, applying Taggart to automatic stay violations means there can be no contempt if the creditor has a non-frivolous argument aimed at explaining why there was no violation of Section 362.
The majority’s opinion also means that bankruptcy courts (and the lawyers who draft proposed orders) must now lay out in detail the types of actions that are prohibited. Otherwise, contempt will be unavailable.
On Rule 3002.1, the lower courts are split about the availability of contempt. The Second Circuit is the first appeals court to reach the issue. There may be a circuit split eventually.
Fortunately, the Rule could be amended without Congressional action to permit contempt sanctions for violations of Rule 3002.1.
This writer predicts there will be a petition for rehearing en banc, but the Second Circuit rarely agrees to sit en banc. The vigorous dissent makes a strong case for sitting en banc.
The opinion will have wide-ranging effect on bankruptcy. For example, the panel made blanket statements without reflecting on how applying Taggart will affect enforcement of the automatic stay.
The circuit should grant rehearing en banc, allowing scholars and the wider community to appear as amici and comment on what may be the most significant circuit court decision this year on bankruptcy law.
Over a vigorous dissent, the Second Circuit overruled the bankruptcy court and in the process made two landmark rulings: (1) The Taggart standard for the imposition of contempt applies to all proceedings in bankruptcy court, not only for violating the discharge injunction; and (2) bankruptcy courts may not impose contempt sanctions for violations of Bankruptcy Rule 3002.1, which requires lenders to give notice within 180 days of fees or expenses being charged against a debtor.
According to the majority, sanctions even for repeated violations of Rule 3002.1 are limited to economic damages, which may be minimal.
The dissent concurred with the broad imposition of the Taggart standard but argued that contempt sanctions should be available under Rule 3002.1 or the bankruptcy court’s inherent powers.
Perhaps accurately, the dissenter said that the majority rendered “a bankruptcy court powerless to levy any sanction under the Rule [3002.1] against a serial violator of the Rule’s provisions over a substantial period of time where those violations . . . did not result in any actual economic harm to the multiple debtors who were the victims of the Rule violations.”