Taking sides with the dissenter and disagreeing with the Second Circuit’s majority opinion on August 2, Bankruptcy Judge Eduardo Rodriguez from the Southern District of Texas held that a debtor can mount a claim for sanctions and punitive damages under Bankruptcy Rule 3002.1(i)(2) when a lender violates Rule 3002.1(b) and (c) by failing to give notice of changes in the payment, charges, fees and expenses claimed by a secured lender.
The facts were complex but boil down to this: A couple filed a chapter 13 petition in 2011 and confirmed a plan. The plan cured arrears on their home mortgage and called for the trustee to make monthly payments. Throughout, the debtors paid what the plan specified in terms of monthly mortgage payments.
The debtors completed their plan payments. The trustee issued a notice of plan completion, and the debtors received a discharge.
Rule 3002.1 Notices Not Given
As later revealed, the lender had changed the monthly payments three times during the life of the chapter 13 plan but never filed the notices required by Rule 3002.1(b) and (c).
After discharge, the lender began claiming the mortgage was in default and threatened foreclosure. To stop foreclosure, the debtors filed a second chapter 13 petition in 2020. The servicer filed a claim that included about $33,000 in arrears on the mortgage.
The debtors filed a complaint against the lender, making a plethora of claims. The adversary proceeding also objected to the claim on the mortgage.
Of principal significance for our story, the debtors sought monetary sanctions and punitive damages under Bankruptcy Rule 3002.1(i)(2) for failure to give the notices required by subparts (b) and (c) of the Rule.
The lender filed a motion to dismiss, claiming that the rule is procedural and does not give rise to a claim for damages. In large part, the lender relied on PHH Mortgage Corp. v. Sensenich (In re Gravel), 20-1, 2021 U.S. App. LEXIS 22752 (2d Cir. Aug. 2, 2021). To read ABI’s report, click here.
The Second Circuit’s Gravel Decision
Gravel made two landmark holdings. First, all three circuit judges agreed that the standard in Taggart v. Lorenzen, 139 S. Ct. 1795 (2019), for violation of the automatic stay applies to all contempt citations in bankruptcy court. In Taggart, the 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.
Over a vigorous dissent, two circuit judges in Gravel held that bankruptcy courts may not impose contempt sanctions for violating Bankruptcy Rule 3002.1. Rather, the majority ruled that a debtor may only recover compensatory damages, which often will be nominal.
Judge Rodriguez Disagrees with Gravel
Judge Rodriguez opened his discussion of the lender’s Rule 3002.1 dismissal motion by laying out the requirements and purpose of the rule. It applies to claims secured by a mortgage on a debtor’s principal residence where the debtor or the trustee is making payments under a chapter 13 plan.
Within 21 days, Rule 3002.1(b) requires the lender to serve notice on the trustee, the debtor and the debtor’s counsel anytime there is a change in the payment. Rule 3002.1(c) similarly requires notice regarding fees, expenses and charges allegedly incurred by the debtor after filing.
If the lender has not given the required notices, Rule 3002.1(i) provides that the court may prevent the lender from presenting evidence about the omitted information or “award other appropriate relief, including reasonable expenses and attorney’s fees caused by the failure.”
The rule was adopted to obviate situations where debtors complete their plan payments, receive discharges and then face foreclosure on a mortgage allegedly in default throughout the chapter 13 case.
The lender argued that Rule 3002.1 is a procedural rule that does not give rise to a cause of action. Judge Rodriguez knocked down that and other arguments.
Judge Rodriguez said he was not required to decide whether the rule creates an independent cause of action because the “plain language” in subsection (i)(2) permits the court to award “other appropriate relief.” He therefore denied the motion to dismiss the claim for damages under (i)(2).
The sanction that the court could impose was a “different question,” Judge Rodriguez said.
The lender argued that the debtor could not pursue sanctions in the second chapter 13 case that occurred during the first chapter 13 case. Again, Judge Rodriguez disagreed.
Finding no cases on point, Judge Rodriguez observed that the lender’s failure to give notices during the first case was continuing to harm the debtors, because the failure to abide by the rules caused them to incur expenses and file the second chapter 13 case.
Judge Rodriguez therefore decided that the plaintiffs could raise a claim in the second case for shortcomings during the first case.
Next, Judge Rodriguez addressed Gravel and the debtors’ right to claim sanctions and punitive damages.
Judge Rodriguez Sides with the Gravel Dissenter
Judge Rodriguez explained why the Second Circuit majority concluded that Rule 3002.1 is limited to non-punitive sanctions. He quoted the dissenter who saw the rule’s plain meaning as giving the court discretion to impose punitive monetary sanctions.
If there were no possibility of punitive damages, Judge Rodriguez paraphrased the dissenter as saying that “mortgagees have little incentive to make the systemic changes required to service loans properly in chapter 13.”
Judge Rodriguez said he “respectfully disagrees with the majority and agrees with the dissent. The plain language of Rule 3002.1(i) places few restrictions on the types of remedies bankruptcy courts can issue.” The rule’s only limit, he said, is the word “appropriate” while the word “including” is not limiting.
For Judge Rodriguez, going beyond compensatory damages “best serves the policy goals underlying the bankruptcy system.” Costs and attorneys’ fees alone “may be insufficient,” he said, because violations “may either go unnoticed by the debtor or the debtor will find it easier to pay the small fees rather than litigate them.”
Judge Rodriguez therefore denied the lender’s motion to dismiss by holding that “sanctions and punitive damages may be assessed under Rule 3002.1(i)(2) as ‘other appropriate relief’ where circumstances warrant. Plaintiffs must nevertheless satisfy their evidentiary trial burden to prove they are entitled to such relief.”
The opinion by Judge Rodriguez has several other holdings on issues that arise from time to time in consumer bankruptcies. He analyzed whether claim preclusion or judicial estoppel would bar the debtor from attempting to avoid the mortgage in the second case when there had been no claim to that effect in the first case.
Judge Rodriguez also denied the lender’s motion to dismiss the debtors’ claims about violating the automatic stay and the discharge injunction.
Observations
Don’t hold your breath waiting for a ruling on appeal. The decision by Judge Rodriguez is interlocutory, and the case doesn’t seem an attractive candidate for an interlocutory appeal.
There may be a settlement, precluding us all from knowing whether the Fifth Circuit would disagree with the Second Circuit.
Without a settlement, the lender will face the expense of a trial before Judge Rodriguez, followed by appeals to the district court and the circuit.
Since appeals could go in favor of the debtor and make bad law for lenders and servicers, the financial community could be better off having Gravel as the only appellate authority regarding Rule 3002.1.
Taking sides with the dissenter and disagreeing with the Second Circuit’s majority opinion on August 2, Bankruptcy Judge Eduardo Rodriguez from the Southern District of Texas held that a debtor can mount a claim for sanctions and punitive damages under Bankruptcy Rule 3002.1 i 2 when a lender violates Rule 3002.1 b and c by failing to give notice of changes in the payment, charges, fees and expenses claimed by a secured lender.
The facts were complex but boil down to this: A couple filed a chapter 13 petition in 2011 and confirmed a plan. The plan cured arrears on their home mortgage and called for the trustee to make monthly payments. Throughout, the debtors paid what the plan specified in terms of monthly mortgage payments.
The debtors completed their plan payments. The trustee issued a notice of plan completion, and the debtors received a discharge.