The Second Circuit’s August 2021 decision in In re Gravel[1] has already received considerable attention and generated much debate. Gravel involved the Vermont bankruptcy court’s initial entry of $375,000 in sanctions against a mortgage creditor based on the creditor’s inclusion of fees on a monthly mortgage statement — fees that were not included in the “amount due” on the statement and for which it did not file notice under Bankruptcy Rule 3002.1(c). The bankruptcy court entered $300,000 contempt sanctions in two chapter 13 cases based on the chapter 13 trustee’s request for violation of its “deem current” orders at the end of the cases, and $75,000 sanctions in the same two cases plus a third case as “other appropriate relief” as provided in Rule 3002.1(i), the remedy provision. After the district court reversed and remanded, the bankruptcy court reduced the $300,000 contempt sanctions to $225,000 but re-entered the $75,000 sanctions for violation of Rule 3002.1(c). The Second Circuit then accepted the matter for direct appeal.
The Second Circuit, in a 2-1 panel decision, first addressed the $225,000 contempt sanctions. The majority found that the language of the “deem current” orders did not give sufficient notice to the mortgage creditor that listing the fees on the monthly statements violated the language in the orders that the loans were current or constituted an “other proceeding” in which the orders provided that the mortgage creditor was barred from disputing the fees. It also cited the Supreme Court’s “no fair ground of doubt” standard in Taggart v. Lorenzen,[2] implicitly holding that there was a fair ground of doubt that the mortgage creditor’s conduct violated the “deem current” orders. The dissent agreed with the majority that the $300,000 was improper.
The majority then addressed the $75,000 in sanctions awarded under Rule 3002.1(i) as “other appropriate relief.” It held that because the other specifically mentioned forms of relief in subsection (i) were compensatory, the phrase “other appropriate relief” should be read as allowing compensatory relief, not punitive relief. The majority also noted that other provisions of the Bankruptcy Code specifically allow punitive damages, citing 11 U.S.C. § 362(k), whereas subsection (i) is silent. Finally, it rejected the bankruptcy court’s reliance on and analogy to Federal Rule of Civil Procedure 37’s discovery sanctions provisions, based on the distinction that Rule 37 protects the “integrity of our judicial process,” whereas Rule 3002.1 protects “the debtor’s interest in fully resolving the debtor’s current status as to particular financial obligations.” The Court concluded that punitive sanctions are not available under subsection (i)’s “other appropriate relief” remedy for violation of the Rule.
The dissent strongly challenged several of the majority’s conclusions with respect to the $75,000 sanctions award. It disagreed with the majority’s conclusion that the other remedies listed in subsection (i) are compensatory, specifically maintaining that the evidence preclusion remedy is punitive. The dissent also strongly challenged the majority’s conclusion that the Rule was intended to protect only individual debtors as opposed to the entire bankruptcy process. Possibly the largest point of contention between the majority and dissent concerned the bankruptcy court’s inherent authority to sanction for violation of Rule 3002.1. The majority found that the bankruptcy court had not based its $75,000 sanctions on its inherent authority and further found that even if it had, there was no specific finding of bad faith that is required for sanctions under a court’s inherent authority. The dissent pointed out that the bankruptcy court had in fact relied in part on its inherent authority to impose the $75,000 sanctions and that the sanctions were possible even without a specifically couched finding of “bad faith. The dissent further pointed out that regardless of this possibility, the factual findings of the bankruptcy court were “replete” with facts that established bad faith, including the mortgage creditor’s earlier agreement to $9,000 in sanctions pursuant to a motion by the trustee in a related matter. The majority countered this in part by focusing on the fact that the fees were not included in the “amount due” section on the monthly statements (and also held that this fact provided an alternative grounds for reversal of the $225,000 contempt sanctions).
The trustee filed a motion for rehearing en banc, which was supported by amici curiae briefs from various parties, including six retired bankruptcy judges. The Second Circuit, however, denied the motion for rehearing on Nov. 1, 2021.
While the Second Circuit largely ignored it, a broader issue raised by Gravel is a bankruptcy court’s authority to enter punitive sanctions for contempt or rule violation and the scope (with respect to amount) of that authority. The district court noted the national disagreement in its opinion reversing and remanding the bankruptcy court’s first decision, even identifying what it termed a “circuit split.” This broader issue will likely continue to be litigated where the stakes justify it.
Reasonable minds might disagree on the takeaways from Gravel, but this author offers the following, at least in the Second Circuit. First, unless the bankruptcy court’s order is very clear in defining the act or omission enjoined or required with respect to noncompliance with the rule, the party attempting to enforce the order will likely have a difficult task. Second, subsection (i)’s “other appropriate relief” remedy does not allow punitive sanctions. Third, upon a clear finding of bad faith by a bankruptcy court that cannot be reversed for clear error on factual findings or for an abuse of discretion for a clearly erroneous assessment of the evidence, a bankruptcy court may be able to impose punitive sanctions for violation of the Rule based on its inherent authority. Fourth, without a clear order prohibiting the conduct, a mortgage creditor’s inclusion of fees that were not previously noticed under the Rule on a written communication that does not plainly demand their payment will likely not support a bankruptcy court’s award of punitive sanctions against the mortgage creditor.