Lending Institution Hit with $375,000 Penalty for Violating Federal Bankruptcy Rule

According to Federal Bankruptcy Rule 3002.1, holders of secured claims on a Chapter 13 debtor's primary residence are required to file a detailed notice with the court for recovery of all post-petition fees, expenses, and charges it seeks to recover from the debtor.¹ The purpose of this requirement is "to promote further transparency and more emphatically safeguard debtors' fresh starts."²   

The rule was implemented in 2011 "in response to a growing problem that had arisen in Chapter 13 cases" in which debtors found "themselves in renewed foreclosure proceedings due to undisclosed and unpaid post-petition charges and fees."³  

Compliance with this rule is important in order to be able to fully recover all of the fees, expenses, or charges that a creditor is rightfully entitled to; and because failure to comply with any federal rule (including 3002.1) can have potentially serious consequences for the violating party.  

A court for the District of Vermont recently issued a ruling which awarded $375,000 in sanctions against PHH Mortgage Corporation for violations of Federal Bankruptcy Rule 3002.1.⁴ In this case, PHH Mortgage Corporation failed to notify the court and the debtors that it would include post-petition charges and fees to debtors' accounts. In summary of the decision, the court indicated the sizeable sanction was awarded “to convey a clear message to PHH, and other mortgage creditors, that they may not violate court orders with impunity and will suffer significant monetary sanctions if they conduct their mortgage operations in a manner that fails to fully comply with Rule 3002.1, violates court orders, or threatens the fresh start of Chapter 13 Debtors."⁵ 

The court claimed it had authority to issue an award for sanctions under Federal Bankruptcy Rule 3002.1(i)⁶, which provides that in the event of a violation of subdivisions (b), (c), or (g), courts have the ability to "preclude the holder from presenting the omitted information, in any form, as evidence in any contested matter or adversary proceeding in this case." This goes on further to allow for an award of “other appropriate relief, including reasonable expenses and attorney's fees."⁷  In support of this decision, the court also expressed that 11 U.S.C. § 105 of the Bankruptcy Code "empowers courts to 'issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of the [Bankruptcy Code]."⁸ 

Bankruptcy Rule 3002.1 also has other notice provisions. The most common and recognizable section, 3002.1(b), pertains to notice of payment changes. The rule states that "the holder of the claim shall file and serve on the debtor, debtor's counsel, and the trustee a notice of any change in the payment amount, including any change that results from an interest rate or escrow account adjustment, no later than 21 days before a payment in the new amount is due."⁹ This means that any time there is a mortgage payment change, notice is required at least 21 days before the change is supposed to take effect.  

Section 3002.1(c) further extends the notice requirement to "fees, expenses, or charges (1) that were incurred in connection with the claim after the bankruptcy was filed, and (2) which the holder asserts are recoverable against the debtor or against the debtor's principal residence."¹⁰ The notice needs to be served within 180 days from the date in which the purported fees, expenses, or charges were incurred.¹¹ Both notices are submitted through an official form as required by Federal Bankruptcy Rule 3002.1(d).

Another important section of the rule is 3002.1(g), which covers responses to notices of final cure payments. After the trustee files the notice of final cure in which he asserts that the debtor has paid in full the amount required to cure any default on the claim, the claimant must file a response within 21 days after service of the notice.¹²  The response must indicate: "(1) whether it agrees that the debtor has paid in full the amount required to cure the default on the claim, and (2) whether the debtor is otherwise current on all payments."¹³ 
There are a few lessons to be learned here. Courts are cognizant of the fact that mistakes do happen, but if they are not addressed properly and promptly, or addressed in a global manner to avoid similar future mistakes, they can be very costly. Therefore, compliance with the bankruptcy code and the bankruptcy rules is essential for lending institutions wishing to maximize recovery and minimize risk.

For questions or additional information on the federal bankruptcy rule, risk assessments, or training resources, contact Milos Gvozdenovic at (216) 739-5647 or mgvozdenovic@weltman.com. 

¹ Fed. R. Bankr. P. 3002.1.
² In re Nicholas and Amanda Gravel, 2016 Bankr. LEXIS 3322, at 11.
³ Id.
⁴ In re Nicholas and Amanda Gravel, 2016 Bankr. LEXIS 3322, at 2.
⁵ In re Nicholas and Amanda Gravel, 2016 Bankr. LEXIS 3322, at 43.
⁶ Id at 13.
⁷ Fed. R. Bankr. P. 3002.1(i).
⁸ In re Nicholas and Amanda Gravel, 2016 Bankr. LEXIS 3322, at 14, citing 11 U.S.C. § 105(a).
⁹ Fed. R. Bankr. P. 3002.1(a).
¹⁰ Fed. R. Bankr. P. 3002.1(c).
¹¹  Id.
¹²  Fed. R. Bankr. P. 3002.1(g).
¹³  Id.