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Bankruptcy Update: Insights to Proposed Amendments to Federal Rules of BK Procedure

by Michael Arnovitz
Reimer, Arnovitz, Chernek & Jeffrey Co., L.P.A. - USFN Member (OH)

and Deanna L. Westfall
Castle Meinhold & Stawiarski, LLC - USFN Member (CO)

The Judicial Conference Advisory Committees on the Bankruptcy, Criminal, and Evidence Rules have proposed amendments to the federal rules and requested that the proposals be circulated to the bench, bar, and public for comment. The comment period for the proposed new rules ends February 16, 2010. The new rules are likely to become effective in 2011.

Some of the proposed changes to the Federal Rules of Bankruptcy Procedure are targeted to the mortgage industry and, specifically, mortgages on primary residences. The rules are intended to ensure that debtors are current on their mortgage payments when discharged in a Chapter 13 case. One of the perceived benefits to the proposed rule changes for mortgage creditors would be the uniformity of the rules with respect to the requirements for proofs of claim, payment changes, and the mechanism to claim and recover post-petition fees and costs. These rules should abrogate the need for the multiple local rules dealing with these items. However, the burden on secured creditors is greatly increased with these rules.

The purpose of this article is to outline the changes to the rules and discuss their perceived impact.

Rule 3001
The most significant changes affect the filing, amending, and supplementing of proofs of claim (POC). Currently, Rule 3001(c) requires that if a claim is based upon a writing, a copy of the writing shall be filed with the POC. Furthermore, Rule 3001(d) requires that proof of perfection of a security interest also be filed with the POC. The proposed amendments expand upon these requirements and add sanctions for failure to timely and completely comply with the new requirements.

Previously, most courts were lenient in allowing amendments to proofs of claim after the bar date for filing claims. Thus, a lender could file the POC stating the arrears and payoff amount, with an attached note and mortgage/deed of trust. This preserved the claim and put parties on notice of the amount owing on the note. The lender could amend, after the bar date, to add information including the assignments or allonges. Under that system, lenders initially provided the information necessary for the debtor to file a plan and then amended the POC to add any additional information regarding the holder. The proposed Rule 3001 is a significant change from this practice.

An additional provision is added to require that any claim based on an “open-end or revolving consumer credit agreement” must include a copy of the “last account statement sent to the debtor prior to the filing of the petition.” [Proposed Rule 3001(c)(1), Fed. R. Bankr. P.]

Next, a series of new requirements are added to cases involving individual debtors (as opposed to business entities). In addition to the note and duly recorded security instrument, the following would be required to be included with the POC form: (1) If the claim includes more than principal, an itemization of all pre-petition interest, fees, expenses, and charges; (2) If the claim is secured, a cure amount as of the petition date; (3) If the claim is secured by the debtor’s principal residence, an escrow analysis as of the petition date. All of these documents must be included in the filing of the proof of claim, which must be filed within 90 days after the first date set for the meeting of creditors pursuant to 11 U.S.C. § 341. [Rule 3002, Fed. R. Bankr. P.]

The proposed rule provides sanctions for any claim holder who fails to include all of the required information by precluding the use of any evidence not provided with the POC in any later proceeding or, alternatively, by awarding other sanctions including attorneys’ fees and costs. [Proposed Rule 3001(c)(2)(D), Fed. R. Bankr. P.] The courts can, however, determine that sanctions are not appropriate in certain circumstances. To do so, they must find that the lender’s failure was “substantially justified or harmless.” This raises the question as to whether it is harmless error to fail to include the assignment to the current holder.

The sanctions provision is unclear as to whether the holder of a claim will be able to amend its claim, in good faith, after the deadline. As a best practice, it is recommended that all documents be provided, including documentation proving that the current note holder is in fact the holder (notes with endorsements or allonges), and that a complete chain of assignments are included in a timely filed POC. With the additional requirement of an escrow analysis as of the petition date, this is quite onerous.

In some jurisdictions, such as Colorado, the information for the POC must be provided prior to the plan objection date. The plan objection date is typically three days prior to the Section 341 meeting. Thus, the deadline is 90 days earlier than the deadline for filing proofs of claim. The plan, if confirmed, becomes a binding contract between the debtor and creditor. This creates difficulties for lenders who learn of the bankruptcy filing shortly before the 341 meeting and have to scramble to provide all of the information necessary for a POC in their objection to plan. Often, obtaining copies of the note, security instrument, assignments, and payment history prior to the objection deadline is difficult.          

Rule 3002.1
Proposed Rule 3002.1 is a completely new rule dealing specifically with liens secured by the debtor’s principal residence. The proposed rule requires that the holder of a claim secured by the debtor’s principal residence is to file a notice of any changes in the post-petition mortgage payment amount, including those arising from escrow adjustments or interest rate changes. The notice must be served on the debtor, debtor’s counsel, and the trustee. The notice must be filed at least 30 days prior to the new payment effective date. This provision fails to take into account home equity lines of credit. Depending on rate fluctuations, these payments could change monthly, and it would be impossible to comply with the provision.

The notice must be in the form required under applicable non-bankruptcy law. It must also be filed as a POC supplement. The rule seems to require that the notice be filed in two separate ways: once as a docket entry as a notice and, again, as a POC supplement in the claims registry. This notice is not subject to Rule 3001(f), which means it is not presumed to be prima facie valid.

Next, the proposed rule requires that a holder of a claim secured by the debtor’s principal residence file a notice of any post-petition fees, expenses, and charges that it asserts are recoverable. The notice must be filed within 180 days of incurring the fee, expense, or charge. It must be served on the trustee, debtor, and debtor’s counsel. The notice must include an itemization of all fees, expenses, or charges assessed against the debtor within the 180-day period. This notice also must be filed as a POC supplement. The debtor or trustee has a one-year period within which to object to the recoverability of such fees, expenses, or charges.

This provision mandates that a mortgage creditor will need to analyze its loans secured by the debtor’s principal residence every 180 days or risk waiving fees, expenses, and charges which are recoverable from the debtor. The debtor or trustee will only need to review each case, every 365 days, as they have one year to object to the recoverability of such items.

The proposed rule also incorporates a provision for deeming the loan current at the date of discharge, which is already being done by local rule in some jurisdictions. The provision requires that within 30 days following the last payment on the arrears, the Chapter 13 trustee shall file and serve upon the claim holder, the debtor, and debtor’s counsel, a notice stating that the amount required to cure pre-petition arrears has been paid in full. In the event the trustee fails to do so, the debtor may file the notice.

The holder of the claim will have a 21-day period in which to file a response. The proposed rule requires the holder to file a response even if the loan is current. If the loan is not contractually current, the holder must file an objection to the notice and set forth an itemized list of all amounts that remain owing, both pre- and post-petition. If a lender fails to respond or fails to provide adequate information regarding the amounts allegedly owing, any remaining claim for pre-petition arrears or post-petition payments, expenses, and fees is waived. The court may, in appropriate circumstances, hold that the claim is not waived, if it finds that the “failure was substantially justified or is harmless.”

Conclusion
The proposed rules are intended to provide the debtor with a fresh start at discharge. The rules shift additional burdens to the secured creditors, specifically those with liens on the debtor’s principal residence. Creditors will need to timely document every aspect of the claim. In addition, creditors must monitor Chapter 13 cases closely, and provide updated information to the court, debtor, and trustee every six months if there are any changes under the note and security interest.

The sanction provisions are the most unnerving, as they seem to move from the historical position that a secured lien passes through bankruptcy unaffected (Dewsnup v. Timm, 502 U.S. 410, 116 L. Ed 2d 903, 112 S. Ct. 773 (1992)) to a new harsh provision allowing involuntary waivers of rights based on technical defects in filing and prosecuting claims.

If the proposed rules pass, these issues will lead to litigation over the extent to which the rules can change creditors’ substantive rights.

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