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Chapter 13 Trustee Pay-All/Conduit Jurisdictions: Some Issues, Challenges, and Pointers

Posted By USFN, Monday, November 7, 2016
Updated: Wednesday, October 26, 2016

November 7, 2016

by Craig Rule
and Heather McGivern
Orlans Associates, P.C.
USFN Member (Michigan)

Chapter 13 trustees who permit or require post-petition mortgage payments to be disbursed through their offices constitute a small — but growing — majority and present a number of unique challenges to mortgage servicers. Based on the authors’ analysis of the most recent disbursement numbers set forth on the webpage of the Executive Office for the U.S. Trustee, it is estimated that ninety-three Chapter 13 trustees are conduit trustees, while eighty-four are not. See https://www.justice.gov/ust/file/ch13ar15-aarpt.xlsx/download.

These “conduit” jurisdictions and trustees impact the way a mortgage servicer should handle many of the fundamental actions that secured creditors take to protect their interests during a Chapter 13 case. This article discusses how conduit claims affect decisions to file a proof of claim or a motion for relief from the automatic stay, change how to approach loan modifications, and amplify the adverse consequences of failing to file a transfer of claim.

Readers should note that not all secured claims in conduit jurisdictions must be wholly paid through the Chapter 13 trustee under all circumstances. For example, Local Rule 3070-1 (Bankr. E.D. Mich. 2016) creates a presumption of trustee payment that must be rebutted if a claim is to be paid directly. In practice, this means that a debtor must be contractually current on the petition date to continue to make post-petition payments directly to a mortgage creditor.

No Proof of Claim = No Payment?
Although the Bankruptcy Code and Federal Rules of Bankruptcy Procedure (FRBP) do not presently require secured creditors to file a proof of claim (POC), there are several possible adverse results of failing to do so on conduit claims. See 11 U.S.C. § 501(a) and FRBP Rule 3002(a). Even if there is little or no pre-petition arrearage, the lack of a filed proof of claim can prevent a mortgage servicer from receiving any payments during the course of a Chapter 13 plan. Though the absence of a filed POC on an unmodified mortgage claim may not result in a full (or even partial) discharge of the obligation, the loss of a potential stream of payments for up to five years makes filing a proof of claim highly advisable. See Matteson v. Bank of America, 535 B.R. 156 (6th Cir. B.A.P. 2015).

While a trustee or debtor is permitted to file a POC on behalf of a creditor, it is by no means certain that either party will do so — or, if filed, that the claim will be accurate in terms of the arrears and ongoing post-petition payments. See 11 U.S.C. § 501(c) and FRBP Rule 3004. Furthermore, if the incorrect servicer is identified or the wrong payment address is noted in the debtor- or trustee-filed POC, it could create an administrative quagmire that causes the trustee to object to, or stop payment on, the proof of claim. If an objection is granted, there is a risk that some or all of the expected payments during the pendency of the bankruptcy case could be subject to discharge at plan completion.

No Post-Petition Payments? MFR Considerations
For mortgage servicers, perhaps the most significant difference between conduit and non-conduit claims is the determination of whether a referral should be made to local bankruptcy counsel to bring a motion for relief from the automatic stay (MFR). This divergence begins when the bankruptcy case is filed. If the proposed Chapter 13 plan intends to have the trustee disburse the post-petition payments, the trustee will generally not begin to make those payments until the plan is confirmed unless directed otherwise by a local rule or court order. As a result, mortgage servicers and their attorneys should carefully examine the proposed plan treatment before filing what could be an impractical MFR. Even if a debtor initially intends to pay a mortgage claim directly, a MFR at the pre-confirmation stage can be a costly alternative to filing an objection to plan confirmation since, in many instances, the debtor may amend the plan to convert the claim to a trustee-paid one.

The discrepancies between conduit and non-conduit claims continue at the post-confirmation stage. Due to other claims that may have priority in distribution under the confirmed plan (such as debtor attorneys’ fees and equal monthly payment secured claims), it is often the case that a debtor is fully performing under a plan even though the post-petition mortgage payments are not current. To avoid filing unfeasible MFRs on conduit claims, servicers and their attorneys should always examine the trustee’s payment histories, which are available online and without cost to creditors. There are several different platforms that Chapter 13 trustees around the country use to provide access to their records. The most frequently-used platform is the 13 Network, which can be accessed at www.13network.com.

Loan Modification Pitfalls
While effective and timely communication among a servicer’s bankruptcy department, loss mitigation department, and local counsel is always of the utmost importance, the failure to do so has even more negative implications for all parties to a Chapter 13 case if post-petition payments are made through the trustee’s office. The troubles often begin at the trial loan modification stage because the disbursements from the trustee must be modified to match the monthly trial payments.

Prompt action by a servicer once the trial modification is offered is necessary to ensure that the Chapter 13 trustee will make the correct payments in the right time frame. In some jurisdictions this simply means that the servicer must notify the trustee (either through direct contact or a filed payment change notice) to adjust the post-petition payment amount for a fixed period. In other courts, which put the entire loan modification burden on the debtor, the debtor’s attorney should be promptly notified so that he or she can take the required action to cause the trustee to effectuate the correct trial payments. In still additional jurisdictions, however, servicers may be held to account if they do not ensure that a trial loan modification receives court approval. In this instance, it is crucial that local counsel be alerted of the trial modification in enough time to obtain bankruptcy court approval either through a motion or through a stipulated order.

Once a debtor is approved for a permanent loan modification, there are a number of pitfalls to avoid. The consequences to all parties in a Chapter 13 case for failing to have permanent loan modifications quickly and accurately effectuated are even more heightened for conduit loans. In conduit jurisdictions, if a permanent loan modification is not approved by the court or brought to the trustee’s attention, not only will the trustee continue to pay any pre-petition arrearage but he or she will also pay the post-petition monthly payments at the pre-modification amount. In many instances, this could result in a significant overpayment to the mortgage creditor, to the detriment of other creditors; the mortgage servicer could face sanctions or a U.S. Trustee investigation. Regardless of whether the post-petition payments are made through the trustee or directly by the debtor, servicers should contact their local bankruptcy counsel to determine whether the bankruptcy court must approve the permanent loan modification before it is tendered to a debtor for signature.

File Transfers of Claim
The consequences of the failure to file a timely transfer of claim are even more pronounced if the post-petition mortgage payments are being disbursed through the Chapter 13 trustee. FRBP Rule 3001(e)(2) requires a transferee to file a transfer of claim when the transfer takes place after the proof of claim is filed. On a non-conduit claim, a delay in filing a transfer of claim will only affect disbursements on the pre-petition arrearage; however, the impact on conduit claims is amplified since the post-petition payments from the trustee will also not make it to the new servicer. In some instances, after the return of checks from the previous servicer, the trustee may seek to disallow the claim in its entirety if a transfer of claim is not filed. Not surprisingly, based on the authors’ experience, the failure of creditors to file transfers of claim and payment address changes constitute one of the biggest frustrations for Chapter 13 trustees and their staff. In order to prevent a potentially significant delay and/or financial loss, mortgage servicers should promptly file a transfer of claim after acquiring servicing rights.

Conclusion
Although not exhaustive, the issues peculiar to conduit jurisdictions discussed in this article represent some of the most common and costly obstacles facing mortgage servicers. As always, mortgage servicers should reach out to their local counsel to discuss other potential pitfalls that may be unique to each jurisdiction.

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