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District Court Reverses Bankruptcy Court’s Sanction of Mortgage Servicer for Including Fees on Monthly Statements without First Filing Required Notices

Posted By USFN, Tuesday, February 13, 2018
Updated: Monday, February 12, 2018

February 13, 2018

by Joel W. Giddens
Wilson & Associates, PLLC – USFN Member (Arkansas, Mississippi, Tennessee)

On December 19, 2017 the U.S. District Court for Vermont reversed a $375,000 sanction. The sanction had been imposed by the chief bankruptcy judge for the District of Vermont on a mortgage servicer for billing fees to debtors without first filing the required notices under Federal Rule of Bankruptcy Procedure (FRBP) 3002.1(c) and for violation of bankruptcy court orders. The bankruptcy court imposed sanctions following a finding of contempt in three Chapter 13 bankruptcy cases on motions filed by the standing Chapter 13 trustee against the servicer. The request by the trustee asking the bankruptcy court to find the servicer in contempt was based on FRBP 3002.1(i)’s “failure to notify” section and for violation of “deem current” orders entered at the completion of two of the Chapter 13 cases.

Background in Bankruptcy Court
FRBP 3002.1, effective December 1, 2011, requires the holder of a claim secured by the debtor’s principal residence to file a detailed notice setting forth fees, expenses, or charges it seeks to recover from the debtor within 180 days after the expenditure is incurred. FRBP 3002.1(i) provides a bankruptcy judge with the authority to take certain actions if the holder fails to disclose a fee or charge, including: precluding the holder from presenting the omitted information — in any form — as evidence in any contested matter or adversary proceeding in the case (unless the failure was substantially justified or harmless); or awarding “other appropriate relief,” including reasonable expenses and attorney fees caused by the failure.

The bankruptcy court imposed a $75,000 sanction ($25,000 in each of the three cases) pursuant to FRBP 3002.1(i) for the servicer’s inclusion of property inspection fees, NSF fees, and late charges on monthly billing statements sent to the debtors over a 25-month period during their bankruptcy plans that had not been included on a FRBP 3002.1(c) notice, and were more than 180 days old. The fees included on the billing statements were fairly minimal (a total of $258.75 in one case; $86.25 in the second case; and $317.00 in the third case); the servicer admitted that they had been included in violation of the bankruptcy rule. In one of the cases, the servicer had already been sanctioned for not applying post-petition payments pursuant to the confirmed plan and had agreed to remediate its practices to comply with local Vermont bankruptcy rules. The imposition of the $300,000 sanction related to the same fees and late charges on the monthly statements and were on statements sent out to the debtors within days after the entry of the “deem current“ orders.

District Court’s Review
The bankruptcy court imposed the sanctions not only pursuant to FRBP 3002.1(i) but also pursuant to 11 U.S.C § 105(a) that provides bankruptcy judges with the authority to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of” the bankruptcy code, and pursuant to its “inherent authority.” The district court analyzed each basis used by the bankruptcy court to impose sanctions and concluded that the bankruptcy court had extended its authority beyond the bounds of the bankruptcy rules, the bankruptcy code, procedural due process, and constitutional protections in contempt proceedings.

First, the district court looked at whether FRBP 3002.1(i) authorized the imposition of punitive damages. The Chapter 13 trustee argued that the “plain language” of the rule embodies a grant of broad authority to craft appropriate remedies and that the sanction imposed by the bankruptcy court fell within the scope of that authority. The trustee pointed out that the power to impose monetary sanctions is necessary to deter mortgage creditors from attempting to collect unauthorized fees and charges, and to avoid the “absurd” result of mortgage creditors facing no negative consequences for violating the rule. The mortgage servicer contended that the history of FRBP 3002.1 (as reflected in meeting minutes of the Advisory Committee on Bankruptcy Rules) demonstrated that, in addition to attorney fees and costs, the rules’ drafters intended the scope of “other appropriate relief” to be limited to discretionary exclusion of information that should have been disclosed and did not indicate an intent to provide a basis, by itself, for disallowance of a claim entirely. The total amount of the sanction, the servicer pointed out, was more than the cumulative amount of its claims, which would be tantamount to their disallowance. That the sanction was ordered by the bankruptcy court to be paid to a non-profit legal service provider in Vermont, and that the debtors were not harmed by the servicer’s actions, was additional proof that the sanction was punitive in nature.

The district court found that the analysis of the extent of the bankruptcy court’s authority to impose sanctions under FRBP 3002.1(i) turned on this principle: “that, however broadly the language of [FRBP] 3002.1(i) sweeps, the powers it bestows cannot be without limit. At the absolute minimum, these powers cannot extend beyond the outer bounds of the Bankruptcy Court, as delineated by statute and precedent.” Because the bankruptcy court exceeded the outer bound of its authority under § 105 (as discussed later in the opinion), the district court concluded that the bankruptcy court also went beyond the scope of FRBP 3002.1.

The district court then turned to the sanction imposed by the bankruptcy court pursuant to 11 U.S.C § 105(a) and the bankruptcy court’s inherent authority. The court acknowledged that there was no debate that bankruptcy courts, like district courts, are vested with inherent authority to craft orders necessary to carry out their mission and may exercise inherent authority to respond to violations of its orders. The court further acknowledged that there was a broad consensus among circuit courts that § 105 empowered bankruptcy courts to adjudicate civil contempt and impose compensatory sanctions in a wide variety of factual and procedural contexts. The court noted, however, that there was a deep division among the appellate courts as to whether bankruptcy courts have the power to punish criminal contempt or impose punitive sanctions. There was no controlling authority in the Second Circuit. (Connecticut, New York, and Vermont comprise the Second Circuit.)

A Look to Other Circuits
After a review of the evolution of the contempt authority of bankruptcy courts and decisions in other circuits, the district court was most persuaded by the decisions that restrict the authority of bankruptcy courts to impose punitive damages. In the case of In re Dyer, 322 F.3d 1178 (9th Cir. 2003), the Ninth Circuit held that neither § 105 nor the bankruptcy court’s inherent authority were proper authority for imposition of “serious” punitive damages — specifically pointing out that § 105 contains no explicit authority to award such damages; rather, only those remedies “necessary” to enforce the bankruptcy code. Civil contempt sanctions (i.e., compensatory damages) are adequate to meet that goal, rendering serious punitive damages unnecessary. While the Dyer court declined to set an amount that rose to “serious” punitive damages, the $50,000 award at issue in that case was sufficient to fall outside of the authority conferred by § 105. The Dyer court further noted that bankruptcy courts are ill-equipped to provide the procedural protections that due process of law requires before the imposition of punishment, and that the administration of punishment by an Article I bankruptcy judge raises constitutional concerns.

In the same vein, the district court found persuasive the Fifth Circuit’s holding in In re Hipp, 895 F.2d 1503 (5th 1990). There, due to the lack of tenure and compensation protections afforded Article III judges, it was constitutionally impermissible for bankruptcy courts to exercise criminal contempt powers.

Finally, the district court found that the narrower construction of the bankruptcy court’s statutory and inherent punitive sanction was consistent with the direction of Second Circuit precedent addressing the scope of bankruptcy contempt authority in other contexts.

Another Appeal: Awaiting Second Circuit’s Ruling
In the end, the district court suggested that 11 U.S.C. § 105 makes it permissible for a bankruptcy court to enter a preliminary finding of criminal contempt with the preparation of proposed findings of fact and conclusions of law. This would allow the offending party an opportunity to make a record of objections but leave the adjudication of the objections, and entry of a final order of contempt, to the district court. Whether bankruptcy courts will follow this suggested procedure remains to be seen. While persuasive authority, the district court’s opinion is not binding precedent and is now on appeal to the Second Circuit Court of Appeals.

The district court’s opinion can be found at PHH Mortgage Corporation v. Sensenich, 2017 U.S. Dist. LEXUS 207801 (D. Vt. 2017).

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