No Punitive Sanctions for Rule 3002.1 Violation

Posted by NCBRC - August 3, 2021

In a decision taking the teeth out of Rule 3002.1’s notice requirement, the Second Circuit found that the Rule does not permit imposition of punitive sanctions. PHH Mortgage Corp. v. Sensenich (In re Gravel), No. 21-1 (2d Cir. Aug. 2, 2021). In a well-reasoned dissent, Judge Bianco argued that the majority incorrectly limited the scope of sanctions available under the Rule.

These three consolidated cases (In re Gravel (21-1), In re Beaulieu (21-2), In re Knisley (21-3)) came before the bankruptcy court upon motions by the Trustee seeking sanctions against PHH for assessing fees against the debtors, in 25 statements per debtor, without complying with the requirement in Rule 3002.1(c) that a mortgage creditor “shall file and serve on . . . the trustee a notice itemizing all fees, expenses, or charges” that the creditor “asserts are recoverable against the debtor” and serve this notice “within 180 days after the date on which the fees, expenses, or charges are incurred.” The trustee also sought sanctions for violations of the court’s Current Orders in the Gravel and Beaulieu cases. Those orders stated that the debtors, who had completed their plans, were current on their mortgages, and prohibited PHH from challenging that finding in “any other proceeding.” (The Knisleys had not yet completed their plan when the trustee filed for sanctions, so there was no similar order involved in that case).

After the motions were filed, PHH admitted that the fees were not properly noticed under Rule 3002.1. It removed the fees and opposed the motions for sanctions.

The bankruptcy court held a consolidated hearing after which it sanctioned PHH in the amount of $75,000 for the Rule 3002.1 violations ($25,000/debtor), and $300,000 based on the violations of the Current Orders ($200,000/Gravel, /$100,000/Beaulieu). PHH appealed and the district court vacated and remanded, finding that the sanctions exceeded the bankruptcy court’s “statutory and inherent powers.” On remand, the bankruptcy court reduced the sanctions based on violations of the Current Orders by 25% to $225,000, and kept the Rule 3002.1 sanctions at $75,000.

The Second Circuit granted leave to appeal to address “whether the bankruptcy court properly sanctioned PHH for violating the Current Orders, and whether the bankruptcy court properly sanctioned PHH for violating Rule 3002.1.”

The circuit court began with the question of whether the bankruptcy court properly exercised its contempt power to impose a $225,000 sanction against PHH for violation of the Current Orders.

Citing Taggart v. Lorenzen, 139 S. Ct. 1795, 1801 (2019), the court found “a bankruptcy court may hold a creditor in contempt for violating the court’s injunction only ‘if there is no fair ground of doubt as to whether the order barred the creditor’s conduct.’” Under this standard the party faced with contempt charges must have had notice of the order, the order must be “clear and unambiguous,” and the violation of the order must be “clear and convincing.”

The court found that the bankruptcy court’s order that the debtors were current on their mortgages did not prohibit any act by PHH. Because it neither enjoined nor mandated any action, it could not be the basis of a contempt finding. “[T]o imply a restraint where none is stated would violate the principle that a party must have ‘explicit notice’ of what is forbidden or required.”

As to the broad injunction against challenging the finding that the debtors were current on their mortgages in “any other proceeding,” the court likewise found there was fair ground of doubt as to whether it would apply to PHH’s out-of-court conduct. Against the Trustee’s argument that overturning the bankruptcy court’s order would be tantamount to allowing banks to charge improper fees with impunity, the court found the fault lay with the ambiguity of the bankruptcy court’s language.

The trustee argued that the court should affirm nonetheless because, even if the bankruptcy court’s contempt power did not support the sanction, the bankruptcy court had the power to award “non-contempt-based sanctions.” The circuit court found that even if there were another theoretical basis for the award, the bankruptcy court itself made clear that it was exercising its contempt power and therefore did not look to whether the sanction was otherwise supportable..

The court turned to the $75,000 sanction for the Rule 3002.1 violations.

PHH argued that Rule 3002.1 does not permit punitive sanctions and the court agreed.

Rule 3002.1(i)(2) provides that upon non-compliance by the creditor, a bankruptcy court may “award other appropriate relief, including reasonable expenses and attorney’s fees caused by the failure.” The court noted that the issue of whether “other appropriate relief” includes punitive sanctions was one of first impression and that the bankruptcy court below was the first and only bankruptcy court to order such sanctions for violation of the Rule. The few other courts addressing the issue found such sanctions impermissible.

Turning to the Rule itself, the court found it was enacted to address the problem of creditors, fearing violation of the automatic stay, assessing fees during bankruptcy without disclosing those additional fees until after discharge.

The Rule offers two types of sanction: precluding the lender from presenting evidence of the claim in court, 3002.1(i)(1), and awarding “other appropriate relief,” 3002.1(i)(1). The court found that, because the phrase “other appropriate relief,” is general, the options for what is included in it are limited by the specific examples given in the Rule: “reasonable expenses and attorney’s fees.” The fact that the Rule also provides that the creditor may be precluded from collecting on the unnoticed claim post-discharge unless the lack of notice is deemed harmless, further supports the conclusion that the Rule was intended to ensure that the debtor does not suffer prejudice from the lack of notice which would interfere with his or her fresh start. Finding that these remedies are non-punitive, the court concluded that punitive sanctions were not available.

The court was unpersuaded by the bankruptcy court’s reasoning that Rule 3002.1 was comparable to Fed. R. Civ. Proc. 37 which permits discovery sanctions, including punitive sanctions. The court found that Rule 37 was intended to punish recalcitrant behavior that disrupts or delays court proceedings, while Rule 3002.1 is intended to protect a debtor’s status with respect to certain financial obligations, which it does without the need for punitive sanctions.

As with the contempt finding, the court declined to address the issue of whether the bankruptcy court had the authority to impose the sanctions under its inherent power bestowed by section 105(a), finding that the bankruptcy court did not cite that section (except in perfunctory terms) as the basis for the sanctions. Furthermore, beyond expressing “concern” as to PHH’s good faith or lack thereof, the bankruptcy court did not find that PHH acted in bad faith.

Finally, the court found that the debtors suffered no harm by the non-compliance with Rule because they were never actually charged the fees, nor did they pay them.

The court dismissed the dissent’s concern that its holding will tie the hands of future courts to deter violations of the Rule, stating: “In any event, the majority opinion does not limit a bankruptcy court’s inherent power to sanction offenders who act in bad faith. That is just not what the bankruptcy court did here; others might be free to do so if they were to make sufficient findings.”

The court vacated and reversed.

Gravel 2d Cir Aug 2021

Judge Bianco concurred in the majority finding that PHH did not violate the Current Orders, but dissented from the decision on the Rule 3002.1 violation, arguing that the Rule permits punitive sanctions and, in the alternative, that the bankruptcy court rested the sanctions, in part, on its inherent powers under section 105(a).

After enumerating instances of PHH’s misconduct, Judge Bianco went on to address the majority’s interpretation of the language in the Rule “other appropriate relief including reasonable costs and attorney’s fees.” He argued that the word “including” should not have been read as a limiting phrase within the context of this particular sanctions provision which was intended to punish a non-compliant lender.

Judge Bianco pointed to the court’s authority to preclude entry of evidence due to violation of the notice requirement as punitive rather than merely compensatory, equating the preclusion provision in Rule 3002.1 to that of Rule 37, which has a punitive component. He observed that, like Rule 3002.1, Rule 37 includes a non-exclusive list of examples that do not specifically include punitive sanctions.

Judge Bianco pointed out that prior to the addition of the “other appropriate relief” language, the Rule already had the evidence-precluding provision. The additional language added in 2011 was intended to provide further deterrence in the form of punitive sanctions.

He argued that limiting an offending creditor’s exposure to compensatory amounts would do little to deter the conduct challenged here, especially where debtors may simply pay the fees, either because they are unaware that the fees are subject to challenge, or because they do not care to undertake the cost and trouble of litigating them.

Judge Bianco argued that his concern about unchecked non-compliance was not mere “hyperventilation,” as characterized by the majority, but a threat to the compelling interest of the judicial branch and the public “in ensuring that the bankruptcy process is not abused by Rule violations or other misconduct.”

The dissent next argued that even if Rule 3002.1 does not authorize punitive sanctions, the bankruptcy properly invoked its inherent power under section 105(a) to assess those sanctions. Specifically, the dissent disagreed with the majority conclusion that the bankruptcy court merely “alluded to” but did not actually rest its decision on its inherent power. In fact, the bankruptcy court stated that it “finds, first, it has the authority pursuant to Rule 3002.1, pertinent caselaw, and its inherent powers, to impose punitive sanctions on PHH for its violations of Rule 3002.1.”

The lack of a separate section in the bankruptcy court’s opinion addressing its inherent power was unnecessary as the identical considerations for its invocation were spelled out in its discussion of Rule 3002.1. Nor was the lack of a specific finding of bad faith of concern where the bankruptcy court stated: “PHH’s conduct cannot realistically be attributed to an innocent mistake. PHH had knowledge of [its obligations]” and “[t]aken together, particularly in the context of prior court warnings, these actions raise serious concerns about whether PHH is making a good faith effort to comply with Rule 3002.1” This, the dissent argued, was sufficient to show conduct “tantamount to bad faith.”

Finally, the dissent argued that the sanction amount of $75,000 was not excessive in light of the fact that PHH is a multi-billion-dollar-company with the expertise and experience to conduct its business within the Rules.

Gravel 2d Cir Concur Dissent

NACBA filed an amicus brief in this case in which it pointed out, among other things, that the fees were not harmless but were added to the loan balance/lien on the property.

Gravel 2d Cir NACBA amicus Aug 2020





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