Big Banks & Small Consequences in Chapter 13

• Publication year: 2023

Big Banks & Small Consequences in Chapter 13

Alexandra P.E. Sickler

BIG BANKS & SMALL CONSEQUENCES IN CHAPTER 13

Alexandra P. E. Sickler^*

Abstract

Mortgage creditors struggle to properly service mortgages in chapter 13 cases, as evidenced by numerous cases describing violations of Bankruptcy Rule 3002.1. The consumer bankruptcy system, however, is not calibrated to compel systemwide compliance from these large, institutional repeat actors. This Essay argues that the Consumer Financial Protection Bureau (CFPB) is well-suited to support the consumer bankruptcy system by exercising its monitoring and enforcement powers to promote, and even compel, mortgage creditor compliance in chapter 13 cases.

Table of Contents

Introduction..........................................................................................560

I. The Consumer Bankruptcy System Isn't Calibrated to Regulate Systemic Noncompliance....................................563

II. Bankruptcy Courts' Creative Attempts to Monitor Mortgage Creditor Noncompliance.......................................569

A. In re Stewart's Attempt to Supervise Proof of Claim Practices ................................................................................ 569

B. Channeling Punitive Damages Awards in In re Sundquist ....... 571

C. Awarding Punitive Damages for Rule 3002.1 Violations ......... 573

III. Using the CFPB to Regulate Mortgage Creditor Compliance with Bankruptcy Laws.........................................576

A. The Consumer Bankruptcy Reform Act of 2022 ....................... 577

B. Extending the CFPB's Supervisory Authority to Consumer Bankruptcy............................................................. 578

C. Using the CFPB Enforcement to Close Consumer Bankruptcy's Remedial Gaps .................................................. 582

Conclusion.............................................................................................584

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Introduction

Obtaining a chapter 13 discharge is an arduous endeavor. The debtor must adhere to a multi-year payment plan and a strict budget that often leaves little to no margin for unexpected expenses. Once the debtor has completed plan payments and cured mortgage arrears, they exit bankruptcy with their discharge. But mortgage creditors often assess fees and costs to the debtors' accounts or change their payment amounts during the case without notifying them.¹ Even if these assessments or changes are lawful, the amounts tied to them may remain hidden to the debtor and the trustee until after the case has closed. Unpaid amounts, as bankruptcy professionals know, lead to defaults. As a result, soon after obtaining their discharge, the debtor may face a new foreclosure proceeding due to the undisclosed—and unpaid—amounts.² While administering chapter 13 cases during the mortgage crisis fallout, bankruptcy courts discovered that mortgage creditors engaged in such practices.³

In 2011, the Federal Advisory Committee for Bankruptcy Rules tried to address this specific problem by promulgating Bankruptcy Rule 3002.1.⁴ This Rule is designed to prevent such "gotcha" fees and charges by imposing post-petition, pre-discharge noticing requirements on mortgage creditors.⁵ To ensure compliance, the Rule provides an array of sanctions. The court may preclude the mortgage creditor from presenting the undisclosed information and award "other appropriate relief, including reasonable expenses and attorney's fees."⁶ But mortgage creditors have struggled to comply with the rule, generating litigation that reveals systemic compliance problems persist in chapter 13 cases.⁷ The more things change, the more they stay the same.

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one bankruptcy court, fed up with repeated violations of Rule 3002.1 across multiple consumer bankruptcy cases, held that punitive damages were appropriate.⁸ In In re Gravel (Gravel I), the chapter 13 trustee moved for sanctions against a mortgage creditor for Rule 3002.1 violations in three separate cases.⁹ The bankruptcy court granted the motions, ordering the mortgagee to pay $75,000 in punitive damages for the Rule 3002.1 violations and an additional $300,000 for violations of the court's orders pursuant to its section 105 powers.¹⁰ Consumer bankruptcy professionals monitored Gravel I for several years to see if appellate courts would uphold the sanctions order. In 2021, the Second Circuit ruled that Rule 3002.1 does not authorize punitive damages.¹¹ Other courts have disagreed, concluding not only that courts may award punitive damages to remedy violations of Rule 3002.1, but also that more limited sanctions would not deter systemic violations.¹²

The obvious tension point is disagreement about whether the language of Rule 3002.1 authorizes courts to order punitive monetary sanctions—a discrete interpretative issue.¹³ But the divide connects more broadly with ongoing challenges to regulate systemic noncompliance in consumer bankruptcy cases. The challenges are multidimensional, arising out of the highly automated nature of modern mortgage servicing and the diffuse, case-by-case, court-centered model of bankruptcy regulation.

Legal scholarship, including mine, extensively documents these challenges, drawing on judicial decisions that expose flaws in the bankruptcy system's ability to deter systemic noncompliance.¹⁴ The scholarship proposes solutions

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such as amplifying private rights of action for consumers in bankruptcy,¹⁵ shifting bankruptcy policymaking from the judiciary to an administrative agency,¹⁶ and capitalizing on natural synergies with the Consumer Financial Protection Bureau's (CFPB) work to support the consumer bankruptcy system.¹⁷

This Essay builds on my previous research, which has made the case that the CFPB is well suited to address systemic noncompliance in consumer bankruptcy cases. First, in Bankruptcy's Adjunct Regulator, my coauthor and I identified defects in consumer bankruptcy's institutional design that allow noncompliance to persist and proposed a framework for how the CFPB could collaborate with bankruptcy's existing regulators to better address these consumer bankruptcy violations.¹⁸ More recently, we examined Congress's proposal to carve out a regulatory role for the CFPB in the consumer bankruptcy system.¹⁹

Recent consumer bankruptcy reform legislation embraces our proposed approach. The Consumer Bankruptcy Reform Act of 2022 ("CBRA") creates a regulatory role for the CFPB in bankruptcy in two ways. First, the CBRA proposes establishing a "Consumer Bankruptcy Ombuds" at the CFPB.²⁰ This ombuds would perform high-level data analysis and reporting, make policy recommendations, and resolve informal disputes between individual debtors and creditors.²¹ Second, the CBRA would give the CFPB supervisory and enforcement authority—but not rulemaking authority—over the Bankruptcy Code.²²

This Essay isolates the special case of mortgage creditor noncompliance in consumer bankruptcy cases—especially chapter 13 cases—to underscore the need for a more comprehensive, less diffuse regulator for the consumer

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bankruptcy system. This Essay proceeds as follows: Section I demonstrates that the consumer bankruptcy system isn't calibrated to combat systemic mortgage creditor noncompliance. Drawing on Bankruptcy's Adjunct Regulator, I briefly highlight the institutional design flaws of consumer bankruptcy's court-centered, litigation-based model of regulation, which explains why widespread violations persist. Section II explores how some bankruptcy courts have tried to creatively address systemwide noncompliance by ordering remedies that have effects beyond the boundaries of an individual case. Here I use well-known cases to illustrate why bankruptcy courts cannot effectively perform the monitoring and enforcement functions of an administrative agency like the CFPB. Section III advocates for empowering the CFPB with the supervisory and enforcement authority proposed in the CBRA to preserve the integrity of the bankruptcy process and promote its policy goals.

I. The Consumer Bankruptcy System Isn't Calibrated to Regulate Systemic Noncompliance

The consumer bankruptcy process is intensely technical and procedural.²³ The Bankruptcy Code and Rules meticulously detail how debtors must marshal their income and assets, and how their debts must be settled before they receive a fresh start.²⁴ During the bankruptcy case, the Code limits the type of collection activity that creditors may pursue.²⁵ Creditors must file a proof of claim in order to obtain their pro-rata share of a debtor's assets and plan payments.²⁶ They must comply with lift-stay procedures to enforce their rights against the debtor's property.²⁷ And they must comply with discharge provisions once the debtor has obtained their fresh start.²⁸

Compliance with the Bankruptcy Code and Rules can be onerous and costly. The requirements imposed on mortgage creditors in chapter 13 cases are illustrative. Chapter 13 debtors pay their mortgage obligations over a three-to-

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five-year plan term.²⁹ During that period, mortgage creditors must adapt their operations to ensure compliance with consumer bankruptcy laws. But compliance can be difficult because chapter 13 bankruptcy permits debtors to cure home mortgage arrearages and continue paying their mortgages according to the chapter 13 plan terms.³⁰ Mortgage creditors must therefore implement systems and procedures that conform to the plan provisions³¹ while also being careful not to violate bankruptcy laws.³²

Mortgage creditors, however, often fail to comply with the numerous technical requirements in the Bankruptcy Code and Rules, leading to legal violations.³³ Indeed, mortgage creditors are repeat violators in chapter 13 cases.³⁴ Their loan administration practices violate bankruptcy laws at critical points in consumer cases: the proof of claim process, the automatic stay, and the

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discharge injunction.³⁵ Undoubtedly, the highly...