December 1, 2011 brought important new bankruptcy rules that affect (a) the proof of claim forms to be used when a borrower is in Chapter 13 bankruptcy and the loan is secured by the borrower’s principal residence, and (b) the follow-up required by the lender to ensure that the claim remains up to date and the borrower is notified of (i) changes to his required payments, and (ii) any fees, expenses, or charges that are to be recovered from him or the principal residence. These rules apply to every Chapter 13 case, regardless of whether it was filed before or after December 1, 2011 (although a lender does not have to file a new proof of claim if it had already filed one before December 1, 2011).
In a December, 2011 article, we highlighted the new rules and noted that while they present questions, the courts would likely produce answers over the next year. That article can be found here.
The courts have provided some answers, which we’ll discuss in this article. The new rules were created to keep the mortgage lender and the borrower on the same page about what is to be paid and when. One reason people file Chapter 13 bankruptcy is because it allows them to avoid a home foreclosure by (a) curing a mortgage arrearage over time through a bankruptcy plan, and (b) making regular payments going forward. If the borrower follows through in Chapter 13, they will emerge from bankruptcy with no arrearage and the threat of foreclosure behind them. While the concept is simple enough, the process of curing a mortgage arrearage in Chapter 13 has often proved to be difficult. For example, while borrowers have been focused on curing their pre-bankruptcy arrearage, they often incur a new arrearage during the bankruptcy case due to, for example, interest and escrow changes that they were not advised of because the lender was concerned about possibly violating the bankruptcy stay. As a result, many borrowers have emerged from Chapter 13 only to find that they are still in arrears. Over time, some bankruptcy lawyers have tried to avoid this outcome by imposing disclosure requirements on lenders in the Chapter 13 plan or even pursuing sanctions against lenders – generating litigation in each case. The new rules were created in the hope of enhancing the communication between the lender and the borrower so that the borrower can emerge from Chapter 13 with no arrearage and so that conflict and litigation are minimized throughout the Chapter 13 process.
With that in mind, below are some questions posed by the new rules and the answers that bankruptcy courts have provided so far. Please bear in mind that most of these answers have come from bankruptcy courts outside of Virginia and therefore are not binding in Virginia and may change if the same question is presented in Virginia. Nevertheless, they provide some guidance.
1. Does the lender have to comply with the requirement to give notice of a new payment amount at least 21 days before the payment is due even if doing so is virtually impossible? (aka, the HELOC question)
Answer: Yes. As noted in our earlier article, “whenever the amount of the mortgage
payment that the debtor (or trustee) must pay will change, the creditor must file and serve a Notice of Mortgage Payment Change … not less than 21 days before the payment changes. Such payment changes may result from escrow adjustments and/or interest rate adjustments. If the payment change is due to an escrow payment change, the creditor must also file an escrow accounting with this Notice.” While the new rules were in the drafting process, there was commentary to the effect that this 21-day-advance-notice requirement will be difficult to comply with if the payment may change every month, such as with a HELOC. And in a case decided in Ohio, a HELOC lender asked to be excused from this requirement, stating that compliance was “virtually impossible” because the payments typically vary from month to month. The bankruptcy court, however, stated that the new rules are mandatory and that the court has no authority to excuse the lender from compliance.
2. Is the lender entitled to any attorney fees it incurs in complying with the new rules?
Answer: No (except that the answer changes to “Yes” if (a) litigation results from the lender’s filings, (b) the lender prevails, and (c) the loan documents and applicable law allow for the attorney fees). In addition to the “Notice of Mortgage Payment Change” form noted above, the new rules require lenders to file, without limitation, (a) a “Notice of Postpetition Mortgage Fees, Expenses, and Charges” form if the lender wants to attach to the loan any fees, expenses, or charges that it incurs, and (b) a “Statement” at the end of the Chapter 13 case indicating whether the lender agrees that the borrower has paid all amounts required to cure the arrearage and whether the borrower is otherwise current. In two Virginia cases and a North Carolina case, the bankruptcy courts ruled that the lender was not entitled to charge the borrower attorney fees for preparing and filing these forms. In one of those cases, the court wrote that completing and filing the form is a “business function that can be done by a claims administrator in the creditor’s own office. It is akin to issuing a receipt for payments received under the Chapter 13 plan and during the course of the chapter 13 case or providing an annual escrow statement. Its preparation is not the practice of law. No legal analysis is generally required. An attorney need not sign it.” However, the court also said that if the borrower challenges the information in the lender’s form and litigation results from that challenge in which the lender prevails, then the lender is entitled to charge the borrower for its attorney fees in that litigation so long as the loan documents and applicable non-bankruptcy law allow for the attorney fees.
3. Can failure to follow the new rules result in harsh sanctions against the lender?
Answer: Yes. The new rules provide that the lender’s failure to make timely filings can result in, among other things, the borrower being awarded attorney fees and the lender being precluded from presenting the omitted information as evidence in a hearing before the bankruptcy court. In a case decided in Texas the bankruptcy court required the lender to pay over $4,100 in attorney fees to the borrower because the lender failed to file a “Notice of Postpetition Mortgage Fees, Expenses, and Charges” with respect to an escrow shortage but then tried to collect the shortage by filing a “Notice of Payment Change.”
4. Do the new rules apply if the mortgage loan is being paid “outside the Chapter 13 plan” – i.e., if the borrower is going to make all payments directly to the lender instead of through the Chapter 13 trustee?
Answer: No. In two cases decided in Florida the bankruptcy courts held that the new rules do not apply if the mortgage is being paid “outside the plan.” In one of those cases the court inferred this result from the new rules’ legislative history, which is generally not a sturdy foundation for a court ruling.
5. Does the lender have to comply with the new rules if the Chapter 13 plan provides that the borrower will surrender the real estate to the lender?
Answer: Yes. In a case decided in Ohio, the bankruptcy court ruled that while at first blush the new rules seem inapplicable when the real estate is to be surrendered – since the borrower is not going to continue making mortgage payments – the rules, as written, do not make an exception in that scenario. The court also pointed out that requiring the lender to continue providing information about changes to its claim, such as the addition of foreclosure costs, is important because it allows “multiple parties” (presumably the debtor and the Chapter 13 trustee) to obtain accurate information for the calculation of the lender’s claim. The court suggested, without saying so, that once the foreclosure takes place and the lender is left with only a deficiency claim, then the new rules would no longer apply.
Neil McCullagh and Jennifer West are two of the attorneys at Spotts Fain PC who work with banks on a wide variety of issues including insolvency, workouts, creditors’ rights, bankruptcy, and collections.