Second Circuit Applies Taggart Standard to Orders Declaring Home Mortgage Loans Current

In a decision that may have significant ramifications in bankruptcy cases, a divided panel of the U.S. Court of Appeals for the Second Circuit ruled in PHH Mortgage Corp. v. Sensenich (In re Gravel), 2021 WL 3277211 (2d Cir. Aug. 2, 2021), that the standard articulated by the U.S. Supreme Court in Taggart v. Lorenzen, 139 S. Ct. 1795 (2019), for the imposition of contempt sanctions due to a violation of the bankruptcy discharge injunction also applied to contempt sanctions imposed for repeated violations of bankruptcy court orders declaring a home mortgage current. In Gravel, the mortgage lender repeatedly sent statements to borrowers that listed (but did not include in the balance owed) fees that were no longer due. The Second Circuit also held that a bankruptcy court may not impose contempt sanctions for a violation of Rule 3002.1 of the Federal Rules of Bankruptcy Procedure ("Bankruptcy Rules"), which requires home mortgage lenders to give notice within 180 days of fees or expenses being charged against a chapter 13 debtor. According to the majority, sanctions for even repeated violations of Bankruptcy Rule 3002.1 are limited to economic, rather than punitive, damages.

Bankruptcy Rule 3002.1

Bankruptcy Rule 3002.1 was implemented in 2011 to avoid situations where chapter 13 debtors have received a discharge but face foreclosure due to undisclosed post-bankruptcy charges imposed by home mortgage lenders prior to the expiration of the automatic stay. The rule was also designed to help mortgage servicers that might otherwise be deemed to have violated the automatic stay by notifying chapter 13 debtors about mortgage defaults. Bankruptcy Rule 3002.1(c) requires a mortgage lender to file a notice itemizing all fees, expenses, or charges incurred in connection with the mortgage during the bankruptcy case within 180 days after the charges were incurred. Under Bankruptcy Rule 3002.1(i), if the mortgage lender fails to file a required notice of such fees, the bankruptcy court may preclude the lender from presenting the omitted information as evidence in the court, "unless the failure is substantially justified or is harmless." Alternatively, the court may "award other appropriate relief, including reasonable expenses and attorneys' fees caused by the failure."

Taggart

In Taggart, the Supreme Court ruled that a bankruptcy court may hold a creditor in civil contempt for attempting to collect on a debt that has been discharged in bankruptcy "if there is no fair ground of doubt as to whether the [discharge] order barred the creditor's conduct." Taggart, 139 S. Ct. at 1801.

Taggart left open the question of whether the "fair ground of doubt" standard should apply to violations of other bankruptcy court orders or provisions of the Bankruptcy Code, such a chapter 11 plan confirmation order, or the automatic stay. Several courts have weighed in on the issue, with mixed outcomes. See, e.g., Deutsche Bank Trust Co. Americas v. Gymboree Group, Inc., 2021 WL 3618229, *11 (E.D. Va. Aug. 16, 2021) ("Because there is fair ground for doubt concerning the requirements of the 2017 Plan and related disbursements, the record does not warrant a finding of contempt."); In re Jeong, 2020 WL 1277575 (B.A.P. 9th Cir. Mar. 16, 2020) (applying the Taggart standard in upholding a bankruptcy court order granting a chapter 7 trustee's request for contempt sanctions for a willful violation of the stay); Tate v. Fairfax Village I Condominium, 2020 WL 634293 (Bankr. D.D.C. Feb. 10, 2020) (citing Taggart in finding a willful violation of the stay in a chapter 13 case and imposing sanctions under section 362(k)(1) of the Bankruptcy Code); In re Franklin, 614 B.R. 534, 546 n.19 (Bankr. M.D.N.C. Jan. 24, 2020) (in a chapter 13 case involving a request for automatic stay violation sanctions under section 362(k), noting the distinction between a discharge injunction and the automatic stay and stating that "[e]ven if the standard in Taggart applied to § 362(k), no reasonable creditor objectively could have believed [the creditor's] actions in this case did not violate the automatic stay"); In re Spiech Farms, LLC, 603 B.R. 395, 408 n.22 (Bankr. W.D. Mich. 2019) (in a chapter 7 case, stating that "[t]his court does not read Taggart to change the Sixth Circuit's standard for determining whether a creditor can be held in contempt for violating the automatic stay").

Gravel

Gravel involved debtors in three separate chapter 13 cases filed in the U.S. Bankruptcy Court for the District of Vermont and the company originating and servicing the home mortgages ("servicer") for all of those debtors. The servicer violated Bankruptcy Rule 3002.1 some 25 times in each of the Vermont cases as well as violating the rule in cases filed in courts. In one of the cases before the Vermont bankruptcy court, the servicer previously agreed to pay a $9,000 sanction for sending erroneous mortgage statements for three years.

In two of the three Vermont cases, the bankruptcy court had entered an order (a "current order") declaring that the debtors were current on all pre- and post-filing payments, fees, and charges. Less than a month after the court issued the current orders, however, the servicer began listing in the debtors' statements fees allegedly incurred during the periods encompassed by the orders, but did not include those fees in the amounts due. In those two cases, the servicer had not filed the notices required by Bankruptcy Rule 3002.1(c). There was no current order in the third case, but the servicer listed fees in that debtor's statements (but did not include the fees in the amount due), without filing a Bankruptcy Rule 3002.1(c) notice.

For violating the rule, the bankruptcy court imposed $75,000 (i.e., $1,000 for each of the 25 violations in all three cases) in sanctions under Bankruptcy Rule 3002.1(i). In addition, invoking its "authority … to impose punitive sanctions on parties who violate court orders," the court imposed a total of $300,000 in sanctions for violation of the two current orders. Reasoning that it "may hold a creditor in contempt for that party's violation of an injunction order," the court applied the Taggart contempt standard and "impos[ed] punitive sanctions" on the servicer for its violation of the orders.

The district court reversed on appeal, ruling that the $375,000 in sanctions exceeded the bankruptcy court's "statutory and inherent powers." The district court remanded the case to the bankruptcy court, which later imposed the same $75,000 in sanctions for violating Bankruptcy Rule 3002.1, but reduced the punitive sanctions for violating the current orders to $225,000.

The Second Circuit granted the servicer's request for a direct appeal of the second sanctions order.

The Second Circuit's Ruling

A divided three-judge panel of the Second Circuit vacated and reversed the second sanctions order.

Initially, Circuit Judge Dennis Jacobs, writing for the majority, explained that a bankruptcy court's "narrowly circumscribed" contempt power derives from a court injunction—an equitable remedy—and section 105(a) of the Bankruptcy Code, which authorizes the court to issue "any order, process, or judgment that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code]."

The majority concluded that the servicer "did not, as a matter of law, violate" the current orders because those orders specifically prohibited the servicer "from disputing that the debtors are current (as set forth herein) in any other proceeding," but "did not enjoin the recording of expired fees on the statements" sent to the debtors. Gravel, 2021 WL 3277211, at **4-5.

In so ruling, the majority applied the contempt standard established in Taggart. "Without an express injunction [barring the servicer from sending out statements contrary to the current order]," the majority wrote, there was a "fair ground of doubt as to whether the listed fees can form the basis for contempt." Id. at *4. According to the majority, the bankruptcy court "could have crafted an order that would have forbidden the conduct" at issue. Id. at *6.

Addressing the $75,000 sanction for failure to file Bankruptcy Rule 3002.1(c) notices, the majority acknowledged that monetary sanctions are permitted by Bankruptcy Rule 3002.1(i). According to the majority, however, "'other appropriate relief' is limited to non-punitive sanctions, as that would cabin it to the most general attribute shared with an award of expenses and fees." Id. at *7. The majority explained that various provisions of the Bankruptcy Code, such as section 362(k)(1), expressly authorize punitive sanctions. In addition, it noted, Bankruptcy Rule 3002.1, unlike Fed. R. Civ. P. 37, which authorizes the imposition of sanctions for failure to comply with discovery orders, does not include provision for "further just orders," indicating that punitive sanctions cannot be imposed for violations of Bankruptcy Rule 3002.1

The majority declined to decide whether the $75,000 sanction was authorized under the bankruptcy court's inherent power, writing that "[t]he sanction was imposed under Rule 3002.1(i), and our holding is that the sanction went beyond the relief authorized by that rule." The majority noted, however, that given the absence of any finding of bad faith below, it was "dubious" whether the bankruptcy court "could exercise its inherent power to do that which is unavailable under powers expressly defined" in Bankruptcy Rule 3002.1(i). Even so, the majority emphasized, if the bankruptcy court had found bad faith, it would be within its inherent power to sanction the offender.

Circuit Judge Joseph Bianco concurred in part and dissented in part. Judge Bianco agreed with the majority's holding that the current orders "did not clearly and unambiguously prohibit" the servicer's conduct for which the bankruptcy court imposed $225,000 in sanctions. Id. at *10 (dissenting opinion). However, the judge vigorously disputed vacatur of the $75,000 sanction imposed under Bankruptcy Rule 3002.1(i), reasoning that the "'other appropriate relief' language in [Bankruptcy Rule 3002.1(i)(2)] conferred upon bankruptcy courts … a proper basis to impose the $75,000 punitive sanction against [the servicer] based upon its flagrant and repeated violations of the Rule." Id. Limiting "other appropriate relief" for a rule violation to reimbursement of costs to a debtor, the judge wrote, "does little to prevent future violations and therefore falls far short of safeguarding the Chapter 13 'fresh start' process for all such debtors." Id. at *16.

Finally, according to Judge Bianco, even if Bankruptcy Rule 3002.1(i) itself did not permit the imposition of sanctions, the bankruptcy court had "independent authority under its inherent powers to impose this $75,000 sanction against [the servicer] for its egregious conduct in violation of the Rule." Id. at *11.

Outlook

In Gravel, the Second Circuit appears to have definitively answered a major question left unanswered by Taggart—namely, whether the "fair ground of doubt" standard applies to contempt for violation of bankruptcy court orders other than orders discharging debtors. Whether other courts will adopt this expansive interpretation of Taggart remains to be seen. The Second Circuit's approach places the burden on parties drafting orders to specify clearly which actions are prohibited to foreclose a "fair ground of doubt" defense.

On September 15, 2021, the chapter 13 trustee filed a petition for rehearing en banc of the Second Circuit's ruling. Given Judge Bianco's vigorous dissent and the potential far-reaching implications of the decision in bankruptcy cases, the court may be inclined to grant the petition.