Bankruptcy Rule 3002.1: An Unlikely New Weapon Against Debtors

It has been five years since Congress and the U.S. Supreme Court enacted Bankruptcy Rule 3002.1.  Hailed as a victory for homeowners against greedy mortgage banks, the rule was designed to force banks to certify to the court that the homeowner was current in payments at the conclusion of a chapter 13 case.

While Rule 3002.1 has provided a helping hand to many debtors, an unintended side effect of the rule has threatened to tip the balance against unsuspecting debtors: chapter 13 trustees are using the rule’s reporting mechanism to deny discharges to debtors after they have completed their chapter 13 plan payments.

While it might seem perverse that a rule designed to help debtors is being used to deny their chapter 13 discharges, the trustees have found a sympathetic ear in some of the nation’s bankruptcy judges.

History Behind Rule 3002.1:  Protecting Chapter 13 Debtors

Bankruptcy Rule 3002.1 was enacted after lawmakers became aware that for many debtors who successfully completed their chapter 13 plans, their problems with the mortgage bank were just beginning.  During many chapter 13 cases, the banks were adding bogus or inflated fees for processing payments or otherwise handling the mortgage accounts, without the homeowners’ knowledge.

Then, after the bankruptcy was completed, the bank would demand hundreds or even thousands of dollars in fees to bring the account current, on pain of foreclosure.  Fresh out of the chapter 13 system, the dismayed homeowner typically had no means to pay these fees.  Too often, the demand for payment threw the homeowner into a downward spiral, leading to foreclosure or another chapter 13 filing.

To prevent this, new Bankruptcy Rule 3002.1 required the bank to file a statement with the court whenever it added a fee or charge to the homeowner’s account during the five-year chapter 13 case.  The rule also required the bank to file a statement at the conclusion of the chapter 13, informing the court whether the homeowner had paid all mortgage payments which had come due during the case.

This new Rule 3002.1 process allowed the courts to supervise banks’ conduct during and after the chapter 13, so that homewners would not be driven in and out of the bankruptcy system due to bank misbehavior.

Trustees Using Rule 3002.1 In An Unexpected Way

Now for the problem: because of the enactment of Rule 3002.1, chapter 13 trustees were for the first time routinely served with an official document, prepared by the bank, detailing the history of payments the debtor paid on the mortgage.  This document sometimes revealed that the debtor had missed a payment or two, or maybe even had stopped paying the mortgage altogether due to a financial crisis.

What no one foresaw was that this put the debtor in jeopardy of losing his or her right to the all-important chapter 13 discharge of debts.

Why?  Because for most homeowners, their chapter 13 plan contains two important provisions: (1) that the debtor will continue making mortgage payments and will be retaining the family home, and (2) that the debtor will, for three to five years, make a monthly payment to the trustee for distribution to other creditors.  These two provisions normally constitute the court-approved chapter 13 repayment plan.

At the end of the plan, for a debtor who had completed making all payments to the trustee, but who had not maintained all payments on the mortgage, trustees began to refuse to certify to the court that the debtor had made “all payments under the plan,” as required by bankruptcy code section 1328(a).  In other words, the debtor had made all the trustee payments, but not all the mortgage payments.

“All payments under the plan” meant both the plan payments and the mortgage payments.  This spelled disaster: the debtor could not receive a discharge of debts.

Ironically, Rule 3002.1 created the mechanism that enabled trustees to see the homeowner’s delinquency in mortgage payments — something trustees typically had no way of knowing before the rule’s enactment in 2011.

Growing Number of Courts Denying Discharge For Missed Mortgage Payments

A handful of chapter 13 trustees around the nation are routinely refusing to certify completion of plan payments for debtors who have missed even one mortgage payment, at the end of the plan.  The number of published bankruptcy cases denying discharge on this basis is growing.  One district has seen an epidemic of such cases: see In re Daggs, No. 10-16518 HRT (Bky. D. Colo. Jan,. 6, 2014); In re Furuiye, No. 10-15854 SBB (Bky. D. Colo. April 7, 2014); In re Gonzales, No. 09-27194 HRT (Bky. D. Colo. June 9, 2015); In re Formaneck, No. 10-20070 MER (Bky. D. Colo. July 13, 2015); In re Cherry, 10-25318 TBM (Bky. D. Colo. Jan. 19, 2016) (granting time to cure default); In re Hort-Kieckhaben, No. 11-13705 EEB (Bky. D. Colo. Feb. 23, 2016); In re Strimbu, 10-19146 MER (March 31, 2016); In re Payer, No. 10-33656 HRT (May 5, 2016) (granting time to cure default); and In re Diggens, No. 10-40335 JGR (Dec. 20, 2016) (loan modification satisfied “all payments” requirement).

What Can a Debtor Do to Avoid This Problem?

Any chapter 13 debtor who owns a home and is continuing payments to the mortgage bank is at risk, unless all the mortgage payments are made during the chapter 13.  The only way for a homeowner to safeguard the right to a chapter 13 discharge is to scrupulously maintain all the mortgage payments.

If mortgage payments are missed during the case, the debtor should consult with his or her lawyer right away.  Solutions could include requesting that the court grant additional time to catch up the payments (as in the Cherry, Payer and Diggins cases noted above), converting to chapter 7, or even (rarely) closing the case without a discharge.