Judge Seeks Creditors' Attention With Discharge Violation Ruling

A Fort Worth bankruptcy judge sent an unmistakeable message to Bank of America and a collection agency in a recent opinion on violation of the discharge: clean up your procedures or pay up. McClure v. Bank of America, Adv. No. 08-4000 (Bankr. N.D. Tex. 11/23/09).

What Happened

The debtors owned a business named Qualico. Like many entrepreneurs, they obtained financing through credit card accounts, which they personally guaranteed. When the business failed, both the company and its owners ended up in chapter 7. The McClures listed several debts owed to Bank of America in their schedules.

Shortly after the McClures received their personal discharge, Bank of America referred two of their accounts to a collection agency. Bank of America did not dispute knowing about the discharge and the opinion is silent as to any explanation for why discharged debts were referred to a collection agency. To compound the confusion, two different Bank of America debts were referred to two different collectors within the same firm.

Upon receiving the accounts, the collection agency, CFG, sought to do a bankruptcy scrub on the accounts. However, the information received from Bank of America was not very helpful. Placed in the social security number field was the tax ID number for the corporation. A search under this number did not turn up the corporation's bankruptcy and no search was done on the individual.

At the fatal moment before the first collection call was placed, Bank of America knew about the discharge, but the collection agency was blissfully ignorant.

The first collector was merely trying to collect upon the corporate account and was not aware that there was a guaranty. However, that did not stop him from telling the individual debtor that someone was headed to his house and that they would be filing suit against him that day. When the collector stopped to take a breath, the terrified debtor informed him of his bankruptcy, which was duly entered into the system. This stopped collection on account #1. However, it did not provide notice to the collector on account #2. He sent the debtor a letter and made a phone call, which no doubt unnerved the debtor who had already provided the agency with his bankruptcy information.

Who Violated the Discharge?

All of the collection activity which took place violated the discharge. However, to hold a creditor liable for contempt, there must be actual notice of the order being violated. Thus, under these facts, who committed a knowing violation: BOA, CFG, Collector #1 and/or Collector #2? Liability as to BOA was easy. They admitted knowledge of the discharge at the time that they referred the debts out for collection. Collector #1 did not know about the discharge at the time he made his threatening call. Neither did Collector #2. However, the collection agency committed a knowing violation when Collector #2 contacted the debtor even though Collector #2 did not.

Here's how the court reached this conclusion. The court did not impute knowledge from the principal to the agent. Additionally, the court did not hold the collection agency liable for negligently performing the bankruptcy scrub. However, once Collector #1 received notice of the discharge, that put the agency on notice. Although Collector #2 could not be held liable for information which never reached him, the agency could be held liable for his unknowing actions. Thus, you have the paradox that neither collector knew about the discharge at the time he undertook the collection actions. However, once the entity knew about the discharge, it could not allow its employee to remain in the dark.

Damages

Damages are always a difficult issue in these cases. While attorney's fees are available, they are poor compensation to the debtor. Mental anguish is hard to prove. In this case, the debtor's doctor testified, but the court found the evidence to be inconclusive. (The court did, however, state that it did not "consider the line between being an aggressive agent and a bully to be so fine that CFG cannot service its clients without resort to such crude scare tactics"). However, the court did not stop there. It stated:

The McClures have, however, expended substantial time and effort in prosecuting this lawsuit. Without the willingness of aggrieved debtors to prosecute violations of the discharge injunction of section 524(a)(2), such violations would go unchecked by the court. The Code has as one of its underlying purposes providing a fresh start to a discharged debtor. (citation omitted). If violations of the discharge injunction go unpunished, creditors will lack the necessary incentive to avoid violating the law, and an underlying purpose of the Code will be undermined. In order to ensure that debtors are not hesitant to prosecute violations of the discharge injunction, they should be awarded actual damages to compensate them for the time and effort they have to expend in the process. In this case, the court awards the McClures $2,500.00 in actual damage for the time and effort they expended in proscuting this adversary proceeding, for which BOA and CFG will be jointly and severally liable.

Memorandum Opinion, pp. 12-13.

(The court also took pains to note that it had not been requested to assess damages under the Fair Debt Collection Practices Act and that such damages would not have been available in any event, since this was a business debt).

The Court also awarded $79,839.14 in attorney's fees. The defendants complained that the debtor's attorney was piling on. However, the court was quick to justify the large award, stating:

CFG and BOA questioned the high cost of attorney services based on want of harm to the McClures. First, the need to encourage enforcement of the discharge injunction counsels against too great parsimony in assessing fees. Second, the refusal of CFG to acknowledge error--and a pre-trial dispute between CFG and BOA over responsibility for the violation of the injunction--added to the cost of the attorneys. Had the two defendants accepted responsibility for their conduct early in this adversary proceeding, the cost of the McClures' counsel would have no doubt been much lower.

Memorandum Opinion, p. 13, n. 27.

However, the final relief awarded was the most interesting. The court awarded conditional sanctions payable to the registry of the court based on the defendants' apparent lack of concern with the law. The Court stated:

(T)he court finds that the actions of BOA and CFG in violating the discharge injunction were sufficiently egregious to warrant sanctions. By failing to adopt measures sufficient to prevent violations of the discharge injunction and then willfully violating the discharge injunction, BOA and CFG have demonstrated a lack of concern for the law. The injunction of section 524(a)(2) and that provided by section 362(a), which in the McClures' case the former replaced (citation omitted), are at the heart of bankruptcy protection. (citation omitted). It is only by reason of these provisions that the court is able to ensure debtors the interim protection promised by the filing of a petition and the true fresh start that a discharge is supposed to bring. To protect its own authority as well as to give debtors the relief Congress intended, a bankruptcy court must act promptly and firmly to stop conduct violative of section 362(a) or 524(a)(2) and to prevent future breach of those provisions. This is particularly important when, as is true of BOA and CFG, the entity violating the stay deals with millions of consumers, many of whom will be in bankruptcy cases; BOA's and CFG's procedures for ensuring compliance with the law must be seamless.

The court, therefore, concludes that it is both reasonable and necessary to sanction BOA and CFG in order to deter BOA and CFG from violating any discharge injunction in the future. See 11 U.S.C. Sec. 105(a).

The court hereby sanctions BOA in the amount of $100,000.00, payable to the registry of the court, and sanctions CFG in the amount of $50,000, also payable to the registry of the court. Each sanction will be suspended and need not be paid if, within 90 days of the entry of this memorandum opinion, by affidavit either the President or General Counsel of each company submits to the court new procedures his or her company has adopted to prevent future violations of any discharge injunction.

Memorandum Opinion, pp. 14-15.

The court's three-fold remedy addressed three different needs. First, the debtors received a small award to vindicate them for having to seek redress from the court. Debtors' counsel received a large award to compensate him for having to pursue the case. Judge Michael Lynn presides over large cases, such as Pilgrim's Pride, and is no doubt used to seeing large fee requests. When compared to the fees charged in mega-cases, the hard-working debtors' attorneys fees likely seemed quite reasonable. Finally, the court saved the largest award as an incentive to fix the problem. The court did not grant the debtor a windfall, but did not overlook the seriousness of the failure either. By ordering a payment to the registry of the court unless procedures were changed, the court took a stand on behalf of the integrity of the larger bankruptcy process and on behalf of other debtors who might be harmed in the future.

This opinion offers some practical advice to counsel defending parties accused of violating the discharge. If there is a clear-cut violation, as there was here, acknowledge liability promptly. The real battle will be over damages, which are difficult for the debtor to establish. A prompt offer of judgment may avoid a large award and an embarassing written opinion later. Further, when there has been a breakdown of procedures as happened here, the time to address those procedures is immediately. The opinion never answered the question of why Bank of America referred two discharged debts to a collection agency. The failure to answer this question may have informed the urgency of the court's insistence that "procedures for ensuring compliance with the law must be seamless."

Debtor Gets Mortgage Claim Denied. Now What?

I am in New York for the Commercial Law League conference, so it is appropriate to blog about a case from the Southern District of New York. While the Southern District of New York is known for its multi-billion dollar cases, a recent case highlights a consumer issue faced by courts nationwide. In (Name Withheld by Request), Case No. 09-22261 (Bankr. S.D. N.Y. 9/29/09), the Debtor's lawyer became frustrated with inconsistent information received from a mortgage servicer and filed an objection to claim. The mortgage servicer's submissions raised more questions, leading to denial of the claim. However, the bigger question is what denial of the claim means for the debtor.

A Proof of Claim Walks Into A Bankruptcy

In this chapter 13 case, PHH Mortgage filed a proof of claim on the debtor’s mortgage. PHH stated that it was the secured creditor. The proof of claim attached the following documents:

(a) a one-page itemization;
(b) pages 9 through 16 of a document identified as New York--Single Family . . . Fannie Mae/Freddie Mac UNIFORM INSTRUMENT MERS;
(c) a 4 page Fixed/Adjustable Rate Rider; and
(d) 16 pages out of a 24 page mortgage showing MERS as mortgage holder and Mortgage World Bankers, Inc. as lender.

In response to an inquiry from the Debtor’s attorney, PHH stated that it was the servicer and that US Bank as trustee for a securitization trust was the actual creditor. This was the first problem. The person who filed the claim was not the holder of the claim, but the agent for an undislosed principal.

The Debtor objected to the claim, arguing that the servicer lacked standing to file the claim and that the proof of claim did not demonstrate a complete chain of title from the originator to the securitization trust.

The Creditor Digs Itself In Deeper

In response to the objection, PHH Mortgage filed an affirmation of counsel, an affidavit and a memorandum of law. These documents created more problems for the purported creditor. The affirmation of counsel attached an Assignment of Mortgage from MERS to US Bank. The document was executed by Tracy Johnson as Assistant Vice-President of MERS. (MERS is Mortgage Electronic Recording Service, which exists to serve as a nominee for mortgage holders and allow mortgages to be transferred without the necessity of a formal assignment. In other words, MERS acts as nominee of whoever holds the mortgage.). It also included a power of attorney authorizing PHH to act on behalf of US Bank. The second affidavit was signed by Tracy Johnson, this time as Assistant Vice-President of PHH.

The Memorandum of Law stated that:

The ownership of the Note and Mortgage were subsequently transferred to US Bank. An Assignment of Mortgage was not executed at the time of the transfer. PHH intends to submit documentation to show that US Bank now has the beneficial interest in the Note and Mortgage by virtue of the pre-existing transfer of this loan. In addition, the documentation will demonstrate that PHH is still authorized to file the Proof of Claim as the loan servicing agent for US Bank.

Memorandum, p. 3.

Unfortunately, PHH did not obtain the documentation. The following exchange took place at the hearing on the claims objection:

THE COURT: . . . what is the evidence of the transfer of the mortgage to US Bank?

MR. ______: All I have is PHH’s representations, Judge.

THE COURT: By the woman who also appears to be working for MERS and who isn’t here.

Transcript, pp. 15-16.

The Ruling

In the end, the Court expunged the claim. The Court’s findings are summarized as follows:

1) The documentation attached to the claim was incomplete and did not identify the holder of the note. Recall that the claim included pages 9 through 16 from one document and 16 pages out of 24 pages of another. The Court this selective attachment of partial documents to be suspicious, since the omitted pages would have identified the holder of the debt. As a result, the Court found that the claim was not entitled to prima facie validity.

2) The Court did not accept the affiant as a custodian of records, apparently due to the fact that the same person claimed to be custodian of records for two different entities and because the affidavit was contradictory.

3) The Note contained a stamp indicating that it was transferred from the securitization trust to the servicer, PHH. As the court stated, "To my knowledge of how these securitized mortgage nonte/trusts are structured, it doesn't make sense and it's not explained anywhere in the affdavit as to how it would make sense that it would be transferred to the servicer of the trust, the note would be transferred to the servicer of the trust. That's an odd thing for me to accept." Transcript, p. 24.

4) There was no evidence of assignment of the mortgage to the purported creditor other than the uncorroborated statement of the servicer.

As a result, the Court stated:

You know what, what I will say is this, the owner of the mortgage as far as I can see and the owner of the note has not filed a proof of claim in the case. That’s what I’ve found. Someone filed a proof of claim who’s not been able to establish that they hold the note and the mortgage.

Transcript, pp. 24-25.

What Does This Mean?

Consider what this means. There is someone somewhere who holds a mortgage upon the debtor’s home. That person is not the person who filed the claim. As a result, the true creditor is somewhere outside of the bankruptcy case. A secured creditor can choose to remain outside of the bankruptcy process, in which case the lien will ride through unaffected. The real creditor may appear at some point and ask to lift the stay. If not, at the end of the case, the debtor will receive a discharge from her personal liability but will still be subject to the lien. Of course, if the creditor is never able to prove up its paperwork, then at some point, the lien would be barred by limitations.

Ignoring What We Know To Be True

This leads to the second important point. Complete, consistent documentation matters. The claim was expunged based on incomplete documentation which failed to identify the holder of the note and the mortgage. The affidavits submitted compounded the problem because the same person claimed to be custodian of records for two different entities. The lawyer for PHH forthrightly acknowledged the problem when he stated:

I agree with you, Judge. I think that the reality is that . . . we’re ignoring what we know to be true because we can’t get our hands on the documents.

Transcript,pp. 16-17.

That is a powerful admission. If the creditor’s lawyer cannot get his hands on the documents, where are they? This case started with an originator who advanced actual money which allowed the debtor to purchase a home. For years prior to bankruptcy, the debtor made payments to a servicer. These payments were accepted. The debtor received statements of account. There was never a question raised as to whether the right person was being paid. It was only when the bankruptcy case was filed that questions were raised about proper paperwork.

This raises an interesting question. Was the right person being paid prior to bankruptcy? One possibility is that PHH’s lawyer is correct and that “we’re ignoring what we know to be true because we can’t get our hands on the documents.” The other possibility is that somewhere along the line, there has been a disconnect between the party entitled to payment and the party receiving payment. In this instance, the aggrieved party would be the true holder of the note and mortgage. If the phantom real holder doesn’t complain that its funds are being diverted, what is the debtor’s right to complain? If the debtor’s loan has been lost somewhere in a securitization black hole, does that mean that the debtor gets a free house? This case points out a difficult tension between acknowledging “what we know to be true” and putting the creditor to its proof.

Dispatches from a Hangdog Bankrupt

This morning I was listening to KUT, our local public radio affiliate, when I heard the story of a rare book dealer who filed for bankruptcy in Austin. His story is told in a series of dispatches which appear on McSweeneys.net, which you can access here. My favorite story (which was featured on the KUT show and can be found in episode 4) was about the Travis County Constable who wept when the debtor's girlfriend invited her in for coffee as she was serving papers on him. My second favorite was the story of the debtor's interview with his attorney about how to value his cat on the schedules. While the attorney is referred to by the pseudonym Mr. H, you can pretty well figure out who it is, since there are not many male consumer bankruptcy lawyers in Austin whose last name starts with H (and no, it is not Pat Hargadon). The dispatches convey a lot of interesting information and capture the human element of failure poignantly. It is well worth your reading.