The intersection of Chapter 13 bankruptcy and escrow accounts is complicated and confusing. Since 2011, various bankruptcy rule and form changes have occurred in an effort to eliminate perceived problems with Chapter 13 escrow issues. This article explains how one of these changes – a revised version of a proof of claim attachment form – actually added to the confusion instead of alleviating it, and how that confusion can be costly to servicers.
Official Form B410A
One of the changes was a new form attachment for mortgage proofs of claim effective December 1, 2011 – Official Form B10A (entitled “Mortgage Proof of Claim Attachment”). An accompanying revision to Bankruptcy Rule 3001 mandated use of Form B10A if a security interest is claimed on the debtor’s principal residence. Four years later, effective December 1, 2015, Form B10A was superseded by a new Official Form B410A (also entitled “Mortgage Proof of Claim Attachment”). Unfortunately, Form B410A often causes issues at the end of a successful Chapter 13 case.
Part 3 of Form 410A contains numerous line items to calculate the prepetition arrearage. They include amounts for “Escrow deficiency for funds advanced” and “Projected escrow shortage,” which the Official Instructionsmake relatively clear are the same amounts as “escrow deficiency” and “escrow shortage” as defined by RESPA in Regulation X, 12 C.F.R § 1024.17. The line item for “Principal and interest” must include only the principal and interest component of the missed prepetition payment and cannot include any escrow portion.
The Disconnect Caused by B410A
Unlike former Form B10A, current Form B410A does not allow a servicer to include the escrow component of the missed prepetition payments in the prepetition arrearage. Instead, escrow is severed from those missed prepetition payments and accounted for in the arrearage by including any escrow shortage/deficiency (or surplus) identified by a petition-date escrow analysis as a separate line item(s). Few, if any, servicing systems of record, however, allow a servicer to simply change the escrow amount of missed prepetition payments. Instead, those payments remain fixed after the bankruptcy case is filed and must be satisfied to advance the contractual due date of the loan. Simply put, the end result is that the servicer’s system of record requires one escrow amount to satisfy missed prepetition escrow payments, and Form B410A requires an escrow shortage/deficiency amount that is virtually never the same. This means that at the end of a successful Chapter 13 case, the mismatch of these two amounts presents a situation in which the debtor can never be precisely “current.”
As a hypothetical, suppose the borrower misses six $1,000 monthly payments each containing a required principal and interest component of $800 and a required escrow component of $200. This means he has missed $4,800 of prepetition principal and interest payments and a $1,200 of prepetition escrow payments. Further suppose that the petition-date escrow analysis recognizes an escrow shortage of $1,040. Part 3 of Form 410A will therefore include $4,800 for principal and interest and $1,040 for escrow in the prepetition arrearage, or a total amount of $5,840. The system of record, though, needs $6,000 to fully pay the six missed prepetition payments of $1,000 each. Holding numerous other variables constant for illustration purposes, this means that at the end of the Chapter 13 case the borrower will be $160 short of being current on his payments.
The Potential Financial Impact
At the end of a Chapter 13 case, upon completion of the Chapter 13 trustee’s repayment of the prepetition arrearage, she is required to file a “notice of final cure payment” pursuant to Bankruptcy Rule 3002.1(f). The servicer is then required to file a response pursuant to subsection (g) stating whether or not the debtor is current on his postpetition payments. In situations like the above hypothetical (which may involve “mismatch” amounts much greater than $160), the servicer will often simply bring the debtor current and waive the difference when performing reconciliation in preparation for a response. Less frequently, the servicer will respond that the debtor is not current but end up writing the difference off because of further debtor objection. Either way, bringing the debtor’s loan current when it is not in fact current often causes an actual monetary loss to the servicer. Over time, these losses of course add up.
This issue will become more and more common in the near future, as three-year Chapter 13 plans based on servicer proof of claims filed after December 1, 2015, approach their end date, and continue to be common so long as Form B410A remains in its present form. Servicing bankruptcy departments, specifically staff and management charged with responding to Chapter 13 trustee notices of final cure, must be aware of this issue. It is not difficult to compare the escrow amounts in the Form B410A with the sum of the missed prepetition escrow payments to determine if there is a substantial difference and whether or not the difference is contributing to a debtor’s delinquency at the end of a Chapter 13 case. Proper education of staff and management on this issue can directly assist servicers in avoiding substantial write-offs.