The Availability of Sanctions Under Bankruptcy Rule 3002.1 for Noncompliance – the Second Circuit’s Decision in In re GravelThe Second Circuit’s August 2021 decision in In re Gravel, 6 F. 4th 503, has already received considerable attention and generated much debate over the last few months. Gravel involved the Vermont bankruptcy court’s initial entry of $375,000 in sanctions against a mortgage creditor based on the creditor’s inclusion of fees on a monthly mortgage statement – fees for which it did not file a notice under Bankruptcy Rule 3002.1(c) but that were not included in the “amount due” on the statement and – where the bankruptcy court had previously sanctioned the mortgage creditor for improper post-petition payment application. On motion filed by the Chapter 13 trustee, the bankruptcy court entered $300,000 in contempt sanctions for violation of its “deem current” orders at the end of two Chapter 13 cases, and $75,000 in sanctions in those two cases plus a third as “other appropriate relief” as provided in Rule 3002.1(i), the remedy provision. After the district court reversed and remanded, the bankruptcy court reduced the $300,000 contempt sanctions to $225,000 but re-entered the $75,000 sanctions for violation of Rule 3002.1(c). The Second Circuit then accepted the matter for direct appeal.

The Second Circuit reversed the bankruptcy court’s decision in a 2-1 panel decision. With respect to the $225,000 contempt sanctions, the majority found that the language of the deem current orders did not get give sufficient notice to the mortgage creditor that listing the fees on the monthly statements violated the language in the orders that the loans were current or constituted an “other proceeding” in which the mortgage creditor was barred from disputing the fees. With respect to the $75,000 sanctions awarded under Rule 3002.1(i) as “other appropriate relief,” the majority held that because the other specifically mentioned forms of relief in subsection (i) were compensatory, the phrase “other appropriate relief” should be read as allowing only compensatory relief, not punitive relief. The majority also noted that other provisions of the Bankruptcy Code specifically allow punitive damages whereas subsection (i) is silent, and rejected the bankruptcy court’s reliance on and analogy to Federal Rule of Civil Procedure 37’s discovery sanctions provisions, based on the distinction that Rule 37 protects the integrity the judicial process whereas Rule 3002.1 protects the debtor’s individual interests. Finally, the majority acknowledged that a bankruptcy court had inherent power to sanction parties who act in bad faith but noted that the bankruptcy court did not make a bad faith finding. The Chapter 13 trustee filed a motion for rehearing en banc, but it was recently denied.

The dissent was unusually strong and comprehensive. It offered several challenges to the majority’s logic and conclusions, challenges that other bankruptcy courts may find compelling.  Indeed, at least one bankruptcy court has already adopted the dissent and held that subsection (i) does allow punitive damages and sanctions for violation of the Rule In re Blanco, 4190170, at *26-27 (Bankr. S.D. Tex. Sept. 14, 2021).

Reasonable minds might disagree on the takeaways from Gravel, but here are a few, at least for future litigation in the Second Circuit. First, and most importantly, subsection (i)’s “other appropriate relief” remedy does not allow punitive sanctions. Second, upon a clear finding of bad faith, a bankruptcy court may impose punitive sanctions for violation of the Rule based on its inherent authority. Third, unless the bankruptcy court’s order is very clear in defining the act or omission enjoined or required with respect to noncompliance with the Rule, the party attempting to enforce the order and hold other parties in contempt for noncompliance will likely fail.

We would offer the following lessons for mortgage creditors from Gravel. First, mortgage creditors should ensure that their procedures remove any fees, expenses or charges that were assessed to the borrower during a Chapter 13 bankruptcy case but for which no Rule 3002.1(c) notice was filed – this after all is the root cause of the dispute in Gravel. Second, mortgage creditors should ensure that their bankruptcy counsel timely respond to notices of final cure filed by the Chapter 13 trustee under Rule 3002.1(f); responses are the proper way under the Rule to state the loan is not in fact current and flesh out any disagreements that may subsequently arise as to the loan status. Third, mortgage creditors should ensure that their counsel respond to motions to deem current and possibly object to any requested relief that goes beyond the subject loan being current at the end of the Chapter 13 case. It is certainly possible that some debtor attorneys will now request that “deem current” orders at the end of Chapter 13 cases are very specific as to prohibited acts and communications to get around the fair notice issues recognized in Gravel (and the U.S. Supreme Court’s 2019 decision in Taggart v. Lorenzen, 139 S. Ct. 1795). Fourth, mortgage creditors should be aware that in bankruptcy cases involving prior sanctions and contempt awards against them, a finding of bad faith becomes more likely when there is a second violation, and should ensure that they immediately receive and respond to allegations of second violations.