The U.S. Bankruptcy Court for the Eastern District of Pennsylvania recently held that a debtor alleged a plausible claim against a mortgage loan servicer under the federal Fair Debt Collection Practices Act (FDCPA) based on the servicer’s proof of claim filed after obtaining a foreclosure judgment.
Construing Pennsylvania law that the mortgage and note merge into a foreclosure judgment, the bankruptcy court held that the servicer potentially violated the FDCPA “by filing (or participating in the filing of) a proof of claim that ignored the existence of the foreclosure judgment and the merger doctrine,” “falsely characterized the legal status of the debt,” and “demanded payment of certain charges incurred post judgment (lender advances for taxes and insurance) that were not authorized by law.”
A copy of the opinion in Bernadin v. U.S. Bank N.A. (In re Bernadin) is available at: Link to Opinion.
The mortgagee obtained a foreclosure judgment against the debtor in 2015, but it did not proceed to foreclosure sale. In 2018, the debtor filed a Chapter 13 bankruptcy. The mortgagee filed a proof of claim listing the principal balance and interest due along with the fees and costs incurred for legal expenses, taxes, insurance, and other collectible charges under the mortgage and note.
The debtor sought to disallow the claim in whole or in part, asking the bankruptcy court to limit the mortgagee’s claim to the amount of the foreclosure judgment plus accrued interest. The debtor also alleged that the proof of claim violated the FDCPA.
The mortgagee and its servicer moved to dismiss. The bankruptcy court examined Pennsylvania’s merger doctrine, which provides that the terms of the mortgage and note merge into a foreclosure judgment. The bankruptcy court recognized an exception to the merger doctrine allowing a mortgage or note provision to survive merger “if it clearly evidences the parties’ intent to preserve the effectiveness of that provision post-judgment.”
After applying the exception to the mortgage and note here, the bankruptcy court allowed the mortgage to include its post-judgment legal expenses but not the post-judgment escrow advances. Concerning the debtor’s FDCPA claim, the bankruptcy court dismissed the claim against the mortgagee with prejudice, finding that the mortgagee was a creditor and not a debt collector. The bankruptcy court also recommended that the district court dismiss the debtor’s FDCPA claim against the servicer with prejudice because the mortgagee’s attorney filed the proof of claim on the mortgagee’s behalf without any allegation that the servicer participated in the filing.
The debtor asked the bankruptcy court to reconsider its ruling on the FDCPA claim against the servicer, arguing that the mortgagee’s attorneys filed the proof of claim using content “prepared or derived from information provided by [the servicer].”
Relying on Third Circuit law that “a debt collector may be held liable for unlawful collection activity carried out by another [debt collector] on its behalf,” the bankruptcy court reconsidered its ruling and determined that “if [the servicer] retained [the bankruptcy attorney] to assist in its servicing efforts by filing the POC … [the servicer] may be held liable if the filing of the POC violated the FDCPA.”
The bankruptcy court rejected the servicer’s position that the opinion of the Supreme Court of the United States in Midland v. Johnson precludes FDCPA liability arising from proofs of claim as a matter of law. As you may recall, the Supreme Court in Midland held that filing proofs of claim on time-barred debt could not violate the FDCPA in part because “[t]he [FDCPA] and the [Bankruptcy] Code have different purposes and structural features,” and “[t]o find the [FDCPA] applicable here would upset that ‘delicate balance.'”
The bankruptcy court construed the Supreme Court’s language supporting the servicer’s position as “dictum,” and it held that “there is no rigid, categorical bar against asserting an FDCPA violation based on conduct relating to the filing of a proof of claim in bankruptcy.”
The bankruptcy court therefore relied on Third Circuit precedent — in existence prior to the ruling of the Supreme Court in Midland v. Johnson — holding that “if a creditor can comply with both the Bankruptcy Code and Rules and the FDCPA, the creditor must do so.”
The bankruptcy court acknowledged that the required proof of claim forms lack “precision to account for cases in which the traditional concept of the ‘principal balance’ (and the additional charges accruing under the note and mortgage) have merged into a prepetition judgment,” but it concluded that creditors can nevertheless complete the required forms accurately without violating the FDCPA.
More specifically, the bankruptcy court advised that “when the [servicer] holds a prepetition judgment in mortgage foreclosure,” the servicer should “treat the judgment as the ‘principal balance’ as that term is employed in [the applicable proof of claim form].”
The bankruptcy court explained that “[f]unctionally, the monetary amount of the judgment is the new ‘principal balance’ of the debt: the judgment has capitalized all of the pre-foreclosure interest and charges that have been included in the judgment and post-judgment interest runs on this new principal balance, not the pre-judgment principal balance.”
“In addition,” the bankruptcy court noted, “the creditor may add to the principal balance/judgment amount any other charges that survived the merger of the note and mortgage into the judgment or that otherwise may be assessed in order to calculate the total debt.”
However, the bankruptcy court had previously found based on the mortgage language in this specific case — which corresponds to standard language in many mortgage instruments — that post-judgment lender advances for taxes and insurance did not survive the merger of the note and mortgage into the judgment.
Notably, the bankruptcy court emphasized that it had not determined the servicer necessarily liable under the FDCPA in connection with the proof of claim. Instead, the bankruptcy court “determined only that . . . [the debtor] has pled sufficient facts to state a claim against [the servicer] under the FDCPA.”