3rd Cir Says Escrow Cushion Pre-Petition Arrears To Be Included in BK Proof of Claim

The United States Court of Appeals for the Third Circuit recently held that the bankruptcy automatic stay prohibits a mortgage loan servicer from accounting for a pre-petition escrow shortage cushion in its post-petition calculation of future monthly escrow payments.


A copy of the opinion is available at: http://www.ca3.uscourts.gov/opinarch/092724p.pdf


Under the terms of bankruptcy petitioners' ("Borrowers") purchase-money mortgage, part of the monthly payment was to be paid into an escrow account to be used by the mortgage servicer to pay for taxes, insurance, and other charges as they became due. As permitted by the federal Real Estate Settlement Procedures Act ("RESPA"), 12 U.S.C. § 2601 et seq., the mortgage servicer required the Borrowers to pay an amount into the escrow account that was higher than required to cover the actual cost of taxes, insurance, and other charges.

The Borrowers subsequently filed for Chapter 13 Bankruptcy. At that time, the Borrowers had an escrow shortage exceeding $5,000, which included $1,787.69 which the servicer had included as part of its escrow cushion pursuant to RESPA but had not yet distributed for taxes, insurance, and other charges.

After the bankruptcy filing, the servicer issued a revised escrow analysis and a demand for payment which indicated that the servicer had increased the monthly escrow payment. Specifically, the servicer calculated the revised escrow payments presuming the escrow balance at the time of the Borrowers' bankruptcy filing was $0, and included specific line items of $210.65 for a '[s]hortage payment' as well as $87.02 for a "r]eserve requirement."

The servicer's proof of claim did not include the $1,787.69 escrow cushion that had not yet been disbursed or paid out on the Borrowers' behalf through the escrow account. The Third Circuit noted that the servicer 'did not seek to recoup the $1,787.69 cushion via the bankruptcy process, but rather by assessing the [Borrowers] higher post-petition monthly escrow payments to make up for the shortfall.'

The Borrowers filed a motion in the Bankruptcy Court to enforce the automatic stay pursuant to 11 U.S.C. § 362(a), compel the servicer to "cease post-petition collection of pre-petition escrow claims," and award the Borrowers attorneys fees and costs. The Bankruptcy Court denied the motion, and the District Court affirmed.

As you may recall, an automatic stay pursuant to 11 U.S.C. § 362(a)(6) "is applicable only to claims that arise pre-petition, and not to claims that arise post-petition." The Bankruptcy Code defines "claim" to mean the: "(A) right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured; or (B) right to an equitable remedy for breach of performance if such breach gives rise to a right to payment, whether or not such right to an equitable remedy is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured, or unsecured." 11 U.S.C. § 101(5).

Addressing Section 101(5), the Third Circuit first noted the United States Supreme Court's observation that the "language "right to payment" in the definition of "claim" meant "nothing more nor less than an enforceable obligation." " In addition, "Congress intended by this language to adopt the broadest available definition of claim." The Third Circuit noted that it had "endorsed this broad interpretation of the term "claim," overruling the narrow "accrual test"" previously established.

Relying on Campbell v. Countrywide Home Loans, Inc., 545 F.3d 348 (5th Cir. 2008), the Third Circuit held that the Borrowers' unpaid escrow shortage constituted a 'claim' under the Bankruptcy Code. The Court reasoned that "the terms of the Borrowers" mortgage establish that the obligation to pay into the escrow account was enforceable." Thus, the servicer 'had a claim for the unpaid escrow.' The Court further clarified that "the contingent nature of the right to payment does not change the fact that the right to payment exists, even if it is remote, and thereby constitutes a "claim" for purposes of § 101(5)."

The Third Circuit rejected the servicer's argument that 'forcing the Servicer to recoup the missed escrow cushion payments through the Chapter 13 plan improperly modifies the Servicer's rights under RESPA and 'Regulation X,' 24 C.F.R 3500.17.' The Court reasoned that "the principle of protecting the debtor from all efforts to collect pre-petition claims outside of the Chapter 13 structure takes precedence over the Servicer's other rights under RESPA to recalculate the escrow payments."

Having determined that the unpaid $1,787.69 escrow cushion should have been part of the servicer's proof of claim in the bankruptcy action, the Third Circuit remanded the matter for the lower court to determine whether the servicer had "willfully violated the automatic stay," and whether the Borrowers were entitled to damages per 11 U.S.C. § 362(k).

The dissenting opinion argued that the servicer's "pre-petition claim should be limited to the amounts actually disbursed." Quoting the Bankruptcy Court's opinion, the dissent reasoned that "a "right to payment," as incorporated in the statutory definition of 'claim' under 11 U.S.C. §101(5) implicitly encompasses a right of retention, which is not subsumed in the servicer's "right to collect" escrow items." Thus, the dissent noted that, "[a]bsent sums actually expended, as permitted under the loan documents to protect its own collateral interest, the Servicer need not include pre-petition escrow arrears in its proof of claim inasmuch as the mortgage instrument only permits the Servicer to retain such funds as reimbursement to the extent of actual advances. Otherwise, the Servicer merely collects and holds such funds for payment to third parties." This conclusion "is consistent with the Second Circuit's interpretation of "claim" in In re Villarie, 648 F.2d 810, 812 (2d Cir. 1981)."
The dissent also argued that "the majority fails to acknowledge that the Servicer acted in accordance with RESPA" and "never even tries to explain why RESPA is inapplicable." Rather, "under the majority's approach, it is difficult to foresee that any mortgage lender that seeks to recalculate escrow due in accordance with RESPA and Regulation X would not be in violation of the automatic stay." This approach, in effect, "abrogates RESPA."