The Volokh Conspiracy - In re Nosek:

An important bankruptcy opinion just down from the 1st Circuit in In re Nosek. The issue in the case was the practice of the lender (Ameriquest), of crediting the debtor's payments under a chapter 13 plan to missed payments first before crediting them to currently due payments. This is Ameriquest's practice outside bankruptcy and it continued to do the same inside bankruptcy.

The debtor complained, arguing that this payment allocation system violated the bankruptcy code. The practical effect (simplified) of the allocation system was that it meant that the debtor's account never appeared to be current in Ameriquest's system. Nosek claimed that she was going to try to refinance her mortgage but was, or would have been unable to do so, because of Ameriquest's payment allocation system. She never actually submitted an application (in light of the fact that this was 2004 at the heyday of subprime refinance lending, she should probably be happy that she was unable to refinance!).

The bankruptcy court initially awarded Nosek $250,000 for pain and suffering from the experience under section 1322(b) of the bankruptcy code. On appeal the district court reversed, saying that for damages to be awarded the court would have to proceed under section 105. On remand, the banrkuptcy court again entered judgment for $250,000 for pain and suffering but then added $500,000 punitive damages against Ameriquest. The court relied on the holding that Ameriquest violated section 1322(b) as the predicate basis for the award of damages under section 105. The district court affirmed.

The 1st Circuit has now entered judgment reversing liability and thus the award of damages. This is a hugely important case, because as bankruptcies rise--especially for homeowners--the underlying practice in Nosek is likely to recur. Affirmance would have required lenders to change their payment posting policies in bankruptcy, either requiring them to adopt new rules that would apply equally both inside and outside bankruptcy or to have two different systems depending on whether a debtor is in bankruptcy. Obviously, affirmance of such huge damages would also have spawned a race to the courthouse to challenge Ameriquest's practices across the country and probably many other lenders that post payments differently from how the bankruptcy court wanted payments posted here. When I spoke at the Tidewater Bankruptcy Conference last January, we dedicated a good portion of our panel to a discussion of the bankruptcy court's holding in the case.

The court wrote:

Analyzing § 1322(b) with these background principles in mind, the bankruptcy court found that Ameriquest had violated the Bankruptcy Code by failing to adequately distinguish between Nosek's pre-petition arrearages and her ordinary post-petition mortgage payments. The court stated:

The system [Ameriquest] was using has design flaws that inevitably lead to a showing that [Nosek is] behind in her payments. It did not distinguish between pre- and post-petition obligations which contradicts with [sic] 11 U.S.C. § 1322(b) which provides for the curing of any default over the course of the plan, a plan which is binding on [Ameriquest]. . . .

With this language, the court implied that Ameriquest's accounting threatened Nosek's opportunity to cure her pre-petition default pursuant to § 1322(b) and the Plan. Ameriquest contests the bankruptcy court's conclusion that the company defied the text of § 1322(b). It argues that the language of § 1322(b) does not impose obligations on any party, let alone a lender. We agree. The plain language of § 1322(b), relied upon by the bankruptcy court to find a violation of the Code, does not impose any specific duties on a lender. It merely lists elements that a Chapter 13 debtor may include in her plan. Accordingly, there is no basis for concluding that Ameriquest violated the text of § 1322(b).

The court held that for there to be a violation of section 1322(b), the lender has to violate an express provision of the debtor's chapter 13 plan. That didn't happen here because neither the code nor Nosek's plan speaks to the issue of how payments should be posted to the debtor's account. So there was no violation of section 1322:

The Plan language says nothing about how Ameriquest must account for pre- and post-petition payments during the course of the repayment period if payments are short, late, or not made at all. Simply put, the terms of the Plan itself do not provide the specificity required to invoke the enforcement authority of § 105(a).

As the plaintiff alleging a violation of the Bankruptcy Code or a related court order, Nosek had the burden of establishing that her cure rights pursuant to § 1322(b) and the Plan were violated or at risk of being violated by Ameriquest's accounting practices. Yet the bankruptcy court concluded that Nosek had not shown any economic harm resulting from Ameriquest's accounting, whether in the form of late fees, finance charges, or an improper notice of default. In addition, the court also rejected Nosek's claim that the Payment History she received prevented her from refinancing her loan. Addressing this issue in the context of Nosek's various state law claims, the bankruptcy court found that any damages based on Nosek's inability to refinance her loan on more favorable terms "would be mere speculation." The court found that Nosek "did not provide a basis to award actual damages. No documents were offered as evidence of the proposed refinancing. No testimony was proffered refinancing was even offered; there was no evidence of the terms of a refinancing which [Nosek] could expect to receive."

Notwithstanding Nosek's failure to prove actual damages sufficient to sustain a Chapter 93A claim, the bankruptcy court concluded that Ameriquest's accounting practices violated Nosek's cure rights pursuant to § 1322(b) and her Chapter 13 Plan, providing a predicate for a damage award under § 105(a). In essence, the court found that Ameriquest's slowness in crediting Nosek's payments to the proper account and its failure to distinguish between pre- and post-petition payments constituted violations of the Bankruptcy Code and her Plan. This conclusion was erroneous. Although a debtor need not show proof of economic damages to establish that her cure rights have been violated, she must at least establish that her right to cure the pre-petition default provided by the Chapter 13 plan has been impaired or threatened by the creditor's actions. Nosek's subjective fear of such impairment, based on a document prepared by Ameriquest for internal purposes only, and in the absence of any evidence that the company regarded her as in default on the basis of its accounting practices, does not suffice. Indeed, Ameriquest stated that its internal records showed that Nosek was considered current in her payment history. The Payment History document, provided only to Nosek on her request and admittedly difficult to decipher, did not show to the contrary. Nosek offered no other documentation indicating that her cure rights were at risk.

The court concludes:

Notwithstanding these legal conclusions, we are not unsympathetic to Nosek's predicament as a debtor seeking to satisfy the terms of her Chapter 13 Plan and stave off foreclosure of her home. Her circumstances are all too common today.15 Given their prevalence, it is troubling that Ameriquest had not established a more efficient and accurate way of handling the accounting issues revealed by this case at the time of trial. We fully understand the bankruptcy court's concerns about the practices that it described.

Nevertheless, the bankruptcy court's legitimate concerns did not justify the remedy that it invoked. Nosek did not demonstrate here that Ameriquest's accounting practices caused her any economic harm or threatened her right to cure her pre-petition default. Morever, even if such a threat had been demonstrated by those practices, there was no language in Nosek's Plan, as it was confirmed, or in § 1322(b), that addressed how Ameriquest was to apply the payments it received from Nosek or from the trustee. Under such circumstances, the Plan would have to be amended to prescribe the accounting practices necessary to protect Nosek's right to cure before Ameriquest could be sanctioned for a violation of an order of the bankruptcy court. In the absence of such specificity, there was no violation of § 1322(b) or the Plan and therefore no basis upon which to award Nosek damages under § 105(a). Because the bankruptcy court's judgment in the adversary proceeding is vacated, the order confirming Nosek's Third Amended Plan, which was based on the erroneous damages award, also must be vacated.

Update:

I had an error in the facts when I originally typed this. I meant to say that Nosek claimed that she was unable to refinance as a result of Ameriquest's actions, rather than that she was unable. So she was not rejected for a refi; in fact, she never actually applied. I've corrected the text.

	[Todd Zywicki, October 8, 2008 at 11:29am] Trackbacks In re Nosek: An important bankruptcy opinion just down from the 1st Circuit in In re Nosek. The issue in the case was the practice of the lender (Ameriquest), of crediting the debtor's payments under a chapter 13 plan to missed payments first before crediting them to currently due payments. This is Ameriquest's practice outside bankruptcy and it continued to do the same inside bankruptcy. The debtor complained, arguing that this payment allocation system violated the bankruptcy code. The practical effect (simplified) of the allocation system was that it meant that the debtor's account never appeared to be current in Ameriquest's system. Nosek claimed that she was going to try to refinance her mortgage but was, or would have been unable to do so, because of Ameriquest's payment allocation system. She never actually submitted an application (in light of the fact that this was 2004 at the heyday of subprime refinance lending, she should probably be happy that she was unable to refinance!). The bankruptcy court initially awarded Nosek $250,000 for pain and suffering from the experience under section 1322(b) of the bankruptcy code. On appeal the district court reversed, saying that for damages to be awarded the court would have to proceed under section 105. On remand, the banrkuptcy court again entered judgment for $250,000 for pain and suffering but then added $500,000 punitive damages against Ameriquest. The court relied on the holding that Ameriquest violated section 1322(b) as the predicate basis for the award of damages under section 105. The district court affirmed. The 1st Circuit has now entered judgment reversing liability and thus the award of damages. This is a hugely important case, because as bankruptcies rise--especially for homeowners--the underlying practice in Nosek is likely to recur. Affirmance would have required lenders to change their payment posting policies in bankruptcy, either requiring them to adopt new rules that would apply equally both inside and outside bankruptcy or to have two different systems depending on whether a debtor is in bankruptcy. Obviously, affirmance of such huge damages would also have spawned a race to the courthouse to challenge Ameriquest's practices across the country and probably many other lenders that post payments differently from how the bankruptcy court wanted payments posted here. When I spoke at the Tidewater Bankruptcy Conference last January, we dedicated a good portion of our panel to a discussion of the bankruptcy court's holding in the case. The court wrote: Analyzing § 1322(b) with these background principles in mind, the bankruptcy court found that Ameriquest had violated the Bankruptcy Code by failing to adequately distinguish between Nosek's pre-petition arrearages and her ordinary post-petition mortgage payments. The court stated: The system [Ameriquest] was using has design flaws that inevitably lead to a showing that [Nosek is] behind in her payments. It did not distinguish between pre- and post-petition obligations which contradicts with [sic] 11 U.S.C. § 1322(b) which provides for the curing of any default over the course of the plan, a plan which is binding on [Ameriquest]. . . . With this language, the court implied that Ameriquest's accounting threatened Nosek's opportunity to cure her pre-petition default pursuant to § 1322(b) and the Plan. Ameriquest contests the bankruptcy court's conclusion that the company defied the text of § 1322(b). It argues that the language of § 1322(b) does not impose obligations on any party, let alone a lender. We agree. The plain language of § 1322(b), relied upon by the bankruptcy court to find a violation of the Code, does not impose any specific duties on a lender. It merely lists elements that a Chapter 13 debtor may include in her plan. Accordingly, there is no basis for concluding that Ameriquest violated the text of § 1322(b). The court held that for there to be a violation of section 1322(b), the lender has to violate an express provision of the debtor's chapter 13 plan. That didn't happen here because neither the code nor Nosek's plan speaks to the issue of how payments should be posted to the debtor's account. So there was no violation of section 1322: The Plan language says nothing about how Ameriquest must account for pre- and post-petition payments during the course of the repayment period if payments are short, late, or not made at all. Simply put, the terms of the Plan itself do not provide the specificity required to invoke the enforcement authority of § 105(a). As the plaintiff alleging a violation of the Bankruptcy Code or a related court order, Nosek had the burden of establishing that her cure rights pursuant to § 1322(b) and the Plan were violated or at risk of being violated by Ameriquest's accounting practices. Yet the bankruptcy court concluded that Nosek had not shown any economic harm resulting from Ameriquest's accounting, whether in the form of late fees, finance charges, or an improper notice of default. In addition, the court also rejected Nosek's claim that the Payment History she received prevented her from refinancing her loan. Addressing this issue in the context of Nosek's various state law claims, the bankruptcy court found that any damages based on Nosek's inability to refinance her loan on more favorable terms "would be mere speculation." The court found that Nosek "did not provide a basis to award actual damages. No documents were offered as evidence of the proposed refinancing. No testimony was proffered refinancing was even offered; there was no evidence of the terms of a refinancing which [Nosek] could expect to receive." Notwithstanding Nosek's failure to prove actual damages sufficient to sustain a Chapter 93A claim, the bankruptcy court concluded that Ameriquest's accounting practices violated Nosek's cure rights pursuant to § 1322(b) and her Chapter 13 Plan, providing a predicate for a damage award under § 105(a). In essence, the court found that Ameriquest's slowness in crediting Nosek's payments to the proper account and its failure to distinguish between pre- and post-petition payments constituted violations of the Bankruptcy Code and her Plan. This conclusion was erroneous. Although a debtor need not show proof of economic damages to establish that her cure rights have been violated, she must at least establish that her right to cure the pre-petition default provided by the Chapter 13 plan has been impaired or threatened by the creditor's actions. Nosek's subjective fear of such impairment, based on a document prepared by Ameriquest for internal purposes only, and in the absence of any evidence that the company regarded her as in default on the basis of its accounting practices, does not suffice. Indeed, Ameriquest stated that its internal records showed that Nosek was considered current in her payment history. The Payment History document, provided only to Nosek on her request and admittedly difficult to decipher, did not show to the contrary. Nosek offered no other documentation indicating that her cure rights were at risk. The court concludes: Notwithstanding these legal conclusions, we are not unsympathetic to Nosek's predicament as a debtor seeking to satisfy the terms of her Chapter 13 Plan and stave off foreclosure of her home. Her circumstances are all too common today.15 Given their prevalence, it is troubling that Ameriquest had not established a more efficient and accurate way of handling the accounting issues revealed by this case at the time of trial. We fully understand the bankruptcy court's concerns about the practices that it described. Nevertheless, the bankruptcy court's legitimate concerns did not justify the remedy that it invoked. Nosek did not demonstrate here that Ameriquest's accounting practices caused her any economic harm or threatened her right to cure her pre-petition default. Morever, even if such a threat had been demonstrated by those practices, there was no language in Nosek's Plan, as it was confirmed, or in § 1322(b), that addressed how Ameriquest was to apply the payments it received from Nosek or from the trustee. Under such circumstances, the Plan would have to be amended to prescribe the accounting practices necessary to protect Nosek's right to cure before Ameriquest could be sanctioned for a violation of an order of the bankruptcy court. In the absence of such specificity, there was no violation of § 1322(b) or the Plan and therefore no basis upon which to award Nosek damages under § 105(a). Because the bankruptcy court's judgment in the adversary proceeding is vacated, the order confirming Nosek's Third Amended Plan, which was based on the erroneous damages award, also must be vacated. Update: I had an error in the facts when I originally typed this. I meant to say that Nosek claimed that she was unable to refinance as a result of Ameriquest's actions, rather than that she was unable. So she was not rejected for a refi; in fact, she never actually applied. I've corrected the text.