This article explains why mortgagees should do their best to send escrow account information to the debtor during all phases of a Chapter 13 Bankruptcy proceeding.  The case discussed below demonstrates the consequences when this is not done and the Chapter 13 Plan has already been confirmed.

Most homeowners are familiar with escrow accounts.  In the context of a mortgage, this is the account maintained by the mortgage company for the payment of municipal taxes, and sometimes insurance, on the property of the homeowner. The monthly mortgage payment is usually comprised of principal, interest and an allotment for the escrow account toward payment of the municipal taxes. The municipal taxes are paid on a quarterly basis directly by the mortgage company to the municipality. It is in the interest of the mortgage company that this is done because it protects its interest in the property. The mortgage contract usually provides for the right of the mortgage company to collect and pay for the property taxes.  

 If the taxes or insurance premiums increase, so does the mortgage payment, and homeowners are notified beforehand of the increase. This notification is usually served through the annual escrow analysis statement and the forthcoming account statements. In addition, the municipality will also notify the homeowner.  The process runs smoothly until there is a default by a homeowner in the monthly mortgage payment, and they eventually file a Chapter 13 Bankruptcy Petition. 

Once the bankruptcy petition is filed issues over the escrow account inevitably surface.  These issues represent a substantial percentage of litigation within the bankruptcy.  They are also a frequent source of motions by the mortgagee for relief from the automatic stay because the debtor failed to receive or understand the notice of an escrow increase.  In certain instances, the mortgagee has been paying the increases for years without the debtor knowing or realizing it. A large accumulated escrow shortage can destroy the debtor’s chances of coming up with a feasible Chapter 13 Plan.

Mortgagees, however, are not without sympathy. Upon default by the debtor pre-petition, the mortgage note is accelerated and foreclosure ensues. The mortgage obligations of the parties are no longer in effect and the mortgagee often stops sending account statements or other information to the debtor.  Once the bankruptcy petition is filed, the mortgagee is even more reluctant to communicate directly with the debtor for fear of violating the automatic stay and being subject to monetary sanctions.

Chase Manhattan Mortgage Corp. v. Padgett, 268 B.R. 309 (S.D. Fla. 2001) is a recent case dealing with both the obligation of mortgagees to send escrow deficiency notices to the debtor and whether the sending of such notices constitutes a violation of the automatic stay. While Padgett deals with the mortgagee’s obligation in a post-confirmation context, mortgagees would be well served in sending escrow notices to the debtor during all phases of the Chapter 13 Proceeding.

The Padgetts were co-mortgagors who fell behind in their monthly mortgage payment to Chase Manhattan Mortgage Corp. (“Chase”) on their Florida homestead.  During January 1994, they filed a Chapter 13 Petition in order to cure the arrears and save the homestead from foreclosure.  During February 1994, they filed their Chapter 13 Plan.  Pursuant to the Plan, the Padgetts were to pay $11,131.69 in mortgage arrears over a period of forty-eight months, and $517.00 in regular monthly mortgage payments over the same period.

The Padgetts amended their Plan three times prior to confirmation.  During November 1994, the Padgetts filed their Third Amended Plan which provided that they would cure the arrears to Chase by paying $237.14 per month while, at the same time, remaining current with the post-petition monthly mortgage payment of $478.72.  During December 1994, the Bankruptcy Court confirmed the Third Amended Plan.

Beginning in 1996, the annual property tax and insurance premiums on the Padgetts’ homestead increased an additional $80.00 per month.  At the time of this increase, the Padgetts did not provide sufficient monthly payments to the escrow account to cover the increase in property taxes and insurance premiums. Chase continued to pay these increases on behalf of the Padgetts’ account as they became due.  Because of Chase’s fears of violating the automatic stay, it did not provide the Padgetts with separate notice of the current escrow deficiencies and advances.

In October of 1996, due to a default by the Padgetts in their monthly payments, Chase moved to dismiss the Third Amended Plan.  In response, the Padgetts filed a Fourth Amended Plan, which maintained the monthly mortgage payments at $478.72.  Chase failed to dispute the arrearage in this Amended Plan nor did Chase notify the Padgetts of any escrow deficiencies, advances or the need to increase the monthly mortgage payments to cover the increases in property taxes and insurance premiums going forward.

Finally, during October 1998, due to the increased payments in property taxes and insurance, Chase notified the Padgetts of an increase in mortgage payments from $478.21 to $561.94.  In November 1998, the Padgetts’ Amended Fourth Plan was confirmed.  The Plan provided that the mortgage payments going forward would be increased to $561.94. However, due to Chase’s failure to notify the Padgetts earlier, the Bankruptcy Court’s Order did not grant Chase the right to recover for its post-confirmation advances.  Chase subsequently filed an appeal contending that the Bankruptcy Court erred in holding that Chase waived its contractual rights under the mortgage to recover advances by its failure to notify the Padgetts of the increases.   

Legal Issues:

In its argument to the District Court, Chase maintained that because it possessed a security interest in the Padgetts’ homestead, the Bankruptcy Court, by holding that Chase waived its right to recover the advances, impermissibly modified Chase’s contractual rights. This, Chase argued, violated 11 U.S.C. §1322(b)(2).  This statute allows a Chapter 13 Plan to modify the rights of secured creditors, but provides an exception for mortgagees, such as Chase, who happen to hold a mortgage on a debtor’s personal residence.

The District Court, in affirming the Bankruptcy Court’s Decision, concluded that once the debtor’s Plan was confirmed the mortgage was reinstated between the parties.  This meant that the rights and obligations of Chase and the Padgetts under the mortgage were back in effect.  One of Chase’s obligations was to notify the Padgetts of any escrow deficiencies. By failing to notify the Padgetts of any escrow deficiencies, Chase had breached one of its obligations under the mortgage agreement.

In affirming the Bankruptcy Court Decision, The District Court, did not have to rely solely on the mortgage agreement. Since this was a federally related mortgage loan, it was subject to the Real Estate Settlement Procedures Act (“RESPA”).  RESPA provides that if a federally related mortgage loan requires the mortgagor to make payments to the mortgagee for deposit into an escrow account then the mortgagor must be given notice on an annual basis that there is an escrow funds shortage.