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Court Holds that Bankruptcy Judges Cannot Impose Punitive Sanctions

Bankruptcy courts lack the power to impose serious punitive sanctions, a federal district judge ruled recently in PHH Mortgage Corporation v. Sensenich, 2017 U.S. Dist. LEXIS 207801 (D. Vt.  Dec. 18, 2018). Judge Geoffrey Crawford reversed a bankruptcy judge’s ruling that had imposed sanctions against a creditor based on Rule 3002.1(i) of the Rules of Bankruptcy Procedure, the bankruptcy court’s inherent authority, and Bankruptcy Code section 105.

The sanctions were awarded in three cases where debtors had to make mortgage payments pursuant to chapter 13 plans.  The mortgage servicer had billed the debtors for fees that the bankruptcy trustee asserted were improper. At a trustee’s request, the bankruptcy court imposed sanctions against the servicer of $375,000: $25,000 for each case under Rule 3002.(i) and $300,000 total for violations of court orders under its inherent powers and section 105. 

Rule 3002.1 permits bankruptcy courts to provide relief to debtors when mortgage creditors fail to disclose certain fees and charges. Rule 3002.1(i) allows courts to remedy violations of certain provisions of Rule 3002.1 by (among other things) “award[ing] other appropriate relief, including reasonable expenses and attorney’s fees caused by the failure.” Whether Rule 3002.1 authorizes punitive sanctions was a matter of first impression. Neither the parties nor the court had found a case where a bankruptcy court had invoked the rule to support sanctions in this manner.

Judge Crawford reasoned that, because Rule 3002.1 is a procedural rule, it cannot enlarge the substantive authority of the bankruptcy courts. If bankruptcy courts do not have the substantive authority under statute and case law to issue punitive sanctions, then a mere procedural rule cannot alter the lack of substantive authority. The court thus concluded that the question under Rule 3002.1(i) was reducible to the question under a bankruptcy court’s inherent powers and section 105.

Judge Crawford observed that “the inherent authority of bankruptcy courts to craft orders to their mission has long been recognized.” 2017 U.S. Dist. LEXIS 207801, at *14–15 (citing In re Kalikow, 602 F.3d 82, 96 (2d Cir. 2010)). Such inherent authority is embedded in section 105, which authorizes bankruptcy courts to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of the Bankruptcy Code.” Judge Crawford recognized a broad consensus among the federal courts of appeals that section 105 permits bankruptcy courts to impose compensatory sanctions. But those appellate courts differ on whether bankruptcy courts can impose punitive sanctions.

Faced with no Second Circuit authority directly on point, Judge Crawford invoked the reasoning of the Ninth and Fifth Circuits in concluding that bankruptcy courts lack the authority to issue such sanctions. The Ninth Circuit has held that the bankruptcy courts lack authority to impose “serious” punitive sanctions, arguing that such sanctions are not “necessary” because other non-punitive sanctions are available. In re Dyer, 322 F.3d 1178, 1193 (9th Cir. 2003). The Fifth Circuit reached the same conclusion, relying on constitutional questions about the permissibility of punitive sanctions issued by non-Article III judges. In re Hipp, Inc., 895 F.2d 1503 (5th Cir. 1990). Here, given the size of the sanctions awards, Judge Crawford concluded that they were a “serious” and impermissible punitive sanction and therefore vacated them.

Finally, Judge Crawford said his ruling does not mean that “bankruptcy litigants are free to engage in contemptuous conduct with impunity.” He noted that a bankruptcy court is “a unit of the district court.” 28 U.S.C. § 151, such that “the district court retains the authority to impose punitive sanctions for criminal contempt before the [b]ankruptcy [c]ourt . . . .  Should the [b]ankruptcy [c]ourt determine that the exercise of that authority would be appropriate, it may refer the matter to the district court.” 2017 U.S. Dist. LEXIS 207801, at *24–25 (citation omitted).