By KatieDickinson, Esq.

BWW Law Group, LLC*

USFN Member (DC, MD, VA)

            Banks, mortgage servicers, and other professionals and institutions in the mortgage lending industry are familiar with the provisions of Regulation Z of the Truth in Lending Act (“TILA”) concerning periodic statements for mortgage loans, contained in 12 C.F.R. § 1026. For a few special types of mortgage loans, however, there are lingering misconceptions about certain exemptions contained in Regulation Z. As defaults and foreclosures have increased with the end of the Covid-19 moratorium, consumer attorneys are scouring their clients’ mortgage loans for any noncompliance with federal laws and regulations. This heightened awareness in both default and bankruptcy contexts makes it an ideal time to review internal procedures for best practices and to improve them wherever possible.

This article discusses two exemptions with especially thorny implications which create opportunities for improvements: the exemption for loans in bankruptcy and the exemption for charged-off loans. These exemptions, though significant, apply under relatively narrow circumstances, which has caused considerable confusion and, in many cases, failure to fully comply with the Regulation.

The Bankruptcy Exemption Is Extremely Limited

The periodic statement requirements for consumers who are in active bankruptcy cases or whose personal liability was previously discharged in bankruptcy (referred to throughout this article as “debtors”) have created particular problems for servicers. As is evident in Freedom Mortgage Corporation’s recent victory in the United States District Court (Freedom Mortgage Corp. v. Dean, 647 B.R. 789 (2023)), even perfectly compliant periodic statements can result in costly litigation. Many servicers are under the impression that the requirement to send periodic statements to debtors is waived entirely; however, the bankruptcy exemption under section 1026.41(e)(5) only applies to loans with debtors meeting one of the following criteria:

1.     The debtor has requested the servicer stop sending periodic statements;

2.     The debtor’s bankruptcy plan either (a) surrenders the property; (b) strips the lien; or (c) otherwise does not provide for payment of the mortgage arrearage or post-petition payments;

3.     The bankruptcy court either (a) grants the servicer’s motion for relief from the automatic stay; (b) enters an order approving a lien strip; or (c) requires the servicer to stop sending statements to the debtor; or

4.     The debtor files a statement of intention to surrender the encumbered property AND the debtor has not made any partial or periodic payments after the commencement of the bankruptcy.

This means that if a debtor makes a single post-petition payment and the Chapter 13 Plan makes some provision for payment of any arrearage, the foregoing exemption is not triggered and the requirement to send periodic statements remains in effect. Over the course of the bankruptcy case, this would only change if the debtor amended the Plan in such a way that it met one of the criteria above or if the bankruptcy court granted the servicer relief from the automatic stay. Furthermore, if a debtor did fall into one of these categories at some point in the bankruptcy case and the servicer had properly suspended sending periodic statements under section 1026.41(e)(5), if the debtor subsequently requests that the servicer resume sending periodic statements (or reaffirms personal liability on the loan), the requirement springs back into effect upon the request or reaffirmation. Note that section 1026.41(e)(5)(iii) permits servicers to require such requests to be directed to a specific address, as long as the consumer is notified “in a manner that is reasonably designed to inform the consumer of the address.”

            Modified Statement Requirements for Loans in Bankruptcy

If the mortgage loan does not fall into one of the four (4) exemption categories under section1026.41(e)(5), the Regulation requires servicers to modify the statements to include certain additional information upon a consumer filing for bankruptcy or receiving a discharge of personal liability for the mortgage loan in bankruptcy. Under section 1026.41(f), while the periodic statement may omit certain information which would have been required absent the bankruptcy or discharge, each periodic statement must now disclose all of the following activity that has occurred since the last periodic statement the servicer issued:

1.     Each post-petition payment received, and the total amount of all such payments received;

2.     Each pre-petition payment received, and the total amount of all such payments received;

3.     Post-petition fees and charges; and

4.     Payments of post-petition fees and charges.

Each statement is also required to disclose the current balance of the debtor’s pre-petition arrearage and the total of all pre-petition payments received since the beginning of the debtor’s bankruptcy case. Finally, the Regulation requires inclusion of a series of bankruptcy-specific disclosures in each periodic statement listed in section 1026.41(f)(3)(vi).

            Compliance with section 1026.41(f) requires servicers to identify all mortgage loans that are subject to these modified requirements and ensure the associated periodic statements contain the necessary disclosures and data. At the same time, for the data included to remain current and accurate, servicers must properly apply each payment received from the borrower and the bankruptcy trustee. As servicers have experienced, this can pose a substantial challenge, since borrowers in bankruptcy frequently miss payments (whether to the servicer or to the bankruptcy trustee) and amend their Chapter 13 plans to alter the arrearage and payment schedule. Of course, servicers already have internal procedures in place to address fluctuating trustee payments and pre-petition arrearages and to monitor the loan for any lapse in post-petition payments, which could necessitate a request for relief from the automatic stay. Nevertheless, because the nature of a bankruptcy case places the borrower and servicer in somewhat adversarial postures, providing these internal numbers to the borrower (and, by extension, the borrower’s bankruptcy counsel) on a monthly basis creates frequent opportunities for conflict where it might not otherwise arise.

            Charged-Off Loans and Dormant Second Mortgages

            Though less complex, the exemption for charged-off loans under section 1026.41(e)(6) may also create trouble for servicers, particularly in the current residential housing market. A servicer is relieved from the obligation to send periodic statements if the servicer:

(i)              Has charged off the loan in accordance with loan-loss provisions; and

(ii)            Will not charge any additional fees or interest on the account; and

(iii)          Provides, within thirty (30) days of charge off or the most recent periodic statement, a periodic statement clearly and conspicuously labeled “Suspension of Statements & Notice of Charge Off – Retain This Copy For Your Records.”

If a servicer complies with the foregoing but later fails to treat the loan as charged off or charges any additional fees or interest on the account, the servicer must resume sending periodic statements to remain compliant with the Regulation and may not retroactively assess fees or interest for the period of time during which the exemption applied. This has become significant recently because of the increase in foreclosures on dormant second mortgages; that is, loans held subject to one or more senior mortgages, which were long considered uncollectible because of a lack of equity in the secured property but are now being transitioned to foreclosure status because of the sharp escalation in home values. This practice has come under special scrutiny among consumer attorneys, in the press, and even before Congress. Because of this increased visibility, problems may arise if servicers take steps to accelerate and foreclose on mortgage loans that have been treated as exempt under section 1026.41(e)(6) when they have failed to resume sending periodic statements for those loans to the consumers.

            Liability and Damages

            There is potential liability under both TILA and the Real Estate Settlement Practices Act (“RESPA”) for failure to comply with Regulation Z, but it is severely limited. A consumer who files a civil action for a knowing violation under TILA section 108 is entitled to actual damages, including charges and interest that could have been avoided, claims for emotional distress, and attorneys’ fees. However, there is a one-year statute of limitations for such actions, which begins to run on the date the violation occurred. RESPA provides for additional statutory damages of $2,000.00 for violations, but only if a servicer displays a pattern or practice of noncompliance (12 U.S.C. §§ 2605(f)(1) & (f)(3)).  Despite the short statute of limitations and the narrow circumstances under which statutory damages are available, class action litigation is not off the table and has actually been initiated against certain entities.

            Final Thoughts

Despite relatively limited statutory liability, consumer attorneys are becoming more interested in identifying these violations as a way of interrupting foreclosures, which may increase costs, liability, and other types of exposure. Servicers need to understand the exemptions and modifications to the periodic statement requirements under Regulation Z and the potential liability for failing to comply, while recognizing that perfect compliance may impose an additional burden and create commensurate costs. Even servicers that implement exemplary procedures may experience errors on their periodic statements. But it remains prudent to make best efforts to comply, as independent, accidental errors presumably will not rise to the level of a ‘knowing’ violation or a pattern of noncompliance. In the current climate, every lending institution and mortgage servicer should examine its periodic statement practices for opportunities to minimize liability exposure.

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