Judicial Conference Proposes Bankruptcy Rule Changes

On August 6, 2021, the Committee on Rules and Practice and Procedure of the Judicial Conference of the United States proposed changes to bankruptcy rules governing the conduct of various federal courts. The 327-page draft includes changes to three rules and creates a fourth one.  

The committee published the changes on the Federal Register for a comment period that began in August 2021 and closed this February. If no changes are made and the package is submitted to Congress by May 1, 2023, the rules will go into effect on December 1, 2023, in keeping with the usual two- to three-year approval process.  

Here is a brief summary of the proposed changes.

‍Restyled Parts III-VI

The Federal Rules of Bankruptcy Procedure have nine parts, each corresponding to the first digit in the rule (e.g. Part 3, FRBP 3002.1). The number restyling project began several years ago to ensure uniform construction, grammar, syntax, and organization across all nine parts. Limited to stylistic changes and not to a rule’s substance, the goal is to make the rules easier to interpret. This should lead to uniform understanding and consistent application.  

Changes to parts three through six include adding uniformity to capitalization style, removing legalese, using bolded fonts to assist in locating relevant rules, and discontinuing “up-style” (all caps) headings, which are hard to read.  

Parts seven through nine will be restyled in the same manner later in 2022 so that the committee can present a complete uniform, restyled ruleset in total to Congress by May of 2023. ‍

Rule 3002.1-Notice Relating to Claims Secured by an Interest in the Debtor’s Principal Residence

Rule 3002.1 contains noticing provisions designed to keep courts, trustees, and debtors informed about the status of a mortgage loan on the debtor’s principal residence – their home.  

‍Subpart (b) deals with payment change notices. The new rule changes subpart (b) to make it clear that a payment change notice that increases the payment must go to the debtor at least 21 days before the change is effective. The rule also modifies the current language to make a notice decreasing the payment effective as of the next payment date.  

Finally, the rule adopts a practice in many districts that allows for annual payment change notices for home equity lines of credit (HELOCs) or revolving accounts. The change makes it easier to comply with the rule when the interest calculation is based on daily simply interest and a moving balance rather than a fully amortizing loan, like most mortgages and deeds of trust.

This rule change marks a substantial departure. Creditors should rely on local counsel’s knowledge of trustee and court requirements to manage payment change deadlines. They should also continue to use the 21-day deadline as a management device for all payment changes. At the same time, creditors may want to allow filing with fewer than 21-days remaining when the payment decreases.

‍Subpart (e) is a little-used provision that limits to one year the objection period for a notice of postpetition fees and costs. The new rule adds a provision that allows the objecting party to request a shorter time period subject to court approval. However, this provision will likely be removed as superfluous because an objecting party could simply file the objection sooner without court approval.  

Proposed subpart (f) is new and causes current parts (f) through (i) to move up one letter in the alphabet. New subpart (f) is captioned “Trustee’s midcase notice of the status of a mortgage claim.” Part (1) sets the timing of any such notice at 18 to 24 months after petition date and requires using a new official midcase audit form for notices.  

‍Subpart (2) requires the creditor to file a response within 21 days, and subpart (2)(B) gives the trustee an option to compel a response if the creditor has not responded. Finally, subparts (2)(C) and (D) cover objections and the requirement for rulings on any such objections.

This controversial new rule was proposed by the American Banking Institute and the National Association of Chapter Thirteen Trustees as a response to what some in the bankruptcy system see as difficult or incorrect servicing practices. Their concern is specifically about inconsistent accounting practices or workarounds during bankruptcy. These often create additional time and work at the final cure stage, according to the interest groups’ comments.

While it might be tempting to believe that these interest groups all support creating a midcase audit, that’s not the case. Public comments from trustees and creditor groups highlight difficulties with the proposal and current Rule 3002.1.  

Concerns include increased costs to trustees and creditors; inconsistent use of the current rule; and the difficulty of coordinating new subpart (f) with current subpart (e), which is the notice of post-petition fees and costs. Notably, 68 of the roughly 130-plus standing trustees authored a comment explicitly opposing this rule.  

In addition, those trustees noted that when a debtor pays a mortgage directly, there is little or no purpose to requiring a trustee to audit a loan at the midcase point. That’s because the trustee has no way of knowing whether a debtor is making direct payments. Coupled with the very real cost of compliance, the trustees argued that the rule’s burden outweighed any benefit.

Finally, the new rule eliminates the notice of final cure in subpart (f) and creates a mandatory end-of-case motion in new subparts (g) and (h). As with new subpart (f), bankruptcy parties opposed this change as overly costly in direct-pay cases.

As drafted, the current rule is likely to be the subject of continued debate. Creditors are advised to pay attention to updates from local counsel concerning any changes to the rule before it’s transmitted to Congress in 2023. It is too soon to tell what the final form (if any) of the rule will take. ‍

Rule 3011-Unclaimed funds in Chapters 7, 11, 12, and 13 Current Rule 3011 pertains to unclaimed bankruptcy funds for all chapters except 9 and 15. The administrative burden of managing unclaimed funds falls on district court clerks, and the duration of that duty is extensive (more than 50 years in rare cases). The proposed rule changes require adopting or creating a searchable unclaimed funds database similar to what most states have now.  

It is unlikely that creditors will be affected by this rule change because accounting for debtor funds is a core function of their business model. In the rare case of “missing funds,” creditors may directly access any new searchable databases or engage local counsel to do so.

‍Rule 8003-Appeal as of Right-How Taken and Docketing the Appeal Current rule 8003 requires an appellant to specify which order or judgment a litigant is appealing. In cases where many issues, orders, or judgments are contained in a single document, the current rule creates additional work for judges and litigants. The proposed rule eliminates some of this ambiguity by loosening the requirements. It allows courts exercising federal appellate jurisdiction over bankruptcy matters more latitude to consider ancillary orders without the risk of losing jurisdiction over the entire appeal process. This rule is also supported by a change to Official Form 417A, the Notice of Appeal and Statement of Election.

Because appeals occur in a fraction of a percent of bankruptcy cases, creditors should continue to rely on local and appellate counsel for guidance should this change take effect.

Rule 9038-Emergency Orders This new rule provides explicit authority and guidance to judges for implementing emergency orders. Drafted in response to the patchwork of administrative orders pertaining to COVID-19, Rule 9038 has three main parts.  

‍Part (a) requires the Judicial Conference of the United States to declare an emergency before the rule can take effect. This part acts as a limit on the judiciary. Part (a) also narrowly defines emergencies as those relating to health or safety, or in the case of natural or manmade disasters, to physical or electronic access to bankruptcy courts.

‍Part (b) further constrains the rule’s geographic reach and requires the Judicial Conference to specify which districts or courts are affected. It also limits order duration to 90 days. Any such order may be renewed, modified, or rescinded on or before that termination date.

‍Part (c) promises to have the most impact on individual cases. Parts (c)(1) and (c)(2) allow for tolling – deadline extensions. Parts (c)(3) and (c)(4) set the default tolling period at 30 days and allow “fine-tuning” of deadlines affected by the rule. Part (c)(5) recognizes that Bankruptcy Rules are subordinate to enacted law and makes it clear that emergency orders may not enlarge or shorten time periods wholly contained in a federal statute.

Other than the shift from a local to a national locus of authority for emergency orders, the rule changes very little. Creditors should continue to rely on local counsel to manage deadlines in individual cases.

‍Conclusion The new rules package contains several changes that create new duties and potential costs for creditors. They include a new midcase audit and mandatory end-of-case motion practice, both of which represent new and increased costs to affected creditors. Creditors should monitor rule change progress through local counsel over the next 14 months to ensure that they are prepared should Congress approve some or all of the changes.

Please note that Ted Cahill is an MDK Alumni member.