Buyers and servicers of “stale,” or time-barred, debt have been watching the bankruptcy and appellate courts closely of late, as court after court has ruled on whether a key component of their recovery strategy – seeking payment related to such time-barred debts by filing proofs of claim in bankruptcy –€” violates the Fair Debt Collections Practices Act (FDCPA).
Indeed, some companies may even have modified their automated systems and instructed their employees to beware of the Eleventh Circuit after Crawford v. LVNV. Those buyers and servicers likely breathed a sigh of relief on May 15, when the Supreme Court held, in Midland Funding, LLC v. Johnson, that the filing of a proof of claim in a bankruptcy case with respect to an obviously time-barred debt is not false, deceptive, misleading, unfair or unconscion able within the meaning of the Fair Debt Collections Practices Act (FDCPA). While the Court’s 5-3 decision certainly provides some cover to creditors going forward, these proofs of claim should be filed with care.
The case comes after a circuit split, with the U.S. Court of Appeals for the Eleventh Circuit holding that filing a proof of claim based on a time-barred debt violates the FDCPA, and the U.S. Courts of Appeal for the Fourth, Seventh and Eighth Circuits reaching the opposite conclusion.
The underlying case involved a dispute between a debtor in a Chapter 13 case in the U.S. Bankruptcy Court for the Southern District of Alabama, and a creditor holding her 10-year-old credit card debt. In March 2014, the debtor filed her Chapter 13 petition. Midland Funding, LLC (Midland), filed a proof of claim in the debtor’s case with respect to the debt. This debt was well past Alabama’s six-year statute of limitations. The trustee objected to Midland’s claim, and the bankruptcy court entered an order disallowing the claim.
After the claim was disallowed, the debtor filed a lawsuit against Midland, alleging that Midland violated the FDCPA when it filed a claim for a debt that was so obviously time-barred. The district court granted Midland’s motion to dismiss the lawsuit. Specifically, the district court held that an irreconcilable conflict existed between the FDCPA and the Bankruptcy Code in that the Bankruptcy Code grants a creditor the right to file a proof of claim on a time-barred debt while the FDCPA prohibits a debt collector from taking action to collect such a debt. Given the irreconcilable conflict, the district court concluded that because the Bankruptcy Code was enacted after the FDCPA, the FDCPA must yield to the Bankruptcy Code.
On the debtor’s appeal, the Eleventh Circuit reversed, finding that there was no irreconcilable conflict between the FDCPA and the Bankruptcy Code: “[a]lthough the Code certainly allows all creditors to file proofs of claim in bankruptcy cases, the Code does not at the same time protect those creditors from liability.” The Eleventh Circuit concluded that a “particular subset of creditors â€” debt collectors â€” may be liable under the FDCPA for bankruptcy filings they know to be time-barred.” With its ruling, the Eleventh Circuit further entrenched the existing circuit split. Midland filed a petition of certiorari.
The Supreme Court
The Supreme Court reversed the Eleventh Circuit’s decision. The Court’s ruling rested primarily on two findings. First, the Court noted that the Bankruptcy Code’s definition of “claim” is the “right to payment,” as determined by state law, and is to be construed broadly under the Court’s ruling in Johnson v. Home State Bank. The term “claim” is broad enough to encompass a claim that is subject to a statute of limitations defense under state law.
Second, the Court reasoned that the Bankruptcy Code and the claims adjudication process provide a framework of protections for the debtors in bankruptcy that do not exist for debtors facing collections lawsuits, such that the creditor’s filing of a proof of claim in a bankruptcy case is not “unfair” or “unconscionable” under the FDCPA. Notably, however, within these findings the Court also provided some caged warnings for creditors.
A Proof of Claim for a Right to Payment Is Not Misleading or Deceptive
Justice Stephen Breyer, writing for the Court, noted that a “claim,” as defined by the Bankruptcy Code, is a right to payment. The creditor does not need to be able to enforce a debt under applicable non-bankruptcy law for it to be a claim â€” it just needs to be able to receive payment for that debt. Alabama state law, which applied to this debt, provides for a right to payment even after the statute of limitations has expired. Further, the Bankruptcy Code provides that the debtor may assert the running of the statute of limitations as an affirmative defense. The debt, therefore, is still a “claim,” and the proof of claim was not false. Midland did not file a proof of claim for something that was not a claim. That proof of claim was not misleading or deceptive.
Under the Court’s reasoning, creditors should ensure, prior to filing a proof of claim, that the debt in question still gives rise to a right to payment. The Court noted differences in state law that creditors should be mindful of. In the majority of states, including Alabama, the right to payment survives the statute of limitations, though the enforceability does not. Stale debt in those states still gives rise to a claim. But in some states, including Mississippi and Wisconsin, the right to payment is extinguished when the debt becomes time-barred. While the Court did not expressly hold that proofs of claim for debt governed by such state law would violate the FDCPA, creditors should be aware of the applicable laws and take appropriate care.
A Debtor in Bankruptcy Is Protected
The Court further noted that while a civil action to seek payment of a time-barred debt may be unfair or unconscionable under the FDCPA, the filing of a proof of claim is not. The Court reasoned that while a debtor defending a civil action may not know of the affirmative defenses available, the debtor in a Chapter 13 proceeding has several protections, including a streamlined adjudication process with a knowledgeable trustee at the helm. Additionally, at the end of the proceeding, adjudicated claims are discharged, and the debt is no longer just unenforceable â€” there is no more right to payment. The Court concluded that a proof of claim for time-barred debt, therefore, is not unfair or unconscionable.
As a practical matter, the Court’s holding on this point can, and should, be narrowly read to apply only to proofs of claim where the staleness is “obvious.” Indeed, several times the Court specifically stated that the proof of claim itself “on its face indicate[d] that the limitations period ha[d] run.” To be sure that the proofs of claim are not later found unfair or unconscionable, creditors filing proofs of claim for time-barred debt should provide sufficient information to allow the trustee and/or debtor to see clearly that the statute of limitations has passed. In fact, the Court concluded that a creditor’s “filing of a proof of claim that on its face indicates that the limitations period has run” is not “false,” “deceptive,” “misleading,” unconscionable” or “unfair” within the meaning of the FDCPA. Accordingly, creditors not providing such information may be opening themselves up to FDCPA actions.
One More Warning from SCOTUS, and Another from Texas
The Court ended its decision with a final note that creditors should take as a warning. The Court recognized that the Bankruptcy Court for the Northern District of Indiana has found the filing of a time-barred claim sanctionable where the creditor did not investigate the possibility of an affirmative defense before filing. The Court did not address whether creditors may be sanctioned for filing these proofs of claim under the Bankruptcy Rules. It only noted that creditors had been sanctioned for this conduct in at least one court. Creditors should be wary of filing their claims in this jurisdiction, and watch closely for courts following in these footsteps.
Finally, only a few days after the Court issued its decision in Midland Funding, the U.S. Bankruptcy Court for the Southern District of Texas refused to dismiss a class action lawsuit also involving a debt-buying defendant. In Jones v. Atlas Acquisition LLC, the plaintiff alleged a long-standing practice of filing proofs of claim not for stale debt, but for undocumented and invalid debt. The defendant allegedly systematically filed proofs of claim that either failed to contain documentation proving the existence of the claim, or that alleged the existence of a debt that was fictional. The bankruptcy court found it had jurisdiction over the matter. While the suit has not yet been adjudicated, it is clear from the allegations alone that debt buyers should protect themselves by showing through documentation that the claim is valid, even if it is time-barred. This litigation further indicates that, notwithstanding the Supreme Court’s Midland ruling, creditors should anticipate proof of claim-related litigation in which plaintiffs assert theories separate from the FDCPA.
Creditors buying and servicing stale debt may move forward and file proofs of claim for that debt, but should take care to heed all of the Court’s subtle warnings. Additionally, the creditors should recognize that these claims may be disallowed as part of the claims allowance process. Creditors should watch for additional objections to their claims as trustees are now on notice of this practice.
Chris Hawkins is a partner in the Birmingham, AL, office of Bradley Arant Boult Cummings, where he regularly advises financial institutions on bankruptcy compliance matters, bankruptcy-related regulatory issues, and bankruptcy-related litigation and enforcement matters. Karlene Archer is an associate in the firm’s Nashville office, and works with financial institutions, particularly mortgage servicers, on bankruptcy-related compliance and enforcement matters. They can be reached at email@example.com firstname.lastname@example.org, respectively
The views expressed in the article are those of the authors and not necessarily the views of their clients or other attorneys in their firm.