Stale Debt and the FDCPA: Unenforceable Does Not Necessarily Mean No Payment

Midland Funding, LLC v. Johnson, ___ U.S. ____, 137 S. Ct. 1407, 197 L. Ed. 2d 790 (2017) –

The question before the court was whether filing a bankruptcy proof of claim for a debt where the limitations period has run was a prohibited practice under the Fair Debt Collection Practices Act (FDCPA). Specifically, would the debt collector be making a “false, deceptive, or misleading representation,” or using an “unfair or unconscionable means” to collect the debt?

In this case a creditor filed a proof of claim in a chapter 13 bankruptcy case for credit card debt. The proof of claim included a comment that it had been more than 10 years since any charges appeared on the account. The applicable statute of limitations was 6 years, so the bankruptcy court disallowed the claim. The debtor then sued the creditor contending that the proof of claim violated the FDCPA. The district court dismissed on the basis that the FDCPA did not apply. However, the 11th Circuit reversed, and the creditor appealed to the Supreme Court.

The majority opinion of the court first addressed whether the proof of claim was “false, deceptive, or misleading.” The court reasoned that “claim” meant a “right to payment” which is usually determined by state law. Here state law provided that the creditor had a right to payment even after the limitations period expired so that the creditor no longer had a remedy for nonpayment.

The debtor argued that “claim” meant an “enforceable claim.” But the Bankruptcy Code does not use the term “enforceable” in defining a “claim.” If a debt is unenforceable, it will be disallowed, but that does not mean it is not a claim. A statute of limitations is an affirmative defense that must be raised by the debtor or trustee.

In considering whether filing a proof of claim for an unenforceable debt was misleading or deceptive, the court took into consideration the legal sophistication of the audience. In a chapter 13 case there is a trustee who is likely to understand the proof of claim process and the significance of the limitations period. Under the circumstances the court concluded that the proof of claim did not constitute a “false, deceptive, or misleading” representation.

The court next considered whether the proof of claim was “unfair” or “unconscionable,” noting that this was a closer question. The debtor argued that in ordinary civil actions courts have found that the practice of collecting a debt known to be time-barred is “unfair.” However, the Supreme Court again drew a distinction based on the nature of a bankruptcy case, including the presence of a chapter 13 trustee. A concern in civil cases is that a consumer might unwittingly pay a time-barred debt. In a chapter 13 case, a “knowledgeable trustee” is available, procedural rules guide evaluation of claims, and the claims resolution process is “generally a more streamlined and less unnerving prospect for a debtor than facing a collection loss suit.”

The debtor also argued that there was no legitimate reason to allow creditors to file claims in the hopes that no one would assert the affirmative defense of the limitations period. However, the court expressed concern that carving out an exception to the simple affirmative defense approach would be a slippery slope. Besides, bankruptcy proceedings are a special case involving a “delicate balance of a debtor’s protections and obligations” that would be upset by application of the FDCPA.

Accordingly, the Supreme Court reversed the 11th Circuit.

Justice Breyer wrote the majority opinion joined by Justices Roberts, Kennedy, Thomas and Alito. Justice Sotomayor wrote a dissenting opinion joined by Justices Ginsburg, Kagan and Gorsuch. The dissenting opinion framed the issue as follows: “Professional debt collectors have built a business out of buying stale debt, filing claims in bankruptcy proceedings to collect it, and hoping that no one notices that the debt is too old to be enforced by the courts. This practice is both ‘unfair’ and ‘unconscionable.'” The dissent closed by inviting Congress to clarify the FDCPA.

Given the 5-4 vote it will be interesting to see whether this decision survives intact. In a further twist, a few months later the Supreme Court unanimously decided that the FDCPA does not apply to a company that purchases and collects defaulted accounts originated by a third party – which undercuts the dissenting opinion analysis since this means that the “unfair” and “unconscionable” test would not be applicable to this practice.

Vicki R Harding Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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