SCOTUS Struggles With Stale Debt Collection in Bankruptcy

Understand the complexities and nuances of the Bankruptcy Code to better advise clients and prepare for court.

By Diane Davis

The U.S. Supreme Court Jan. 17 questioned just how much leeway the debt buying and collection industry should have in the bankruptcy system to collect on stale debts (Midland Funding, LLC v. Johnson, U.S., No. 16-348, argued 1/17/17).

Federal appeals courts are split on whether it violates the Fair Debt Collection Practices Act to file a proof of claim in a bankruptcy proceeding on a debt that the debt collector knows is otherwise time-barred.

Permitting such conduct could potentially flood the bankruptcy system with meritless claims, to the detriment of creditors; but disallowing it might flood Article III courts with FDCPA claims, the parties argued.

Some on the court, like Justice Sonia Sotomayor, appeared to struggle with the veracity of the debt collector’s “business model.” But others, like Justice Stephen G. Breyer, appeared to struggle more with the possibility of two different courts deciding the same issue—the bankruptcy court, and an Article III court on the Fair Debt Collection Practices Act.

The court’s decision in the case will come before the end of June when the court finishes its session. While it is hard to predict how the court will rule, it is apparent that the debtor doesn’t have as clear of a case as one might think.

Need to Resolve Circuit Split

The case is on appeal from the Eleventh Circuit, which held that a debt collector violates the Fair Debt Collection Practices Act’s (FDCPA) prohibition against misleading or deceptive practices if the debt collector files a proof of claim on a time-barred or “stale debt” ( Johnson v. MIdland Funding, LLC, 2016 BL 164318, 823 F.3d 1334 (2016)).

The Supreme Court agreed to hear Midland Funding’s case to resolve a circuit split on whether filing a proof of claim in a bankruptcy proceeding on a debt that a debt collector knows is otherwise time-barred violates the FDCPA. The FDCPA prohibits debt collectors from “using any false, deceptive, or misleading representation or means in connection with the collection of any debt.”

Midland Funding is a debt collector that acquired debtor Aleida Johnson’s defaulted credit card debt.

Midland’s ‘Business Model’ Questioned

“Nothing in the Bankruptcy Code excuses a creditor from application of the FDCPA and there was no good argument today that it does,” G. Eric Brunstad, senior research scholar at the Yale Law School, a partner at Dechert, and an adjunct professor of Law at New York University, New York, told Bloomberg BNA via e-mail after oral argument. Brunstad has argued 10 cases before the Supreme Court and filed an amicus curiae brief in support of the debtor.

“The filing of a proof of claim is an act to collect a debt. Of course, the ordinary rules that govern debt collection activities apply, including the FDCPA,” Brunstad said.

“Justice Sotomayor summed it up best when she commented that it was quite a business model for a creditor to be able to file a stale proof of claim and then, when the creditor is caught doing something it is not supposed to be doing, simply withdraw its claim to avoid a sanction,” Brunstad said. “Application of the FDCPA is necessary to curb the abuse,” he said.

Sotomayor pressed Kannon K. Shanmugam, Williams & Connolly LLP, Washington, who represented petitioner Midland Funding, whether they had a good faith basis to believe that the statute of limitations wasn’t applicable.

Midland didn’t believe that it was legally required to do an “exhaustive inquiry,” Shanmugam responded. He also noted that there was no record on this issue.

Sotomayor said she was “confused” by Midland’s argument that just because the Bankruptcy Code anticipates that some people will file unenforceable claims proves that the Code “invites unenforceable claims?”

Justice Elena Kagan asked counsel for a more “common sense” approach. She asked Shanmugam “why would anybody want these proofs of claim to flood into the bankruptcy system?”

According to Shanmugam, Congress “consciously put the burden on the trustee and other parties in interest in the Bankruptcy Code. The trustee or the debtor or any other party in interest can come in and object and the issue can be litigated,” he said.

Looking at Practicalities

Calling it a “practical question,” Justice Samuel A. Alito Jr. asked both Shanmugam and Daniel L. Geyser, Stris & Maher LLP, Dallas, who represented the debtor, why wouldn’t a trustee just automatically object to anything that is over the statute of limitations? Alito seemed to be more concerned with details concerning trustees in a bankruptcy case.

Geyser responded that the cost of objecting is sometimes more than the benefit of excluding the claim. These are “nuisance-value” claims, Geyser said. He also explained that according to the National Association of Bankruptcy Attorneys it takes two to three hours to do all of the paperwork to object and serve the parties. The trustee in the Middle District of Alabama processes between 6,000 and 7,000 claims a month, Geyser said. To review the claims, “they would have to review a claim every two minutes for 365 days a year,” he said.

Geyser also pointed out that, especially in Chapter 13 cases, trustees assume that creditors are acting in good faith. The trustee doesn’t know what the creditor is thinking and may not object if he thinks the creditor may have some basis for tolling the statute of limitations, he said.

“Midland wouldn’t file these claims if the system actually functioned the way that Congress intended,” Geyser argued.

A ‘Difficult Case.’

Alito said he found this a “very difficult case,” especially if the debtor’s representation of Midland’s business model is correct because it doesn’t seem that it has “much, if any, social utility.”

On the other hand, Alito said he had trouble fitting the debtor’s argument into the concept of an affirmative defense. "[A]n affirmative defense was a rule of law that may allow the defendant to prevail if the defendant asserts the defense. But you want to switch—you’re switching that over to the side of the plaintiff or the person filing the claim,” Alito said to debtor’s counsel.

Two Court Cases, Plus Sanctions?

The debtor has a “good argument,” Breyer said, but it was “worrying him” that there are two sets of courts—one with the power to sanction—and the other an Article III court, which “presumably will automatically give $1,000 per violation, … plus attorneys’ fees, plus costs.” According to Breyer, "[w]e want bankruptcy matters decided in a bankruptcy court.”

Congress designed the FDCPA for remedies for professional debt collectors who are “inventive” and “impose heightened risks,” according to Geyser.

If the states were so worried about that, why don’t all states do what two do—if the statute of limitations runs, the debt is forever barred? Justice Anthony M. Kennedy queried.

Chief Justice John G. Roberts Jr. wanted to know where you litigate the issue of good faith.

Good faith would be litigated in an FDCPA lawsuit, Geyser said. Given the speed of the proof of claims process in the bankruptcy court, the “odds” are that the objection would be adjudicated before the FDCPA suit is far underway, which is what happened in this case, according to Geyser.

Bankruptcy System Not Working

This case is “as much about abuse of bankruptcy as it is about a violation of the FDCPA,” Sarah E. Harrington, Assistant to the Solicitor General, Department of Justice, Washington, D.C., who represented the United States as amicus curiae, told the court.

The one thing everyone agrees on in this case is that “if the bankruptcy system works as Congress intended, 100 percent of time-barred claims will be disallowed,” Harrington said.

Kagan asked Harrington to take the viewpoint that under the Code, these kinds of claims, although unenforceable, can be filed and wanted to know what follows from that?

Harrington agreed it would not be unfair then. It’s “unfair” in this case, Harrington said, because the creditor doesn’t have a right to get paid in bankruptcy on this type of claim. It’s also “misleading,” she said, because “when you file a proof of claim under Rule 9011 you’re making an implicit representation that you have done a reasonable investigation and have a good faith basis for believing that the claim is warranted.”

Midland’s Rebuttal: ‘Recipe for Clogging Courts.’

The court should be “concerned about the breadth” of the debtor’s position, Midland Funding argued in its rebuttal. A holding in the debtor’s favor would be a “recipe for clogging the courts with these sorts of FDCPA claims,” Shanmugam said.

If there is a problem with the operation of the bankruptcy system, “it’s a problem that Congress or the advisory committee are the best situated to remedy,” Shanmugam argued. One solution would be for Congress to shift the burden of the limitations defense back to the creditor, he said.

Kannon K. Shanmugam of Williams & Connolly LLP, Washington, D.C., represented petitioner Midland Funding, LLC.Daniel L. Geyser of Stris & Maher LLP, Dallas, represented respondent Aleida Johnson.Sarah E. Harrington, Assistant to the Solicitor General, Department of Justice, Washington, D.C., represented the United States as amicus curiae.

To contact the reporter on this story: Diane Davis in Washington, D.C. at DDavis@bna.com

To contact the editor responsible for this story: Jay Horowitz at JHorowitz@bna.com

For More Information

The written transcript of the oral argument is available at: https://www.supremecourt.gov/oral_arguments/argument_transcripts/2016/16-348_2cp3.pdf

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