Supreme Court Debt Collection Ruling Problematic, Attorneys Say

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By Diane Davis

The U.S. Supreme Court’s decision that debt collectors can file “stale” claims in bankruptcy without violating federal law may have raised more questions than it answers on issues like exposure to sanctions and malpractice claims.

Two bankruptcy attorneys, one focused on debtor’s issues and the other on the creditor side, examined implications of the court’s ruling in Midland Funding, LLC v. Johnson at a May 17 American Bankruptcy Institute webinar.

They found that there are areas of the decision that are confusing or where practitioners can disagree.

The May 15 decision “creates a lot of confusion and burden on the bankruptcy system” that didn’t exist before the opinion, Thad O. Bartholow, a partner with Kellett & Bartholow PLLC, Dallas, said. Bartholow primarily represents consumer debtors.

Bill Rochelle, ABI editor-at-large and panel moderator, agreed. He said the high court “opened up a can of worms” with this opinion, adding that these “thorny issues” may be the subject of future litigation.

Craig Goldblatt of WilmerHale, Washington, D.C., who represents secured creditors, financial institutions, and insurance companies, disagreed with Bartholow’s assessment, finding the court’s rationale behind the decision clear.

Justice Stephen G. Breyer, writing for the majority in Midland Funding’s 5-3 decision, held that the filing of a proof of claim that is obviously time-barred doesn’t violate the Fair Debt Collection Practices Act because it isn’t “false, deceptive, or misleading.”

A proof of claim is a document filed with the court stating the amount owed by a debtor to the creditor.

Justice Sonia Sotomayor, writing for the dissent, said that filing a stale claim is unfair and unconscionable. “Debt collectors do not file these claims in good faith; they file them hoping and expecting the bankruptcy system will fail,” she said.

Using Sanctions

Midland Funding “blows a hole for debt buyers to use the bankruptcy process in a completely unique way,” Bartholow said.

According to Bartholow, the debt-buying industry could bring up debts that are 20 or 30 years old, and that “scares him.”

Debtor’s counsel and Chapter 13 trustees need to be on their toes, he said.

U.S. trustees are already filing lawsuits against debt buyers and invoking Rule 11 sanctions to stop claims purchasers, Bartholow said.

Rule 9011(b) of the Federal Rules of Bankruptcy Procedure, the bankruptcy counterpart to Rule 11 of the Federal Rules of Civil Procedure, allows a court to sanction attorneys or parties who submit court documents for an improper purpose or that contain frivolous arguments or arguments that have no evidentiary support.

Bartholow said he’s seen some enforcement in this area.

The Supreme Court’s decision “ought to be the death knell of sanctions under Rule 9011,” Goldblatt said.

Both Bartholow and Goldblatt are actively involved in litigation of cases under the fair debt collections law.

Midland Funding says that proofs of claims in a bankruptcy case must be accurate and truthful, not false and misleading, Goldblatt said.

“Creditors filing them must show a ‘prima facie’ case for the claims and affirmative defenses that might be available,” he said. The ball is then in the debtor and trustee’s court to defend the claim, Goldblatt said.

A prima facie case is one that is “accepted as correct until proved otherwise.”

If a creditor comes into court and makes a prima facie case, then the claim can’t be false or sanctionable, Goldblatt said.

There was “no allegation at the pleading level” in court documents that Midland Funding knew it’s claim was time-barred when it filed its proof of claim, Bartholow said.

Debt collectors fall under the ambit of the FDCPA and are subject to “higher scrutiny,” he said.

“Debtors are worse off as a result of the decision, Bartholow said, agreeing with Sotomayor’s assessment.

There is a “risk of revival of debt,” he said. The payment of a time-barred debt by a trustee could be viewed as allowing the debt to “spring back to life,” Bartholow said.

Unanswered Question

The Supreme Court’s ruling answered only one question that was before it, Bartholow said. The court didn’t rule on whether the Bankruptcy Code impliedly repealed part of the FDCPA, he said.

Justice Sotomayor leaves this question open in her dissent, Bartholow said.

Goldblatt disagreed. The repeal question was “overtaken by events” and wasn’t a “live question anymore,” he said.

Breyer took care to distinguish between the concern over an individual in a civil suit that may be without counsel who gets intimidated by a lawsuit, and a debtor in the Chapter 13 bankruptcy process, Goldblatt said. The first individual might send a check to deal with an unfair debt collection practice, he said.

A debtor, who probably has counsel, invoked the bankruptcy court process himself, has a trustee appointed to his case, and can take advantage of the automatic stay in bankruptcy halting collection action, Goldblatt said. That individual doesn’t respond to the proof of claim with a check, he said.

More Malpractice Claims?

The decision may open up debtor’s attorneys or trustees who fail to object to time-barred claims to malpractice claims.

Bartholow said he was “terrified” by this prospect. It’s hard to know about all the debts in a debtor’s “universe,” he said. That lack of knowledge could expose him to malpractice claims, Bartholow said.

The Chapter 13 trustees who filed an amicus brief in Midland Funding said they “fund their operations from a percentage commission on payments under the plan,” according to their brief filed with the court.

“The reasonable expenses of the operation dictate the percentage (up to a cap), so the cost of the exercise Midland and other debt collectors demand affects the fee required to operate trustees’ offices. That fee is ultimately borne by the debtors who must pay a higher commission to the trustee and creditors who may receive smaller distributions as a result,” the brief states.

The issues addressed by the Chapter 13 trustees is a “policy matter” that can be looked at further, Goldblatt said.

There is a “crazy quilt of practice” among Chapter 13 trustees across the country with some objecting to all time-barred claims and others not objecting, Goldblatt said.

Bartholow agreed that there is a “disuniformity of practice among trustees.”

“Is the system properly suited to the Bankruptcy Code?” Goldblatt queried.

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

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

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