Supreme Court Rules Creditors May Pursue Claims for Stale Debt in Bankruptcy

With its recent opinion in Midland Funding, LLC v. Johnson, the Supreme Court has put to rest the question of whether or not filing stale claims violates the Fair Debt Collection Practices Act (“FDCPA”), determining that proofs of claim filed for stale debt do not violate the FDCPA. This is the latest development in an issue the New England Bankruptcy Law Blog has followed as it has migrated its way through the courts since last June.

According to Midland, shortly after Aleida Johnson filed for Chapter 13 bankruptcy relief, Midland Funding filed a proof of claim for outstanding credit card debt of approximately $1,800. On its face, the proof of claim stated that the last charge on the debtor’s account was made more than ten years prior to the bankruptcy filing—clearly outside of the relevant statute of limitations for enforcement under state law. (Although the relevant state law nevertheless permitted a creditor to receive payment on account of its stale claim.) After the debtor objected, the bankruptcy court disallowed Midland’s claim. The debtor then filed a lawsuit in the district court, seeking damages for violations of the FDCPA. The district court found that the FDCPA did not apply to filing proofs of claim; however, the 11th Circuit Court of Appeals disagreed and reversed the decision. Midland appealed the 11th Circuit’s decision to the Supreme Court. At issue was whether filing a proof of claim on account of a stale debt was “false,” “deceptive,” “misleading,” “unconscionable,” or “unfair” as those terms are used in the FDCPA.

Siding with the majority of courts that have ruled on this issue, the Supreme Court determined that filing a proof of claim on account of stale debt is neither “false,” “deceptive,” “misleading,” “unconscionable,” nor “unfair.” The Court rejected the debtor’s contention that “claim” under the Bankruptcy Code means “enforceable claim.” The Court further found it was “more difficult to square [the debtor’s] interpretation with other provisions of the Bankruptcy Code.” For example, in the definitions section in the Bankruptcy Code, the term “claim” includes claims that are disputed (by such affirmative defenses as statutes of limitations). 

The majority was also not persuaded by the debtor’s arguments that finding in favor of Midland would encourage debt collectors to buy up stale debts at steep discounts and then file proofs of claim in bankruptcy proceedings, hoping to fool careless trustees. In particular, the Court pointed to the relative sophistication of parties in bankruptcy—particularly the trustees—who are well equipped to challenge creditor claims when necessary.

The Court determined that it should leave the current system intact, in which creditors’ proofs of claim are prima facie evidence of the creditors’ claim but subject to challenge on account of affirmative defenses and otherwise. This would allow the bankruptcy system to weed out defective claims. And to rule otherwise would require a far greater examination of the claims process than the Midland case contemplated. For example, would a creditor need to assess the merit of all affirmative defenses to its claim prior to filing a proof of claim? 

The debtor and the United States, which had filed an amicus brief, had more traction with the dissent. Justice Sotomayor, joined by Justices Ginsberg and Kagan, wrote with concern that the majority’s ruling does nothing to stem the practices of debt buyers who are now seeking to take advantage of bankruptcy courts to be paid on stale debts because they are not able to do so in state courts. Because creditors’ rights to collect on time-barred claims vary from state to state, creditors should consult with counsel when preparing proofs of claim.

The majority appears to come to the right answer; but this may not be the end of the story.  The Court leaves the door wide open for debtors and trustees to seek sanctions under Rule 9011 against creditors trying to game the system. And the dissent suggests, rather strongly, that Congress should amend the FDCPA to specifically address attempts by creditors to collect on time-barred debt in bankruptcy. 

There’s more to come on the intersection of the Bankruptcy Code and the FDCPA, we are sure.  

Anthony Manhart is a Partner at Preti Flaherty and serves as Co-Chair of the Bankruptcy, Creditors' Rights and Restructuring Group. His practice focuses on bankruptcy and creditors' and debtors' rights, representation of Chapter 7 trustees and various parties in formal insolvency and collection proceedings and out-of-court workouts. He also serves on the Panel of Chapter 7 Trustees for the District of Maine.

Eleventh Circuit Decides Surrender Means Just That

In the recent opinion of In re Failla, the Eleventh Circuit ruled that when a debtor indicates in a Chapter 7 bankruptcy schedules case that she or he intends to “surrender” property subject to a secured claim, the debtor can’t renege on that commitment. The Court of Appeals therefore affirmed the bankruptcy court’s order requiring the debtors to cease opposition to a secured creditor’s subsequent foreclosure of the surrendered property.

The Faillas indicated in their Chapter 7 Statement of Intention that they intended to surrender their residence, which was worth less than the mortgage loan it secured. The Chapter 7 trustee then abandoned the property, and the mortgage lender commenced foreclosure proceedings. The Faillas, who were still living in the house, filed state court pleadings contesting the foreclosure. Rather than simply seeking bankruptcy stay relief and proceeding in state court, the mortgage lender sought relief in the bankruptcy court, asserting that the debtors had surrendered their rights to the property, and had no right to contest the foreclosure. The bankruptcy court agreed and entered an order directing the Faillas to cease opposition to the foreclosure, failing which the court would revoke their Chapter 7 discharge.

The district court affirmed the bankruptcy court’s ruling, as did the Court of Appeals. Taking a dim view of the Debtors’ behavior, the Court reasoned that a § 521 “surrender” was a relinquishment of the debtor’s rights in the property to the bankruptcy trustee and the creditor, and that if the trustee then abandons the property, the surrendering debtor must “get out of the creditor’s way.” Noting that a debtor should not be able to “undo his surrender” by opposing the foreclosure in state court after having obtained a discharge in bankruptcy, the Court stated that “[i]n bankruptcy, as in life, a person does not get to have his cake and eat it too.”

For any assistance with secured claims in bankruptcy cases, contact Preti Flaherty’s Bankruptcy, Creditors’ Rights, and Restructuring Practice Group.

Supreme Court to Rule on Stale Claims and FDCPA

As reported on our blog, the Eleventh Circuit ruled that filing a time barred proof of claim does not violate the Fair Debt Collection Practices Act, an issue which has divided courts and Courts of Appeals. The Supreme Court has granted certiorari in the case of Midland Funding LLC v. Johnson. (See here.)  Presumably, this will resolve the circuit split on the issue and provide guidance for creditors and debtors on this tough issue.

Stay tuned. We will report back after the Supreme Court rules.

For any assistance with filing claims in bankruptcy cases, contact Preti Flaherty’s Bankruptcy, Creditors’ Rights, and Restructuring Practice Group.