Debt buyers can file time-barred claims with impunity in chapter 13 cases.
By Columbia – Lexington Bankruptcy Attorney Lex Rogerson
In a big win for the debt-buying industry, the U.S. Supreme Court has held that companies that buy debts the original creditors could not collect do not violate the Fair Debt Collection Practices Act by filing bankruptcy claims that are barred by the statute of limitations.
The opinion, issued on May 15, leaves the bankruptcy claims allowance process as the only the available check — and an imperfect one, at that — on collection of time-barred debt in bankruptcy cases. Midland Funding, LLC v. Johnson.
Who are debt buyers?
Let’s say John has fallen far behind on his Visa card with Citibank and now owes $10,000. Citi has given up on trying to collect from him and written off the debt. But the debt doesn’t just disappear, and for at least a while, it could conceivably still be collected.
In steps Midland Funding (or one of its competitors). Midland is willing to pay Citi $400 for the right to collect from John. It’s betting it can get John to pay a lot more than that — and it’s willing to use all kinds of tactics, legal or not. Citi is glad to get a little return on this loss. And if Midland can get John to pay a quarter of the amount owed, it makes a profit of over $2,000.
In practice, debt buying doesn’t happen at this individual level. Major creditors sell bad debt in bundles of thousands of accounts at a time, almost always at literally pennies on the dollar. Inevitably, those bundles include debt that is disputed, is too old to collect, or has already been paid.
Unfair or unconscionable?
The FDCPA makes it illegal for collectors to use any “false, deceptive, or misleading representation” or any “unfair or unconscionable means” to collect a debt. A collector who uses such tactics can be required to pay actual and statutory damages, plus the consumer’s attorney fees.
The law of each state contains a statute of limitations that gives a creditor a certain maximum time — typically three to six years — to collect a debt in court. If the creditor files after that period, the court must dismiss its claim.
Every court that has considered the issue has determined that filing suit on an obviously time-barred debt violates the FDCPA. These courts have stressed that most consumers who get sued do not take the trouble and expense to respond. As a result, the creditor or collector ends up with a default judgment against the consumer that should never have been entered. So when a collector attempts this tactic, its conduct is unfair and unconscionable.
Why should the result be different when, instead of suing in state court, the collector files a claim in bankruptcy court? This is where the Court wandered onto thin ice.
A bad claim is still a claim
Writing for the Court majority, Justice Stephen Breyer pointed out that a statute of limitations removes the remedy for a debt but does not extinguish the creditor’s right to payment. Stated differently, age does not make a debt go away; it just prevents the creditor from enforcing it by a lawsuit. But the Bankruptcy Code and rules permit a creditor to file a claim, and that right is not limited to enforceable claims. So the creditor is within its rights to file the claim, even if it is stale.
Besides, Breyer continued, chapter 13 trustees can object to claims that are not enforceable. If they are stale, bankruptcy courts will presumably disallow them in a very simple process.
Three dissenting members of the court, led by Justice Sandra Sotomayor, pointed out the system rarely works that way. To begin with, debt buyers buy billions of dollars worth of time-barred debt, paying the original creditors as little as two cents on the dollar. Then they flood the bankruptcy courts with thousands of claims. Chapter 13 trustees simply cannot review all these claims for timeliness.
From the view of one who works in the system every day, Sotomayor is right. To begin with, chapter 13 debtors and their lawyers typically have no reason to object to unsecured claims. And aside from the noble goal of preserving the available plan funds for valid claims, trustees have little practical incentive to screen for stale claims. Even if they do, the claim itself may not reveal that it is barred. So stale claims routinely end up being paid.
Winners and losers
Getting paid on unenforceable claims is basic to the business model of debt buying companies. When you pay 2 cents for a widget on which you can collect 5 cents, you’re ahead of the game.
As pointed out in a prior article, the Court’s decision will have little effect on chapter 13 debtors, whose plan payments typically bear little relationship to their total unsecured debt. Instead, creditors with legitimate claims suffer as funds that should go to them are diverted to bad claims.
The debt buying business becomes increasingly profitable with large volume, and as more and more time-barred claims are filed with impunity, real creditors will get less and less.