Court to consider if debt collectors are liable for filing claims barred by the statute of limitations.
By Lex Rogerson, Columbia – Lexington Bankruptcy Attorney
The US Supreme Court has agreed to decide whether a collection agency that attempts to collect a time-barred debt by filing a bankruptcy claim commits an unfair debt collection practice. Midland Funding, LLC, v. Johnson.
The high court will review a May 2016 decision of the Eleventh Circuit Court of Appeals holding that filing a time-barred bankruptcy claim violates the federal Fair Debt Collection Practices Act. That law prohibits false, deceptive, or misleading conduct in the collection of debts.
Actually, the Eleventh Circuit had decided that stale claims can trigger FDCPA liability two years before, in a case called Crawford v. LVNV Funding, LLC. In May’s Johnson decision, the court reaffirmed that holding and went one step further. It held that the Bankruptcy Code, by permitting creditors to file proofs of claim, does not protect debt collectors from this liability.
Since the Johnson decision, two other courts of appeal have disagreed. Using slightly different reasoning, the Seventh and Eighth Circuits dismissed FDCPA suits based on stale bankruptcy claims. Conflicts between circuits tend to make the Supreme Court more likely to hear a case.
What is a stale bankruptcy claim?
State statutes of limitation restrict the time a creditor may sue to collect a debt. These periods vary from state to state, with most states allowing from three to six years from the last payment or charge. If a creditor sues after this period has run, the debtor can defend by pleading that the debt is time-barred.
Statutes of limitations do not forbid creditors from using other means, such as collection letters or offers to settle for a discount, to collect debts. The courts are divided on whether the FCDPA and state debt collection practices laws permit these other means of collection.
Which creditors does this affect?
The FDCPA regulates conduct by debt collectors who collect debts for others. It does not apply to creditors collecting their own debts. But it does apply to debt buyers who buy debts that are already in default.
In recent years we have seen a huge increase in the market for bad debt. Companies like Midland Funding and LVNV Funding purchase portfolios of defaulted credit card accounts for a surprisingly few pennies on the dollar. If they can recover even a small percentage of the debt, they make a killing. The economics of this market create a powerful incentive for overreaching. And bankruptcy cases provide a relatively low-effort method to get that small recovery — which becomes a huge recovery when debt buyers repeat this tactic millions of times.
Whom do stale bankruptcy claims hurt?
At first blush this seems a simple issue of between the debtor and the holder of a time-barred claim. After all, a wrongly allowed claim has to be paid. But because of the way bankruptcy works, the people who really suffer from stale claims are other creditors.
In most bankruptcy cases, unsecured creditors share a fixed amount of money. In chapter 7, the debtor’s non-exempt assets determine that amount, while the debtor’s disposable income also determines the amount in chapter 13. But in either case, typically, a pre-determined pot of money is available for distribution to unsecured creditors.
Debtors usually do not care how much of this pot goes to each creditor. Their obligation is simply to fund the pot. So debtors have little incentive to object to stale claims. But as creditors file more dollars’ worth of claims, each creditor stands to receive a smaller share of the pot. So when a creditor files a time-barred claim and no one objects, the creditors holding valid claims receive less than they should. And creditors rarely review other creditors’ claims, much less object to them. This creates an opening for debt buyers to collect uncollectible debts at the expense of their fellow creditors.
So if the Supreme Court ultimately allows debtors to recover under FDCPA for stale bankruptcy claims, it would make debtors a sort of private police force preserving the integrity of the claims process — and serving the interests of creditors with meritorious claims.