On January 17, 2017, the United States Supreme Court heard oral argument in the case of Midland Funding, LLC v. Johnson, an appeal from the Eleventh Circuit bringing to a head two issues that had been boiling for several years: (i) whether the filing of an accurate proof of claim for an unextinguished time-barred debt in a bankruptcy proceeding violates the Fair Debt Collection Practices Act (FDCPA); and (ii) whether the Bankruptcy Code, which governs the filing of proofs of claim in bankruptcy, precludes application of the FDCPA to the filing of an accurate proof of claim for an unextinguished time-barred debt.
In Johnson, the Eleventh Circuit revisited the issue of whether debt collectors are barred by the FDCPA from filing proofs of claims in bankruptcy when those claims are based on unenforceable consumer debts under state law. The Eleventh Circuit affirmed its prior decision in Crawford v. LVNV Funding, LLC, 758 F.3d 1254 (11th Cir. 2014), concluding that when a “creditor is also a ‘debt collector’ as defined by the FDCPA, the creditor may be liable under the FDCPA for ’misleading’ or ‘unfair’ practices when it files a proof of claim on a debt that it knows to be time-barred, and in doing so ‘creates the misleading impression to the debtor that the debt collector can legally enforce the debt.’”
In 2008, Stanley Crawford filed for protection under chapter 13 of the Bankruptcy Code. A debt buyer filed a proof of claim in that case related to a debt with no account activity since late 2001. Under the Alabama three-year statute of limitations that governed the account, Crawford’s debt became unenforceable in both state and federal court in October of 2004. Crawford filed an adversary proceeding in his bankruptcy case alleging an FDCPA violation, which the Bankruptcy Court dismissed on the debt buyer’s motion – a ruling the District Court affirmed.
Crawford was appealed to the Eleventh Circuit which reversed the District Court’s decision. Section 1692e(2)(A) of the FDCPA prohibits the false representation of the character, amount, or legal status of any debt. Section 1692e(5) prohibits a threat “to take any action that cannot legally be taken or that is not intended to be taken.” In Crawford, the Eleventh Circuit held that knowingly filing a time-barred proof of claim violated FDCPA prohibitions against unfair, unconscionable, deceptive or misleading conduct. The Court’s rationale was based on the same concerns underlying the rule against litigating time-barred debts – the debtor’s faded memory, lost records, ignorance of statute of limitations and expense associated with contesting the sale. The Eleventh Circuit held that a debt collector violated the FDCPA by filing a proof of claim on a debt that was time-barred.
Since then, however, many courts have rejected Crawford. The Eighth Circuit, in Nelson v. Midland Credit Management, Inc., 828 F.3d 739 (8th Cir. 2016), was especially critical of the Crawford rationale, noting that the bankruptcy process protects debtors against harassment and deception. The Eighth Circuit noted, “[u]nlike defendants facing a collection suit, bankruptcy debtors are aided by ‘trustees who owe fiduciary duties to all parties and have a statutory obligation to object to unenforceable claims.’” The Eighth Circuit reasoned that “[d]efending a lawsuit to recover a time-barred debt is more burdensome than objecting to a time-barred proof of claim.” The Court found, “there is no need to protect debtors who are already under the protection of the bankruptcy court, and there is no need to supplement the remedies afforded by bankruptcy itself.”
Beyond the substantive arguments about whether the filing of a proof of claim on a debt outside the statute of limitations violates the FDCPA, courts began wrestling with whether the Bankruptcy Code preempts the FDCPA an issue specifically left unanswered in Crawford. As with the substantive analysis, Circuit Courts have been split on the preemption issue. The Ninth Circuit in Walls v. Wells Fargo Bank N.A., 276 F.3d 502 (9th Cir. 2002), held that the FDCPA is not needed to protect debtors protected by the automatic stay and other provisions of the Bankruptcy Code.
Other courts have reached the opposite conclusion, reasoning one federal statute does not preempt another when they address the same subject in different ways. Cases from the Seventh Circuit ( Randolph v. IMBS Inc., 368 F.3d 726 (7th Cir. 2004)) and Third Circuit (Simon v. FIA Card Servs., N.A., 732 F.3d 259 (3d Cir. 2013)) held a federal statute implicitly repeals another when there is “an irreconcilable conflict between the statutes or a clearly expressed legislative decision that one replaces the other.”
Since the preemption argument was not addressed in Crawford, the District Court in Johnson was the first to confront the preclusion question that the Eleventh Circuit left open. In Johnson, the debtor filed for Chapter 13 bankruptcy relief. A debt collector filed a proof of claim that disclosed on its face that the claim was barred by the statute of limitations. The debtor sued the debt collector, alleging that the filing of the proof of claim was deceptive and misleading under § 1692e and unfair and unconscionable under § 1692f. The District Court found that there was an irreconcilable conflict between the Bankruptcy Code and the FDCPA, because a creditor can properly file a proof of claim on a time-barred debt under the Bankruptcy Code as long as the underlying debt has not been extinguished under state law, but the same creditor cannot file the proof of claim without violating the FDCPA, as construed by Crawford. In other words, the District Court said, “the Code authorizes filing a proof of claim on a debt known to be stale, while the [FDCPA] (as construed by Crawford) prohibits that precise practice,” and “those contradictory provisions cannot possibly be given effect simultaneously.” And in the face of that conflict, the District Court ruled that the FDCPA “must give way” to the Bankruptcy Code.
The Eleventh Circuit reversed stating that it saw no irreconcilable conflict between the Bankruptcy Code and the FDCPA. The Court pointedly ruled: “[A]lthough the (Bankruptcy) Code certainly allows all creditors to file proofs of claim in bankruptcy cases, the Code does not at the same time protect those creditors from all liability. A particular subset of creditors – debt collectors – may be liable under the FDCPA for bankruptcy filings they know to be time-barred.” In finding no conflict between the federal statutes, the Eleventh Circuit noted “when a particular type of creditor” – a “debt collector” as defined under the FDCPA – files a proof of claim for a debt it knows is out-of-statute, the creditor must “still face the consequences” imposed by the FDCPA for a ’misleading’ or ’unfair’ claim.”
Midland petitioned the Supreme Court to grant certiorari and the reply by Johnson agreed with the need for review. As Midland pointed out in its reply brief, the case presented an unusual situation where both petitioner and respondent agreed that the questions presented implicate clear circuit conflicts on important issues of federal law.
THE ORAL ARGUMENT
Much of the focus during Midland’s argument was on answering the question why creditors are allowed to file such claims in the first place. Midland’s counsel noted that under the Bankruptcy Code, a creditor may file a proof of claim in a debtor’s bankruptcy. A “claim” is defined as a “right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured.” In prior cases, the Supreme Court interpreted this language to create an “entitle[ment]” for creditors to file a proof of claim in a bankruptcy proceeding where a “right to payment” exists. A “right to payment” under the Bankruptcy Code “is nothing more nor less than an enforceable obligation.”
Consumer advocates, including Johnson, argued that there is no “right” to file a time-barred claim when there is no right to have that claim repaid in a Chapter 13 bankruptcy proceeding. Courts, including the Eleventh Circuit in Johnson, have regularly rejected this argument because the Code does allow claims in a Chapter 13 bankruptcy proceeding by a party who does not necessarily have a right to have his claim paid.
In all but a few states, the expiration of a statute of limitations does not extinguish the right to payment; it only extinguishes the remedy of judicial prosecution of the claim. So, although a party may not be able to enforce its claim because of a statute-of-limitations bar, that party still may assert the claim. As noted by the Eleventh Circuit in Johnson, the Bankruptcy Code’s procedure for addressing proofs of claim demonstrates that some filed claims will not ultimately be paid in a bankruptcy proceeding. Where a proof of claim is filed in a bankruptcy case, that claim is generally “deemed allowed,” so it will be viewed as a valid claim and paid out of the bankruptcy estate. However, the bankruptcy trustee is charged with examining proofs of claim and objecting to the allowance of any claim that is improper. Once the trustee objects, the bankruptcy court is in turn charged with determining whether the claim “is unenforceable against the debtor . . . under any agreement or applicable law for a reason other than because such claim is contingent or unmatured.” Under the Bankruptcy Code, “The estate shall have the benefit of any defense available to the debtor . . . including statutes of limitation.”
Thus, where the bankruptcy process is working as intended, a time-barred proof of claim may be filed, but will not be paid by the bankruptcy estate. As the Fourth Circuit noted, going through this exercise may inure to the benefit of the consumer debtor since debtors often fail to list all debts in the bankruptcy schedules. As the Fourth Circuit stated in Dubois, “If the debt is unscheduled and no proof of claim is filed, the debt continues to exist and the debt collector may lawfully pursue collection activity apart from filing a lawsuit. This is detrimental to the debtor and undermines the bankruptcy system’s interest in “the collective treatment of all of a debtor’s creditors at one time.” Clearly, then, when a time-barred debt is not scheduled the optimal scenario is for a claim to be filed and for the Bankruptcy Code to operate as written.”
Questions for counsel from some of Justices, especially Justice Sotomayor, indicated concerns with the Bankruptcy claims administration procedures that supposedly incentivize the filing of stale debt, in hopes that no party objects. Counsel for Midland rejected that line of questioning by pointing to the Bankruptcy Code, the Bankruptcy Rules of Procedure and the accompanying advisory committee notes, observing: “Congress very consciously put that burden on the trustee and other parties in interest in the Bankruptcy Code.” Other justices seemed to disagree with the line of thinking indicated by Justice Sotomayor’s questions, wondering why debtors or trustees do not simply object to these claims if they are time-barred.
Counsel for Johnson faced tough questioning from the Court about the breadth of his position that a creditor must have a good-faith belief that they have a valid claim that is immune from objection in order to file a proof of claim. Chief Justice Roberts led a line of questioning along with Justices Kagan, Breyer and Alito, testing the scope of the consumer’s enforceability argument and demonstrating a concern that, if Johnson’s position was adopted, it would not be solely limited to the defense of a limitations period, but would implicate other defenses as well, yielding unintended consequences.
Still, other questions focused on bankruptcy court jurisdiction and whether the proper remedy to attack unlawful behavior, if any, was through an FTC enforcement action, or a sanctions motion, rather than an FDCPA claim.
The questioning during the argument demonstrated a divided bench. The Court is likely to issue its decision before June 30, 2017. Meanwhile, hopefully the Supreme Court will provide much-needed clarity on whether the filing of an accurate proof of claim for an unextinguished time-barred debt in a bankruptcy proceeding violates the FDCPA and whether the Bankruptcy Code precludes application of the FDCPA in this context.
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