Supreme Court Contemplates Stale Debts during Bankruptcy

Members of the Supreme Court appeared divided in oral arguments last week while hearing a case to determine if a credit collection agency can pursue bankruptcy claims that would otherwise be time-barred.

The case, Midland Funding, LLC v. Johnson, presented the quandary of whether filing a proof of claim for an unextinguished, time-barred debt in a bankruptcy proceeding violates the Fair Debt Collection Practices Act (FDCPA), according to court documents. The case arose when a debt buyer filed a proof of claim in the bankruptcy case of one of its debtors hoping to collect on the claim if no one objected to the proof of claim.

During oral argument, Justice Sonia Sotomayor challenged the legitimacy of Midland’s business model and questioned whether filing such time-barred claims wasn’t adding unnecessary administrative burdens on bankruptcy courts. In the opinion of Wanda Borges, commercial law and creditors’ rights attorney and member of Borges & Associates LLC, Justice Sotomayor did little to hide her displeasure with the entire concept of allowing a state claim to be filed in a bankruptcy case.

“This model is beautiful,” Sotomayor said. “You file a claim you know is old. If you get paid, wonderful. If somebody objects, you withdraw it. There's no sanction that's possible.” 
Supreme Court Chief Justice John Roberts, Justice Samuel Alito and Justice Stephen Breyer had questions as to why time-barred claims aren’t simply objected to by trustees and expressed concern at turning a bankruptcy matter into a federal question that could only be decided by U.S. district courts.

Trade creditors should take note of how the Supreme Court decides this case because some courts are looking at personal guarantors and/or sole proprietors as individuals who may be subject to protection under the FDCPA. Borges’s advice when it comes to bankruptcy matters: if it’s a stale claim in which the statute of limitations has run, don’t bother filing a claim, as it may be considered to be an attempt to collect a time-barred debt.

Although the FDCPA is applicable to third-party debt collectors, the filing of a stale claim may be considered a violation of the automatic stay, she said. If a collection agency files the claim on behalf of the creditor and the court determines it is an attempt to collect a debt and therefore a violation of the FDCPA, it can wind up costing thousands in fines and attorneys’ fees. Only Justice Breyer raised the issue of an automatic stay violation. Most of the discussion centered on whether or not the filing of a time-barred proof of claim was sanctionable under bankruptcy and federal rules. However, a discussion of the “safe harbor” provision allowing a withdrawal of a violative claim to avoid the imposition of sanctions showed that most creditors would escape sanctions as a result.

In the Midland case, because the date of the last transaction was more than six years before the petitioner’s filing, the debt was time-barred under the relevant Alabama state law. The Eleventh Circuit reversed a lower district court’s ruling, saying the debt collectors violate the FDCPA when they file such claims. The Eleventh Circuit also said that despite agreeing with the district court that the Bankruptcy Code allows creditors to file proofs of claim on time-barred debts, applying the FDCPA to such conduct does not give rise to an irreconcilable conflict with the Code. That ruling contradicts rulings in the fourth, seventh and eighth circuits, which hold that filing an accurate proof of claim for a time-barred debt in a bankruptcy proceeding does not violate the FDCPA.

– Nicholas Stern, editorial associate and Wanda Borges, Esq., Borges & Associates, LLC

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