The conflict of circuits widened when the Seventh Circuit handed down a split decision on Aug. 10 holding that filing a proof of claim based on a stale debt does not violate the federal Fair Debt Collection Practices Act, or FDCPA.
In the majority opinion by Circuit Judge Joel M. Flaum, the Chicago-based appeals court took sides with the Courts of Appeals for the Eighth and Second Circuits, which both hold that the FDCPA is not violated when a creditor files a proof of claim based on a debt where collection is precluded by the statute of limitations. In dissent, Chief Circuit Judge Diane P. Wood would have followed the Eleventh Circuit, which holds that filing a stale claim violates the FDCPA.
In the Eleventh Circuit case from 2014, Crawford v. LVNV Funding LLC, the Supreme Court denied certiorari last year.
The Stale Debt Collection Business
An industry was created when debt collectors began paying small amounts to buy debts where statutes of limitations would preclude recovery. The claim purchasers file proofs of claim when the debtors file bankruptcy. The purchasers’ claim forms typically disclose all required information that should alert trustees and debtors to the fact that collection of the debts would be time-barred.
The business model is based on the assumption that there will be no objection to the claims in some cases, either through inadvertence or because objecting is not economically justifiable or is not covered by counsels’ flat-fee arrangements.
Since the creditors will have paid so little for the claims, the allowance of just a few will still make the business profitable.
The Majority Opinion
The case in the Seventh Circuit was a consolidated appeal from three decisions, two from Indianapolis and one from Chicago. In all three, the district judges dismissed the FDCPA suits, holding that the Bankruptcy Code provides a safe harbor that permits filing stale claims. The appeal was argued on June 1.
The debtors contended that the claims-filing process is reserved for enforceable claims. They relied in large part on the Seventh Circuit’s 2013 Phillips opinion holding that a lawsuit to collect a stale debt violates the FDCPA.
Like other courts reaching the same conclusion, the Seventh Circuit reasoned that there is no FDCPA violation because the Bankruptcy Code’s expansive definition of “claim” and other provisions combine to allow a debt collector to file a stale proof of claim when a lawsuit on the same debt would result in liability.
Examining the claims-filing and allowance process, Judge Flaum concluded that the “Bankruptcy Code contemplates that creditors will file proofs of claim for unenforceable debts . . . and that the bankruptcy court will disallow those claims on the debtor’s objection.” The “established procedures,” he said, “confirm that the Bankruptcy Code anticipates that creditors will file proofs of claim on stale debts.”
Although the Bankruptcy Code allows creditors to file stale claims, the question remained as to whether the debt collector’s conducted violated the FDCPA.
Unlike the filing of a lawsuit where the debtor does not have a lawyer automatically, Judge Flaum said that the problem is “less acute” in a “counseled” bankruptcy where the debtor ordinarily has a lawyer and trustees are obliged to object to defective claims. Since a “reasonably competent” lawyer would know the claim to be stale, he said there was no deceptive, misleading, unfair or abusive conduct giving rise to FDCPA liability.
Judge Flaum included a significant carveout in his holding. If the bankrupt has no lawyer, “this opinion does not foreclose relief under the FDCPA,” he said.
The Dissent
Judge Wood found little difference from Phillips where filing suit on a stale claim violates the FDCPA. Although the Bankruptcy Code allows creditors to file claims based on contingent or unliquidated debts, she said those categories do not cover “a concededly stale debt.”
The “public policy” shown in Bankruptcy Rule 9011(b) “demands that we do not protect frivolous, bad-faith, or unfounded claims,” Judge Wood said.
Judge Wood would have followed the Eleventh Circuit because, she said, it is “unrealistic to think that the pro se litigant or the busy trustee will catch every scheduled stale claim.”
The majority opinion did not reach an issue in one of the district court decisions. In the Chicago case, the district judge also dismissed on the ground of res judicata because there was no objection to the claim before the chapter 13 plan was confirmed. In July, a district judge in Georgia held that res judicata does not apply. To read ABI’s discussion of Willis v. Cavalry Investment LLC, click here.
To read about the Eighth Circuit’s opinion in Nelson v. Midland Credit Management Inc., click here.
The circuits are also split on whether the later-adopted Bankruptcy Code impliedly repealed the FDCPA with respect to debtors who are in bankruptcy. Sensibly, the Supreme Court should grant certiorari and decide both circuit splits at once.