It could only happen in California. For filing a $3,400 unsecured deficiency claim that was disallowed, an auto lender became liable to reimburse the trustee for $14,400 spent in expunging the claim.
Like the case under the federal Fair Debt Collection Practices Act coming to the Supreme Court this term, the appeal in California involved a business practice where a lender was attempting to use the Bankruptcy Code to collect more than state law would permit in some cases.
It could only happen on the west coast because Section 1717 of the California Civil Code turns a unilateral obligation to pay attorneys’ fees into a reciprocal liability. In other words, if a contract imposes counsel fees on one party, California law imposes the obligation on both. The fee-shifting statute applies only “in an action on a contract.”
The chapter 7 debtor conceded owing about $17,300 on an auto loan. In her schedules, she bifurcated the loan, showing $13,900 as secured and $3,400 as unsecured. She stated her intention to reaffirm her auto loan but never did.
Not in default, the debtor continued making payments on the auto loan before and after receiving a discharge. The lender accepted the payments and never declared a default.
The trustee informally objected when the lender filed a $3,400 unsecured claim, the same amount shown in the debtor’s schedules. Since the lender did not withdraw the claim, the trustee pursued a formal objection, causing the bankruptcy court to hold several hearings.
Ultimately, the bankruptcy court disallowed the unsecured claim, estimating the contingent and unliquidated claim at zero. The bankruptcy court assessed the trustee’s $14,400 in legal fees against the lender. The lender appealed.
The Ninth Circuit Bankruptcy Appellate panel affirmed in a non-precedential per curiam opinion on Oct. 27.
Because the debtor was current on the auto loan, the unsecured claim was only contingent. For the same reason, it was also unliquidated, the BAP said, because the amount of the deficiency “was not readily ascertainable.”
Under those circumstances, the bankruptcy court did not abuse its discretion by estimating the claim at zero, thus disallowing the unsecured claim.
Arguing that California’s reciprocity statute should not apply, the lender lost again.
The appellate panel said that the lender initiated an action on a contract by filing a deficiency claim. Had the lender won in bankruptcy court, it would have been entitled to inflate its claim by including attorneys’ fees. Since the lender lost, the BAP said “the estate should likewise be able to do so on a reciprocal basis.”
The lender also argued that the amount of the trustee’s fees was unreasonable “under a cost-benefit analysis.”
The appellate panel noted that the lender would have recovered only $300 if the deficiency claim had been allowed. The trustee’s legal expenses increased, the BAP said, because the lender “continually chose to litigate” on a claim that “would reap $300 from the bankrupt estate.”
The panel said that conceding payment of the claim “would have been detrimental to the estate.”
In a state without a fee-reciprocity law, the trustee would have consumed the entire estate in objecting to the deficiency claim. Assuming a trustee elsewhere therefore would not have objected, this business practice would succeed in other states, assuming that filing a claim did not violate Rule 9011.
The case is somewhat similar to Midland Funding LLC v. Johnson, where the Supreme Court granted certiorari to decide whether filing a claim barred by the statute of limitations violates the FDCPA. In those cases, debt collectors pay pennies to buy time-barred claims, knowing that some trustees or debtors will lack the incentive or financial ability to object.
If the opinion in Midland Funding is favorable to debtors and trustees, the decision may indicate that the Supreme Court will not allow creditors to take advantage of loopholes in bankruptcy law to realize value on debts that would not be collectible outside of bankruptcy. For ABI’s discussion of Midland Funding, click here.