Debt collection is a multi-billion dollar industry, and it is only growing. One of debt collectors’ tactics is to get people who owe long past due debts to pay those debts despite the fact that the debts cannot be collected as a matter of states’ statutes of limitations. Debt collectors do so in a variety of ways, including filing collection actions in state courts and hoping that debtors will not assert the statute of limitations as a defense. Fortunately, the Fair Debt Collection Practices Act (FDCPA) deems this tactic a misleading and unfair practice. Courts hold that debt collectors violate the FDCPA when they file debt collection actions in state courts on debts that they are barred from collecting under statutes of limitation. Based on the FDCPA, debt collectors have entered into consent decrees with the federal government and paid millions of dollars in restitution to debtors for trying to collect time-barred debts through state court debt collection proceedings.
The FDCPA also has pushed debt collectors to look to another venue to collect on time-barred debts: bankruptcy proceedings. When a person files bankruptcy, particularly chapter 13 bankruptcy, debt collectors file proofs of claim asserting a right to collect these debts. It seemingly is up to the debtor, or the trustee, to object to the claim on the basis that collection of the debt is barred by the applicable statute of limitations. In recent years, debt collectors have added to their business model specifically buying debts that will be collected through bankruptcy proceedings and then filing claims in hopes that the debtor, trustee, or another party will not object. The practice has the potential to be quite lucrative. About a million people file for bankruptcy every year. One-third of those cases are filed under chapter 13. And given that Americans owe trillions of dollars in consumer debt, many of those cases likely include time-barred debts. The questions thus becomes, is filing a proof of claim for a time-barred debt a violation of the FDCPA?
The answer to this question split courts. Some courts said no, the FDCPA does not apply, reasoning that bankruptcy affords debtors its own set of protections. Other courts said yes, the FDCPA applies, and a private party or the government can sue a debt collector for filing time-barred claims in bankruptcy, potentially winning sanctions. This split among courts was brought to the Supreme Court, which yesterday held (in a 5-3 opinion, Midland Funding LLC v. Johnson) that the FDCPA does not apply to proofs of claim filed by debt collectors for time-barred debts. The majority, in short, reasoned that the Bankruptcy Code and other rules provide a way for debtors and trustees to identify and respond to these claims, as well as the ability for bankruptcy judges to levy sanctions against debt collectors for filing time-barred claims. The dissent, in contrast, noted that the realities of bankruptcy practice make it so that trustees and other parties are short on both time and money, such that the protections built into the Code are not protections in reality. Instead, the bankruptcy claims process now sets a “trap for the unwary.”
If you want to read more about the decision itself, see my co-blogger Adam Levitin’s post on Credit Slips. The on-the-ground question for consumers now is, what can people do to protect themselves? There are a couple actions that debtors can take to make sure that they do not fall into that trap and that time-barred claims are not paid out through their chapter 13 bankruptcy cases. If they are represented, they can ask their counsel to examine claims submitted by debt collectors. Indeed, all debtors’ counsel now should be on notice that they must examine claims submitted by debt collectors. Regardless of whether they are represented, debtors should specifically inquire about claims submitted by debt collectors, either through their counsel or by themselves.
That debtors make sure to double-check debt collectors’ submitted claims is very important. As noted in the dissent, and as my co-authors and I have shown in our recent work, less than half of chapter 13 cases end with a discharge of debts. If a time-barred debt is included in a chapter 13 case, and the case is dismissed, that debt is reactivated, and the statute of limitations on collection begins anew. As Justice Sotomayor wrote in the dissent, debtors will “walk out of bankruptcy court owing more to their creditors than they did when they entered it.”