Monday, February 17, 2020

Sixth Circuit Side Steps the Bona Fide Error Defense

A recent opinion issued by the Sixth Circuit should prove helpful to attorneys facing unsettled issues of state law.  As drolly described by the Court, “[a] lawyer sued two lawyers, and each side hired more lawyers.  Five years later, after ‘Stalingrad litigation’ tactics, discovery sanctions, and dueling allegations of professional misconduct, we are left with $3,662 in damages and roughly $180,000 in attorney’s fees.”  Van Hoven v. Buckles & Buckles, 2020 U.S. App. LEXIS 1483, *2 (6th Cir. Jan. 16, 2020).   So what caused this apocalyptic litigation war?  A series of post judgment garnishments.

In Van Hoven, a law firm enforced a judgment by filing a series of garnishments.  With each garnishment, the law firm included within the post-judgment costs accrued to date their garnishment filing fees.  The consumer contended that the law firm violated §1692e of the FDCPA by seeking the costs of each garnishment, contending that doing so violated Michigan law because: (a) the law firm was not allowed to include the costs of the present garnishment within the amount due; and (b) the law firm was not allowed to include the costs of prior unsuccessful garnishments.  Michigan law, at the time, was unclear as to whether a creditor could include the costs of the present garnishment in their calculation of costs.  At the trial court level, the consumer and the class she represented were successful and were awarded a total of $3,662.00 in damages and $186,600.00 in attorney’s fees.  The law firm appealed.

On appeal, the Sixth Circuit was left to address whether “an inaccurate statement about state law counts as a ‘false … representation’?”  Id. at *8.  The Court started by noting that not every violation of state law is a violation of the FDCPA.  In order for an inaccurate statement about state law to be actionable, the statement must be both inaccurate and material.

While the Court quickly determined the statements at issue were material, it ultimately concluded they were not false.  “Even though the Act covers ‘false’ material statements about state law, that does not mean it extends to every representation about the meaning of state law later disproved.”  Id. at *9.  While the Court considered the Supreme Court’s holdings in Jerman v. Carlisle, 559 U.S. 573 (2010) and Heintz v. Jenkins, 514 U.S. 291 (1995), it veered away from employing the bona fide error defense when considering the law firm’s interpretation of Michigan law.  In doing so, the Court explained that “[t]he key question … is not whether the bona fide error defense applies to interpretations of state law; it is whether this is a cognizable “false representation.”  Id. at *21.

Instead, the Court turned to Rule 11, stating that “[m]ore helpful is the analogy to sanctions based on attorneys’ statements in litigation” and noting that it is only sanctionable to advance legal contentions that are not warranted by existing law.  Id. at *13.   Key to the Court’s determination that the statements were not false was the fact that at the time the statements were made (and the costs sought), the law was unsettled.[1]  The Court noted that

[i]n dealing with open questions of state law, excellent arguments sometimes will appear on either side.  And we generally don’t think of a position on the meaning of state law as false at the time it was issued whenever a higher court over time takes a different position in a later case … A representation of law is not actionably false every time it turns out wrong.”

Id. at *14.  Drawing from Rule 11 and its threshold for sanctions, the Court held that “a lawyer does not ‘misrepresent’ the law by advancing a reasonable legal position later proved wrong. This logic applies with even more force to representations of law given the frequent before-the-case difficulty, sometimes indeterminacy of legal questions.”  Id.

Applying this rationale, the Court reversed the district court on the issue as to whether the law firm made misrepresentations in seeking its current garnishment costs.  The Court additionally remanded the remaining issue (whether the law firm improperly sought costs for prior unsuccessful garnishments) to the district court to determine whether that claim was subject to the bona fide error defense.

The opinion provides an excellent road map for law firms dealing with unsettled areas of law and should provide law firms with additional avenues for defense.

[1] Michigan later amended its rules to clarify that creditors may include their current costs in their garnishment requests.

Monday, February 10, 2020

CFPB Issues Semi-Annual Report to Congress

The CFPB has issued its semi-annual report to Congress.  The Report, which covers April through September of 2019, is mandated by Dodd-Frank and was released in conjunction with Director Kraninger’s testimony to the House Financial Services Committee.  Here are a few of our key take-aways.

Credit Reporting is a Focus of the Bureau.  The Report identifies credit scoring and credit reporting as a source of major concern for consumers.  Specifically, the report notes that the reporting of collections and bankruptcies have a significant impact on consumer credit scores and upon consumer lending. The Report also confirms what litigation trends are showing - credit reporting has surpassed debt collection as the most complained of consumer product.  In the twelve-month period ending September 30, 2019, credit reporting accounted for 43% of all consumer complaints.

Debt Collection Rule – Mum is the Word.  The Report is silent as to when a final debt collection rule will be forthcoming.  The Report simply indicates that the proposed rule was published and that the Bureau is reviewing the submitted comments with no indication as to when the final rule will be forthcoming.  Keeping in mind that the reporting period covered ended in September, perhaps that is not unusual except for the fact that the Report includes footnoted updates as to other issues addressed in the report.  Moreover, debt collection complaints no longer are the most complained of consumer product, having been surpassed by credit reporting.  For the year ending September 30, 2019, debt collection only accounted for 24% of all consumer complaints.

Friday, January 31, 2020

Deepening Circuit Split, Third Circuit Holds that Items Seized Pre-Petition Did Not Violate Automatic Stay

The Third Circuit has recently held in In re Denby-Peterson, 941 F.3d 115 (3rd Cir. 2019) that creditors who refuse to relinquish an item that was seized pre-petition are not subject to sanctions because their refusal does not violate 11 U.S.C. § 362’s automatic stay. The case further deepens a circuit split on the issue.

The Facts

As the Third Circuit explained, “the center of this bankruptcy appeal is “‘America’s first sports car’: The Chevrolet Corvette.” Joy Denby-Peterson purchased a 2008 Corvette in July 2016, and several months later the vehicle was repossessed when Denby Peterson failed to make all of the required loan payments. After repossession, Denby-Peterson filed an emergency Chapter 13 Bankruptcy petition in the Bankruptcy Court for the District of New Jersey. She then notified her creditors of the filing and demanded return of the Corvette. The creditor refused to do so, and Denby-Peterson filed a motion for turnover seeking an order (1) compelling the return of the Corvette, and (2) imposing sanctions for an alleged violation of the automatic stay. After a two-day hearing, the Bankruptcy court ordered the creditor to return the Corvette as required by 11 U.S.C. § 542(a), but denied the request for sanctions. On the latter point, the bankruptcy court reasoned that the creditor’s refusal to return the Corvette was not a violation of the automatic stay absent a court order requiring turnover. Denby-Peterson appealed to the district court (which affirmed on similar grounds) and again to the Third Circuit.

The Third Circuit’s Ruling: Meaning of Section 362’s Automatic Stay and the Interplay of Section 542’s Turnover Provision

Noting a split in authority among the federal circuits, the Third Circuit sided with the minority of circuits by holding that a secured creditor does not violate § 362’s automatic stay by maintaining possession of collateral that it lawfully repossessed pre-petition, even after notice of the debtor’s bankruptcy. The Court began its analysis by considering the plain language of Section 362(a)(2), which provides (as relevant here) that the filing of a bankruptcy petition “operates as a stay . . . of . . . any act to . . . exercise control over property of the estate.”  11 U.S.C. § 362(a)(3). The court noted that the operative terms and phrases of the Section are “stay,” “act,” and “exercise control” and concluded, after a review of the ordinary meaning of those terms, that “Section 362(a)(3) prohibits creditors from taking any affirmative act to exercise control over property of the estate.” The Court further held that this duty “is prospective in nature . . . the exercise of control is not stayed, but the act to exercise control is stayed.” Denby-Peterson, 941 F.3d at 126 (emphasis in original).  Based on this enunciation of the rule, the Court held that on the facts of this case, “a post-petition affirmative act to exercise control over the Corvette is not present,” and thus there was no violation of the automatic stay. Id.

The Court also considered and rejected a related argument made by the debtor that Section 362 should be read in pari materia with 542(a)’s “allegedly self-effectuating” turnover provision. Section 542 provides that an entity in possession, custody, or control of property of the debtor “shall deliver” the property to the bankruptcy trustee. The Court acknowledged that Section 542 uses mandatory language – “shall deliver” – but explained that the question in this case “is when must a creditor deliver?” The Court analyzed Section 542’s provisions and held that “it would be illogical for us to interpret the turnover provision as imposing an automatic duty on creditors to turn over collateral to the debtor upon learning of a bankruptcy petition.” Id. at 130. Doing so would allow debtors to temporarily strip creditors of their rights to assert affirmative defenses such as laches, or to claim that the property is not property of the estate. While the Court agreed that creditors could still make these arguments in the course of the bankruptcy proceedings if the collateral was immediately turned over, it held that it did “not read the turnover provision as placing the onus on creditors to surrendering the collateral and then immediately file a motion in Bankruptcy Court asserting their rights.” Therefore, the Court reasoned, the mandatory language in Section 542 does not lead to the conclusion that Section 362’s automatic stay is self-effectuating.

The Court also rejected the notion that § 362 and § 542 must be read together, reasoning that “[e]ven assuming the turnover provision is self-executing . . . there is still no textual link between Section 542 and Section 362.  The language of the automatic stay provision and the turnover provision do not refer to each other. The absence of an express textual link between the two provisions indicates that they should not be read together, so violation of the turnover provision would not warrant sanctions for violation of the automatic stay provision.” Id. at 132.

Widening of a Circuit Split

As the Third Circuit noted, its decision in Denby-Peterson deepened a split among the circuits on the meaning of Section 362’s automatic stay provision. The Third Circuit joined the Tenth and D.C. Circuits in holding that a secured creditor does not have an affirmative obligation to return a debtor’s collateral immediately upon notice of the bankruptcy. On the other side of the split, the Second, Seventh, Eighth, and Ninth Circuits have held that Section 362 requires a creditor to immediately return collateral that was repossessed pre-petition as soon as the creditor knows of the bankruptcy filing.

This leads to a complicated state of the law, especially for nationwide creditors. In some circuits, a creditor is permitted to ignore a post-petition demand for the return of collateral that was lawfully repossessed pre-petition. In other circuits, however, that same conduct could expose the creditor to sanctions for willful violation of Section 362’s automatic stay. And still in other circuits, the law is wholly unclear and the creditor must make a calculated risk of either returning the collateral thereby necessitating the expenditure of more resources to protect its rights, or possibly be subject to sanctions.

Due to the deep (and deepening) circuit split, the state of the law related to § 362 is obviously disuniform. In December 2019, the Supreme Court agreed to decide the issue presented by Denby-Peterson by granting certiorari in a Seventh Circuit case, In re Fulton, 926 F.3d 916 (7th Cir. 2019). The Fulton court held that the Bankruptcy Code’s turnover provision requires immediate turnover of estate property that was seized pre-petition; look for the creditor’s attorneys in that case to rely heavily on Denby-Peterson’s reasoning in seeking to obtain a creditor-friendly ruling at the Supreme Court.

Zachary Dunn is an attorney practicing in Smith Debnam Narron Drake Saintsing & Myers, LLP’s Consumer Financial Services Litigation and Compliance Group

Bureau Sheds Light on its Abusive Acts or Practices Standard in New Statement of Policy

The CFPB has issued a Statement of Policy which seeks to “convey and foster greater certainty above the meaning of abusiveness”  and provide a framework for its exercise of supervisory and enforcement authority as to abusive acts or practices.  Under Dodd Frank, the CFPB has supervisory and enforcement authority over abusive acts or practices in connection with consumer financial products or services. The Policy reflects an effort by the CFPB to resolve uncertainty as to the scope and meaning of abusiveness in the content of its enforcement actions.

Here’s what you need to know:

·        Historically, the Bureau has included in its enforcement actions an abusiveness claim with its unfair and deceptive claims, but not alleged any specific course of action distinguishing the two claims.  Because of this dual pleading, little clarification has been provided by the Bureau previously as to the abusiveness standard.

·         The Policy sets forth three pillars:

o   First, in its supervision of covered entities and enforcement actions, the Bureau will only challenge conduct as being abusive if it concludes the harm to consumers outweighs the conduct’s benefit.  The Bureau further makes clear that the balancing test will consider not only quantitative analysis but also qualitative analysis.

o   Second, the Bureau will generally avoid challenging conduct as abusive that relies upon the same set of facts as claims for unfair or deceptive.  In other words, it will not “pile on.”  Instead, where it pleads stand-alone abusiveness, it intends to clearly plead such claims in a manner which will clearly demonstrate the nexus between alleged facts and the Bureau’s analysis of the claim. 

o   Finally, the Bureau sets out what may be termed as a sort of “safe harbor” for those who are in good faith attempting to comply with the abusive standard.  In those instances, the Bureau indicates it will not seek certain monetary relief based upon abusiveness where the good faith can be demonstrated.  The Bureau makes clear, however, that this is not an affirmative defense.  What this means, in essence, is that it will be imperative for covered entities to demonstrate through their compliance management system their good faith attempt to adhere to the standard and if that can be demonstrated, the Bureau will be less likely to seek certain civil monetary penalties.  What it does not mean is that the Bureau will not seek relief – the Statement of Policy makes clear that the Bureau still intends to seek legal and/or equitable remedies, including damages and restitution.

·         While the Statement of Policy should be viewed positively by the consumer finance industry, readers should be aware that it is simply that -a statement of policy and does not carry the legal import of a published rule.  Moreover, as a Statement of Policy it is subject to amendment or revocation at any time, particularly in times of political change.

Tuesday, January 7, 2020

CFPB’s Rulemaking Agenda Provides Glimpse into 2020

Photo by Michael Longmire on Unsplash
The CFPB’s 2020 Rulemaking Agenda provides a preview of the Bureau’s intended rulemaking activities for 2020.  Here are the highlights of what we can look forward to in 2020:

Business Lending Data (Pre-rule Stage):  Under Dodd Frank and the Equal Credit Opportunity Act, the CFPB has rulemaking authority to require lenders to collect and submit data concerning credit applications made by women-owned, minority-owned and small businesses.  The Bureau intends to hold a symposium on small business data collection in 2020. 

Higher-Priced Mortgage Loan Escrow Exemption (Pre-rule Stage): The Bureau is conducting preliminary analysis for rulemaking which would exempt certain lenders and higher priced mortgage loans from the FRB rule requiring the establishment of escrow accounts for payment of property taxes and insurance payments.

Debt Collection Rule (Proposed Rule Stage): The Agenda does not provide any further hints as to when a final rule will be published but does acknowledge that the Bureau is conducting consumer testing of disclosures related to time-barred debt.  Proposed Section 1006.26(c) was reserved for that purpose.  The Agenda indicates that, after testing, the Bureau will assess whether to publish a supplemental Notice of Proposed Rulemaking related to time-barred debt disclosures.  No anticipated date for a final rule is included in the Agenda which may suggest a delay to allow the Bureau to include the time-barred debt provisions before publication of the final rule.

Home Mortgage Disclosure Act Data (Proposed Rule Stage):  The Bureau has indicated new proposed rules will be forthcoming as to the publication of HMDA data, as well as the collection and reporting of data points.  The anticipated date for the NPRM is mid-summer.

Payday Lending (Final Rule):  As many recall, the CFPB rolled back the final rule issued in 2017 after a change in leadership.  The CFPB now anticipates publishing its new rule in the Spring of 2020.

Friday, November 22, 2019

Fifth Circuit Pumps The Brakes On Arbitration

In a recent appeal directly to the Fifth Circuit from a Southern District of Texas Bankruptcy Court, the court affirmed the bankruptcy court’s denial of a motion to compel arbitration. In Henry v. Educational Financial Service, the Chapter 13 debtor initiated an adversary proceeding against her creditor asserting the creditor violated the discharge injunction by attempting to collect a discharged debt.  Relying upon an arbitration provision in the underlying credit application that stated that “[a]ny controversy or claim arising out of or related to this Note or an alleged breach of this Note, shall be settled by arbitration,” the creditor moved to compel arbitration,  The bankruptcy court denied the motion and certified its order for an interlocutory appeal directly to the Fifth Circuit in light of the US Supreme Court’s recent ruling in Epic Systems Corp. v. Lewis, 138 S. Ct. 1612 (2018).

While the Federal Arbitration Act (the “FAA”) requires courts to enforce arbitration provisions in accordance with their terms, the Court addressed the question of what happens when there are two competing federal statutes – in this case, the FAA and the Bankruptcy Code. In those instances, where the statutes cannot be harmonized and one must displace the other, the court looks to congressional intent.  Relying upon its prior decisions in the context of discharge injunctions, the Court noted that bankruptcy courts have discretion to decline to enforce arbitration agreements when: (a) the proceeding adjudicates statutory rights provided by the Bankruptcy Code; and (b) if requiring arbitration would conflict with the purposes of the Bankruptcy Code.  Because a debtor’s right to be free from collection efforts after discharge is a creature of the Bankruptcy Code and an action to enforce that right implicates an important bankruptcy policy - specifically, the ability of the bankruptcy court to enforce its own orders, the Court concluded that based upon its prior precedent, the bankruptcy court had discretion to deny the motion to compel arbitration.  

The Court further looked at what impact, if any, the Supreme Court’s 2018 decision in Epic Systems v. Lewis, 138 S. Ct. 1612 (2018) might cast upon the existing Fifth Circuit precedent and determined that in this instance, there was none.  In Epic Systems, the Court stated that

When confronted with two Acts of Congress allegedly touching on the same topic, this Court is not at liberty to pick and choose among congressional enactments and must instead strive to give effect to both.  A party seeking to suggest that two statutes cannot be harmonized, and that one displaces the other, bears the heavy burden of showing a clearly expressed congressional intention that such a result should follow.  The intention must be clear and manifest.

Epic Sys., 138 S. Ct. at 1623-24.   The Fifth Circuit determined that Epic did not change the existing Fifth Circuit precedent and affirmed the bankruptcy court’s denial of the motion to compel.  The case serves as a reminder for creditors attorneys that at least in the bankruptcy setting, arbitration provisions are not necessarily a trump card.