District Court Reverses Bankruptcy Court Order Imposing Sanctions on Mortgage Servicer

 

By: Landon G. Van Winkle

 

The U.S. District Court for the Eastern District of North Carolina recently reversed an order of the U.S. Bankruptcy Court for the Eastern District of North Carolina. The bankruptcy court order held mortgage servicer Newrez, LLC (“Newrez”) and the holder of the mortgage note at issue in civil contempt for failing to abide by the terms of the individual debtors’ confirmed chapter 11 plan (the “Plan”). Newrez, LLC v. Beckhart, No. 7:20-cv-00192-BO, 2021 U.S. Dist. LEXIS 125293, at *1 (E.D.N.C. July 6, 2021). The district court found that the nebulous terms of the Plan, coupled with Newrez’s good faith reliance on the advice of counsel in interpreting those terms, was sufficient to establish that Newrez had an objectively reasonable basis for its conduct, thus insulating it from civil contempt sanctions under the rule established in Taggart v. Lorenzen, 139 S. Ct. 1795 (2019).  The court’s reversal emphasizes the benefits to a creditor of securing legal advice when the bankruptcy court orders governing the creditor’s claim are unclear.

 

The controversy centered around the Plan’s treatment of Newrez’s secured claim. At the time the debtors filed their voluntary chapter 11 case in 2009, they owned a beach house subject to a mortgage with a prepetition arrearage in excess of $22,000, arising from ten months of missed payments. The Plan made no provision for the repayment of the prepetition arrearage, or for the post-petition payments that came due prior to confirmation. It was confirmed over the objection of Newrez’s predecessor in late 2010, and the debtors began making payments under the Plan around the same time. Newrez began servicing the mortgage in 2014, and treated the loan as if it were in default from that time through 2019, based on the significant uncured arrearage. The debtors repeatedly contended that the loan was current based on the terms of the Plan, and challenged Newrez’s determination that it was in default.

 

In January 2020, the debtors filed a motion in the bankruptcy court seeking to have Newrez and the holder of the loan held in civil contempt for failing to comply with the terms of the Plan, and sought significant sanctions. Following an evidentiary hearing, the bankruptcy court entered an order finding Newrez and the holder in civil contempt, and assessing monetary sanctions in excess of $110,000, consisting largely of lost wages, a loss of a fresh start, and attorneys’ fees. Newrez appealed and the district court reversed.

 

In analyzing the bankruptcy court’s order, the district court recited the standard for civil contempt clarified by the Supreme Court in Taggart: A creditor may be held in civil contempt for violation of a bankruptcy court’s order if there is no “fair ground of doubt as to whether the order barred the creditor’s conduct.” Taggart, 139 S. Ct. at 1799. Thus, civil contempt is appropriate only where there is “no objectively reasonable basis for concluding that the creditor’s conduct might be lawful.” Id.

 

In holding that there was a fair ground of doubt as to whether the Plan required Newrez to treat the mortgage as current and not in default, the Court focused on the multiple questions the Plan left unanswered regarding the mortgage:

 

Nothing in the confirmation order expressly addressed what amount [the debtors] would owe on the loan as of November 25, 2010 or how the $22,836.40 in pre-petition arrearage would be repaid, if at all. Although the order set a due date for the first payment, it offered no guidance on how much that payment would be.

 

Beckhart, 2020 U.S. Dist. LEXIS 125293, at *7. Further, the court observed that the terms of the Plan created additional confusion, because the Plan purported to leave the rights of the holder of the mortgage unmodified except as expressly provided in the Plan, but the Plan did not expressly provide for any treatment of the arrearage or post-petition payments. Id.  Similarly, the court found that because Newrez had repeatedly sought and relied upon the advice of outside counsel in conducting itself under the Plan, it had an objectively reasonable basis to believe that its conduct was lawful. Id. at *8-9 (citing Waller v. Sprint Mid Atl. Tel., 77 F. Supp. 2d 716, 722 (E.D.N.C. 1999)). It also found that the same reliance on outside counsel made clear that Newrez had acted in good faith in adopting a reading of the Plan “that seemed consistent with the contractual terms of the loan.” Id. at *8. Because Newrez established both that there was a fair ground of doubt as to whether the Plan prohibited its conduct, and because it had an objectively reasonable basis for acting as it did, the court concluded that the bankruptcy court’s order finding it in contempt “falls far short of the standard required for a finding of civil contempt,” and reversed the order and remanded the matter to the bankruptcy court for further proceedings.

 

Beckhart showcases the dual benefits to a creditor in seeking competent legal advice where there is any question about the interpretation or effect of bankruptcy court orders on the creditor’s claims. First, relying on the advice of counsel can help establish that a creditor was acting in good faith, which is significant since Taggart did not foreclose the permissibility of holding a creditor in contempt when it acts in bad faith. See Taggart, 139 S. Ct. at 1802 (“Our cases suggest, for example, that civil contempt sanctions may be warranted when a party acts in bad faith.”). Second, acting on the good faith advice of counsel can supply the creditor with an objectively reasonable basis for concluding that its conduct is permitted under the order at issue. This is particularly beneficial where, as in Beckhart, the order is unclear and subject to multiple reasonable interpretations.

 

 Landon G. Van Winkle is a member of Smith Debnam's Consumer Financial Services Litigation and Compliance and Bankruptcy teams.

Mere Retention of Property of the Estate Does Not Violate the Automatic Stay

 

By: Landon G. Van Winkle

 

The Supreme Court of the United States has resolved a split in the circuits as to whether an entity that is passively retaining possession of property in which a bankruptcy estate has an interest has an affirmative obligation under the Bankruptcy Code’s automatic stay, 11 U.S.C § 362, to return that property to the debtor or trustee immediately upon the filing of the bankruptcy petition. The case, City of Chicago v. Fulton, No. 19-357,  resolves this split in favor of the creditor.

 

Background

 

The case arose from four separate chapter 13 bankruptcy cases in which the debtors sought to regain possession of their vehicles from the City of Chicago, which had seized and impounded the vehicles prepetition due to unpaid parking tickets and similar traffic fines. The bankruptcy court in each instance found that by refusing to return possession of the vehicles to the chapter 13 debtors after they had filed their respective bankruptcy cases, the City had “exercised control” over property of the estate in violation of 11 U.S.C. § 362(a)(3). The bankruptcy court ordered the City to return the vehicles and imposed sanctions for the City’s violation of the automatic stay. The cases were consolidated and certified for direct appeal to the U.S. Court of Appeals for the Seventh Circuit, which affirmed the bankruptcy court relying on its prior holding in Thompson v. General Motors Acceptance Corp., 566 F.3d 699 (7th Cir. 2009), that a creditor must return a debtor’s vehicle upon the debtor’s filing a petition for bankruptcy in order to comply with the automatic stay.

 

Resolution of the case involved interpretation and construction of three related statutory provisions in the Bankruptcy Code, specifically 11 U.S.C. §§ 541, 362, and 542, which govern property of the estate, the automatic stay, and turnover, respectively. Under the Bankruptcy Code, property of the estate includes all property, wherever located and by whomever held, in which the debtor holds any legal or equitable interest as of the petition date. The Bankruptcy Code’s automatic stay generally protects property of the estate from the collection efforts of prepetition creditors, and prohibits, among other things, “any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate.” 11 U.S.C. § 362(a)(3).  Section 542(a) of the Bankruptcy Code requires that an entity in possession, custody, or control of certain property of the estate must account for and turnover such property to the trustee, or debtor, unless such property is of inconsequential value to the estate. 11 U.S.C. § 542(a).

 

The Court’s Decision

 

In an 8-0 opinion (Justice Barrett took no part in the consideration or decision of the case), the Court vacated the judgment of the Court of Appeals and remanded the case for further proceedings. In its opinion, the Court largely adopted the minority position espoused by the Third, Tenth, and D.C. Circuits and held that “mere retention of property does not violate §362(a)(3).” Slip Op. at 1. To reach this outcome, the Court first construed the operative words in § 362(a)(3), and then considered the interaction between § 362(a)(3) and the turnover provision, § 542(a). First, the Court held that the most natural reading of the terms “stay,” “any act,” and “exercise control,” appearing in § 362(a)(3) was that this subsection prohibited “affirmative acts that would disturb the status quo of estate property as of the time when the bankruptcy petition was filed.” Id. at 3. Next, the Court found that its interpretation of § 362(a)(3) was bolstered by the separate turnover provisions contained in § 542(a) of the Bankruptcy Code. Construing § 362(a)(3) to create an affirmative turnover obligation on creditors, the construction urged by the debtors, “would create at least two serious problems.” Id. at 5. First, construing § 362(a)(3) as a “blanket turnover provision” would render the turnover provision in § 542(a) mere surplusage, since a creditor would be forced to turnover estate property immediately to avoid “exercising control” over it, notwithstanding the provisions of § 542. Id. Second, and relatedly, construing § 362(a)(3) to mandate turnover in every case would create a contradiction between that section and § 542(a), which excuses a person from turning over property if, among other exceptions, it is of inconsequential value to the estate. Id. As the Court noted, “it would be ‘an odd construction’ of §362(a)(3) to require a creditor to do immediately what §542 specifically excuses.” Id. (quoting Citizens Bank of Md. v. Strumpf, 516 U.S. 16, 20 (1995)). Finally, the Court agreed with the City of Chicago that the insertion of the phrase “or to exercise control over property of the estate” into § 362(a)(3) by BAFJA in 1984 “simply extended the stay to acts that would change the status quo with respect to intangible property and acts that would change the status quo with respect to tangible property without ‘obtain[ing]’ such property.” Id. at 7 (quoting 11 U.S.C. § 362(a)(3)).

 

Having concluded that mere retention of estate property following the petition date did not violate § 362(a)(3), the Court vacated the judgment of the Court of Appeals and remanded the case. It expressly declined to decide “how the turnover obligation in §542 operates.” Id. It also did not analyze subsections (a)(4) and (a)(6) of § 362, which the bankruptcy court in one of the four original bankruptcy cases had held that the City had also violated, since the Court of Appeals had also not reached that issue. Id. at 7 & n.2.

 

Conclusion

 

            The Court’s opinion resolves a circuit split and added much-needed clarity to an issue that has sharply divided lower courts for decades. Creditors may now rest assured that as long as their passive retention of collateral seized prepetition is consistent with maintaining the status quo as of the petition date, they will not run afoul of the automatic stay.  However, Fulton leaves open the question of whether the same creditor has any affirmative turnover duties under § 542(a), or whether it is entitled to await service of a summons and complaint in an adversary proceeding seeking turnover.

Landon Van Winkle is an associate at Smith Debnam and member of the firm's Consumer Financial Services Litigation and Bankruptcy sections.

 

Post-Discharge Credit Inquiries by Mortgage Servicer did not Violate FCRA

 By: Landon G. Van Winkle

 

A divided panel of the U.S. Court of Appeals for the Ninth Circuit recently held that a mortgage servicer had a permissible purpose for pulling the consumer reports of three borrowers for whom it serviced two mortgages even though the borrowers’ personal liability on the mortgages had been discharged in bankruptcy. Marino v. Ocwen Servicing, LLC, 978 F.3d 669 (9th Cir. 2020).  Specifically, the servicer was authorized to access the borrowers’ consumer reports in order to evaluate them for loss mitigation options, such as a loan modification, short sale, or deed-in-lieu of foreclosure. Id. at 675.

The borrowers each owned a home subject to a mortgage serviced by Ocwen Loan Servicing, LLC (“Ocwen”). The borrowers subsequently filed bankruptcy, and each received a discharge, which discharged their personal liability under their respective mortgages. Following the discharges, Ocwen obtained the borrower’s credit reports. The borrowers, eight in total, sued Ocwen in a putative class action, alleging that it willfully violated the FCRA by obtaining their consumer reports without a permissible purpose, in alleged violation of 15 U.S.C. § 1681b(f)(1).

The U.S. District Court for the District of Nevada granted Ocwen’s motion for summary judgment. In doing so, it relied on a prior unpublished decision from the Ninth Circuit, Vanamann v. Nationstar Mortgage, LLC, 775 F. App’x 260 (9th Cir. 2018). In Vanamann, the Ninth Circuit dealt with identical facts—a borrower whose personal liability on a mortgage that was discharged in a bankruptcy and a mortgage servicer who subsequently accessed the borrower’s credit report. Marino, 978 F.3d at 672 (citing Vanamann, 775 F. App’x at 262). There, the plaintiff alleged only a willful violation of the FCRA, requiring her to demonstrate that Nationstar “engaged in conduct ‘known to violate the [FCRA]’ or acted in ‘reckless disregard of [a] statutory duty.’” Vanamann, 775 F. App’x at 262 (quoting Safeco Ins. Co. of Am. v. Burr, 551 U.S. 47, 56–57 (2007)). To prove reckless disregard, the plaintiff had to prove that Nationstar’s interpretation of the FCRA was objectively unreasonable. Id. Nationstar argued that it had a permissible purpose under § 1681b(a)(3)(A), which permits a consumer reporting agency to furnish a consumer report to a person which the agency has reason to believe “intends to use the information in connection with a credit transaction involving the consumer . . . or review or collection of an account of, the consumer . . . .” 15 U.S.C. § 1681b(a)(3)(A). The Ninth Circuit assumed that Nationstar lacked a permissible purpose under § 1681b, but nevertheless affirmed the dismissal of the plaintiff’s FCRA claim, because the plaintiff could not demonstrate that Nationstar’s conduct was known to violate the FCRA, or that its interpretation of § 1681b(a)(3)(A) was objectively unreasonable. Id. Crucially, the panel noted that the FCRA contained no provision “addressing bankruptcy discharges for Nationstar to interpret, much less interpret recklessly.” Vanamann, 775 F. App’x at 262. Based on the nearly identical facts at issue in Vanamann, the district court concluded that Ocwen could not have willfully violated the FCRA, and therefore granted its motion for summary judgment.

On appeal, the Ninth Circuit affirmed the district court and cited Vanamann approvingly. However, it followed a somewhat circuitous route in analyzing the case. Rather than follow the straightforward process in Vanamann, in which the panel assumed that Nationstar had violated the FCRA, but found that any such violation could not have been willful, the Marino majority instead made a point to address the “threshold question of whether the defendant violated the FCRA.” Marino, 978 F.3d at 671. Addressing this “threshold question” was important, according to the majority, in order to “prevent the law in this area from stagnating.” Id. The majority’s basis for this approach was its view that since a defendant in an FCRA case could “nearly always avoid liability so long as an appellate court ha[d] not already interpreted” the FCRA provision at issue, if the appellate courts simply continued to dispose of cases on the basis that there was no negligent or willful violation of the FCRA, then “the question of statutory interpretation will likely never be answered.” Id. at 673–74.

Therefore, the majority first examined whether Ocwen’s conduct violated § 1681b(f)(1). Ocwen argued that § 1681b(a)(3)(A) provided it with a permissible purpose, because it was using the borrowers’ credit reports to evaluate them for loss mitigation options. Id. at 675. The borrowers argued that because they had vacated and “surrendered” their homes prior to Ocwen’s credit inquiries, and because they had never expressed any interest in avoiding foreclosure, Ocwen lacked a permissible purpose. Id. at 675–76. In rejecting these arguments, the majority observed that nothing in § 1681b(a)(3)(A) required a consumer to affirmatively request a foreclosure alternative before a servicer could review the consumer’s account to determine his or her eligibility. Further, the discharge injunction in the U.S. Bankruptcy Code specifically excepts from its ambit “a secured creditor’s efforts to seek ‘periodic payments associated with a valid security interest in lieu of pursuit of in rem relief to enforce the lien.’” Id. at 675 (quoting 11 U.S.C. § 524(j)(3)). Similarly, it was largely irrelevant whether the borrowers had vacated their homes prior to the credit inquiries at issue, since Ocwen “could have reasonably thought that even a debtor that moved out of his or her home might be interested in returning if Ocwen made a sufficiently attractive offer.” Id. at 676. The majority thus held that Ocwen articulated a permissible purpose to access the borrowers’ consumer reports under § 1681b(a)(3)(A). In dicta, however, the majority sought to cabin this holding somewhat when it opined that “[w]e imagine that if a consumer clearly informs the servicer or lender that he or she has no interest in avoiding foreclosure, then the servicer or lender might lack a permissible purpose for continuing to review the consumer’s credit.” Id. Then, in a single paragraph, the majority noted its “agreement with the district court that Ocwen did not willfully violate the FCRA.” Id. at 676.

Judge Bea concurred in the result and the reasoning of the majority regarding its conclusion that Ocwen did not willfully violate the FCRA. Id. at 676 (Bea, J., concurring). However, Judge Bea chided the majority for including “discussion of two matters not essential to the determination of this case.” Id. First, Judge Bea took issue with the majority’s analysis of whether Ocwen’s conduct violated the FCRA, an analysis which he noted was “not relevant to the decision of the case before us.” Id. Second, he took issue with the majority “imagin[ing] a hypothetical, which Plaintiffs did not plead nor prove, that the majority states may constitute a statutory violation of the FCRA.” Id. at 677. Judge Bea’s concern with the majority’s inclusion of a hypothetical FCRA violation appears particularly valid in the Ninth Circuit, where “dicta in panel opinions may become the binding law of the circuit.” Id. at 679 (citing United States v. Johnson, 256 F.3d 895, 947 (9th Cir. 2001)).

Mortgage servicers, at least in the Ninth Circuit, should take some comfort in the Court’s finding that such servicers retain a permissible purpose for accessing a borrower’s consumer report even after the borrower’s personal liability on the mortgage has been discharged, so long as the servicer intends to use the report to evaluate the borrower for loss mitigation options. However, mortgage servicers should remain wary of the limitations on this permissible purpose forecast by the Marino panel, and should consider adopting a policy to limit or modify future credit inquiries for loss mitigation accounts where the borrower unequivocally informs the servicer that he or she is not interested in pursuing loss mitigation options.

Landon Van Winkle is an associate at Smith Debnam and member of the firm's Consumer Financial Services Litigation and Bankruptcy sections.

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

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.

Eleventh Circuit Refuses to Impose a ‘Least Sophisticated Consumer’ Standard to Discharge Violations

The Eleventh Circuit recently affirmed a Florida bankruptcy court’s denial of plaintiff’s motion for sanctions. In doing so, the Court rejected the consumer’s attempt to import the FDCPA’s “least sophisticated consumer” standard to its discharge violation analysis. Roth v. Nationstar Mortg., LLC, (In Re Roth) 935 F.3d 1270 (11th Cir. 2019). 

In Roth, the consumer filed a Chapter 13 and indicated in her petition that she was surrendering certain non-homestead property which was subject to the mortgage of Nationstar’s assignor. The consumer’s Chapter 13 Plan was confirmed and after she completed her payments under the Plan, a discharge order was entered. As such, the mortgage on the surrendered property was discharged. The order stated that “a creditor may have the right to enforce a valid lien such as a mortgage or security interest. . . Also, a debtor may voluntarily pay any debt that has been discharged.” Id. at 1273. Post-discharge, Nationstar, instead of foreclosing, sent Ms. Roth an Informational Statement which contained an amount due, due date and instructions as to how to pay Nationstar. Importantly, the Informational Statement also included a lengthy disclaimer which provided as follows:

This statement is sent for informational purposes only and is not intended as an attempt to collect, assess, or recover a discharged debt from you, or as a demand for payment from any individual protected by the United States Bankruptcy Code. If this account is active or has been discharged in a bankruptcy proceeding, be advised this communication is for informational purposes only and is not an attempt to collect a debt. Please note, however Nationstar reserves the right to exercise its legal rights, including but not limited to foreclosure of its lien interest, only against the property securing the original obligation.

Id.

Based upon the Informational Statement, the consumer filed a Motion for Sanctions asserting that Nationstar’s Informational Statement was an impermissible attempt to collect a discharged debt and, therefore, violated 11 U.S.C. §524’s discharge injunction. The Bankruptcy Court denied the motion and on appeal, the district court agreed. The consumer then appealed the decision to the Eleventh Circuit.
On the appeal to the Eleventh Circuit, the issue before the Court was whether the Informational Statement was a prohibited debt collection communication under 11 U.S.C. §524. The Court held that it was not. In doing so, the Court rejected the consumer’s argument that the Court should apply the FDCPA’s “least sophisticated consumer“ standard to its §524 analysis, noting that “what counts as ‘debt collection’ under one statutory scheme is not necessarily ‘debt collection’ under the other.” Id. at 1277.
Instead, the Court looked at whether the objective effect of the Informational Statement was to pressure the consumer to repay a discharged debt. Looking at the plain language of the Informational Statement and in particular, the disclaimer language, the Court concluded the Informational Statement did not constitute an impermissible debt collection in violation of §524. The Court noted that there was a disclaimer on the face of the statement in bold print. Id. Additionally, the statement was labeled as an “Informational Statement” and did not demand payment. Instead, the statement repeatedly stated that it was for informational purposes only and was not an attempt to collect a debt. Moreover, in large letters the Statement noted that any payments would be “voluntary.” The court found that “including an ‘amount due,’ ‘due date,’ and statements about the negative escrow balance does not diminish the effect of the prominent, clear and broadly worded disclaimer.” Id. Further, the court reasoned that if it were to consider the Informational Statement a violation of the discharge injunction, “there would be little daylight between (1) a legitimate attempt by Nationstar to inform Roth how she could regain the property and (2) an unlawful attempt at debt collection in violation of §524.” Id.

Creditors should take note of the Court’s adherence to an objective standard under 11 U.S.C. §524 and its refusal to impose the FDCPA’s “least sophisticated consumer” standard upon the Bankruptcy Code. Creditors should be aware, however, that nothing in the opinion undermines the application of the “least sophisticated consumer” standard in the context of an adversary proceeding seeking damages for violations of the FDCPA.

First Circuit Affirms Bankruptcy Court’s Judgment in Favor of Mortgage Company

By Caren D. Enloe

A First Circuit Bankruptcy Appellate Panel (the “Panel”) recently held that a mortgage company’s communications did not violate the discharge injunction when viewed under an objective standard and considering the facts and circumstances surrounding the communications. Kirby v. 21st Mortg. Corp., 599 B.R. 427 (2019). 

In Kirby, the consumers filed Chapter 7 while engaged in a state sponsored Foreclosure Diversion Program.  After the Kirbys received their discharge, the parties continued with the diversion program, including mediation. Post discharge, but within the context of the mediation and other loss mitigation efforts, the mortgage company sent a series of communications to the Kirbys in care of their counsel.  All but one of the documents contained a bankruptcy disclaimer informing the Kirbys that

To the extent your original obligation was discharged, or is subject to an automatic stay of bankruptcy under Title 11 of the United States Code, this notice is for compliance and/or informational purposes only and does not constitute an attempt to collect a debt or to impose personal liability for such obligation. However, a secured party retains rights under its security instrument, including the right to foreclose its lien.

Id. at 434.  After all attempts at loss mitigation failed, the Kirbys’ counsel sent a cease and desist notice to the mortgage company.  After receipt of the cease and desist, the mortgage company sent an annual escrow account disclosure statement, a letter regarding a possible short sale as an alternative to foreclosure and a PMI Disclosure, all of which were addressed to the Kirbys in care of their counsel.  The mortgage company additionally sent a Right to Cure directly to the Kirbys which contained a bankruptcy disclaimer. In total, the mortgage company sent 24 written communications to the Kirbys or their counsel in the 26 month period following the discharge.

Post foreclosure, the Kirbys reopened their bankruptcy and initiated an adversary proceeding alleging, in part, that the mortgage company’s post-discharge communications were coercive attempts to collect a debt in violation of the discharge injunction.  The bankruptcy court disagreed and granted summary judgment in favor of the mortgage company.

On appeal, the issue before the court was whether the post-discharge communications improperly coerced or harassed the Kirbys into paying the discharged debt.  While the Kirbys argued that the sheer volume of the communications amounted to coercion, even if the individual communications did not, the Panel did not agree and concluded that the surrounding circumstances and context in which the communications were sent eliminated any coercive or harassing effect of the post-discharge communications. Id. at 444.

In reaching its decision, the Panel noted that the discharge injunction does not prohibit every communication between a creditor and debtor—only those designed to collect, recover or offset any discharged debt as a personal liability of the debtor. The court then examined the individual communications sent by the mortgage company.  Regarding the letters sent during mediation period, the Panel first observed that each of the communications was sent to the Kirbys’ counsel and not directly to the Kirbys.  Moreover, all but one of those communications included “unambiguous bankruptcy disclaimers informing Mr. Kirby that if he had received a bankruptcy discharge, 21st Mortgage was not attempting to collect a debt from him personally and the correspondence was for informational purposes only.” Id. at 444.  The communication which did not include the bankruptcy disclaimer was an ARM Notice which merely informed the Kirbys of a change in interest rate.  With respect to the ARM Notice, the lack of a bankruptcy disclaimer did not concern the Panel and was not a per se violation of the discharge injunction because it was evident from the circumstances that there was no coercion or harassment.  Id.  Moreover, the Panel noted, when debtors initiate contact with a creditor to negotiate alternatives to foreclosure after post-discharge, certain communications from the creditor are logical and will not violate the discharge injunction. Id. at 445.  The Panel also concluded that the post mediation communications were either sent for informational purposes or to enforce the Defendant’s mortgage foreclosure rights and therefore did not violate the discharge injunction.

Based on the totality of the circumstances surrounding the post-discharge communications, together with the substance of those communications, the Court concluded that the correspondence in question, whether viewed individually or cumulatively, was not coercive or harassing and did not violate the discharge injunction.  Id. at 448.

Caren Enloe is a partner with Raleigh, NC’s Smith Debnam and leads the firm’s Consumer Financial Services Litigation and Compliance Group. 

Bankruptcy Disclaimer Did Not Violate FDCPA

A district court in Michigan recently dismissed an FDCPA action, holding that a letter which included a bankruptcy disclaimer was for informational purposes only and did not violate the FDCPA.  Tyler v. Fabrizio & Brook, P.C., 2019 U.S. Dist. LEXIS 33450 (E.D. Mich. Mar. 4, 2019).  At first glance, the decision appears to be in conflict with the Sixth Circuit’s prior decisions in Glazer v. Chase Home Fin. LLC, 704 F.3d 453 (6th Cir. 2013) and Scott v. Trott Law, P.C., 2019 U.S. App. LEXIS 1015 (6^th Cir. Jan. 11, 2019).  In those cases, the Sixth Circuit concluded that foreclosure proceedings are debt collection.

The case centers around a single letter and a bankruptcy disclaimer.  In 2015, Tyler’s mortgage debt was discharged in bankruptcy.  In 2016, the bank engaged the defendant law firm to foreclose on the underlying real property.  The law firm then sent Ms. Tyler the following letter:

Dear Borrower(s),

BANK OF AMERICA, N.A., successor by merger to LaSalle Bank Midwest, N.A. fka Standard Federal Bank has retained our law firm to begin foreclosure proceedings on the above referenced property. As of the date of this letter, you owe $27,036.78. Because of interest, late charges and other charges that may vary from day to day, the amount due [*8]  on the day you pay may be greater, and an adjustment may be necessary after our client receives your payment.

Unless you notify this office within 30 days after receiving this notice that you dispute the validity of the debt or some portion of it, this office will assume that the debt is valid. If you notify this office in writing within 30 days of receiving this notice, this office will obtain verification of the debt or a copy of a judgment and mail a copy of it to you. If you request in writing within 30 days after receiving this notice, this office will provide you with the name and address of the original creditor if different from the current creditor.

Thank you for your attention to this matter.

Very truly yours,

Devara Walton

Real Estate Default Team

FABRIZIO & BROOK, P.C.

FABRIZIO & BROOK, P.C. IS THE CREDITOR'S ATTORNEY AND IS ATTEMPTING TO COLLECT A DEBT ON ITS BEHALF. ANY INFORMATION OBTAINED WILL BE USED FOR THAT PURPOSE. HOWEVER. IF YOU ARE IN BANKRUPTCY OR HAVE BEEN DISCHARGED IN BANKRUPTCY, THIS LETTER IS FOR INFORMATIONAL PURPOSES ONLY AND IS NOT INTENDED AS AN ATTEMPT TO COLLECTA DEBT OR AS AN ACT TO COLLECT, ASSESS, OR RECOVER ALL OR ANY PORTION OF THE DEBT FROM YOU PERSONALLY

Tyler at *7-9.

Tyler sued the law firm, claiming the letter violated 15 U.S.C. §1692e and asserted that the language “you owe $27,036.78” was misleading since the debt had been discharged in her bankruptcy. The law firm moved to dismiss, alleging that the letter was not an attempt to collect a debt, but instead for informational purposes only.

The court determined that the letter’s primary purpose was informational and to notify Tyler that foreclosure proceedings were about to start.  The court noted that the letter did not explicitly ask for payment, did not provide a due date for payment, did not provide a payment coupon and did not provide an address to mail payment.  Moreover, the court noted the letter contained a bankruptcy disclaimer which was on the same page as the remainder of the letter and “arguably the most conspicuous thing on the letter.”  Id. at *6.

The court’s decision is difficult to reconcile with its Circuit’s recent holding in Scott v. Trott Law, P.C.  in which the Sixth Circuit confirmed its view that foreclosure proceedings are debt collection.  The district court attempted to reconcile its decision by noting that the letter was not a required step in the foreclosure or actual foreclosure activity.  Instead, the court noted that “the letter was a courtesy to Tyler letting her know that foreclosure proceedings were about to start.  Its primary purpose to inform.” Id. at *5. 

Foreclosure law firms should continue to monitor developments in this area closely.  A split in the circuits as to whether non-judicial foreclosure constitutes debt collection may be resolved shortly by the Supreme Court.  Oral arguments were heard in January regarding this issue and a decision is expected this Spring.

Supreme Court Reverses Bankruptcy Proof of Claim Case

“The law has long treated unenforceability of a claim (due to the expiration of the limitations period) as an affirmative defense … And we see nothing misleading or deceptive in the filing of a proof of claim that, in effect, follows the Code’s similar system.”

Midland Funding, LLC v. Johnson, (May 15, 2017).


Yesterday, the Supreme Court reversed the Eleventh Circuit’s holding in Midland Funding v. Johnson in a 5-3 split. Their decision resolves a circuit split as to whether the filing of a time barred proof of claim violates the FDCPA. For those familiar with the oral arguments in this matter, it should come as no surprise that the dissent was written by Justice Sotomayor and joined by Justices Ginsburg and Kagan. The majority opinion was authored by Justice Breyer.

 Johnson in the Lower Courts

Aleida Johnson filed her Chapter 13 bankruptcy petition in 2014. Midland Funding, LLC, a debt buyer, filed a proof of claim which disclosed on its face that the claim was barred by the applicable statute of limitations, listing the date of last transaction as May 2003. Johnson sued Midland in federal court, alleging that Midland had violated sections 1692e and 1692f of the federal Fair Debt Collection Practices Act by filing a time barred proof of claim.  

Midland moved to dismiss asserting that Johnson’s FDCPA claims were precluded by the Bankruptcy Code. The district court concluded that that the Bankruptcy Code expressly provided for the filing of a claim irrespective of whether it is time barred so long as the creditor has a right to payment that has not been extinguished by state law while the FDCPA prohibited debt collectors from doing so. The district court further concluded that the Bankruptcy Code and FDCPA were in irreconcilable conflict and that the later statute, the Bankruptcy Code, impliedly repealed the earlier statute, the FDCPA. Johnson v. Midland Funding, LLC, 528 B.R. 462, 470 (S.D. Ala. 2015). 
On appeal, the Eleventh Circuit reversed, holding that the Bankruptcy Code and FDCPA were not in irreconcilable conflict. Instead, “[t]he FDCPA easily lies over the top of the Code’s regime, so as to provide an additional layer of protection against a particular kind of creditor.” Johnson, 823 F.3d at 1341. The court concluded that the two statutes could be reconciled because “they provide different protections and reach different actors.” Id. at 1340. While the Bankruptcy Code allows creditors to file proofs of claim even with respect to time barred debt, it does not require that they do so and they “are not free from all consequences of filing these claims.” Id. at. 1339. 

Supreme Court

The significance and divisiveness of the issues led both the petitioner and respondent to agree that the issues merited review. The parties’ consensus fast tracked the courts’ consideration of the petition and the following issues were certified for appeal in October: (a) whether the filing of an accurate proof of claim for an unextinguished time barred debt in a bankruptcy proceeding violates the FDCPA; and (b) whether the Bankruptcy Code, which governs the filing of proofs of claim in bankruptcy, precludes the application of the FDCPA to the filing of an accurate proof of claim on an unextinguished time-barred debt. 

Like the majority of the circuits that had previously examined the issue, the court held that the filing of a proof of claim, which on its face indicates the limitations period has run, does not fall within the scope of the FDCPA. Specifically, the Court determined that the filing of the proof of claim did not fall within the “five relevant words” of the FDCPA: false, deceptive, misleading, unfair or unconscionable. 

False, Deceptive or Misleading

In concluding that Midland’s proof of claim was not false, deceptive or misleading, the Court explored the issue of whether the Bankruptcy Code’s definition of a claim requires the claim be enforceable, as well as the respective burdens imposed upon the parties by the statute of limitations. Regarding enforceability, the Court held that the Bankruptcy Code does not contain a requirement that a claim be enforceable. In fact, the Court observed that “[t]he word enforceable does not appear in the Code’s definition of ‘claim’”. Instead, Section 101(5) (A) states that a claim is a right to payment, “whether or not such right is … fixed, contingent, … [or] disputed.” Midland Funding, LLC v. Johnson, slip op. at 4.


The Court also addressed one of the issues which troubled several justices during oral argument: reconciliation of the statute of limitations as an affirmative defense rather than as a condition precedent to filing a claim. At oral argument, Justice Kennedy posed a number of questions to Johnson’s counsel and the Department of Justice (appearing as amicus curiae) raising concerns with Johnson’s assertion that a debt collector can violate the FDCPA by filing a time barred proof of claim. Justice Kennedy’s questions seemed to reflect a two fold concern. First, that by its inherent nature, the statute of limitations is an affirmative defense and secondly, that, in a majority of states, the running of the statute of limitations does not extinguish the debt. Both Justices Kennedy and Alito seemed to share a concern with reconciling those concepts with the position of Johnson which would place an affirmative duty on the claim filer not to file the time barred proof of claim in the first place rather than upon the trustee or other interested party to object. In addressing those concerns, the Court noted that under relevant state law (Alabama), the creditor has a right to payment even after the statute of limitations has expired, meeting the definition of a claim. Additionally, the Court determined that the Bankruptcy Code’s provisions make clear that the running of a limitations period is an affirmative defense, “a defense that the debtor is to assert after a creditor makes a “claim.”

The Court went on to conclude that “[t]he law has long treated unenforceability of a claim (due to the expiration of the limitations period) as an affirmative defense … And we see nothing misleading or deceptive in the filing of a proof of claim that, in effect, follows the Code’s similar system.” Id. at 5.  


Unfair or Unconscionable

Whether the filing of a proof of claim on “obviously” time barred debt is unfair or unconscionable presented a closer question. Like many of the lower courts which had examined the issue, the Court immediately noted the differences between the context of a civil suit and a Chapter 13 bankruptcy proceeding. In a Chapter 13 bankruptcy proceeding, the claims procedure makes it “considerably more likely that an effort to collect upon a stale claim … will be met with resistance, objection, and disallowance” and minimize the risk to the debtor. Id. at 7.  

In its examination under the lens of unfair or unconscionable, the Court returned to its concerns with the debtor’s proposition that the initial burden is on the creditor to insure it files proofs of claim only on debts which are not time barred. The Court noted the practical issues of carving out and defining the boundaries of an exception if it were to change the simple affirmative defense approach. “Does it apply only where … a claim’s staleness appears “on [the] face” of the proof of claim? Does it apply to other affirmative defenses or only to the running of a limitations period?” Id. at 8. The Court concluded that finding the FDCPA applicable to such proofs of claim would ultimately add to the complexity of the claims process and shift the burden from the debtor to the creditor to investigate the staleness of any claim. The Court ultimately concluded that the practice of filing proofs of claim on time barred debt is neither “unfair” or “unconscionable” within the terms of the FDCPA.

Limitations on the Court’s Decision

The Court’s decision is a major win for the industry and is a continued reflection of the Court’s practical approach to claims under the FDCPA. Having said that, it is important to note that the Court’s decision is limited to claims which are otherwise accurate and on their face indicate the limitations period has run. It is important to note that the Court’s opinion does not expressly address the broader issue of whether the Bankruptcy Code precludes the application of the FDCPA. In fact, the opinion may suggest otherwise. By applying the FDCPA’s “five relevant words” to the claim at issue, the Court’s opinion suggests that the FDCPA may, under different circumstances, have some application to the claims process.

District Court Takes on the Intersection of Bankruptcy and the FDCPA

A New York District Court recently tackled the intersection between bankruptcy and pre-petition FDCPA claims and the application of judicial estoppel to undisclosed claims.  In December 2013, Jeziorowski filed a complaint alleging violations of the Fair Debt Collection Practices Act (FDCPA) and the Telephone Consumer Protection Act of 1991 (TCPA). Jeziorowski v. Credit Prot. Assn., L.P., 2017 U.S. Dist. LEXIS 66084 (W.D.N.Y. 2017). Shortly after filing suit, Jeziorowski filed bankruptcy pursuant to Chapter 7. At his 341 meeting, Jeziorowski orally informed the trustee about his pending FDCPA and TCPA claims.  The trustee instructed him to have his attorney report to the court if the pending claims had more value than $1,000. Shortly thereafter, Jeziorowski was granted his discharge. At the time of his discharge, the FDCPA/TCPA lawsuit remained pending and Jeziorowski had not amended his schedules to reflect the claims.

Two years later, Jeziorowski requested the bankruptcy be reopened to allow him to amend his schedules to include the FDCPA and TCPA claims. Shortly after, Jeziorowski filed a motion in the pending FDCPA/TCPA litigation to substitute the trustee as plaintiff. In response, the defendant opposed the motion, arguing that both Jeziorowski and the trustee should be judicially estopped from pursuing the FDCPA and TCPA claims and requesting the complaint be dismissed with prejudice.

The intersection of bankruptcy and pre-petition consumer protection claims is a tricky one.  The proper functioning of the bankruptcy system requires a full disclosure of all claims. The failure to do so may prevent the unwary consumer from pursuing them. In a Chapter 7, disclosed claims may be abandoned by the trustee post discharge and returned to the debtor to pursue.  However, undisclosed claims remain property of the estate and the debtor may be estopped from pursuing them. In short, the doctrine of judicial estoppel prevents consumers from gaming the system.   

In addressing the defendant’s judicial estoppel argument, the court first noted that for judicial estoppel to apply, “1) a party’s later position must be ‘clearly inconsistent’ with its earlier position; 2) the party’s former position has been adopted in some way by the court in the earlier proceeding; and 3) the party asserting the two positions would derive an unfair advantage against the party seeking estoppel.” Jeziorowski at *6.  The court noted, however, that the failure to disclose an asset does not necessarily preclude his claims when the non-disclosure is inadvertent. The court went on to state that even if the debtor is judicially estopped from pursuing an undisclosed claim, a trustee is not necessarily estopped from pursuing the same claim on behalf of the creditors.  

Rejecting the defendant’s judicial estoppel argument, the court reasoned that neither the debtor nor the trustee were judicially estopped from pursuing the FDCPA and TCPA claims. In doing so, the court relied heavily on the fact that Jeziorowski had orally disclosed the pending litigation to the trustee at his 341 meeting.  The court concluded, therefore, that “there is no basis for concluding that Jeziorowski deliberately asserted inconsistent positions to gain an advantage; on the contrary, there is every reason to conclude that his nondisclosure was inadvertent and that he acted in good faith.” Id. at *10. Moreover, the court concluded that there was no reason to judicially estop the trustee from pursuing the claims. “Estopping the trustee … would work the sort of unfair windfall – this time, to the defendant – that equity is designed to prevent.” Id. at *9.

The opinion serves as a reminder that, at the outset of every litigation, defense counsel should determine whether the plaintiff has filed bankruptcy and closely examine any bankruptcy petition for a disclosure of the claims. Generally, a court will invoke the judicial estoppel doctrine if the plaintiff was deliberately asserting inconsistent positions in order to play “fast and loose with the courts.” Ryan Operations G.P. v. Santiam-Midwest Lumber Co., 81 F.3d 355, 358 (3d Cir. 1996).

 

 

Objection to Proof of Claim Not Barred by Res Judicata

A Virginia bankruptcy court recently ruled that an objection to a proof of claim was not barred by the doctrine of res judicata when an order of confirmation was entered prior to the objection being filed.  In re Haskins, No. 15-60644 (W.D. Va. Jan. 27, 2017) [Dkt No. 31].  The creditor, a debt buyer, filed its unsecured proof of claim prior to confirmation of the debtor’s Chapter 13 plan.  The proof of claim conformed with the requirements of Rule 3001 of the Bankruptcy Rules of Procedure, including the provisions requiring the creditor to state the date of the last transaction and the date of last payment.  On its face, the proof of claim disclosed the claim was time barred.  The debtor’s Chapter 13 plan was confirmed after the filing of the proof of claim.  Three months later, the debtor objected to the debt buyer’s proof of claim as time barred.  At the hearing, the debt buyer contended the confirmation of the debtor’s Chapter 13 plan had a res judicata effect on the disposition of the claim and the objection should be denied on that basis.

In upholding the objection to the claim, the court first noted the distinction between the treatment of secured and unsecured claims in the context of a Chapter 13 confirmation.  Secured claims are individually treated and valued.  By contrast, unsecured claims are treated collectively with no consideration given to each claim’s individual value.  Instead, unsecured claims are treated in a single class and the plan must provide a pool of funds to be distributed pro rata to the class.  In keeping with this, the Bankruptcy Code provides a mechanism by which secured claims may be challenged in conjunction with confirmation of the plan.  There is no similar mechanism for unsecured claim.  The court therefore concluded that the debtor did not have a statutory mechanism to initiate a proceeding to determine the allowed amount or validity of an unsecured claim until the proof of claim is filed.

The court continued its analysis by reviewing the conclusive nature of a confirmation order. The court took notice that “[s]ection 1327 of the Bankruptcy Code provides that ‘[t]he provisions of a confirmed plan bind the debtor and each creditor, whether or not the claim of such creditor is provided for by the plan, and whether or not such creditor has objected to, has accepted, or has rejected the plan.’”  Id. at p.9.  Confirmation, therefore, has a “preclusive effect foreclosing relitigation of ‘any issue actually litigated by the parties and any issue necessarily determined by the confirmation order.’”  Id. (emphasis supplied).  The court therefore concluded that the confirmation order only precludes an issue or matter which was previously litigation or determined by confirmation.

Turning to the facts of the case, since the court did not at confirmation determine the amount of each general unsecured claim, it concluded that the issue of the claim’s validity had not been previously litigated, particularly since the deadline to file proofs of claim was subsequent to the deadline to object to confirmation.  Moreover, given that neither the claims process set forth in 11 U.S.C. 502 nor the objection process set forth in Rule 3007 set a deadline for objecting to a proof of claim, providing a confirmation order with a res judicata effect as to an objection to a general unsecured claim would “conflate the confirmation process with the claims allowance process.” Id. at p. 12.    The court therefore determined that the objection was not precluded by res judicata. 

Supreme Court Agrees to Hear FDCPA Proof of Claim Case

Last week, the Supreme Court agreed to hear Midland Funding v. Johnson and resolve the split in the circuits over whether the filing of a time barred proof of claim violates the FDCPA and whether the Bankruptcy Code preempts the FDCPA regarding proofs of claim. As many know, Johnson was the Eleventh Circuit’s encore act to Crawford v. LVNV in which it not only supported its position in Crawford but expanded it by addressing the issue left unanswered in Crawford: whether the Bankruptcy Code preempts the FDCPA where the debt collector files a proof of claim on a debt it knows to be time barred. Johnson v. MidlandFunding, LLC, C.A. No. 15-11240, 2016 U.S. App. LEXIS 9478 (11th Cir. May24, 2016).


Recap of Johnson


In Johnson, the Court answered that question in the negative, finding that the Bankruptcy Code does not preempt the FDCPA. Instead, “[t]he FDCPA easily lies over the top of the Code’s regime, so as to provide an additional lawyer of protection against a particular kind of creditor.” Johnson at *15. In its analysis, the Court found that the Bankruptcy Code and FDCPA “differ in their scopes, goals, and coverage, and can be construed together in a way that allows them to coexist.” Johnson at *13-14. The court concluded that the two statutes could be reconciled because “they provide different protections and reach different actors.” Johnson at *14. While the Bankruptcy Code allows creditors to file proofs of claim even with respect to time barred debt, it does not require that they do so. While “creditors can file proofs of claim they know to be barred by the relevant statute of limitations, those creditors are not free from all consequences of filing these claims.” Johnson at *10. The court read the statutes together as “providing different tiers of sanctions for creditor misbehavior in bankruptcy.” Johnson at *15 The Court was adamant that regardless of the circumstances if a debt collector, as defined by the FDCPA, “files a proof of claim for a debt that the debt collector knows to be time-barred, that creditor must still face the consequences imposed by the FDCPA for a ‘misleading’ or ‘unfair’ claim.” Johnson at *16. 

The Aftermath of Johnson and Crawford

Since Johnson, two more circuits have weighed in on the proof of claim issue. In Owens v. LVNV Funding, LLC, the Seventh Circuit held that in states where the statute of limitations does not extinguish the debt, the filing of a time barred proof of claim does not give rise to an FDCPA claims where the proof of claim does not contain inaccurate information and where the defendant has not otherwise engaged in deceptive or misleading debt collection practices. Owens v. LVNV Funding, LLC, 2016 U.S. App. LEXIS 14706 (7th Cir. Aug. 10, 2016). Two weeks later, the Fourth Circuit followed suit holding that the filing of a time barred proof of claim does not violate the FDCPA when the statute of limitations does not extinguish the debt. Dubois v. Atlas Acquisitions, No. 15-1495, 2016 U.S. App. LEXIS, *22-23 (4thCir. Aug. 25, 2016).

The circuits have also taken opposite positions on the issue of preemption. While the Johnson court held that the Bankruptcy Code does not preempt the FDCPA, other circuits have disagreed. It has long been the Ninth Circuit’s position that the Bankruptcy Code preempts the FDCPA in a bankruptcy setting. Walls v. Wells Fargo Bank,  276 F.3d 502 (9th Cir. 2002). The Second Circuit similarly held in Simmons v. Roundup Funding, LLC, 622 F.3d 93 (2nd Cir. 2010) that the proof of claims process is solely the dominion of the Bankruptcy Code. The Third and Seventh Circuits meanwhile have taken the contrary position, holding that the Bankruptcy Code does not preempt the FDCPA. See Randolph v. IMBS, Inc. 368 F.3d 726 (7th Cir. 2004); Simon v. FIA Card Servs., 732 F.3d 259 (3d Cir. 2013).

Johnson in the Supreme Court

The significance of the issues and the divisiveness of the issues led both the petitioner and respondent in Johnson to agree that the issues presented were worthy of the Supreme Court’s attention. The parties’ agreement fast tracked the courts’ consideration of the petition.  

The issues certified for appeal are: (a) whether the filing of a an accurate proof of claim for an unextinguished time barred debt in a bankruptcy proceeding violates the FDCPA; and (b) whether the Bankruptcy Code, which governs the filing of proofs of claim in bankruptcy, precludes the application of the FDCPA to the filing of an accurate proof of claim on an unextinguished time-barred debt. Currently, the petitioner’s brief is due the end of November.

Bankruptcy Court Shuts the Door on Trustee's Settlement of TCPA Claim

By: Caren Enloe and Parker Dozier

September 26, 2016

A bankruptcy court has dealt a blow to a TCPA defendant’s attempt to moot a class action lawsuit by entering into a settlement with the class representative’s bankruptcy trustee.  In re Presswood, Case No. 12-60237 (Bankr. S.D. Ill. 2016).   In Presswood, the Chapter 7 debtor, a sole proprietor, received two prepetition faxes which he alleged violated the TCPA.  Three years after filing a Chapter 7 bankruptcy, the debtor filed a class action for violations of the TCPA.  After filing the class action, the debtor amended his bankruptcy schedules to disclose the pre-petition TCPA claim, valuing the claim at $500 and seeking to exempt it on his Schedule C.   The trustee did not object.  Thereafter, the trustee entered into a proposed settlement with the TCPA defendant for $10,000.00 and filed an application to approve compromise.  The debtor objected, calling into question the trustee’s standing and submitting that the proposed settlement amount grossly exceeds the value of the claim.  Specifically, the debtor alleged that the settlement was an attempt to “buy off” the class action.

The bankruptcy court in reviewing the application to approve settlement first addressed the issue of the standing of both the debtor to object to the proposed settlement and the trustee to settle the suit.  In reviewing the two competing interests, the court noted that, in order for the debtor to have standing, he must have a pecuniary interest in the outcome.  However, “if as posited by the Debtor on his amended Schedule C, the cause of action is actually worth no more than the claimed exemption, the issue becomes not whether the Debtor has standing to challenge the Trustee’s proposed settlement, but, rather, whether the Trustee has standing to settle a suit that is not property of the bankruptcy estate.” 

After conducting a valuation hearing as to the value of the debtor’s TCPA claim based upon two faxes, the court determined that it could not find that the value of the TCPA claim exceeded the $500 exemption claimed by the debtor.  Moreover, the court was troubled by the fact that there were no other class representatives and that a dismissal of the debtor’s claims would defeat the class action in its entirety because the statute of limitations had run.  “By offering to settle the estate’s claim for $10,000, which is over three times more than the highest possible recovery under the relevant sections of the TCPA and twenty times the value supported by the evidence, the Court can only conclude that Pernix is attempting to “buy off not only the estate’s claim but those of all of the other putative class members as well.”

This case is reminiscent of the spate of recent offer of judgment cases. See Campbell-Ewald Co. v. Gomez, 136 S. Ct. 663 (2016).  Defendants’ attempts to moot class actions by settling with the named plaintiff have met the same fate as the defendant in this case.  Ironically, the defendant in this matter had a better chance of the settlement being approved, and therefore the class action being dismissed, if it had offered a lower, more realistic settlement amount to the trustee.  Offering $1,000.00 instead of $10,000.00, which the court found suspect, could have led to the settlement being approved and the class action’s dismissal because the statute of limitations would have been a bar to a new named plaintiff being substituted.