U.S. Supreme Court: Stale Claims, Attorneys and Trustees in Chapter 13 & Dissent’s Call for Congress to Overrule (Midland Funding v. Johnson)

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Chapter 13 of the Bankruptcy Code

By Donald L. Swanson

The case is Midland Funding, LLC v. Johnson, Supreme Court Case No. 16-348 (decided May 15, 2017).   It’s about creditors filing proofs of stale claims (i.e., claims barred by statute of limitations) in Chapter 13 cases.

The Facts

Aleida Johnson files Chapter 13 bankruptcy.  Then, Midland files a proof of claim for a credit-card debt of $1,879.71,  specifying that the debt is more than 10 years old and beyond the 6 year statute of limitations.  Johnson’s bankruptcy attorney objects to the claim, Midland does not respond, and the Bankruptcy Court disallows Midland’s claim.

Then, Johnson sues Midland for violating the Fair Debt Collection Practices Act (the “Act”).  The District Court and the Court of Appeals disagree on whether the Act applies to Midland’s proof of claim, and the U.S. Supreme Court agrees to hear the case.

On May 15, 2017, the Supreme Court makes this ruling:

Since Midland’s proof of claim “on its face indicates that the limitations period has run,” the proof of claim is neither “false,” “deceptive,” “misleading,” “unconscionable” nor “unfair,” within the meaning of the Act.

The ruling is by a five-Justice majority (Breyer, Roberts, Kennedy, Thomas and Alito), with three Justices dissenting (Sotomayor, Ginsburg and Kagan) and one Justice (Gorsuch) not participating.

The Majority Opinion

The majority says a proof of claim disclosing facts that show the claim to be stale is not “false,” “deceptive” or “misleading” under the Act.  Here’s why:

A “claim” in bankruptcy is a “right to payment” and is to be given “the broadest available definition.”  For example, (i) § 502(b)(1) says an “unenforceable” claim will be disallowed: it does not say that an “unenforceable” claim is not a “claim,” and (ii) §101(5)(A) says a “claim” is a “right to payment,” even if that right proves to be unenforceable.

“The law has long treated” a statute of limitations argument “as an affirmative defense” that a debtor must raise.  The Bankruptcy Code adopts this same view (see §§502, 558).

In Chapter 13, the trustee is sophisticated and “likely to understand” these statute of limitations rules.

The majority also rejects “unconscionable” and “unfair” characterizations under the Act for several reasons.

First, several courts say the knowing assertion of a stale claim, in an ordinary collection lawsuit, is “unfair” because the debtor might pay the stale claim “unwittingly” or to avoid cost or embarrassment.  Such a concern is “significantly diminished” in Chapter 13 because, (i) the consumer initiates the bankruptcy, (ii) a knowledgeable trustee is involved, and (iii) claims review processes are “streamlined.”

One benefit to a Chapter 13 debtor from the filing of a stale claims is this: a debtor can discharge the stale claim and keep it off credit reports.

“More importantly,” an exception to “the simple affirmative defense approach” would require defining the boundaries of the exception.

The Act and the Bankruptcy Code have different purposes: (i) the Act seeks to help consumers “by preventing consumer bankruptcies in the first place,” while (ii) the Bankruptcy Code creates and maintains the “delicate balance of a debtor’s protections and obligations.”  To find the Act applicable here would upset that “delicate balance.”

The Dissenting Opinion

The dissenting Justices find Midland’s actions to be both “unfair” and “unconscionable.”  They decry the efforts of “debt buyers,” who purchase consumer debts from creditors and then attempt to collect what they can from the debtors and keep the profits:

–Such buyers “pay close to eight cents per dollar” for debts under three years old, pay “as little as two cents per dollar” for debts over six years old, and pay “effectively nothing” for debts over 15 years old;

–These buyers knowingly file suit on stale claims, hoping the debtor won’t raise the affirmative defense or won’t respond at all.  And such buyers have won “billions of dollars in default judgments” against consumer debtors on stale claims.

–“Every court to have considered the question,” has found such conduct “unfair” and “unconscionable” under the Act.

–“It does not take a sophisticated attorney to understand why” such practices are “unfair.”  It only takes “common sense” to conclude that “one should not be able to profit on the inadvertent inattention of other” or that “the law should not be a trap for the unwary.”

The dissent concludes with a call for Congress to overrule the majority decision:

“I take comfort only in the knowledge that the Court’s decision today need not be the last word on the matter. If Congress wants to amend the FDCPA to make explicit what in my view is already implicit in the law, it need only say so.  I respectfully dissent.”

How Chapter 13 Cases Actually Work

Once again, I’m struck by the failure of the U.S. Supreme Court to appreciate how bankruptcy cases actually work.  Here are two examples from the Midland Funding, LLC v. Johnson opinion.

  1.  Debtor Attorneys: Omitted from the discussion!

An important professional in a Chapter 13 case – perhaps, the most important professional – is debtor’s attorney.  Yet, there is nary a substantive reference to the role of a debtor’s attorney in the entire Midland v. Johnson case, other than in the recitation of facts (Debtor’s attorney is the one who objected to Midland’s stale claim).  There’s much talk in the opinion about the Chapter 13 trustee as a sophisticated player [rightly so], but there’s nothing about the debtor’s attorney.

This is a shame.  Why and how an important legal opinion like this can fail to even mention the debtor attorney role is puzzling.

For example, the Dissent seems exercised about the majority opinion and calls on Congress to change the majority ruling because, “most debtors who fail to object to a stale claim will end up worse off than had they never entered bankruptcy at all.” But Congressional involvement is not needed.  There is a simple and easily administered solution.

–Debtor attorneys will add the following item to their Chapter 13 case checklists–if it isn’t already there:

“Review filed claims, after claims deadline expires, and object to stale claims.”

–And, of course, their authorized fees (which are paid through the Chapter 13 plan) will need to increase accordingly.

Here’s why this checklist item is now an added service worthy of additional compensation.  A typical Chapter 13 bankruptcy happens like this:

The debtor files Chapter 13 because a bunch of unsecured debts cannot be paid.  The Chapter 13 plan proposes to pay all disposable earnings over several years to the Chapter 13 trustee, who will then distribute such funds under a confirmed plan.  The distributions go, as required by statute, (i) first, to administrative (e.g., attorney fees), priority (e.g., taxes) and secured (e.g., car loan) claims, and (ii) then, whatever is left over, to unsecured claims pro rata, who often receive only a few cents on each dollar.

So, if an unsecured claim is unenforceable because of a statute of limitations issue but is allowed in the Chapter 13 case anyway:

–the ones injured by the allowance are the other unsecured creditors, whose pro rata shares are diminished by the allowance of a stale claim; and

–the debtor has little reason to care, because the amount debtor must pay under the plan will not be affected by the stale claim’s allowance.

Now, as explained in the Midland v. Johnson dissent, the Chapter 13 debtor must care.  And debtor attorneys need to act accordingly.

  2.  Chapter 13 Trustees: Duties regarding stale claims?

The majority opinion seems to misunderstand what Chapter 13 trustees actually do.  The majority seems to think there is a sophisticated bankruptcy administrator in every Chapter 13 case, called a trustee, [this much is true] who has unlimited capacity to examine every claim filed in every Chapter 13 case for staleness [this part is not true].

Chapter 13 of the Bankruptcy Code places explicit responsibility for examining and objecting to claims upon the trustee.  Here’s how:

–§ 1302(b) says:  “The trustee shall—(1) perform the duties specified in sections . . . 704(a)(5)”; and

–§704(a)(5) says: “The trustee shall— . . . (5) if a purpose would be served, examine proofs of claims and object to the allowance of any claim that is improper.”

However, the trustee’s obligation, under such statutes, to examine claims arises only when “a purpose would be served.”  Does the majority ruling now require Chapter 13 trustees to examine all claims for staleness?  Maybe so.  But such an examination would be redundant of the added checklist item for debtor’s attorney mentioned above: i.e., no purpose “would be served” by the trustee’s examination.

And the majority ruling will, undoubtedly, result in a much higher volume of stale claims filings: the dissent refers to a “deluge” of such filings.  Where is the compensation going to come from for any expanded efforts by the Chapter 13 trustee to examine claims?

Conclusion

It will be interesting to see what the fallout and effect will be from the Supreme Court’s majority decision in Midland v. Johnson and the dissent’s call for Congressional action.

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