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The Supreme Court Will Answer Whether Collection of Time-Barred Debt in Bankruptcy Violates the Fair Debt Collection Practices Act

Lots of people and companies buy old debt—for example, hedge funds, private equity firms, and even some commercial bank affiliates. Typically, this is debt that the original creditor has charged off and sold for a fraction of the legal balance. In some cases, the debt has grown so old that a statute of limitations makes it technically unenforceable. But that doesn’t always stop the debt buyer from attempting collection.

A few weeks ago, Jeff Novel wrote about a Fifth Circuit case that addressed whether debt collectors violate the Fair Debt Collection Practices Act (“FDCPA”) by sending collection letters that offer to “settle” unenforceable debt. The Fifth Circuit concluded that the letters could violate FDCPA—but noted a split of authority among the federal circuits.

Last week, the US Supreme Court agreed to review a similar issue—whether debt collectors violate FDCPA by filing a proof of claim in a bankruptcy for old, unenforceable debt. In the collection letter cases, debt collectors are incentivized to buy the debt and send the letters because any payment from the debtors would probably put the collectors in the money. Likewise for bankruptcy proofs of claim: there is a chance that nobody notices that the debt is time-barred, so any recovery—even pennies on the dollar—would create a net gain on the investment. This is especially true in Chapter 13 cases, where the debtor has no incentive to vet the various claims, because he will pay the same monthly amount regardless of how large his debts are. Ditto for trustees and other creditors, who have no economic incentive to review the dozens or hundreds of claims filed in every Chapter 13 case. As a result, courts often approve the claims and debt buyers get paid.

As in the collection letter cases, the issue turns on whether the proof of claim is a “misleading” or “unfair” practice. An affirmative answer would likely bar the practice and may impact the broader distressed debt market. A negative answer would likely allow the practice to continue. We will continue to monitor the case and will report back.

The case is Midland Funding, LLC v. Johnston—you can read the briefing here.