Earlier this week, the U.S. Supreme Court held that a creditor who deliberately files a bankruptcy proof of claim for a time-barred claim does not violate the Fair Debt Collection Practices Act (FDCPA). Midland Funding v. Johnson, No. 16-348, 581 U.S. __ (May 15, 2017) (slip op.). The 5-3 decision authored by Justice Stephen Breyer was met with a blistering dissent by Justice Sonia Sotomayor.  While the decision will help unscrupulous debt collectors, it will likely hurt legitimate creditors such as banks.

The FDCPA imposes penalties for “unfair and unconscionable means to collect a debt.” 15 U.S.C. § 1692f. All states have statutes of limitation setting a time limit on bringing certain types of lawsuits.  Once the limitations period has passed, a creditor may not sue to collect the debt.  The debt does, however, in some sense continue to exist.  If the debtor chooses to repay a time-barred debt, the creditor can keep the money.  As a banker, please be sure to send a thank-you note when this happens; you’ll be in no danger of writers’ cramp given the infrequency of the occurrence.

Courts have held that filing a civil lawsuit to collect a debt known to be time-barred violates the FDCPA. See e.g., Phillips v. Asset Acceptance, LLC, 736 F.3d 1076, 1079 (7th Cir. 2013).  This is so even though rules of pleading do not require the creditor’s complaint to state that the lawsuit is timely.  Rather, the statute of limitation creates an affirmative defense, meaning that the defendant has the burden to plead and to prove that the claim is time-barred.  Courts reason, however, that knowing the borrower has an ironclad defense is just the same as knowing that the debt isn’t valid for any other reason.  To sue on a claim known to be invalid constitutes “misleading” and “unfair” conduct in violation of the FDCPA.

In Midland the Supreme Court created a different rule for bankruptcy proofs of claim:  Even if the claim is subject to an ironclad defense, filing a proof of claim does not violate the FDCPA.  The Court reasoned that since the debtor initiates the bankruptcy proceeding (in Midland, under chapter 13 of the Bankruptcy Code), “the consumer is not likely to pay a stale claim just to avoid going to court.” Midland, slip op., at 6.  Further differentiating a bankruptcy proceeding from non-bankruptcy litigation, the Court cited the involvement of a knowledgeable trustee and the streamlined claims resolution procedure. Id. “These features of a chapter 13 bankruptcy proceeding,” concluded the Court, “make it considerably more likely that an effort to collect upon a stale claim in bankruptcy will be met with resistance, objection, and disallowance.” Id. at 7.

The Court was also troubled that “a change in the simple affirmative defense approach, carving out an exception, itself would require defining the boundaries of the exception.” Id. at 8.  What if it’s an affirmative defense other than statute of limitations?  What if the affirmative defense is not obvious from the face of the proof of claim?  Better to have a bright-line rule, consisting of “the simple affirmative defense approach” – which apparently is that there will never be a penalty under the FDCPA for filing a claim that is valid but for the possible, or even definite, existence of an affirmative defense. Id.

In the real world, banks may pay a price for the Midland decision.

This is great news for debt collectors who have made a business model out of buying up stale debt for pennies on the dollar, filing thousands of proofs of claim, and hoping that a few of them will slip by without objection. But how does this affect banks?  Shouldn’t bankers rejoice at any limitation courts impose on the broad reach of the FDCPA?

Certainly that’s one way to look at it. But in the real world, banks may pay a price for the Midland decision.  If Midland truly means that it’s okay to file a claim even when there’s an ironclad affirmative defense, then it opens the doors for the filing of invalid claims that in the past would not have been filed.  Bankruptcy trustees will need to respond.  Instead of allowing without further inquiry a claim that appears legitimate on its face, trustees can be expected to ask the creditor:  Is the claim time-barred?  Have you released the claim (release is another affirmative defense)?  Have you already been paid (yes, that’s right, payment is an affirmative defense)?  A reputable bank would never deliberately file a claim for a loan that was repaid, released or otherwise legally uncollectable.  Yet banks may increasingly be called upon to respond to due-diligence inquiries from trustees.  Not only would they bear their own expenses in responding, but in chapter 7 cases would suffer reduced recoveries on account of the increased legal fees of the trustee.  And banks’ recoveries will be diluted by distributions on account of time-barred claims since some, inevitably, will slip through.

Midland might in a technical sense be a pro-creditor decision, but it could prove costly to banks and other legitimate creditors.