Time-barred debts and bankruptcy

The U.S. Supreme Court recently issued a controversial decision about creditors filing claims in bankruptcy proceedings after the legal deadlines have passed to collect those debts in lawsuits. This holding may affect our clients on both sides of the issue: creditors seeking to collect on older debts as well as consumers filing bankruptcy for relief from crushing debts, some of which may have become stale.

Federal consumer protection

In May in the case of Midland Funding, LLC, v. Johnson, the high court said that a debt collector does not violate the Fair Debt Collection Practices Act, called the FDCPA, if it files a claim against the debtor in a bankruptcy proceeding on a debt that is considered not collectible because the statute of limitations has expired. The statute of limitations is the legal deadline for filing a lawsuit to collect a debt. If a creditor files a suit to collect a debt after the statute of limitations has expired, the statute of limitations would be a valid defense.

The FDCPA is the main federal law protecting consumers from predatory collection practices. The law makes it unlawful for debt collectors to engage in behavior that is:

• False

• Deceptive

• Misleading

• Unconscionable

• Unfair

Broadly, in bankruptcy, a creditor that believes it has a valid claim can file it in the bankruptcy proceeding to receive payment from the debtor’s assets, if available. The objection in the Midland Funding case was that to file a time-barred claim would violate the FDCPA. The thinking goes that the statute of limitations may go unnoticed in the bankruptcy and the claim could be paid in the bankruptcy when it could not have been paid in a lawsuit, an outcome arguably unfair to the debtor.

Basically, the Supreme Court opinion said that it does not violate the FDCPA to file a time-barred claim in bankruptcy because the Bankruptcy Code views a “claim” broadly and the claim will be disallowed if “unenforceable.” The court said that the bankruptcy trustee is likely to object based on the statute of limitations.

The court was sharply divided. However, it will be the job of bankruptcy attorneys to follow how these claims are handled in bankruptcy going forward and provide legal advice to clients accordingly. Anyone dealing with a time-barred claim in a bankruptcy situation should talk to an experienced lawyer for understanding of the legal issues and guidance.