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Bankruptcy Court: A Safer Place for Debt Collectors

Last year, the United States Supreme Court held that the FDCPA’s unique restrictions on debt collectors do not necessarily translate well in the world of bankruptcy. In Midland Funding. LLC v. Johnson, 137 S. Ct. 1407 (2017)—a case our firm was involved in, and which you can read about here—the Supreme Court held that, regardless of lower courts’ holdings that the FDCPA prohibits debt collectors from filing lawsuits in state court for time-barred debts, those same debt collectors have a right to file proofs of claim in bankruptcy courts for the same debts.

Earlier this month, applying the principles of Midland Funding, a Maryland bankruptcy court held  that a debt collector who would be prohibited from filing a collection lawsuit under state law is nonetheless allowed to file a proof of claim in bankruptcy court. See In re Chorba, Case No. 17-380 (Bankr. D. Md. Mar. 8, 2018).  Under Maryland’s consumer protection statute, a debt collector that is not licensed cannot sue for a debt, and any judgment an unlicensed debt collector might obtain can be attacked as a void judgment. After an unlicensed debt collector filed proofs of claim in the debtor’s chapter 13 case, the debtor sued the debt collector.

The bankruptcy court granted the debt collector’s motion to dismiss. Drawing on the Supreme Court’s reasoning in Midland Funding, the court held that the debt collector’s unlicensed status does not negate its underlying right to payment—e.g., it does not invalidate the agreement to sell the claim to the unlicensed debt collector, nor does it invalidate the debtor’s underlying obligation. And, because the Bankruptcy Code defines a claim as a right to payment, even unlicensed debt collectors may file claims. Because the Maryland consumer protection law ostensibly would “penalize a party for exercising a right under the Code,” it is preempted by the Bankruptcy Code.

The full impact of Midland Funding is not yet known. The district court in that case held that, with respect to time-barred proofs of claim, an irreconcilable conflict existed between the FDCPA and the Bankruptcy Code.  And thus, “the Act must give way to the Code.” The Supreme Court did not reach that issue, instead deciding that time-barred proofs of claim simply are not misleading under the FDCPA.  Questions remained about what, if any, conduct in bankruptcy might still lead to liability under the FDCPA or state-law counterparts. And, beginning just a few months after Midland Funding, we saw new theories of liability arise under the FDCPA. The decision in In re Chorba is a logical extension of Midland Funding’s recognition of what a claim is.  Litigation about the boundaries of Midland Funding’s rationale will no doubt continue, but one thing is certain: debt collection is different when it comes to bankruptcy claims.