Sixth Circuit Releases Remarkable Opinion on Debt Buyers, Mootness and Sanctions

Unsecured claims held by credit card companies, and in particular by debt buyers, have kept bankruptcy judges and appellate courts busy recently. In the typical case, a credit card company or debt buyer files a claim which contains a summary listing the original creditor, the last four digits of the account number and the amount of the claim. The debtor objects on the basis that the claim is not supported by the documents establishing the claims and/or that the debtor does not know who the debt buyer is. The creditor will offer varying amounts of proof ranging from none to the debtor's schedules and a business records affidavit with respect to the claim.

Some of the recent decisions include: In re Kirkland, 572 F.3d 838 (10th Cir. 2009), holding that an unsubstantiated claim may not be allowed upon objection by the trustee; In re Plourde, 418 B.R. 495 (1st Cir. BAP 2009), holding that failure of creditor to provide proof of nature of claim relegated claim to subordinated status for penalties; and In re DePugh, 409 B.R. 84 (Bank. S.D. Tex. 2009), holding that creditor who failed to include supporting documentation could not amend claim after objection was filed without leave of court.

U.S. Bankruptcy Judge Jeff Bohm (author of the DePugh decision) has adopted a Notice and Order That Federal Rule 15, As Made Applicable Bankruptcy Rule 7015, Shall Apply Whenever an Objection to a Proof of Claim is Filed," which provides that creditors who amend their claims without leave of court after an objection has been filed shall be subject to sanctions.

Suffice it to say that credit card creditors have not been feeling the love lately. However, a new decision out of the Sixth Circuit gives debt buyers a modicum of respect. In In re Wingerter, No. 08-4455 (6th Cir. 1/25/10), the Sixth Circuit reversed a bankruptcy court's sanctions order which struck at the heart of a debt buyer's business model.

The case began with a claim for $431.57 filed by B-Line, LLC, a debt buying firm. B-Line had bought the claim from Covenant Management, LLC, who in turn had purchased it from the original creditor, GTE. Unlike many of these cases, the Debtor insisted that he had never owed a debt to GTE. When B-Line could not obtain proof that the debt existed, it withdrew the claim.

However, that was not the end of the story. The Bankruptcy Court issued a series of show cause orders to B-Line to explain its business practices in general and its handling of the specific claim as well. The Court found that B-Line had violated Rule 9011(b) by failing to make a "reasonable pre-filing inquiry" that the claim was valid and supported by evidence.

The Bankruptcy Court stated:

This Court finds that B-Line did not fulfill its Rule 9011 obligations in filing the B-Line POC without having possession of the underlying transactional documents or any reliable proxy for such documents. As a prospective matter, B-Line and other purchasers in the claims trading industry should understand that this Court views the filing, without review of originating documents, of a proof of claim by an assignee/purchaser to fall short of reasonable inquiry under Rule 9011 when the obligation has not been scheduled by the debtors and the purchase of the claim was not accompanied by reliable representations of claim validity. Because of the time and energy that B-Line's senior management devoted in response to this Court's show cause order, however, the Court does not view any further sanctions to be necessary in this case.

In re Wingerter, 376 B.R. 221, 238 (Bankr. N.D. Ohio 2007).

This left B-Line in the awkward position that it had dodged the bullet on sanctions in the particular case, but would be subject to sanctions in the future if it continued to file claims based on electronic records without viewing the originating documents. B-Line appealed to the Bankruptcy Appellate Panel which dismissed the appeal as moot. With one judge dissenting, the Sixth Circuit reversed both the Bankruptcy Appellate Panel and the Bankruptcy Court.

B-Line's Business Model

One thing which is interesting about this opinion is that the court of appeals went to great lengths to explain how a debt buyer, such as B-Line, does business. This business model forms the backdrop for the opinion.

B-Line is a business entity that specializes in purchasing "consumer bankruptcy debt." It purchases such debt from both original creditors and intermediaries. B-Line then files proofs of claim in the respective debtors' bankruptcy cases, or has existing proofs of claim transferred to it.

When B-Line purchases a claim, it does not acquire the supporting documentation. Instead, it requests several pieces of information from the claim's seller that B-Line stores in an electronic database. This information typically includes the debtor's name, address, contact information, and Social Security number, as well as the original account number, the original creditor's name, the original amount owed, the date the original account was opened, and the bankruptcy case information.

B-Line relies on the sellers from whom it purchases the claims to provide accurate, truthful information, and it negotiates a purchase agreement with these sellers to protect itself in case a seller misrepresents the validity of a claim. The purchase agreement requires, in particular, a warranty that each claim sold to B-Line "represents a legal, valid and binding obligation of the related Debtor." To keep down its costs, B-Line does not request copies of a claim's originating documents unless a debtor challenges the claim.

Opinion, p. 2.

Appeal Not Moot

The Bankruptcy Appellate Panel ruled that because no monetary sanctions were assessed that there was no live controversy to appeal. However, the Bankruptcy Court's order found that B-Line had violated Rule 9011 but that it did not view "any further sanctions to be necessary in this case." The Court of Appeals found that this was a non-monetary sanction which could be appealed just as an attorney could appeal a non-monetary sanction which affected his reputation. The majority concluded:

Compared to the somewhat vague injury to "reputation" suffered by sanctioned attorneys, which has the potential to harm their economic interests, B-Line's injury is more direct and certain because part of the company's core business practices has been declared sanctionable. B-Line's business is thus thrown into uncertainty, either forcing the company to comply with the bankruptcy courts more stringent (and more expensive) filing requirements or placing it at risk of being sanctioned in bankruptcy courts throughout the country. The court's sanctions order, therefore, has caused direct, financial injury to B-Line. Under these particular circumstances, B-Line's appeal of the court's sanctions order is not moot.

Opinion, p. 9.

Debt Buyer's Conduct Not Sanctionable

The Court of Appeals disagreed with the Bankruptcy Court's conclusion that B-Line did not conduct an adequate pre-filing inquiry. The Bankruptcy Court found that B-Line's inquiry was insufficient because it did not review original documents and because it did not obtain representations and warranties from the seller.

The Court of Appeals found the factual conclusion that B-Line did not obtain representations and warranties as to the validity of the claim to be clearly erroneous. It pointed to specific language in the transfer documents in which Covenant warranted that the accounts were eligible for purchase.

The Court ruled that reliance on Covenant's representations and warranties, along with the due diligence of both debt buyers was sufficient to constitute reasonable pre-filing inquiry. The Court of Appeals credited testimony that B-Line had purchased over 1,000 accounts from Covenant and that only two had been found to be invalid. It also discussed the due diligence which B-Line and Covenant conducted, which included review of electronic databases and the fact that the debtor had received several validation notices from debt collectors but had never disputed the debt.

Finally, the Court of Appeals found that failure to attach documentation to the proof of claim was not sanctionable in and of itself. The Court stated:

Admittedly, as the bankruptcy court stressed, B-Line's proof of claim was submitted on an incomplete Form 10. This deficiency violated Rule 3001(c) of the Federal Rules of Bankruptcy Procedure, which requires that a proof of claim based on writing include a copy of that writing. The ramifications for this type of violation are well-established, however, and do not result in sanctions. See Heath v. Am. Express Travel Related Servs. Co., Inc. (In re Heath), 331 B.R. 424, 433 (B.A.P. 9th Cir. 2005) (explaining that a failure to comply with Rule 3001 results in the creditor's proof of claim not being prima facie evidence of the claim's validity and amount). Not complying with Rule 3001 might be a factor in determining whether a Rule 9011(b) violation has occurred under different circumstances, but it is not a relevant factor in this case given the track record and warranties between Covenant and B-Line and the efforts that both businesses undertook to validate the Wingerter claim.

Opinion, p. 13.

What It Means

Wingerter is significant because it is an appellate level decision which examined the practices of a debt buyer and did not find them wanting. B-Line did a good job of explaining how its business model worked and how it provided adequate protections. While many credit card cases are decided based upon an insufficient record, B-Line provided an extensive record. This case is also very important because the Court of Appeals considered disruption of a creditor's business model to be a relevant factor. Rather than dictating that the creditor change its business practices, the Court looked at whether the creditor's existing practices could be reconciled with the obligations under Rule 9011. Finally, the court of appeals refused to get on the lack of documentation bandwagon, finding that failure to attach supporting documents deprives a claim of prima facie validity, but does not indicate bad conduct by the creditor.

This is a case where the system worked. A creditor filed a claim which probably was not valid. The debtor challenged it. When the creditor could not obtain verification, it withdrew the claim. However, you can't help but notice that an awful lot of ink was devoted to one claim for $431.57.

On Gunslingers, Presumptions and Burdens of Proof

There have been an increasing number of cases dealing with objections to assigned credit card debt. These cases are a bit like a showdown between gunfighters with bad aim: there is a lot of shooting, but no one hits anything. While a gunfight where no one gets shot is a good thing, the court must still decide whether to allow or disallow the claim even when there is little or no evidence introduced. As a result, rules on presumptions and burden of proof often dictate the result.

Prima Facie Valid Or Not

The starting point is Fed.R.Bankr.P. 3001(f) states that “A proof of claim executed and filed in accordance with these rules shall constitute prima facie evidence of the validity and amount of the claim.” Thus, if the creditor files its claim in accordance with the rules, it starts out with a presumption of validity. However, before the claim receives prima facie validity, it must be filed in accordance with the rules, particularly Rule 3001. Among other things, Rule 3001(c) provides that if a claim is based upon a writing, that writing must be attached or a statement must be provided explaining why the writing cannot be attached. Several courts have held that merely attaching a summary which lists the name of the original creditor, the last four digits of the account number and the balance claimed to be owed does not meet the requirement that the writing be attached to the claim, thus depriving the claim of prima facie validity. In re Tran, 369 B.R. 312 (S.D. Tex. 2007); In re Cox, 2007 Bankr. LEXIS 4048 (Bankr. W.D. Tex. 2007).

Courts have required different levels of documentation to satisfy the prima facie validity requirement. At the low end are courts requiring as little as a copy of an account statement from the original creditor, In re Griffin, 2007 Bankr. LEXIS 1749 (Bankr. W.D. Tex. 2007), while some courts require copies of the underlying contract, account statements and/or proof of assignment of the debt. In re Armstrong, 320 B.R. 97 (Bankr. N.D. Tex.2005)(account statement plus proof of assignment), In re Tran, 369 B.R. 312 (S.D. Tex. 2006)(requiring original contract), In re Leverett, 378 B.R. 793 (Bankr. E.D. Tex. 2007)(requiring documentary evidence of how claimant acquired the claim and proof that it is the holder of the claim); In re Plourde, 397 B.R. 207 (D.N.H. 2008)(requiring original contract plus statements plus proof of assignment); In re Kendall, 380 B.R. 37 (Bankr. N.D. Okla. 2007)(requiring contract plus itemization plus proof of assignment).

Effect of Prima Facie Validity

A recent opinion explained how failure to satisfy the requirements for prima facie validity affected the burden of proof on a claims objection.

Having little to none of the requirement information attached for a credit card debt, Roundup’s claim did not comply with Rule 3001(c). The Court, therefore, concludes that Roundup Funding’s claim is not entitled to prima facie validity under Bankruptcy Rule 3001(f). Without such validity, Debtors needed only to object to the claim pursuant to the applicable rules or statute, which they did. Debtors had listed this debt as ‘disputed’ so they did not judicially admit that they owe it. Although the Debtors did not attach any evidence to their objection to Claim Number 12, such as an affidavit, the objection was sufficient by being signed by their counsel under penalty of Rule 9011. (citation omitted).

After the Debtor’s valid objection, Roundup Funding had the burden of offering supporting documentation to carry its burden of proof in the face of an objection. It had to establish the claim by a preponderance of the evidence. (citation omitted). Roundup Funding presented no evidence to support its claim. Its information was submitted in the form of a response with attached exhibits, all in the nature of argument, and not by affidavit or by witness testimony. It provided no evidence to link the entity assigning the claim with an entity listed on the Debtor’s schedules. In any event, this attachment page to the claim is not a business record of the Debtor’s credit card account within the meaning of Federal Rule of Evidence 803(6).

In re Reyna, No. 08-10049 (Bankr. W.D. Tex. 7/28/08), Memorandum Opinion and Order, pp. 8-9; In re Plourde, 397 B.R. 207 (Bankr. D. N.H. 2008)(if claim is not prima facie valid, valid objection is all that is necessary to put creditor to its proof).

If the claim is entitled to prima facie validity, the Debtor must introduce sufficient evidence to rebut the prima facie case. In order to rebut the prima facie validity of a claim, the objecting party must produce “evidence tending to defeat the claim that is of a probative force equal to that of the creditor’s proof of claim.” In re Simmons, 765 F.2d 547, 552 (5th Cir. 1985). Sometimes the claim itself may be sufficient to rebut its own prima facie validity. In the case of In re Bootka, No. 08-11506 (Bankr. W.D. Tex. 2/23/09), the attachment to the proof of claim stated that the debt had been charged off more than four years before the petition date. As a result, the debt appeared to be barred by the four year statute of limitations applicable in Texas. The creditor filed an affidavit from the prior owner of the claim stating that a payment had posted to the account on January 18, 2008. This was significant because a payment could revive the statute of limitations under Texas law. However, the Court found that the creditor failed to meet its burden of proof because it did not state who made the payment or when it was actually made (as opposed to when it was posted). As a result, the prima facie case was rebutted and the creditor failed to prove its case by a preponderance of the evidence.

Judicial Estoppel/Party Admission

Sometimes, the creditor can prove its case simply because the debtor has already admitted the validity of the claim. If the debtor has scheduled a claim which can be identified to the proof of claim in approximately the same amount and has identified the claim as undisputed, then the debtor will be estopped to deny the validity of the claim or will be deemed to have made a party admission. Of course, if the debtor has scheduled the claim as disputed or if there is a significant variation between the claim and the schedules, then judicial estoppel will not apply. The case of In re Cox, 2007 Bankr. LEXIS 4048 (Bankr. W.D. Tex. 2007) illustrates how far the judicial admission doctrine may extend. In that case, the debtor scheduled three claims owing to Chase Bank. As an illustration, one claim was scheduled in the amount of $20,312.83 with the last four digits 0445. B-Real, LLC filed a claim in the amount of $21,534.50 in the name of B-Real, LLC/Chase Bank USA, N.A. on a claim with the last four digits 0445. The claim (as amended) was supported by account statements from Chase Bank showing the amount owed. Although the identity of the creditor was different, the court still found that the debtor had made a party-admission that the debt was owed. See also In re Kendall, 380 B.R. 37 (Bankr. N.D. Okla. 2007)(if debtor has listed claim as not disputed in its schedules, this is some evidence of validity). On the other hand, where the identity of the creditor was different, the schedules and the claim included different portions of the sixteen digit account number and the claim amounts were different, the court refused to apply judicial estoppel. In re Reyna, No. 08-10049 (Bankr. W.D. Tex. 7/28/08).

Judicial estoppel will only apply as to the debtor. Several courts have refused to apply judicial estoppel to the chapter 13 trustee. In re Plourde, 397 B.R. 207 (Bankr. D.N.H. 2008); In re Bootka, No. 08-11506 (Bankr.W.D. Tex. 2/23/09). The opinion from the Western District of Texas is based on Fifth Circuit precedent requiring that parties be identical for judicial estoppel to apply. Kane v. National Union Fire Insurance Co., 535 F.3d 380 (5th Cir. 2008). This result seems to follow the logic of judicial estoppel the closest, since only the party making the admission should be estopped. An opinion by the 10th Circuit BAP held that the trustee would not be bound by the debtor’s admission in the schedules, but that the schedules provided some evidence in favor of allowing the claim. In re Kirkland, 379 B.R. 341, 344, n. 12 (10th Cir. BAP 2007).

Proof of Assignment

Courts have disagreed on the extent to which proof of assignment must be established. The most creditor-friendly courts note that Rule 3001 only requires proof of assignment where the original creditor has previously filed a proof of claim. In re Gonzales, 356 B.R. 905 (Bankr. S.D. Fla. 2006); In re Griffin, 2007 Bankr. LEXIS 1748 (Bankr. W.D. Tex. 2007). Where only one creditor files a claim with respect to a debt scheduled by the debtor, the creditor will not be required to show how the debt was assigned to it. These cases take the position that if the debtor owes the debt and only one party is claiming to own it, that the debtor should not escape payment based on failure of the specific creditor to establish how it came to own the account. On the other hand, some courts have required proof of assignment and have gone further and required that the assignment reflect the specific debt rather than merely a blanket assignment. In re Armstrong, 320 B.R. 97 (Bankr. N.D. Tex.2005); In re Leverett, 378 B.R. 793 (Bankr. E.D. Tex. 2007); In re Kendall, 380 B.R. 37 (Bankr. N.D. Okla. 2007). Finally, some courts require proof of assignment, but will accept a blanket assignment. In re Samson, 392 B.R. 724 (Bankr. N.D. Ohio 2008).

Other Objections

Assuming that the claim is supported by prima facie evidence, the debtor’s objection to the claim must fall within one of the grounds identified by 11 U.S.C. §502(b), including that a claim is not enforceable under applicable law. In re Kirkland, 379 B.R. 341 (10th Cir. BAP 2007). Thus, a debtor could not object to a claim on the basis that the creditor had failed to redact the debtor’s social security number as required by Bankr. Rule 9037. Cordier vs. Plains Commerce Bank, No. 08-2037 (Bankr. D.Ct. 3/26/09). While the creditor violated a procedural rule, this was not a statutory ground for denying the claim.

Failure to file a timely claim is a stated ground for objection under 11 U.S.C. §502(b)(9). However, what happens if the claims bar date runs while the case has been dismissed, but is later reinstated? A thoughtful opinion holds that due process requires that the court be allowed to set a new bar date in this instance. In re Gulley, No. 07-33271 (Bankr. N.D. Tex. 3/3/2009).

Conclusion

Courts are struggling with objections to assigned credit card debt. Courts generally agree that a mere account summary prepared by the assignee will not satisfy the requirement to attach the documents on which the claim is based. However, courts differ as to whether the underlying contract or the account statement must be produced. A series of account statements will show that the debtor used the card and establish the pattern of dealings between the parties. This may be enough to prove the existence of a contract. Creditors should look to the proof required by a state court. If a sworn account or account statements would be adequate in state court, it should be sufficient in bankruptcy court. The underlying contract should not be necessary to satisfy the prima facie validity requirement (although many courts have required it). However, if the debtor objects to items such as calculation of interest or fees, the creditor may be required to provide the agreement in order to satisfy its ultimate burden of proof.

Courts also differ on whether proof of an assignment should be provided. On the one hand, proof of assignment is an element in establishing that the creditor is the holder of the claim. However, where the debtor has admitted owing the underlying account and no other party has filed a claim, it may be reasonable to conclude that a valid assignment occurred. Some courts have noted that Fed.R.Bankr.P. 3001(e) only requires proof of assignment of a claim if another creditor has already filed a claim. This may be misleading. Rule 3001(e) is designed to settle disputes between an original creditor and a party claiming to be an assignee. Where the claim is assigned prior to bankruptcy or prior to a claim being filed by the original creditor, there is no need to resolve this dispute. Instead, the issue concerns the more fundamental question of whether the creditor holds the claim.

The process for determining allowance of an assigned credit card debt can be summarized as a decision tree.

1. Does the claim include sufficient documentation to receive prima facie validity?
If yes, debtor must rebut prima facie case before creditor must put on case.
If no, debtor need only raise a valid objection to require creditor to carry burden of proof.

2. If claim is prima facie valid, has debtor rebutted the prima facie case?
If yes, creditor must prove claim by preponderance of the evidence.
If no, claim is allowed.

3. Has debtor judicially admitted validity of claim?
If yes, claim is allowed (unless a party other than the debtor is objecting).
If no, creditor must prove claim by preponderance of the evidence.

4. Has creditor established valid assignment of claim?
If yes, claim is allowed assuming creditor has met other requirements.
If no, claim is denied unless debtor is judicially estopped from denying claim or in jurisdictions which do not require proof of assignment.

5. If neither party has prevailed at this point, who produced more credible evidence?
If creditor, then claim is allowed.
If debtor, then claim is denied.

This article originally appeared in the ABI Consumer Bankruptcy Committee Newsletter, Vol. 7, No. 2 (April 2009).

Debt Buyers Win Respect in New Opinion

Debt buyers are not the most popular people these days. However, their role as economic scavengers was acknowledged in a recent opinion from Judge Leif Clark of San Antonio. In re Salvador Santana, No. 07-30027 (Bankr. W.D. Tex. 5/21/08).

In Santana, Portfolio Recovery Associates, LLC filed a Notice of Transfer of Claim with respect to a claim that they had acquired from Capital One in the amount of $604.19. The Debtor objected on the basis that "a third party purchasing the instrument at a very reduced cost and having [the] Bankruptcy Court enforce payment is not in the best interest of the debtor."

While the Debtor's objection was no doubt accurate (that is, that is not in the best interest of the debtor to recognize the transferred claim), this was not a valid objection.

Judge Clark recognized that a purchaser of claims was entitled to enforce the full amount of the claim regardless of what it paid. While the creditor might receive a windfall, it was also assuming the risk of default by the debtor. As a result, the benefit should accrue to the debt buyer and not the debtor.

Judge Clark wrote:

"The holder of a claim is permitted to sell the claim for less than the face amount of the claim, and the transferee is entitled to enforce the claim for its face value, even though the transferee bought the claim at a discount. In other words, the debtor is not entitled to the benefit of the discount. This is so because the discount represents the transferee's assumption of risk of payment at less than the face amount of the debt. The transferor 'cashed out' its risk of nonpayment by agreeing to accept less than face value from the transferee, but again the debtors are not entitled to the benefit of that de facto writedown. Insofar as the debtor is concerned the original debt is till owed to whomever is the current rightful owner of the obligation. the transferee 'bought' the obligation, and is now the rightful owner entitled to enforce the debt at its face value. Because this is a chapter 13 case, it is almost certain that the debt will not be paid at its face value. . . . Thus, the transferee has factored in these risks when it set the price to be paid for the claim that it purchased. To realize the benefit of its bargain, however, it needs to be able to enforce the full amount of the claim purchased. And so the law allows."

Only in bankruptcy court would a claim for $604.19 merit such a thoughtful opinion!