We all remember The Devil and Daniel Webster – the Devil comes to collect a seven year old debt (secured by Jabez Stone’s soul), only to be foiled by the great trial lawyer Daniel Webster – thanks to a skilled litigator, the old debt is forgiven!

Earlier today, the Supreme Court granted certiorari on an issue that (a) is pretty important in the world of consumer debt collection, and (b) makes some folks pretty darn furious. The issue is this: if you file a proof of claim in a bankruptcy case, and you know such claim is barred by the applicable statute of limitations, are you committing a “misleading” or “unfair” practice under the Fair Debt Collection Practices Act (FDCPA)? (Coverage of the case and copies of the briefs can be found here, on the SCOTUSBlog.)

Who does this? There are lots of funds out there that purchase charged-off consumer debt. Some of that debt is quite old. John Oliver has spoken extensively about this industry on his show – here’s a link to the hilarious (or infuriating, it is actually both) episode where he bought, and forgave, $15 million in old, uncollectible medical debt.

Why do people do this? Those old and cold claims can lead to a nice little recovery when the party owing the funds files a Chapter 13 case that pays creditors 5, or 10, or even a penny on the dollar. In Chapter 13 cases, no one really has an incentive to scrub all the claims that are filed, and so a great many of these claims – completely invalid, mind you – slip by unnoticed and get a distribution. If the charged-off debt is sold for pennies on the dollar – or fractions of a penny – the returns are spectacular, even though the old debt is in every way invalid.

How Can These Invalid Claims Get Paid? It is because no one raises an objection to them during the bankruptcy case. The Debtor doesn’t have any interest or incentive to scrub the claims – he or she is paying the same amount over the course of the Chapter 13 plan no matter how large or small the creditor pool is. The Debtor doesn’t have the money to scrub the claims, or any incentive to do so. The Chapter 13 trustee has no practical ability to scrub the claims – there are thousands, or tens of thousands, of Chapter 13s pending in every single bankruptcy court across this country – no Chapter 13 trustee has the time or ability to review each claim. The other creditors won’t do it – why would a creditor owed, say, $2,000, scheduled to get a distribution of $100 in the case (over 3-5 years, to boot), spend a few thousand dollars reviewing each and every proof of claim field in the bankruptcy case (there are often a few dozen claims, or more)? And without any party to note the time-barred claim to the Bankruptcy Court, the Bankruptcy Court never knows to disallow the claim.

So What will The Supreme Court Do? The Supreme Court will decide if this practice is “misleading” or “unfair” as those terms are used in the FDCPA. If the Supreme Court rules against the debt collectors, they will be liable for attorneys’ fees and additional damages for each invalid claim that is filed. The practice will end in an instant, as now there would be penalties for seeking recovery of time-barred debt. But if this practice does not violate the FDCPA, then the bankruptcy system will continue to be used to collect time-barred debt.

This is a tough one for The Bankruptcy Cave. Legitimacy of the system requires that invalid claims receive no distribution. Holders of valid claims should not be taxed due to an inability of any other party to practically review the claims. On the other hand, an expired claim is subject to a defense – and its not a creditor’s job to raise defenses to its own claims. We think this will be a great ruling, either way. Stay tuned!