Friday, February 20, 2009

Bankruptcy Code Preempts State Fair Debt Collection Claim, and Precludes Federal One, Against Creditor Filing Proof of Claim on Time-Barred Debt

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys,

B-Real, LLC v. Chaussee (In re Chaussee)
Ninth Circuit BAP No. WW-08-1114-PaJuKa
December 18, 2008


The act of a creditor filing of a proof of claim in a bankruptcy case on a debt that is time-barred does NOT of itself subject the creditor "to liability for violation of state and federal fair collection laws." State consumer protection laws which might prohibit such creditor behavior are preempted under the Supremacy Clause, and the federal Fair Debt Collection Practices Act is precluded by the claim-determination scheme of the Bankruptcy Code. This was an issue of first impression in the Ninth Circuit, resolved in a lengthy opinion (43 pages, including the 11-page concurring opinion).

Procedural Context

A Chapter 13 debtor in the Western District of Washington filed an adversary proceeding against a collection company, B-Real, LLC, for violations of the Washington Consumer Protection Act and the federal Fair Debt Collection Practices Act. The alleged violations arose from B-Real "filing two proofs of claim in Debtor’s bankruptcy case for debts Debtor maintains she did not owe and were time-barred." Bankruptcy Judge Karen Overstreet denied a motion to dismiss Debtor's adversary proceeding complaint for failure to state a claim, and B-Real appealed.

The Preempted State Law Claim

The BAP stated its "task in resolving the preemption issue here is to determine whether the [Washington Consumer Protection Act], as a state regulation, is consistent with the structure, purpose, and operation of the Code as a whole." It relied primarily on a 1996 Ninth Circuit opinion, MSR Exploration, Ltd. v. Meridian Oil, Inc., 74 F.3d 910. There the court of appeals did not allow a Chapter 11 debtor to sue a creditor for malicious prosecution in federal district court, after the creditor had filed a proof of claim in bankruptcy court. That proof of claim had been disallowed after objection by the debtor. The Ninth Circuit had held that debtor's state law malicious prosecution claim "was completely preempted by the structure and purpose of the [Bankruptcy] Code."

The Ninth Circuit relied on MSR Exploration and its progeny for the following arguments for preemption:
1) "A comprehensive federal system": the detailed Bankruptcy Code is intended by Congress to be a comprehensive federal system to bring together and resolve all of the rights and duties of debtors and creditors.
2) Uniformity: there is a "need for uniformity in bankruptcy law [so that is] a factor militating against allowing the assertion of state law claims against actors in bankruptcy cases."
3) Would deter participation in the claims process: "[T]he threat of later state litigation may well deter debtors and creditors alike from participating in bankruptcy cases." "Allowing debtors to recover under the CPA solely because a creditor filed a proof of claim may skew the incentive structure of the Code and its remedial scheme and could discourage creditors from filing a claim." It "might encourage debtors to dispense with the claim objection process in favor of an adversary proceeding, needlessly casting all concerned into costly litigation."
4) Misconduct in connection with bankruptcy case: Although "not all state claims 'related to bankruptcy' may be preempted by the Code, in [its prior] decisions the Ninth Circuit and this Panel have steadfastly held that the Code preempts substantive state law claims and remedies for alleged misconduct that occurs in connection with a bankruptcy case."
5) Broad definition of "creditor": Although B-Real's claim was allegedly not against debtor but someone with a similar name, because of the Code's broad definitions of "creditor" and "claim," disputed claims must nevertheless be resolved within the bankruptcy system.
6) Sufficient bankruptcy sanctions: "[T]he availability of sanctions for the filing of an improper claim in a bankruptcy proceeding, whether through the use of Rule 9011 or § 105(a), reflects Congress’s intent that the law relating to bad faith and willful misconduct in bankruptcy proceedings be developed case-by-case in the context of the federal bankruptcy law, not by application of state law."

The Precluded Fair Debt Collection Practices Act Claim

The BAP relied greatly on the 2002 Ninth Circuit opinion Walls v. Wells Fargo Bank, N.A., 276 F.3d 502, in which the Court of Appeals had upheld a federal district court's dismissal of a class action case filed on behalf of former Chapter 7 debtors on a Fair Debt Collection Practices Act ("FDCPA") claim against a creditor for accepting house payments on a discharged debt. The Ninth Circuit panel had held that a FDCPA-based alleged violation of a bankruptcy discharge is precluded by the Bankruptcy Code.

In Walls, the Ninth Circuit highlighted that debtor's FDCPA claim was exclusively based on an alleged violation of the bankruptcy discharge. In that prior case the Court reasoned:
The Bankruptcy Code provides its own remedy for violating § 524, civil contempt under § 105. To permit a simultaneous claim under the FDCPA would allow through the back door what Walls cannot accomplish through the front door—a private right of action. This would circumvent the remedial scheme of the Code under which Congress struck a balance between the interests of debtors and creditors by permitting (and limiting) debtor’s remedies for violating the discharge injunction to contempt. “[A] mere browse through the complex, detailed, and comprehensive provisions of the lengthy Bankruptcy Code . . . demonstrates Congress’s intent to create a whole system under federal control which is designed to bring together and adjust all the rights and duties of creditors and embarrassed debtors alike.” [Citing MSR Exploration.]
The BAP here also relied on MSR Exploration's emphasis on the Bankruptcy Code being a " 'whole system' designed to comprehensively define all rights and remedies of debtors and creditors" The Panel made much of the fact that MSR Exploration "dealt with precisely the type of creditor conduct involved here, the filing of a disputed proof of claim in a bankruptcy case." Even though MSR Exploration dealt with the preemption of state law claims, the Panel found the same reasoning "also applicable in analyzing whether Debtor’s FDCPA claim is precluded under these facts." It held that "where the [Bankruptcy] Code and Rules provide a remedy for acts taken in violation of their terms, debtors may not resort to other state and federal remedies to redress their claims lest the congressional scheme behind the bankruptcy laws and their enforcement be frustrated."

The Panel pointed out how the procedures in the bankruptcy system for filing and resolving objections to claims "clearly conflict" with the detailed debt validation procedures of the FDCPA, and therefor "the provisions of both statutes cannot compatibly operate."

The Panel also found unpersuasive debtor's argument that the bankruptcy Code does not provide appropriate remedies for dealing with "a creditor's misconduct in filing an improper proof of claim." It found debtor's burden of objecting to a claim to be reasonable, a sensible responsibility which debtor bought into with her voluntary filing of the bankruptcy case. The Panel also found that Rule 9011 "provides an adequate remedy for dealing with baseless proofs of claim," along with the court's authority under § 105(a) “to impose sanctions for a pattern of bad faith conduct that transcends conduct addressed by particular rules or statutes.”

The Panel finally noted that "we join what appears to be a significant majority of courts from across the country that have come to the same conclusion" that the Bankruptcy Code precludes a debtor's FDCPA claim for the filing of a proof of claim.

The Concurring Opinion

The concurring judge got to the same conclusions that the state law was preempted and the FDCPA was precluded, but wrote to argue that "the act of filing a proof of claim is neither a violation of the CPA by definition nor a debt collection act under the FDCPA."

The state Consumer Protection Act addressed "unfair acts or practices" occurring "in the conduct of any trade or business." The judge believed that the "filing of a proof of claim cannot reasonably be construed" to be conduct within that language.

The judge also argued that the filing of a proof of claim is not a debt collection activity under the FDCPA, since the former is part of a debt validation procedure in bankruptcy court while the latter governs "the methods used to collect a debt" and has "nothing to do with whether the underlying debt is valid." And the purpose of the FDCPA, protecting consumers from abusive debt collectors, is not "implicated" in the claims procedures in consumer bankruptcy cases "because the claims process is highly regulated and court controlled."

by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
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