Pre-Filing Protections for the Debtor

Protecting Your Debtor from “Pressure and Discouragement”

The United States Supreme Court may have said it best in Local Loan v. Hunt when it explained: “[o]ne of the primary purposes of the Bankruptcy Act is to relieve the honest debtor from the weight of oppressive indebtedness, and permit him to start afresh” with “a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of pre-existing debt.” [1]

Protecting the debtor from that pressure and discouragement is the bankruptcy lawyer’s task, beginning when the lawyer is retained and continuing through the bankruptcy process and even beyond. It is often an urgent task, since intense pressure and extreme discouragement are what bring the client to the lawyer. This article explores what statutes may be available, and what remedies they provide, at each stage of the debtor’s case.

I. Pre-filing Protections: Helping your client before the case is filed

As a result of some of the changes instituted in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005(BAPCPA), substantial time may elapse between the decision to retain bankruptcy counsel and the filing of a bankruptcy petition. What can counsel do to protect the client immediately from intense pressure applied by creditors?

A. Fair Debt Collection Practices Act and Pre-Bankruptcy Debts

One potential source of pre-filing protections for the debtor is the federal Fair Debt Collection Practices Act, or FDCPA. The FDCPA, effective since March of 1978, regulates the conduct of "debt collectors" collecting “consumer debts.” Generally, it prohibits harassment, abuse, false or misleading representations, invasions of privacy, and unfair or unconscionable collection methods.[2] Violations of the FDCPA give rise to a private right of action, including actual damages, attorneys’ fees, and statutory damages up to $1000. Actual damages can include compensation for emotional distress,[3] although proof of treatment for such distress may be necessary.[4]

Not all potentially invasive or harassing contacts with the debtor-client will be covered by the statute, however. Specifically, and perhaps most importantly to the debtor filing for bankruptcy, the FDCPA does not cover the actions of a creditor collecting on their own debts. This extends to all officers and employees of a creditor, and any employee in a "collections department" owned by the creditor and collecting exclusively therefor.[5] The argument for this distinction is one based in the competitive market--a creditor with a valuable reputation and an interest in its ongoing client base is unlikely to sully its "good name" with acts of harassment or abuse.[6] This argument also explains why the definition does include creditors using any name other than their own to collect debts.[7]

The term "debt collector," for purposes of the FDCPA, applies to two main categories of persons: those who are in a business the principle purpose of which is the collection of debts, and those who regularly collect (or attempt to collect) the debts of another.[8]Primarily, this would include debt collection agencies and their employees, as well as the emerging category of debt buyers and their servicers. This term also applies to practicing attorneys.[9]

The conduct proscribed by the FDCPA is significant, and thirty years of case law under the Act provide countless examples. Several types of conduct are particularly relevant to a debtor facing bankruptcy, however, especially during the period following an attorney consultation but preceding formal filing.

First, a debt collector is not permitted to contact a consumer after the debt collector knows that the consumer is represented by an attorney, and has been provided with the attorney's name and address.[10] In addition, if a consumer writes to the debt collector that he refuses to pay the debt or that he wants communication to stop, the debt collector is not permitted further contact.[11]Contacts with neighbors, family members, employers or other third parties may place extreme pressure on the client, and a debt collector is forbidden to do so.[12] Debt collectors may call others seeking to obtain location information, but not if this information is already available to them.[13]

The FDCPA prohibits "false, deceptive, or misleading representation" while collecting a debt, and provides sixteen specific examples. Perhaps most relevant to the consumer/debtor facing possible bankruptcy is the false or deceptive threat of suit.[14] A debt collector's threat of suit may be deceptive because it's not really intended, not as imminent as it's represented, or beyond the legal or contractual authority of the debt collector. For instance, a threat of suit by a lawyer not licensed in the debtor's home state and without an arrangement to hire local counsel is prohibited.[15]

Actual collection suits can violate the FDCPA if not filed in the proper venue. According to section 1692i(a)(2) of the Act, a debt collector must bring any legal action against a consumer in the "judicial district or similar legal entity" in which that consumer lives or in which the contract for the debt was signed.[16] Under this provision, an attorney who files suit against a debtorin the wrong Virginiajudicial district would be in violation of the statute.[17] There is a split of authority, though, on whether a garnishment on an otherwise valid judgment violates the FDCPA where the consumer has left the relevant judicial district.[18]

Finally, the FDCPA proscribes "unfair or unconscionable means" in debt collection. This language might cover a client with previously authorized automatic debits from their bank account.Facing bankruptcy, the clientcalls the debt collector to revoke the prior authorization, only to see that money continue to be debited. Any debits after authorization is revoked may violate the FDCPA.[19]

B. Pre-Bankruptcy Debits and the Electronic Funds Transfer Act

Electronic transfers from a debtor’s bank account are also regulated by the Electronic Funds Transfer Act (EFTA). When a client wishes to stop preauthorized automatic debits, they should notify both the debt collector(or creditor) and their bank. Notifying the bank at least three days prior to a transfer effectively revokes prior authorization.[20]

If a consumer learns that the now-unauthorized transfer still occurred, they can notify their bank again, and begin the error resolution process. The bank must, within ten business days, investigate the alleged error and mail the results to the consumer, or provisionally re-credit the consumer’s account while the investigation continues.[21] If an error is determined, the bank has only one day to correct the error.[22] If the bank does the investigation, but “knowingly and willfully” concludes that no error exists, when from all the evidence one reasonably does, they may be liable for treble damages.[23]

Violations of the EFTA entitle the consumer to actual damages, statutory damages up to $1,000, and attorneys’ fees.[24]

C. Payday Lenders and the Virginia Consumer Protection Act

The Virginia Payday Loan Act (VPLA), which governs the conduct of lenders licensed to offer short-maturity loans on security of a check or other account information, proscribes certain harassing or threatening behavior. A violation of this Act constitutes a violation of the Virginia Consumer Protection Act, and thus entitles the debtor to actual damages, statutory damages of $500, and attorneys’ fees.[25]

Several of the “prohibited business methods” outlined in the statute are particularly relevant to the pre-bankruptcy client under pressure to repay the loan. For example, the VPLA does not allow a payday lender to seek an electronic debit authorization from the borrower to pay back the loan.[26] It also prohibits suing to collect on a payday loan until 60 days after default.[27] The VPLA also incorporates the protections of the FDCPA on harassment, false or misleading representations, and unfair practices, from 15 USC §§ 1692d-1692f.[28] That includes “causing a telephone to ring or engaging any person in telephone conversation repeatedly or continuously with intent to annoy, abuse, or harass any person at the called number.”[29]

Finally, the statute prohibits a payday lender from threatening (or actually initiating) criminal proceedings against the debtor—and a violation of this provision entitles the debtor to a civil penalty of three times the original check.[30]

D. The Fair Credit Billing Act and Regulation Z.

The Fair Credit Billing Act prohibits a credit card issuer from offsetting credit card debt with funds the consumer has on deposit with that same institution.[31] There’s an exception: a written agreement “whereby the cardholder agrees to periodically pay debts incurred in his open end credit account by permitting the card issuers to periodically deduct…”[32] Credit unions assert they have a right to offset because 12 USC 1757(11) makes them secured creditors, although one reported decision did not agree.[33]

There is a private right of action for violation of this Act, including actual damages and statutory damages of not less than $200 or more than $2000.[34]

II. After Filing: Protections for your client during their bankruptcy

A. The Automatic Stay

The instant a bankruptcy case is filed, the debtor and the debtor’s property are placed under the protection of the bankruptcy court.[35]The instrument of that protection is the automatic stay, found at 11 USC §362.

The automatic stay is“an instrument of awesome breadth and power” and “[f]ew other legal steps that may be taken on behalf of a consumer can bring about relief so simply, so effectively and so dramatically.”[36] The stay is applicable to “all entities.”[37] It is a “self-executing provision of the Bankruptcy Code and begins to operate nationwide, without notice, once the debtor files the petition for relief.”[38]The automatic stay bars any ongoing or futurelegal action against the debtor.[39] The stay also prevents the enforcement of judgments and liens.[40] Finally, in addition to barring legal proceedings, the automatic stay bars any “act to collect, assess, or recover any [pre-bankruptcy] claim against the debtor.”[41]

The statute further provides that a willful violation of the automatic stay entitles the debtor to actual damages, costs and attorney’s fees, and possibly punitive damages.[42]Actual malice is not required to constitute a willful violation, as “[i]gnorance of the legal effect of the automatic stay is no excuse.” [43] To constitute willfulness, “the creditor need not act with specific intent but must only commit an intentional act with knowledge of the automatic stay.”[44] However, the “purpose” of the act must be “an attempt to collect the debt.”[45]

When “a debtor is forced to resort to the courts to enforce his rights” under the automatic stay, attorney’s fees may be awarded.[46]While some courts have held that the debtor must suffer some out of pocket loss before attorneys’ fees can be awarded, that is apparently not required in the Fourth Circuit.[47]An award of actual damages is mandatory upon a finding of a willful violation.[48] However, “a damage award must not be based on mere speculation, guess or conjecture.”[49]

Actual damages may include payments made to a creditor, but also loss of use damages where property is repossessed or retained. When a bank wrongfully sold a debtor’s truck after a Chapter 13 bankruptcy was filed, the Western District of Virginia Bankruptcy Court awarded actual damages of $7,000 for the value of the truck, plus $3,000 “for the time and expense incurred in this matter,” as well as attorney’s fees and punitive damages.[50] In a similar Eastern District bankruptcy case, where the vehicle was ultimately returned, the court awarded$3300 for damages caused to the vehicle, as well as $2,244 for attorney’s fees, and punitive damages.[51] The court cited “the nature and extent of harm to the debtor” as one factor considered in the award of $5,000 in punitive damages.[52]

A violation of the automatic stay, courts have concluded, “allows for recovery for emotional distress.”[53] The individual must suffer significant harm; fleeting and trivial distress is not compensable.[54] In Green Tree Servicing, LLC v. Taylor, a repossession agent of Green Tree twice entered Taylor mobile home in violation of the stay, frightening the debtor who suffered from psychogenic seizures.[55] The court upheld an award of $5,000 actual damages, which encompassed both “the time and effort” the debtor spent defending her rights and also “real emotional injury.”[56]

One of the purposes of punitive damages provided by 362(k) is to compensate “losses rationally related to violating the stay.”[57] Nevertheless, “punitive damages require egregious factual circumstances.”[58] In 1986, the Fourth Circuit upheld punitive damages of $10,000 where one of the debtor’s employees was injured during a post-filing repossession and the repossessing creditor’s employee was armed.[59] However, since that case, $5,000 appears to be largest punitive damages award for a stay violation in any reported case in Virginia. The court in Bush v. Nations Bankawarded punitive sanctions of $5,000, but with $4,000 suspended if the creditor paid the actual damages and attorneys’ fees within 10 days.[60] Punitive damage awards of $2,500 and $3,525 from the bankruptcy courts have been reversed on appeal.[61]

In contrast, the Central District of California court in In re Henryawarded $65,700 in punitive damages against a mortgage holder who contacted the debtors, mostly by phone, ninety-three times over seven months in violation of the automatic stay and discharge injunction.[62] The Middle District of Florida court awarded $35,000 in punitive damagesfor repossessing debtors’ Volvo in violation of the automatic stay.[63] The creditor, Onyx, filed a proof of claim in the bankruptcy case, and received several warning phone calls when the debtors learned that Onyx’s repo agent was looking for their car. In the Northern District of Ohio, the court awarded $51,000 in punitive damages—half to the debtors and half to the Chapter 7 estate—for repeated phone calls and letters in violation of the automatic stay.[64]

B. FDCPA and False Proofs of Claim in Chapter 13 Bankruptcies

Though the Bankruptcy Code is the main source of legal remedies for the debtor during the automatic stay period, it is not the only source. For instance, a debtor may be able to rely on the FDCPA, as enforced through the bankruptcy court.

The primary example of where the FDCPA might apply is the filing by a creditor (who otherwise qualifies as a "debt collector" under the Act's definition) of a false or fraudulent proof of claim in a Chapter 13 bankruptcy. The argument is that filing a false proof of claim is a deceptive and misleading practice, in violation of section 1692e, and an unfair means to collect a debt, in violation of 1692f.

There is a significant split of authority on whether FDCPA violations can in fact be brought in the bankruptcy courts, and specifically whether the Bankruptcy Code preempts the FDCPA for actions governed by the Code. The Ninth Circuit has held that, for conduct regulated by the Bankruptcy Code, the debtors exclusive remedy is in the code.[65] In contrast, the Seventh Circuit recently stated that "[o]verlapping statues do not repeal one another by implication" and debtors/consumers are free to pursue remedies under both the Bankruptcy Code and the FDCPA.[66] Currently, the Fourth Circuit has not adopted either one of these positions.

Moreover, there remains some question as to whether a debtor can pursue an FDCPA violation for a false proof of claim. A few courts have held that a "misstatement" in a proof of claim is not grounds for an FDCPA suit where the debtor failed to file an objection to the claim during the bankruptcy.[67] However, at least one court has found that, where the debtor seeks simultaneous relief under the Bankruptcy Code and the FDCPA, and has not attempted to bypass the remedies under the Code (i.e. where a timely objection was filed to the proof of claim), a claim under the FDCPA is not barred.[68] Another court also recently held that debtors in Chapter 13 may bring an FDCPA claim against a debt collector for filing a time-barred proof of claim.[69]

This issue remains, for the most part, undecided in Virginia and the Fourth Circuit. Though it was recently discussed in In Re Varona in the Eastern District Bankruptcy Court, the debtors did not assert that the FDCPA applied directly to their claim, so any analysis by the court is most likely non-binding dicta.[70] Therefore, with no binding precedent on point, this remains for the moment a possible remedy for debtors.

III. The case continues after the discharge

A. Bankruptcy Code and the Discharge Injunction

According to the Supreme Court, “[t]he principal purpose of the Bankruptcy Code is to grant a `fresh start' to the `honest but unfortunate debtor.'"[71]For the debtor, “the discharge is unquestionably the heart and soul of the ‘fresh start.’”[72]

When a bankruptcy case is discharged, the automatic stay is replaced by the discharge injunction, which prohibits “the commencement or continuation of an action, the employment of process, or an act, to collect, recover or offset any such debt as a personal liability of the debtor.”[73]There is no provision analogous to § 362(k) providing for the debtor’s express right of action. However, violations may be sanctioned under the bankruptcy court’s civil contempt powers.[74] The standard of willfulness in Strumpfalso applies to discharge violations.[75]