Availability of the FDCPA's Bona Fide Error Defense to Debt Collectors Who Don't Seek Legal Advice

A recent Federal case has suggested that it is difficult, if not impossible, for a debt collector to shield itself from liability for violation of the Fair Debt Collection Practices Act (FDCPA) due to a misunderstanding of the law unless it has sought the advice of legal counsel or a governmental agency.

In Ruth v. Triumph Partnerships, et.al., decided by the U.S. Court of Appeals for the Seventh Circuit in August, the Plaintiff consumer filed a class action lawsuit alleging that the Defendant collector violated the FDCPA by notifying the consumer that information related to the debt could be shared with third parties for the purposes of servicing the account unless the debtor completed and returned an included "Opt-Out Response Form" (a violation of the provision precluding threats of action that cannot legally be taken). The collector defended on the ground that because after soliciting sample letters from a vendor, submitting the notice to the collector's compliance department for approval, and consulting applicable industry publications, it had concluded that the language was required under the Gramm-Leach-Bliley Act's notice provisions and not in violation of the FDCPA, the collector could avoid liability under the bona fide error defense.


The court disagreed. It first recited the elements of the FDCPA's bona fide error defense: (1) that the violation was unintentional, (2) that the violation resulted from a bona fide error, and (3) that the error occurred despite the collector's maintenance of procedures reasonably adapted to avoid the error. The court then noted a circuit split currently existing as to whether the bona fide error defense applies to legal errors like the one in this case at all, and the U.S. Supreme Court's recent granting of certiorari in Jerman v. Carlisle, McNellie, Rini, Kramer & Ulrich on that very issue. The Second, Eighth, and Ninth Circuits currently hold that the bona fide error defense applies only to clerical errors, and not mistakes of law, while the Sixth and Tenth Circuits have held that mistakes of law do qualify for the bona fide error defense.

The Ruth court declined to take a side in the circuit split, finding that even if the bona fide error defense is available to collectors who commit an FDCPA violation as a result of a misunderstanding of the law, the defense was not available to the collector in the case at bar because it had not taken actions sufficient to satisfy the requisite third element of the defense.  In order to satisfy this element, the court held, it was not enough to consult industry pamphlets and attend FDCPA compliance training; but rather:

"if the bona fide error defense is available at all for errors of law, it is available only to debt collectors who can establish that they reasonably relied on either: (1) the legal opinion of an attorney who has conducted the appropriate legal research, or (2) the opinion of another person or organization with expertise in the relevant area of law—for example, the appropriate government agency."

Therefore, in the absence of record evidence that the collector sought an opinion from a legal or regulatory authority, the court entered judgment against the collector on the availability of the bona fide error defense.

This decision should be of note to collectors, especially if the U.S. Supreme Court sides with the Sixth and Tenth Circuits in the case before it (which will be monitored on this blog, and more on which can be read here, and the lower court's decision here).  Obtaining a legal opinion from an experienced attorney is a relatively inexpensive endeavor (sometimes less than $1,000) when compared to potential liability in an FDCPA class action lawsuit (which could be up to $500,000 or more, plus costs and attorney's fees).

Chrysler Fraudulent Transfer Case Study Part I - Background

In my last post, I promised to break down the lawsuit filed recently by Chrysler LLC's creditors alleging fraudulent transfer against Daimler AG. That project begins with this entry, which discusses the procedural background, the parties, and the attorneys.

Chrysler LLC filed for Chapter 11 Bankruptcy relief earlier this year, at least in part in order to allow it to restructure itself for the purposes of partnering with Italian automaker Fiat. Since then, Chrysler LLC has been reorganized into a new company called Chrysler Group LLC, of which Fiat is part owner. As part of the Bankruptcy, in June the Federal government helped finance the sale of most of Chrysler LLC's assets to Chrysler Group LLC (New Chrysler) in the amount of $6.6 billion paid to Chrysler LLC (Old Chrysler). The Bankruptcy continues with respect to the remaining assets of Old Chrysler.

The Plaintiff in the fraudulent transfer action is the committee of creditors of Old Chrysler (New Chrysler is not involved). The Defendants are Daimler AG, several of its American subsidiaries, and several common members of the boards of Daimler AG and Old Chrysler (although Old Chrysler is the Bankruptcy debtor, it is not a fraudulent transfer lawsuit defendant). Daimler AG is a German company whose earliest predecessor began operations in the 1800s. In 1926, the company became Daimler-Benz AG, the name by which it was known until 1998, when it merged with Chrysler, and Daimler and Chrysler became sister companies under the newly created parent company DaimlerChrysler AG. What's now Daimler AG is the remainder of DaimlerChrysler AG after its sale of Chrysler to Cerberus Capital Management in 2007.

Daimler AG is sued in its capacity as the owner of Old Chrysler. The creditor's committee obtained court authority to pursue Daimler AG in the Bankruptcy Court earlier this month. Creditor's counsel has apparently taken the case on a contingency fee basis, which means their analysis of the claims made by the committee is that there is more than minimal merit to them (documents indicate the firms may have agreed to be responsible for a certain portion of the litigation costs as well, another good indicator of counsel's positive impression of the claims). They do appear to have been advanced $2 million in fees for taking the case, however. Commercial collection cases are often taken on a contingency fee basis (by my firm for example), but fraudulent transfer actions would only be pursued on contingency when the analysis of the claims indicates a strong likelihood of recovery of a significant amount of money. When there is too much of a risk of little or no recovery, creditor's attorneys will pursue the case (as long as it has merit), but only if the client agrees to pay for our services by the hour, and often in advance.

Obviously, this lawsuit does not represent the run of the mill collection case, and neither the complexity of the corporate structures involved in this lawsuit, nor their size, is typical. But as we will discuss in further detail in coming posts, the next with respect to the allegations of fraudulent transfer under the Bankruptcy Code, the issues and the analysis are quite similar.

The Daimler Chrysler Fraudulent Transfer Lawsuit: A Case Study

Earlier this month, United States Bankruptcy Judge Arthur Gonzalez in New York entered an order allowing an organization of creditors of former Chrysler LLC to file a lawsuit against Daimler AG alleging fraudulent transfer of a significant portion of Chrysler's assets on the eve of the 2007 sale of Chrysler by Daimler to Cerberus Capital Management LP. The lawsuit was filed Monday, and I have reviewed a redacted version thereof.

The 31 page complaint alleges that Daimler recognized in 2006 that its merger with Chrysler would ultimately prove to be detrimental to Daimler, partially because Chrysler's pension and employment related liabilities (and Daimler's potential responsibility for those liabilities) outweighed its assets, the most valuable of which were its financial services subsidiaries (collectively FinCo). According to the complaint, in an effort to segregate FinCo from Chrysler's liabilities in anticipation of selling the company, Daimler carried out an intricate restructuring plan, which resulted in Daimler and its own subsidiaries receiving in excess of $9 billion in Chrysler assets in exchange for Chrysler's receipt of a promissory note valued at roughly $1.5 billion and equity in arms of Daimler that were allegedly "worthless." Then, it is alleged, Daimler sold a majority of FinCo (without Chrysler's liabilities) to Cerberus for roughly $7 billion, $3.45 billion of which went to Chrysler, $2.275 billion to FinCo (who then immediately paid off the note owed to Daimler), and $1.212 directly to Daimler. According to the complaint, these transfers were made with the knowledge on the part of Daimler that there were numerous lawsuits pending against Chrysler that could be satisfied, at least partially, with the transferred assets; and with the intent on the part of Daimler to defraud Chrysler creditors.

The creditors seek damages against Daimler on theories of constructive and intentional fraudulent transfer under the Bankruptcy Code, and on state law causes of action for breach of Daimler's fiduciary duty as sole shareholder and controlling force behind all Chrysler decisions, unjust enrichment, and corporate alter ego liability. Daimler has filed no formal response to the complaint yet, as the time to do so has not come, but their initial reaction to the lawsuit is that it is without merit.

This case should be of interest to business debtors and creditors of all shapes and sizes (and their attorneys) because it highlights the remedies available to creditors when assets that could be used to satisfy creditor claims are transferred beyond the reach of creditors without justification, and hopefully it will provide the public some insight into how these remedies are obtained (or avoided). Over the next few weeks we will present a discussion on each theory of liability raised by Chrysler's creditors (and on the defenses raised by Daimler), with an aim toward relating these issues to more typically-structured businesses and their attorneys.

Upcoming Collection Law Seminar

On September 21, 2009 I will be speaking at a National Business Institute seminar entitled Collection Law from Start to Finish. The topics of discussion will range from presuit collection strategies to bankruptcy implications and ethical considerations in the representation of creditors. I have been an NBI faculty member and speaker for over a decade. At this seminar I will focus on preventative collections, designing collections systems, judgment collection law, including execution and garnishment, fraudulent conveyances, and the ethics of collections. For more information, or to register for this program, click here.

Debt Collection as a Permissible Purpose for Obtaining Credit Reports under the Fair Credit Reporting Act (FCRA)

A recent case decided by the U.S. Court of Appeals for the Ninth Circuit, Pintos v. Pacific Creditors Association, No. 04-17485 (April 30, 2009), has held that the Fair Credit Reporting Act (FCRA) does not give a creditor the right to obtain the credit report of a consumer in determining the likelihood of collecting a debt unless the debt has either arisen out of a transaction for which the consumer actively sought credit or been reduced to judgment. The ruling has been hailed by consumer advocates as a victory for individual privacy rights as much as it has been feared by credit professionals. According to this reader, however, the effect of Pintos is not as far-reaching as it appears at first glance.

The Plaintiff is a consumer residing in California. Her car was towed to an impound lot as a result of her failure to renew her vehicle registration. Subsequently, after the consumer failed to pay the towing fees or retrieve her car, the towing company sold the vehicle at auction. The sale of the vehicle did not satisfy the outstanding balance in full, and as a result, the towing company referred the remaining balance to the Defendant, a collection agency. In determining the likelihood of recovery of the balance, the Defendant obtained a credit report on the Plaintiff from Experian.

The Plaintiff filed suit, alleging that there was no permissible purpose under the FCRA for the Defendant to obtain her credit report. The Defendant contended that it was authorized to do so under 15 U.S.C. 1681b(a)(3)(A), which provides that a consumer reporting agency may provide a consumer credit report to a person it has reason to believe "intends to use the information in connection with a credit transaction involving the consumer on whom the information is to be furnished and involving the extension of credit to, or review or collection of an account of, the consumer."

The Ninth Circuit held that since the Plaintiff did not initiate the transaction with the Defendants, the transaction did not involve the Plaintiff, and as a result the first part of 1681b(a)(3)(A) was not satisfied. The Court based this decision on several sources of authority:

• Mone v. Dranow, 945 F.2d 306 (9th Cir. 1991) The Defendant in this case had obtained a copy of the Plaintiff's credit report prior to initiating a lawsuit against the Plaintiff seeking damages for alleged unfair competition. The court, without discussion, concluded that the Defendant couldn't rely on 1681b(a)(3)(A) because it did not use the credit information in connection with a credit transaction involving the consumer.
  

• Andrews v. TRW, Inc., 225 F.3d 1063 (9th Cir. 2000) The Plaintiff's identity was stolen, and several credit cards were applied for using her social security number. The credit card companies sought credit reports from the Defendant credit bureau. The court found that this scenario does not constitute a credit transaction "involving the consumer" inasmuch as the consumer was not a willing participant in any transaction but an innocent bystander, and as a result the Plaintiff's claims were allowed to proceed to the jury.
  

• Hasbun v. County of Los Angeles, 323 F.3d 801 (9th Cir. 2003) The Defendant, a government child support enforcement body, pulled the Plaintiff's credit reports after determining that the Plaintiff was in violation of a child support order. The Plaintiff filed suit, alleging that this was not a permissible purpose under the FCRA. The Ninth Circuit found that the child support enforcement agency did have a permissible purpose to obtain the credit report, relying on Federal Trade Commission (FTC) commentary found in the Appendix to 16 Code of Federal Regulations (CFR) Part 600, that stated that "[a] judgment creditor has a permissible purpose to receive a consumer report on the judgment debtor for use in connection with collection of the judgment debt, because it is in the same position as any creditor attempting to collect a debt from a consumer who is the subject of a consumer report," as well as authority from the Sixth Circuit in Duncan v. Handmaker, 149 F.3d 424 (6th Cir. 1998), stating that collection of a debt is considered to be the "collection of an account" under the FCRA, and therefore debt collection provides a permissible purpose to pull a consumer report.

The Pintos Court held that the Defendants did not have authority to obtain a copy of the Plaintiff's credit report. In so holding, the Court attempted to distinguish itself from Hasbun on the ground that whereas Hasbun involved the collection of an account that had been adjudicated by a court of competent jurisdiction, Pintos, like Mone and Andrews, did not. Therefore, according to the Pintos Court, a judgment creditor has a permissible purpose to obtain a credit report under Hasbun, but a nonjudgment creditor does not under Mone and Andrews.

This distinction is fictional. Hasbun's reasoning that a judgment creditor could obtain a credit report under Section 1681b(a)(3)(A) was based on the above quoted language in the FTC commentary to the CFR. The Pintos Court cites the first part of the FTC commentary, that "[a] judgment creditor has a permissible purpose to receive a consumer report on the judgment debtor for use in connection with collection of the judgment debt..." But in drawing the distinction between a judgment creditor and any other creditor based on this language, the Court ignores the second part of the FTC's statement, which was quoted by Hasbun, "...because it is in the same position as any creditor attempting to collect a debt from a consumer who is the subject of a consumer report." According to Hasbun and the FTC, a judgment creditor is no different than any other creditor. The Pintos decision fails to properly address this notion. Instead, the Court concludes, without citation, that under Hasbun, "[i]f a debt has been judicially established, there is a credit transaction involving the consumer, no matter how it arose."

The Pintos Court's distinction between judgment creditors and ordinary creditors is further belied by the Hasbun Court's reliance upon Duncan in reaching its decision. Duncan announced the principle that when a law firm obtains the credit report of a debtor prior to judgment in connection with its representation of a creditor in a lawsuit arising from a debt, it does so with authority under 1681b(a)(3)(A) and 1681b(a)(3)(E). The Court noted, in accordance with Mone, that if the lawsuit is not for collection of a debt, there is no permissible purpose.

Finally, the effect of Pintos is limited by the operative facts of that case. The majority found it significant that the Plaintiffs were not willing participants in a "credit transaction." In light of the FACTA definition of "credit," found at 15 U.S.C. 1691a(d), many debtors are. For instance, in some circumstances, where an individual receives medical treatment from a provider without paying for that treatment in advance, there can be said to be an implicit agreement by the provider to defer payment for the services, and as a result, the patient may be considered a participant in a credit transaction. Likewise, wherever payment is made by a postdated check or otherwise accepted over time, a credit transaction may be found to exist. The dissenting Judge in Pintos believed that the Plaintiff there was involved in a credit transaction by virtue of the California Code provision allowing for deficiency claims against the owners of vehicles that are impounded and sold to compensate the towing company. Of course, each case is different.

Essentially, obtaining a credit report on an individual in furtherance of examining the likelihood of collecting a delinquent account remains a valuable tool to creditors and collection professionals, and legal advice as to the propriety of doing so under a particular set of circumstances should be obtained in lieu of across the board abandonment of this practice in the wake of Pintos.