The U.S. Bankruptcy Court for the Southern District of New York recently denied a lender’s motion to dismiss concerning the Court’s power to issue an order over a nationwide class action to remedy alleged widespread violation of the discharge injunction under section 524(a) of the Bankruptcy Code.
This action was premised upon the alleged violation of the debtor’s (“Debtor”) and the putative class members’ bankruptcy discharges for alleged failure by the lender – which had sold and assigned most but not all of its rights in the debts -- to update their credit reports that list their debts post-discharge under Section 727 of the Bankruptcy Code as being “charged off,” rather than being “discharged in bankruptcy.”
A copy of the opinion is available at: http://www.nysb.uscourts.gov/sites/default/files/opinions/245564_63_opinion.pdf
As you may recall, “[t]he failure to update a credit report to show that a debt has been discharged is also a violation of the discharge injunction if shown to be an attempt to collect a debt.” 4 Collier on Bankruptcy, paragraph 524.02(2)(B) (16th Ed. 2013), at page 524-23.
The creditor (“Creditor”) argued that it had no obligation to revise or correct the credit reporting because it sold its debt pre-bankruptcy and pre-discharge to a third party. Therefore, Creditor argued, it neither had an obligation with respect to credit reporting under the federal Fair Credit Reporting Act, 15 U.S.C. § 1681 et seq. (“FCRA”), nor under Section 524(a) of the Bankruptcy Code, because it no longer has a debt to enforce. Creditor also argued that it has no other duties under Section 524(a) of the Bankruptcy Code after the sale of the debt.
In denying Creditor’s motion to dismiss, the Court rejected Creditor’s contention that its credit reporting obligations are determined by the FCRA because the complaint does not assert a FCRA claim. Instead, it asserts a claim specifically under Sections 105(a) and 524(a) of the Bankruptcy Code for violation of the discharge under Section 727 of the Code.
Because the FCRA did not expressly repeal or curtail Creditor’s obligations under Section 524(a), the Court concluded that even if Creditor did not have any ongoing duty under the FCRA to correct Debtor’s credit reports, the Complaint’s Section 524(a)/105(a) claim was not preempted.
As you may recall, Section 524 of the Bankruptcy Code “operates as an injunction against 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, whether or not discharge of such debt has been waived.” 11 U.S.C. Section 524(a). See also In re Torres, 367 B.R. 478, 489-90 (Bankr. S.D. N.Y. 2007).
The Court turned to Creditor’s next argument that it cannot be liable under Section 524 having sold its debt pre-discharge, and thus having no plausible interest in continuing to enforce the discharged debt. Unfortunately the Court was not persuaded by the Creditor’s argument for two reasons.
First, the complaint alleged that after the debt was discharged post-sale, Debtor called Creditor to request removal of the “charged-off” notation on his account. Creditor allegedly refused to remove the notation initially, and only did so after the Court issued an opinion involving another matter (In re Odenthal).
Second, the complaint alleged that Creditor chose not to update the credit reporting because it had not sold and assigned all of its interest in the debts, and continued to receive payments either directly or indirectly on discharged debts. More specifically, Debtor alleged that Creditor adopted a practice of refusing to update credit information with regard to debts discharged in bankruptcy because it sells those debts and profits by the sale and subsequent debt collection efforts by the purchaser. According to Debtor, Creditor allegedly knew that if credit information is not updated, many class members will feel compelled to pay off the debt even though it is discharged in bankruptcy. Therefore, according to Debtor, the buyers of Creditor’s debt knew and were willing to pay more for the fact that they will be able to collect portions of the debt, despite the discharge of that debt in bankruptcy.
Accepting the allegations as true, the Court found that the complaint stated a cause of action for breach of the discharge under Sections 727 and 524(a)(2) of the Bankruptcy Code, for intentionally assisting in the collection of discharged debt by not correcting the debtors’ credit reports.
In addition, the Court reached its conclusion, in part, on the fact that the credit reports list the debt as “sold,” but did not identify the purchaser. Therefore, as for as the Debtor is concerned, the only creditor to approach to correct the credit report is the Creditor.
The Court then turn to Creditor’s argument that the Bankruptcy Court lacked subject matter jurisdiction. More specifically, the power to enforce the discharge injunction of any debtor with the exception of debtors who received a discharge in the Southern District of New York. There are three theories upon which courts have refused to entertain nationwide debtor class actions to remedy discharge violations or have circumscribed them on a district-by-district basis.
The first is premised upon the notion that the Court lacks jurisdiction over debts other than the debtor before it because under 28 U.S.C. Section 1334(b), any determination affecting the lead plaintiff’s bankruptcy estate has no relation to the claims of the other debtor class members. See, e.g., In re Knox, 237 B.R. 687, 693-94 (Bankr. N.D. Ill. 1999). The Court rejected this theory because jurisdiction under 28 U.S.C. Section 1334(b) extends to “all civil proceedings arising under title 11,” including 11 U.S.C. Section 524 and 727. These provisions prohibit the collection of in personam debts that have nothing to do with the debtor’s estate or in rem jurisdiction.
The second is theory is based on 28 U.S.C. Section 1334(e), which states, “[o]nly the district court in which a case under title 11 is commenced or is pending shall have exclusive jurisdiction of all the property, wherever located, of the debtor as of the commencement of such case, and of property of the estate and overall claims or cause of action that involve construction of section 327 of title 11 [pertaining to retention and compensation of professionals].” See Williams v. Sears Roebuck & Co., 244 B.R. 858, 866 (Bankr. S.D. Ga. 2000). The Court rejected this theory because this action did not involve a debtor’s interest in property of the estate and is not related to Section 327 of the Bankruptcy Code. Again, the Court explained that this was an action to enforce the discharge injunction prohibiting collection of in personam claims against members of the debtor class that arose pre-bankruptcy.
The third theory is premised on 28 U.S.C. 1334(b). As you may recall, 28 U.S.C. 1334(a) states, “[e]xcept as provided in Subsection (b) of this section, the district courts shall have original and exclusive jurisdiction of all cases under title 11.” That provision thus gives the district courts exclusive jurisdiction of the bankruptcy case generally, that is, the Chapter 7 case at hand. Subsection (b) states, “except as provided in Subsection (a)(2) [which is irrelevant], and notwithstanding any act of Congress that confers exclusive jurisdiction on a court or courts other than the district courts, the district courts shall have original, but not exclusive, jurisdiction of all civil proceedings arising under title 11, or arising in or related to cases under title 11.” 11 U.S.C. Section 1334(b). Therefore, the Court held it has original jurisdiction to issue any order relating to the cause of action at hand arising from Sections 727, 524(a)(2) and 105(a) under title 11.
In reaching its conclusion that the Court has the statutory power and subject matter jurisdiction to decide this nationwide class action, the Court noted that it relied largely on the First Circuit’s analysis of 28 U.S.C. 1334 and Section 105(a) in Bessette v. Avco Financial Services, Inc., 230 F.3d 439 (1st Cir. 2000), and Judge Isgur’s opinion in In re Cano, 410 B.R. 506 (Bankr. S.D. Tex. 2009). The issue of whether class certification was appropriate was not addressed in this opinion.
Accordingly, the Court denied Creditor’s Motion to Dismiss.
Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
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