POSTED: Monday, November 24th, 2008 at 1:00 am

BY: dmc-admin

Whether the purchaser of a debt is a “debt collector” or “creditor” depends on whether the debt is in default at the time of purchase. But the law does not define when a debt goes from mere delinquency into default status.

A sharply divided Seventh Circuit panel on Nov. 13 concluded that, where no payments had been made on the debt for two years, it was in default, even though the original creditor never gave the debtor notice to that effect.

Versia S. McKinney borrowed $5,200 from the Small Business Administration, but stopped making any payments in 2002. Without ever declaring the debt in default and demanding immediate payment of the outstanding balance, the SBA sold the debt in 2002 to a third party, which then sold it to Cadleway Properties Inc.

In 2004, Cadleway sent a collection letter, which included standard notices required by the Fair Debt Collection Practices Act (FDCPA). It included a notice that McKinney had 30 days to notify Cadleway if she disputed the debt, or Cadleway would assume it was valid. The notice contained a form on which McKinney could confirm the balance or state the amount she believed to be the correct balance.

Instead of returning the notice, McKinney sued under the FDCPA. The district court held that Cadleway was a debt collector under the Act, and that the notice was confusing on its face to an unsophisticated consumer.

Cadleway appealed, and the Seventh Circuit reversed. The lead opinion, written by Judge Diane S. Sykes, agreed that Cadleway was a debt collector, but held the notice was not confusing.

Judge Daniel Manion wrote a concurring opinion, suggesting that Cadleway was not a debt collector, but stating it was unnecessary to reach the issue, since the notice was not confusing in any event.

Judge Ilana Diamond Rovner dissented, agreeing with the district court that Cadleway was a debt collector, and that the notice was misleading.

Debt Collector

The lead opinion first explained why Cadleway was a debt collector subject to the FDCPA, rather than a creditor.

The court noted that, while the FDCPA defines “creditor” to exclude persons who collect debts “for another,” the definition of “debt collector” includes any person primarily engaged in the collection of debts.

Thus, Cadleway could logically be considered either one. However, precedent says the two are “mutually exclusive.” Schlosser v. Fairbanks Capital Corp., 323 F.3d 534, 536 (7th Cir. 2003).

For persons who purchase debt to collect in their own right, rather than for another, the court in Schlosser said the distinction between debt collectors and creditors depends on whether the debt was in default when purchased.

Judge Sykes wrote, “So one who acquires a ‘debt in default’ is categorically NOT a creditor; one who acquires a ‘debt not in default’ is categorically NOT a
debt collector (emphasis added by court).”

The lead opinion also found it irrelevant that the SBA never informed McKinney she was in default and demanded payment in full (as the contract permitted). Because McKinney had made no payments for at least two years, the court concluded the debt was plainly in default.

Judge Manion took issue with this analysis, noting that the issue was not squarely presented in Schlosser. Instead, the court there only considered whether a party was a debt collector if it attempted to collect on a debt it believed to be in default at the time it acquired the debt.

Manion opined, “Since Cadleway was collecting on a debt it now owned for itself, it should not be considered a debt collector, regardless of whether or not McKinney’s loan was in default”

Notice

Although the lead opinion concluded Cadleway was a debt collector, it found the notice was not confusing, and summary judgment should have been entered in its favor.

The usual means of proving a notice confusing under the FDCPA is to present expert testimony to that effect, which McKinney did not present.

In addition, she testified that the notice was not confusing to her personally; finally, the court found nothing facially confusing about the notice.

Judge Rovner dissented from this aspect of the lead opinion.

Rovner concluded that an unsophisticated debtor would not know from the letter whether she was required to return the notice stating that she either admits or disputes the debt, or whether return of the notice was optional.

Rovner further concluded that the notice would be confusing to a debtor who knows she owes some money to the creditor, but is not sure how much.

Analysis

Given the facts in the case, the opinion necessarily sheds little light on the oft-asked question, “When does a loan cross the line from delinquency into default under the FDCPA?”

The lead opinion merely holds that, where no payments have been made on the loan for more than two years, it has crossed the line into default status.

Nevertheless, footnote 2 of the opinion does cite a Second Circuit case on the issue that offers more guidance, Alibrandi v. Fin. Outstanding Servs., Inc., 333 F.3d 82 (2d Cir. 2003).

The court in Alibrandi noted, “Unfortunately, the FDCPA does not define so key a term as ‘default.’” Alibrandi, 333 F.3d at 86.

The court declined to adopt a bright-line rule that a loan goes into default immediately after payment becomes due. While such a rule would benefit consumers in this regard, the court found it would result in other adverse consequences for debtors that it deemed ill-advised. Id., at 87.

The Alibrandi opinion also notes that numerous other federal statutes do define “default,” and that those periods range from 30 to 270 days after a debt becomes due. Id., at 86-87.

Finally, in a footnote, the court stated that the interests of all parties is best served by affording creditors and debtors leeway in contractually defining their own periods of default. Id., at 87, n. 5.

As a final note, attorneys for debtors should be aware of a Third Circuit opinion cited in both Judge Sykes’ lead opinion and Judge Manion’s concurrence. F.T.C. v. Check Investors, Inc., 502 F.3d 159(3d Cir. 2007). Judge Sykes found it persuasive; Judge Manion maintained it was incorrectly decided (the Third Circuit held that the defendant was a debt collector subject to the FDCPA).

The egregious facts in Check Investors should be emphasized by any debtor’s attorney faced with a creditor’s argument which cites Judge Manion’s opinion as persuasive authority.

In Check Investors, the defendant — a convicted felon — went into the business of buying debts for collection, based on his belief that, by buying the debts outright, he would be a creditor, rather than a debt collector, and thus be exempt from regulation on how he collects them. Id., at 162-163.

Acting on that belief, he threatened debtors with criminal prosecution, added fees in excess of those allowed by state law, referred to debtors as “retards” and “thieves,” and engaged in “saturation phoning” — calling one debtor 17 times in 10 minutes.

He also obtained payment of one debt from the debtor’s mother by repe
atedly threatening to imprison her son if she didn’t pay. Id., at 163-164.

As a theoretical matter, Judge Manion’s position — one who collects only debts he has purchased is a creditor rather than a debt collector –- has a certain logical appeal.

However, simple recitation of the facts in Check Investors will go a long way towards removing that appeal.

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