Providing Equitable Outcomes for Expired Debts

The average American household owes over $136,000 in debt. Some of this debt, however, is stale.

Due to the expiration of the statute of limitations—which can range from three to six years depending on the state—creditors cannot prevail if they bring a lawsuit to collect on certain debt. Yet, most collectors will pursue the debt anyway, sometimes using deceptive tactics and overwhelming the judicial system with litigation along the way.

In a recent paper, Marc McAllister of Texas State University argues that the current scheme governing expired debt—also known as time-barred debt—does not generate fair financial outcomes and only serves to overburden the judicial system. McAllister proposes several reforms to alleviate the courts of excessive litigation relating to time-barred debt, as well as ensure that all debtors—especially unsophisticated ones—are treated fairly.

Time-barred debt has not been erased. Debtors, however, can assert a legal defense against paying the debt, which would prevent a collector from enforcing the claim in court.  Still, consumers, unaware of the laws governing time-barred debt, often find themselves in situations where they reassume some or all of the debt.

For example, debt collectors will attempt to collect time-barred debts by offering to settle the debt for 10 percent to 40 percent of the initial amount owed, explains McAllister. In responding to these settlement offers, some debtors—unaware of the statute of limitations bar—will elect to pay the full settlement amount, discharging their debt in full. Others may choose to pay the settlement amount partially. Under a well accepted rule, the partial payment will imply a promise to pay the entire debt and revive the statute of limitations, unless otherwise indicated. Collectors often do not inform debtors of this result, trapping unsophisticated debtors into re-committing to their entire debt.

To prevent windfalls to creditors just based on the debtor’s level of sophistication, McAllister contends that companies attempting to collect on time-barred debt should include a disclosure relating to the debt’s status. The notice should indicate that the statute of limitations has expired and that the collector cannot sue for the debt.

He further proposes that this disclosure provide debtors with two options: to pay the full settlement amount or to make a partial payment of the amount. For the latter option, McAllister recommends that the disclosure clearly explain the effect of the partial-payment rule and include a mechanism by which debtors can indicate their intent to pay only a certain amount.

But some debt collection companies find it “ridiculous” to send consumers notices disclosing that the statute of limitations has expired and alerting consumers of the partial payment rule.  “People are obligated to pay their debts, whether the statute of limitations period has run or not,” Rozanne Andersen, former chief executive officer of a debt collection company association, has reportedly said.

Other financial associations believe that such disclosures would only be appropriate if a collector has been found to mislead consumers purposely. They add that determining if a debt has expired is “challenging and requires a legal judgment,” due to the complex legal landscape varying by state law and the debt type. In each individual circumstance, collectors would need to research whether partially paying the debt would revive it in full. Providing this disclosure would be akin to the collector providing legal advice to the debtor, which debt collectors worry could be construed as an “unauthorized practice of law.”

Still, McAllister maintains that such disclosures should be provided to level the playing field for both debtors and collectors.

Of course, McAllister notes that some debtors will choose not to respond to creditors’ offers of settlement, often leading the collector to file suit against the debtor. Although the debtors could invoke the statute of limitations as an affirmative defense, if they also fail to respond to the lawsuit they could face a default judgment amounting possibly to over 300 percent of their initial debt. And even though most courts hold that filing a lawsuit to collect a time-barred debt is a violation of the Federal Debt Collection Practices Act (FDCPA), relaxed judicial standards relating to default judgments promote these suits. Bold collectors, McAllister says, continue to litigate.

To prevent default judgments on time-barred debts, McAllister asserts that the FDCPA should be amended to state clearly that filing a lawsuit to collect an expired debt violates the Act. Making explicit the unlawfulness of these collection suits will deter collectors from filing, McAllister says. Instead of requiring debtors to assert an affirmative defense based on the statute of limitations, creditors who file a collection lawsuit should be required to prove that the debt is not time-barred. These solutions would prevent unfair default judgments and the judicial effort expended for such cases.

But some financial associations disagree that collection efforts of time-barred debts should be restricted. Banking industry groups have noted that often “consumers wish to repay time-barred debts based on a number of considerations, including a sense of personal obligation and their desire to protect their credit history.”

Yet another business association notes that the debt collection industry itself has significantly lessened the number of lawsuit relating to time-barred debts. Many debt collectors apparently believe that filing suit on a time-barred debt would contradict their interest. Still, McAllister argues that reforms are still needed, especially in the context of default judgments.

McAllister does acknowledge that, in response to settlement offers from creditors, some savvy consumers may file suit against these collectors for violating the FDCPA. Generally, courts agree that a creditor violates the FDCPA by threatening to file a lawsuit on time-barred debts. Some courts have ruled that creditors violate the FDCPA when merely attempting to settle a time-barred debt after failing to notify the debtor of the debt’s expired status. Some debtors may take advantage of these holdings by filing their own lawsuits against their creditors.

But to protect creditors from frivolous lawsuits and alleviate the courts of a flood of lawsuits, McAllister recommends that the FDCPA be amended to allow collection of time-barred debts through collection letters, but only if a disclosure similar to his proposed notice is included. If creditors include such disclosures, they may not be sued, McAllister says.

McAllister concludes that this framework of reforms would not only assist the courts in minimizing the potential for excessive frivolous litigation, but would also reinvigorate the purpose of the FDCPA—to eliminate abusive and deceptive practices by collectors.

McAllister’s paper appeared recently in the Washington and Lee Law Review.