Introduction

The variety and types of claimants scheduled on a debtor’s schedules and who file claims can be quite varied. The following discussion focuses on those claimants who, while holding claims that may otherwise be allowable, face the bar of a statute of limitations. The article will provide an overview of statutes of limitation, including a definition, historical background, and discussion of their procedural impact on claims. A definition of the term “claim,” and burdens of proof in the objection process will be examined within the context of claims whose enforcement may be barred by a statute of limitations. A thorough analysis of the case of In re Varona will follow, which includes an examination of whether claimants whose filed claims are barred by statutes of limitation should be subjected to sanctions and penalties. The article will conclude with an overview of the impact of statute of limitations related issues in § 523 dischargeability actions.

Statutes of Limitations

“Generally speaking, a statute of limitations establishes the time period within which lawsuits may be commenced after a cause of action has accrued. It is an affirmative defense,

affecting the remedy, but not the existence of the underlying right.” Stuart v. American Cyanamid Co., 153 F.3d 622, 627 (2nd Cir. 1998). “Statutes of limitations differ from statutes of repose because the former ‘bars plaintiff[s] from bringing an already accrued claim after a specified period of time,’ whereas the latter ‘terminates a right of action after a specific time, even if the injury has not yet occurred.’” Fields v. Legacy Health System, 413 F.3d 943, 952 (9th Cir. 2005) citing Rice v. Dow Chemical Co., 875 P.2d 1213, 1217 (Wash. 1994).

Accordingly, statutes of limitations can serve to bar claimants from prosecuting actions on their claims after a certain amount of time has expired, even if the underlying indebtedness is not disputed.

At early common law, there was no bar to an action for enforcement of a legal right. Statutes of Limitations had their origin in 1623 in the Statute of 16 Jas. I, ch. 16 that was enacted in England. Hart v. Deshong, 8 A.2d 85, 86 (Del. Super. 1939). The intention of legislation enacting various statutes of limitations is generally to protect against mistakes made in the evaluation of the viability of such claims due to evidentiary difficulties presented after the passage of time. Wood v. Carpenter, 101 U.S. 135, 139, 25 L. Ed. 807 (1879); Campbell v. City of Haverhill, 155 U.S. 610, 617, 15 S. Ct. 217, 220, 39 L. Ed. 280 (1895); Lynch v. American Motorists Ins. Co., 101 F. Supp. 946, 949 (N.D. Tex. 1951). The result can sometimes be harsh, especially if the passage of time would not, under the circumstances, provide an impediment to meeting evidentiary burdens to establish the underlying debt. It has been said that “[s]uch periods are established to cut off rights, justifiable or not, that might otherwise be asserted and they must be strictly adhered to by the judiciary. Remedies for resulting inequities must be provided by Congress, not the courts.” Kavanagh v. Noble, 332 U.S. 535, 539, 68 S. Ct. 235, 237, 92 L. Ed. 150, 153, 48-1 U.S. Tax Cas. (CCH) 9114, 36 A.F.T.R. (P-H) 383 (1947).

From a bankruptcy perspective, it can be said that a statute of limitations serves as a defense to a claim asserted after pre-petition expiration of the applicable limitation period even if such claim is otherwise valid, and even if the passage of time did not serve to provide an obstacle to proving up such claim. (Hereafter, underlying debt that is subject to a statute of limitations defense shall be referred to as “Stat Debt,” and bankruptcy claims founded upon Stat Debt shall be referred to as “Stat Debt Claims.”)

Claims and Related Issues

An overview of issues related to Stat Debt Claims presupposes familiarity with definitions and procedural matters pertaining to claims. This section will provide a statutory definition of the term “claim,” discuss methods of asserting claims, shifting burdens of proof in the claim objections process and the results of a failure to object to a claim – all within the context of Stat Debt Claims. The section which follows – a comprehensive overview of the case of In re Varona – will examine these issues in greater detail.

A. Who holds a “claim?” The United States Bankruptcy Code, 11 U.S.C. §101(5) states that the term “claim” means:

(A) right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured; or

(B) right to an equitable remedy for breach of performance if such breach gives rise to a right to payment, whether or not such right to an equitable remedy is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured, or unsecured.

The United States Supreme Court, in Johnson v. Home State Bank, 501 U.S. 78, 83, 111 S.Ct. 2150, 115 L.Ed.2d 66 (1991), provides that the term “claim” has “the broadest possible definition.” The foregoing definition and construction of such definition begs the question – does a creditor, whose enforcement of its otherwise justified claim against a debtor is barred by a statute of limitations, hold a “claim” against such debtor as defined under the Code? Logic indicates that the better answer is yes. Such creditor, under this scenario, holds a right to receive payment from the debtor. The statute of limitations could serve as a bar to enforcement of the right to payment only if the debtor affirmatively avails himself of the limitations defense in the event a complaint or other similar action such as a proof of a Stat Debt Claim is filed.

In general, claims arise in a bankruptcy proceeding in one of two ways. A claim can be set forth in a debtor’s schedules,

or a party can file a proof of claim. Section 501 of the Code allows several parties to file a proof of claim, including the underlying creditor, a party indebted to the underlying creditor along with the debtor or who has secured the creditor, the debtor or the trustee. If a claim is filed, it is deemed allowed unless a party in interest objects. See 11 U.S.C. § 502(a).

Based upon the above, it can be said that a Stat Debt Claim qualifies as a “claim” under the Code. If the Stat Debt Claim is scheduled (and not listed as being disputed, contingent or unliquidated), or if a proof of claim for the Stat Debt is filed under § 502(a) of the Code, and no objection is filed, such Stat Debt Claim should be allowed.

B. Burden of Proof in the Claims Objection Process

If an objection to a Stat Debt Claim is filed, an issue is raised as to who bears the burden of proof during the objection process.

From a bankruptcy perspective, the general rule is that a correctly filed proof of claim constitutes prima facie evidence of the validity and amount of the claim.

The party objecting to the proof of claim bears the burden of going forward, i.e., producing sufficient evidence to defeat the claim. In re BRI Corp., 88 B.R. 71, 73 (Bankr. E.D. Pa. 1988). As stated by the court in In re Schaumburg Hotel Owner Ltd. Partnership, 97 B.R. 943, 950 (Bankr. N.D. Ill. 1989) “[c]laims filed in bankruptcy are prima facie presumed valid under 11 U.S.C. § 502(a) and are prima facie proof of their validity under Bankr.R. 3001(f).”

Once an objecting party comes forward with sufficient evidence to rebut the validity of a claim, the burden then shifts to the claimant to prove the validity of its claim by a preponderance of the evidence. In re Galloway, 220 B.R. 236, 244 (Bankr. E.D. Pa. 1998).

The court in In re Professional Investors Insurance Group, Inc., 232 B.R. 870 (Bankr. N.D. Tex. 1999) considered such burden of proof issues when presented with an objection to a possible Stat Debt Claim. The claimant bank filed a secured proof of claim, asserting a security interest in shares of stock. The debtor objected, arguing that the claim was barred by a statute of limitations. The court considered complex choice of law issues as well as the issue of which statute of limitations of one of three different states applied. The claimant ultimately prevailed, demonstrating that even if the burden shifts back to a claimant in an objection to claim which raises a limitations defense, it is possible under certain circumstances for the claimant to prevail.

In re Varona

As stated before, if a holder of a Stat Debt Claim files a proof of such claim in a bankruptcy proceeding, and if no objection is filed with respect to such claim, the claim will be allowed. Some may argue that the filing of the proof of the Stat Debt Claim is a wrongful act in and of itself that should be sanctioned. A determination that a Stat Debt Claim is subject to disallowance can only be made upon examination of the claim. If a party adverse to the claimant properly examines a Stat Debt Claim, such adverse party will likely file an objection or other similar proceeding if the perceived benefit of objecting exceeds the cost of doing so. In the case of In re Varona, — B.R. —, Case No. 07-71761-SCS, 2008 WL 2150109 (Bankr. E.D. Va. May 22, 2008), the holder of two garden variety Stat Debt Claims faced off with angry debtors who took exception to the filing of proofs of these claims. Aggressively asserting multiple arguments to sanction this claimant, the debtors obtained nothing more than an order allowing the claimant to withdraw its claims. The case is highlighted in this article to demonstrate that the filing of a proof of a Stat Debt Claim (that would otherwise be allowed but for the statute of limitations defense) should not be considered a wrongful act and should not be sanctioned.

The debtors in Varona filed their petition under Chapter 13 of the Code in 2008. An assignee, who acquired credit card debt charged off in 2000 and 2001, filed two separate proofs of claims based upon this old debt. The debtors objected to both claims alleging, inter alia, that the claims had not been reduced to judgment, and that the state statute of limitations on collecting the debt underlying each claim had expired. The debtors further alleged that the proof of claim

was not filed in good faith and was fraudulent. The objecting debtors also moved for an award of attorney’s fees and sanctions against the claimant. Shortly thereafter, the claimant filed notices of withdrawal for both claims. The debtors objected and the claimant sought leave to withdraw the claims. Slip op. at 4-5.

The bankruptcy court commenced its legal analysis with the caveat that the dispute was being considered:

at a time when bankruptcy courts are examining the integrity of the claims process in various contexts. See, e.g ., Nosek v. Ameriquest Mortgage Co. (In re Nosek), — B.R. —-,Case No. 02-46025-JBR, 2008 WL 1899845, at *4 (Bankr.D.Mass. Apr.25, 2008); In re Countrywide Home Loans, Inc., 384 B.R. 373, 394-95 (Bankr.W.D.Pa.2008) (describing pending proceedings by the Chapter 13 Trustee and the United States Trustee to examine loan histories and impose sanctions on a creditor).

Slip op. at 6. The court summarized the three arguments asserted by the objecting debtors, that the claims were: (1) Fraudulent and subject to sanctions under § 105 of the Code; (2) an attempt to collect a time-barred complaint in violation of the Fair Debt Collection Practices Act (“FDCPA”), 15 U.S.C. § § 1692-1692p; and (3) prejudicial against the debtors and that the doctrine of laches prevented enforcement of same. The court then noted the claimant’s defense that the underlying claims were not fraudulent as the claims were not extinguished by the running of the statute of limitations under state law. Slip op. at 6-7.

Holding for the claimant, the court issued rulings on seven separate matters, six of which will be discussed in further detail.

A. The Claims Process in Bankruptcy Cases – Claim filings are authorized under § 501 of the Code, the requirements of a proof of claim set forth in Fed. R. Bankr. Pro. 3001, and Official Form 10 imposes other requirements. The Official Form instructions warn filers about criminal penalties (under 18 U.S.C. § 152) for making false statements in a proof of claim. Fed. R. Bankr. Pro. 3001(f) provides that a proof of claim executed and filed in accordance with the applicable rules constitutes prima facie evidence of the validity and the amount of the claim. A claim is deemed allowed unless one of the nine events set forth in § 502(b) of the Code is triggered. Once the objecting party meets its burden of presenting sufficient evidence to overcome the prima facie effect of the filed proof of claim, the burden then shifts to the creditor to establish the amount and validity of its claim. Slip op. at 8-11.

B. Imposition of Sanctions for Filing False or Fraudulent Claims – There is a split of authority as to whether or not a bankruptcy court may utilize § 105 of the Code to impose sanctions for the filing of a fraudulent proof of claim. The Varona court concluded that § 105 does indeed empower the court to impose sanctions for the filing of a false or fraudulent claim. Slip op. at 11-17.

C. Laches – Laches cannot be used as a legal theory to impose sanctions upon a claimant on a Stat Debt Claim. Slip op. at 17.

D. Applicability of the FDCPA – Faced with the issue of whether a proof of claim may be the subject of a FDCPA violation, a majority of courts have concluded the FDCPA is not intended to provide a remedy for claims filed in a bankruptcy proceeding (citations omitted). The practices that the FDCPA was enacted to guard against do not apply in bankruptcy. Debtors are protected by knowledgeable counsel in bankruptcy proceedings. The FDCPA is inapplicable to bankruptcy claims. Slip op. at 17-23.

E. The Claims Were not Fraudulent – The Varona court reiterated that the United States Supreme Court ruling in Johnson, supra, that Congress intended to adopt the broadest possible definition of the term “claim” when it enacted 11 U.S.C. § 101(5). The validity of claims is to be determined by reference to state law. As the claimant was unable to produce the contract which formed the basis of its claims, the law of the forum state governs. In the forum state, the statute of limitations does not extinguish a debt – it merely operates to bar enforcement. Furthermore, the defense of the statute of limitations is an affirmative defense which must be raised by the defending party, who bears the burden of proof on the issue. A successfully raised statute of limitations did not render the claims false or fraudulent – the claims were not extinguished, they simply could not be enforced. Therefore, sanctions are not appropriate. Slip op. at 23-27.

F. Attorneys Fees Should not be Awarded – As the court concluded that the subject claims were not false or fraudulent, it declined to award the objecting debtors attorneys fees.

Slip op. at 27-28.

Statute of Limitations Issues in § 523 Dischargeability Actions

The prior discussion considered potential ramifications for filing a Stat Debt Claim whose enforcement is subject to the bar of a statute of limitations. Suppose, however, a claimant’s claim is allowed in bankruptcy. Can a statute of limitations for bringing a fraud or other similar claim against the debtor serve to bar an action under § 523 of the Code for exception to discharge if the action is otherwise brought in a timely manner under the Code? The answer is probably no.

If the claimant’s claim is allowed, the claimant should be able to satisfy the “establishment of debt” requirement for bringing a dischargeability action. The term “debt” is defined under § 101(12) of the Code as meaning “liability on a claim.” Establishment of debt, as will be shown below, is a requirement for a claimant to bring a § 523 action with regard to a particular debt. If the creditor is unable to establish its debt, there will be no debt to except from discharge. Two cases shed more light on this topic

. In In re McKendry, 40 F.3d 331 (10th Cir. 1994), following a foreclosure of real property, a mortgage lender obtained a deficiency judgment against the debtor. Seven days after the judgment was entered, the debtor filed a petition under Chapter 7 of the Code. During the bankruptcy proceeding, the judgment creditor filed an adversary proceeding under § 523 of the Code seeking to except its debt from discharge alleging fraud on the part of the debtor. The debtor defended the action by arguing that the state statute of limitations for fraud had long expired. The bankruptcy court agreed, holding that the dischargeability action was time-barred under the state statute of limitations for fraud, and the district court affirmed. On appeal, the Tenth Circuit framed the underlying issue as follows: “[W]here a debt has been reduced to judgment in state court, can the bankruptcy court be barred by a state statute of limitations from considering the underlying nature of the debt in determining whether that debt is dischargeable.” Id. at 334. The Circuit Court reversed, holding that Brown v. Felsen, 442 U.S. 127, 99 S.Ct. 2205, 60 L.Ed.2d 767 (1979) controls. In Brown, the Supreme Court ruled that the doctrine of res judicata does not apply when determining whether a debt reduced to judgment is dischargeable. In other words, a creditor is not required to anticipate a potential future § 523 action when reducing its claim to judgment in state court. In effect, the Tenth Circuit applied a two part test to determine if the dischargeability action could proceed. First, there must be establishment of the debt. Here, the court considers state statutes of limitation to determine whether the debt was established prior to the filing of the bankruptcy petition. Second, once the debt is established, the second issue is whether the dischargeability action was brought timely under the Code. Federal bankruptcy law should be applied to determine whether or not the debt is dischargeable – not state law relating to statutes of limitations. Since the creditor established the debt, the Tenth Circuit remanded for consideration of the issue of whether or not the debt was incurred as a result of fraud and thus non-dischargeable. Id. at 337.

Later, in the case of In re Banks, 225 B.R. 738 (Bankr. C.D. Cal. 1998), the bankruptcy court considered a situation where a creditor in a § 523 action did not obtain a judgment prior to the filing of the debtor’s bankruptcy. The court adopted the two part test set forth in McKendry. First, the court ruled that establishment of the debt is determined under state statute of limitations law. If suit is not brought before expiration of the limitation period, the debt cannot be established. However, if the debt is established, dischargeability of the debt is a question of federal bankruptcy law – not state law. Id. at 744-45. The court continued by concluding that it was not necessary for the claimant to obtain a judgment prior to the bankruptcy filing. All that was necessary was for the claimant to “establish” its claim via a “timely affirmative act” required by operation of law (e.g., the filing of a complaint), prior to expiration of the limitation period. The Banks court ruled further that it was not necessary for the claimant to have raised issues related to the § 523 action in state court and stated that:

public policy supports the position that the pre-petition expiration of the applicable state statute of limitations for the cause of action predicated on the § 523(a) theory of liability should not presumptively preclude the creditor from pursuing a dischargeability action on that ground in the bankruptcy case.

Id. at 746. Citing Fed. R. Bankr. Pro. 4007(b),

the court concluded that once the underlying debt is established, the state statute of limitations becomes immaterial. Since the claimant filed actions in state court on the underlying claims prior to expiration of the state statute of limitations, the claimant succeeded in establishing its debt. This allowed the Court to determine the nature of the debt in the context of dischargeability litigation. Id. at 747.

Referring back to In re Professional Investors Insurance Group, Inc., supra, we saw a situation where, when presented with a possible limitations defense by a debtor, the claimant was able to meet its burden of proof, and prove that its claim was not barred by a statute of limitations. Suppose the claimant in that case wanted to bring a § 523 action against the debtor. Assuming that the action would have been brought in a timely manner under the Code, the foregoing cases suggest that the bankruptcy court would not need to consider whether or not the statute of limitations for bringing a fraud action against the debtor had run. Once the claimant established its debt, such claimant would be free to prosecute its § 523 action.

Conclusion

As a matter of policy, there is no good reason to prohibit the filing of a proof of a Stat Debt Claim, assuming the claim is otherwise valid and proper under the Code and Rules, and assuming the statute of limitations is an affirmative defense which does not serve to extinguish the underlying debt. If no objection is filed, the claim should properly be allowed. Indeed, in many cases, there simply is little or no incentive for interested parties to invest the time and expense to object to such claims. Considering that statutes of limitations were enacted to overcome evidentiary difficulties in proving older claims, it does not seem fair to impose sanctions upon a party for merely filing a Stat Debt Claim if it has proof of the underlying debt. However, while the act of filing a Stat Debt Claim may not be wrongful in and of itself, the claimant would likely be unable to establish its debt in a § 523 action, and thus would not be able to except such debt from discharge.

It may be unfair to strike a claim or deny establishment of a debt due to nothing more than the passage of time. Ultimately, this is a matter to taken up with the legislative body that enacted the subject statute of limitations. At the end of the day, however, a person who defeats a claim on a debt using a limitations defense as a shield gets a free pass. Such person should not be able to use the statute of limitations as a sword in an offensive manner against the creditor to whom he or she is indebted.

This article was first published in the July/August, 2008 edition of the American Bankruptcy Institute Journal.

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