Wednesday, June 13, 2007

Assigned Credit Card Debt: A Problem of Paper, Electronic Images and Faith

Two recent decisions from Texas Bankruptcy Courts highlight the practical problems inherent in proving up a claim based on assigned credit card debt. However, they also illustrate the tenuous connection between trust and value in the electronic age.

The Cases

The two cases involved a common fact pattern but different outcomes. In both cases, a debtor incurred credit card debt and then filed bankruptcy. In the bankruptcy case, a third party filed a proof of claim as the assignee of the original creditor. The Debtor then objected on the basis that the entity claiming to hold the claim was unknown to it and that the documentation attached to the claim was insufficient. In In re Tran, No. 05-82180 (Bankr. S.D. Tex. 9/6/06)(Brown, Ch.B.J.) aff’d, eCast Settlement Corporation v. Tran, No. H-06-2965 (S.D. Tex. 5/14/07)(Miller, .J.) , the Court required the assignee to meet the same burden of proof which would apply to a suit on a contract in state court and the claims were denied. In In re Joe Ray Griffin, No. 06-11130 (Bankr. W.D. Tex. 5/17/07)(Monroe, B.J.), the Court allowed the claim on a finding that the underlying claim was undisputed without requiring the assignee to establish its provenance.

Lack of Evidence Dooms Tran Creditor

The Tran opinion takes a very methodical approach to the claims objection. The Court started with the question of whether the objection raised by the Debtor fell within a ground established under §502(b). The Court found that the Debtor’s objection that it did not owe any money to eCast Settlement Corporation fell within the statutory language that the claim should be allowed unless it was enforceable under any agreement or applicable law.

The Court then sought to determine who had the burden of going forward under Fed.R.Bankr.P. 3001. Under Rule 3001(f), a properly filed proof of claim is entitled to prima facie validity. If the claim is entitled to prima facie validity, the objecting party must go forward with evidence to rebut the prima facie case, at which point the burden shifts to the creditor. On the other hand, if the claim is not properly filed, it is not entitled to prima facie validity and the creditor bears both the burden of going forward with the evidence and the burden of persuasion. The Court noted that in order to be entitled to prima facie validity, a claim based on a writing must be supported by a copy of the writing or by a statement that the writing has been lost or destroyed. Fed.R.Bankr.P. 3001(c). The Court then found that under Texas law, a claim on a credit card is treated as a claim for breach of a written contract so that a copy of the written contract was necessary to give the claim prima facie validity. Since the assignee attached only a summary of a few pertinent details relating to the contract, the Court concluded that the claim was not entitled to prima facie validity and placed the entire burden on the putative claimant. The Court rejected the argument that the creditor could substitute a summary for voluminous documents on the basis that the creditor had not shown that the underlying contract was voluminous.

In this case, allocating the burden was tantamount to determining the objection. Because the creditor had the entire burden, it had to prove the existence of a contract. The Court discussed the types of evidence which could prove the existence of a contract under Texas law.

“Under Texas law, the affidavit of a custodian of the creditor’s records, whose duties include having custody and control of records related to the debtor’s account which purports to: (1) authenticate the credit card agreement documents and monthly statements; and (2) state the account balance due and unpaid, may be sufficient to prove the formation or the terms of the agreement. (citation omitted). The elements of breach of contract may be proved by introduction of debtor’s signatory reply to the bank’s predecessor in interest’s revolving credit offer; bank’s subsequent issuance of new credit cards to debtor with proof of use; monthly statements billed to debtor and debtor’s payment including a copy of a canceled check showing a payment to the bank based upon the debtor’s unique identifying revolving credit account number; admission of the debtor in debtor’s discovery responses; and subsequent absence of payment. (citation omitted). Where one bank has purchased the revolving account from another bank, the custodian of the purchaser bank’s records is competent to testify about the predecessor bank’s records in the purchaser’s possession. (citation omitted). “

Order Regarding Objection to Claims, p. 8.

Here, the creditor did not offer any of these forms of proof. Instead, the creditor sought to have the debtor prove up certain credit card statements relating to the account. The court found these statements to be insufficient to prove the existence of a contract and also insufficient to establish the Debtor’s liability to eCast. As a result, the Court denied the claims.

The Tran case was appealed to the U.S. District Court which entered an order affirming the Bankruptcy Court on May 14, 2007. The District Court opinion brought out an additional fact not apparent from the Bankruptcy Court opinion. Apparently eCast Settlement Corporation had produced general assignments from various banks to it, which did not specifically reference the Tran account. However, these assignments were excluded from evidence as hearsay.

The District Court agreed with the Bankruptcy Court that failure to attach the writing that the claims were based upon deprived the claims of their prima facie validity. The District Court noted that eCast’s “boilerplate” statement about summarizing voluminous documents might satisfy the proof of claim form but did not satisfy Rule 3001(c). The District Court also agreed with the Bankruptcy Court that failure to establish prima facie validity under Rule 3001(f) left the entire burden on eCast.

The District Court agreed that eCast had failed to satisfy its burden of proof. The Court’s discussion is very illuminating as to what evidence would have been sufficient.

“ECast had the opportunity to introduce evidence during the evidentiary hearing held June 20, 2006 before Chief United States Bankruptcy Judge Karen Brown to support its claim beyond what was attached to its proofs of claim. As discussed above, eCast introduced evidence and examined Teresa Tran at that hearing. The court found that there were several key documents, any of which could have satisfied eCast’s burden of proof had they been entered into evidence. An affidavit from the custodian of records: (i) authenticating the credit card agreement; (ii) authenticating monthly statements; or (iii) certifying the unpaid balance and balance due could have met eCast’s burden. (citation omitted). More relevant to eCast’s situation, the court found that one who has purchased an account from a bank may rely upon the custodian of the purchaser’s records to fulfill the requirements above. (citation omitted). Rather than introduce any of the types of evidence discussed above, eCast attempted to introduce general assignment agreements from three banking institutions which were excluded on evidentiary grounds. (citation omitted). The Court notes that eCast offered no witness to establish the validity of their claim as discussed above and no affidavit to authenticate documents as discussed above. Furthermore, eCast failed to offer any evidence beyond a few monthly statements—clearly insufficient on their own—to establish the existence of a contract or the amount owed under Texas law. The court proceeded a step further showing that even if eCast had established the validity of their claim, they still failed to establish the amount of their claim pursuant to Texas law.”

Memorandum and Order, pp. 11-12. The District Court approved of the Bankruptcy Court’s reasoning in this regard and thus affirmed the decision to deny the claims.

In a curious ruling, the District Court held that eCast was not required to prove that it was the assignee of the original creditors. It stated, “It was not assigned the burden to prove it rightfully acquired the claim. There are specific elements that ECast must establish to show an enforceable contract. . . . However, eCast was not required to produce assignments or transfer documents, and doing so would not alone have established a valid and enforceable claim under Texas law.” Memorandum and Order, p. 12.

Finally, the District Court ruled that eCast should not have been allowed to amend its claims to include the required proof. The Bankruptcy Court had denied an oral motion to continue the hearing on the basis that the hearing had been long scheduled. The District Court found that undue delay was a proper ground for denying a request for leave to amend.

As a result, the District Court affirmed the Bankruptcy Court in all respects.

Statements Good Enough For Griffin Creditor

The creditor in the Griffin case was able to prevail because it managed to amend its claim to point that it reached prima facie validity. In Griffin, the creditor filed a claim in the name of “B-Real, LLC/Chase Bank, N.A.” According to the court, the original claim was “woefully deficient” in that it was supported only by a summary reflecting the closing balance, but did not even include an account number. Upon receiving an objection, the creditor amended its proof of claim to attach account statements for the debt for several months prior to bankruptcy. However, it did not include any documentation showing a transfer of the debt from Chase Bank, N.A. to B-Real, LLC.

Judge Monroe found that in order for a claim filed by the original creditor to have prima facie validity, it must include the following elements:

the name and account of the debtor or debtors;
the amount of the debt;
it must be in the form of a business record or other reliable format; and
if the claim includes charges such as interest, late fees and attorney’s fees, the summary must include a statement giving a break-down of those elements.

Judge Monroe found that the account statements attached to B-Real’s claim satisfied these elements, stating “They are sufficient for all parties to assure themselves that the claim that is being asserted in the amended claim appears valid…” As a result, Judge Monroe found that the claim was entitled to prima facie validity. However, from there, the court had to decide whether the creditor asserting the claim had to prove its ownership of the claim. The Court noted that Fed.R.Bankr.P. 3001(e)(1) required evidence of transfer of the claim only if the claim is transferred after the original creditor files a proof of claim. The Court declined to impose an additional requirement not found in the rules (i.e., that a assignee who is the first person to file a claim on the account must prove the transfer). The Debtor did not produce any evidence. As a result, the court found that the prima facie validity of the claim carried the day and denied the objection.

Reconciling the Two Cases

Although the two cases arrived at different results, they share some common reasoning:

Both cases agree that a mere summary attached in support of a proof of claim is insufficient;
Both cases appear to agree that a properly proven up account statement may be sufficient for some purposes; and
Both cases agree that an assignee is not required to prove how it acquired the claim if the original creditor has not previously filed a proof of claim.

The key distinction between the two cases appears to be that in Griffin, account statements attached to the amended proof of claim were found to be adequate to give the claim prima facie validity. In Tran, the Bankruptcy Court expressly stated that “The writing required by Rule 3001(c) which must be filed with a claim in order to entitle that claim to prima facie evidentiary effect is, under Texas law, the written contract between the parties.” Because the District Court held that eCast’s “boilerplate” was not sufficient to convey prima facie evidentiary value, it did not reach the issue of what would have been adequate. However, the District Court went on to state that a business records affidavit proving up the account statement would be sufficient to satisfy the creditor’s burden of persuasion. But did the District Court really mean this? In Tran, the Debtor admitted to owing at least one of the debts in the approximate amount claimed by the creditor. An admission from the Debtor should have had the same evidentiary value as a properly proven account statement (which the District Court suggested would have been adequate). However, the District Court did not acknowledge this evidence. Thus, while the District Court opinion in Tran seems to suggest that a properly proven account statement would be adequate to prove the debt, it is not clear that the District Court intended to depart from the Bankruptcy Court’s insistence on producing the contract. As a result, the ultimate meaning of Tran is pretty murky.

Contracts, Account Statements and Faith

One summer during college, I worked in the installment loan department of a bank. My duties included typing up promissory notes and security agreements. After a loan officer personally met with the customer to execute the documents, they would come back to the installment loan department where they were kept in a vault. Under this model of credit, the obligations of the parties were easy to determine. All someone needed to do was to go to the vault and find the promissory note (assuming that I had not misfiled it). The customer’s signature appeared on the operative documents and an actual bank officer was present at the time that it was executed.

Credit cards used to be one step removed from this paradigm. Back in the old days, a person would present their credit card, which would be imprinted onto a form and signed by the customer. The credit card slip was like a miniature promissory note. Critically, it was a document signed by the customer. The charge slip would be mailed into the credit card issuer who would enter all of the charges onto a statement and send it to the customer. When the customer received the statement, he could compare it to his copies of the charge slips and dispute any items which were not correct. However, as to any other terms, such as interest or fees, he pretty much had to trust the credit card company to accurately implement the contract. While the customer may have received a copy of the contract at some point, it is unlikely that he ever kept a copy. Thus, credit cards required a higher degree of trust than a traditional promissory note.

Credit cards have continued to evolve from hard copy miniature promissory notes to electronic impulses. Today customers may or may not sign a credit card slip. If the charge statement is signed at all, it is likely to be stored as a digital image. More likely, the credit card is swiped through an electronic reader, entered into an online form or given out over the telephone. The electronic data representing the charges is stored in a computer somewhere and converted into a statement. Customers may elect to receive their statements electronically and have their payments automatically withdrawn from their bank accounts. As a result, both paper and human involvement have been greatly reduced. Credit card issuers merge, change names or sell portfolios with great frequency so that statements are likely to appear from unfamiliar parties. As a result, the element of trust or perhaps blind faith assumes a greater and greater role. The ordinary customer must have faith that the company sending out the statement indeed owns the account, that the customer’s transactions have been accurately converted into electronic data and that the issuer has accurately applied the contract.

When accounts enter charge-off or bankruptcy status, any connection to the signed promissory note sitting in a vault at the bank is long gone. Companies purchase large portfolios of accounts with minimal documentation. Accounts may change hands multiple times as they are sold and resold for progressively less. At the end of the process, the account may be reduced to a series of numbers reflecting the account number and the amount claimed to be owed. Neither the customer nor the final creditor are likely to have a copy of the original agreement or the original statements. At this point, there is little more than faith to connect the series of numbers with an actual commercial transaction that occurred at some point in the past.

The transition from paper documents to faith-based electronic data has significant consequences for the legal system. At one end of the spectrum is the original Tran opinion, which requires the creditor to produce its contract and its statements, much like the bank which could take the note out of the vault. Under this model, the debtor can scrutinize every transaction against the contract and verify that the calculations are correct. Of course, there is really no way for the debtor to know whether the document being produced as the contract bears any semblance to the original, since the customer likely did not read or retain that document. In this instance, producing the contract is a well-meaning but largely empty gesture.

Judge Monroe’s opinion in Griffin places a higher emphasis on the role of faith. The debtor receives a statement each month. Under federal law, the debtor can dispute the charges on the statement. If the debtor does not dispute the charges, then the parties have chosen to believe that the information contained on the statement is correct. The numbers on the statement become the reality for the parties regardless of what the contract actually provided. When a debtor completes her schedules, she is likely to rely on the account statements. If there is a congruence between the debt claimed and the debt scheduled, it is reasonable for the court to assume that amount is correct. If the parties have a substantive dispute, it is more likely to involve whether a charge was incurred or even whether the debtor ever opened the account. However, the parties are unlikely to litigate about interest rates or over limit fees for the simple reason that it is not practical to do so.

Assignees and Faith

The truly curious aspect of both the Bankruptcy Court opinion in Griffin and the District Court opinion in Tran is that neither court thought that it was important for the person claiming to be the creditor to prove that they actually owned the debt. Part of the standard prove-up for a promissory note is that a creditor show that they are the owner and holder of the note. However, in both of the recent cases, this element was treated as irrelevant. Indeed, only Judge Monroe sought to justify his position.

Judge Monroe relied on the fact that Rule 3001(e) required a transferee to provide evidence of the transfer if someone else had already filed a proof of claim. He stated that “this court should not impose any additional requirement on a claim transferee that does not appear in the Rules of Bankruptcy Procedure or the statute itself.” This argument fails to recognize the difference between the two circumstances. Where one creditor has already filed a claim and a second creditor also files the same claim, there must be a procedure to choose between the two competing claimants. Rule 3001(e) serves to resolve disputes between creditors.

On the other hand, when a stranger appears claiming to own the debt, the issue is whether the putative claimant is the rightful creditor or an imposter. If the legitimate creditor fails to file a claim, this should not mean that any opportunistic party should be able to step in and file a claim for their own account. Owning the claim is the central fact of being a creditor so that this should not be too much to ask.

Judge Monroe was apparently willing to take it on faith that a person in possession of the account statements was a legitimate assignee rather than an interloper. If a person claiming to be an assignee files a claim and includes copies of the account statements, there are four likely possibilities:

(1) The person is a legitimate assignee and obtained the statements from the original creditor;
(2) The person received a legitimate assignment of the claim but then assigned it on to a third party;
(3) The person hacked into the legitimate creditor’s computer and appropriated the data; or
(4) The person obtained the statements from the debtor (either through trickery or through more low tech methods such as going through the debtor’s trash).

Of these possibilities, the first is the most likely and the others are likely to be smoked out by appearance of a competing creditor. Additionally, the criminal penalties for filing a false proof of claim combined with the probability of getting caught should deter most scam artists. On the other hand, requiring a legitimate assignee to prove its ownership of the claim may cause some proper claims to be denied due to lack of documentation. As a matter of efficiency (rather than strict legal construction), using possession of the account statements as a substitute for proof of assignment will probably lead to allowance of more legitimate claims than the alternative.


Weldon Ponder said...

I totally disagree with the premise that a creditor filing a proof of claim should be given a free pass on proving its ownership of the claim. That is a vital link in proving up the validity of the debt (as in "owner and holder of the note"). If the poor debtor wants to argue that he's paid all or a part of the debt, he's got to produce documentation from his financial records (canceled checks, etc.). Why should the creditor or its assignee, whose record-keeping capabilities are immensely greater than that of the individual cardholder, get by with less of a burden?

Greg Phillips said...

When a "previously unknown entity" shows up in Court asking for money, shouldn't our first question ask if this entity has standing? If so, these cases might have come out differently. Section 501(a) and Rule 3001(a) make reference to a "creditor" not an "entity." Section 101(10)(A) defines creditor as "an entity that has a claim against the debtor..." The term "claim" is defined in Section 101(5)(A) as a "right to payment..." These definitions also apply to Rule 3001 per Rule 9001. To have standing, wouldn't an entity that is previously unknown to the debtor have to present evidence that it has "a right to payment against the debtor?" I don't have any cases right at hand, but I'm pretty sure the Bankruptcy Court applies state law in determining contract rights. If so, Texas law does not get lost in the claims determination process because a "right to payment against the debtor" turns on both the debtor's contractual obligation and the existence of a valid assignment. As for industry standards, I believe that if the Courts would require the eCasts of the world to presesnt a valid assignment, they could figure out a way to do it.

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