The U.S. Court of Appeals for the Seventh Circuit recently concluded that collection letters sent to consumers offering to settle their debt but warning them that the settlement “may have tax consequences” did not violate the federal Fair Debt Collection Practices Act (FDCPA).
The plaintiffs had argued that the letters were false and misleading because they were insolvent and, as such, would not have incurred any tax liability for any discharged debt. The Seventh Circuit rejected the argument, concluding that the term “may” only meant there could be tax consequences, and it was possible insolvent debtors would become solvent before settling their debt, thus triggering potential tax consequences.
In so ruling, the Seventh Circuit determined the language was literally true and the use of “may” instead of “shall” was not likely to confuse even an unsophisticated consumer. Accordingly, the Seventh Circuit affirmed the dismissal of the plaintiffs’ lawsuits for failure to state a claim.
A copy of the opinion in Amy Dunbar v. Kohn Law Firm, S.C. is available at: Link to Opinion.
The two plaintiffs each received collection letters from different collection law firms. Each letter offered the plaintiffs the opportunity to settle their debts at a reduced amount. Both letters also contained language warning the plaintiffs that settling their debt for a reduced amount “may have tax consequences.” Both plaintiffs alleged they were insolvent when they received the letters.
The plaintiffs brought suit, claiming the collection letters were misleading because, as a result of their insolvency, they would not have had to pay taxes on any discharged debt.
Both cases were dismissed for failure to state a claim. The judges concluded that notifying the plaintiffs that a debt settlement “may” have tax consequences is neither false nor misleading. Both plaintiffs appealed, and the Seventh Circuit consolidated the appeals.
As you may recall, the FDCPA makes it unlawful for a debt collector to use “any false, deceptive, or misleading representation or means in connection with the collection of [a] debt.” See 15 U.S.C. § 1692e.
The standard applied in the Seventh Circuit is one of an objective “unsophisticated consumer,” where the question becomes “whether a person of modest education and limited commercial savvy would be likely to be deceived” by the debt collector’s representation. The objective test disregards “bizarre” or “idiosyncratic” interpretations of collection letters. A collection letter can be “literally true” and still be misleading, — for example, if it “leav[es] the door open” for a “false impression.”
According to the Court, dismissal on the pleadings for FDCPA claims is proper only in “cases involving statements that plainly, on their face, are not misleading or deceptive.”
The Seventh Circuit quickly concluded that the statements at issue were literally true. In general, discharge of a debt is considered taxable income. See 26 U.S.C. § 61(a)(11). There are, however, recognized exceptions where the discharge of a debt is not taxable income, including when the discharge occurs while the taxpayer is insolvent. Id. § 108(a)(1)(B), (d)(3).
According to the Court, even assuming the plaintiffs were insolvent when they received the letters, the general statement that a settlement “may” have tax consequences was true on its face.
The Court acknowledged that a literally true statement may be misleading if it gives a false impression. The plaintiffs argued that the letters gave a false impression because they (i) might trick the consumer into believing they will be reported to the IRS if they do not pay the full amount, and (ii) might lead the consumer to believe they will have tax liability if they settle the debt even if they were insolvent.
As to the first argument, the Seventh Circuit concluded it was a “bizarre” or “idiosyncratic” interpretation of the letter, as the letter made no reference to reporting anything to the IRS.
As to the plaintiffs’ second argument, the Court concluded that even an unsophisticated consumer will not confuse the word “may” to mean “will.” The Court held that “the use of the word ‘may’ signals only that tax consequences are possible in the case of some debtors, not that tax consequences are possible or likely (much less certain) in this particular debtor’s circumstances.” The Court also reasoned that an insolvent consumer can emerge from insolvency at any time.
The Court rejected the plaintiffs’ argument that the tax consequences warning gave a false impression that the debtors should pay their entire debt to avoid tax liability. “The letters are invitations to settle the debt and are clearly meant to encourage the debtor to take advantage of the discount offered. A rational debtor knows that income taxes are calculated as a percentage of income, and he would likewise understand that even if the discount counts as taxable income, the benefit would still outweigh the cost. That makes it all the more implausible that the tax-consequences warning would dupe a debtor into paying the full debt amount.”
The Seventh Circuit quickly rejected the plaintiffs’ reliance on two prior rulings, concluding that they were easily distinguished. First, in Lox v. CDA, Ltd., 689 F.3d 818 (7th Cir. 2012), the collector sent the consumer a letter threatening to take legal action against the consumer, including seeking attorney’s fees. The contract between the creditor and the consumer, however, did not allow for the recovery of attorney’s fees. As a result, the Seventh Circuit concluded the letter was deceptive because it threatened to take action it was not authorized to take.
Similarly, in Gonzales v. Arrow Financial Services, 660 F.3d 1055 (9th Cir. 2011), the collector sent the consumer a letter saying that if the account was being reported to the credit bureaus, the collector was going to report the accounts as settled. The problem for the collector, however, was that the debts at issue were more than seven years old and obsolete. As such, the collector could not report the accounts to the credit bureaus.
The Ninth Circuit concluded that even though the conditional language of “if the account was being reported” made the statement literally true, there were no circumstances where they could report the obsolete accounts. Therefore, according to the court in Gonzales, the letter was misleading.
The Seventh Circuit also distinguished the Lox and Gonzales cases on other grounds. First, the circumstances in those cases were static — there were no circumstances under which the collectors could collect attorney’s fees or report the obsolete accounts. Solvency, according to the Court, is fluid, and a consumer can become solvent before settling their debts.
Second, the collectors in this case had no way of knowing whether the plaintiffs were insolvent. In Lox and Gonzales, on the other hand, the collectors knew, or should have known, that attorney’s fees were not permitted and that obsolete accounts could not be reported.
Next, the Seventh Circuit rejected the plaintiffs’ reliance on several trial court cases that were inapplicable to the facts of this case. In one of those cases, the collector threatened to take action that, according to the plaintiff’s complaint, they had no intention of taking. In the other cases, the collection letters mischaracterized mere possibilities as certainties, which is the exact opposite of what happened here.
Finally, the Seventh Circuit rejected the trial court’s opinion in Sledge v. Sands, 182 F.R.D. 255 (N.D. Ill. 1998). In that case, the collection letter stated “under certain circumstances, cancellation or discharge of [a] debt may be considered income by the IRS and state taxing authorities.” The district court had concluded that if a majority of the debtors that received the letter would not realize income for the discharged debt, then the statement created a misleading impression in violation of the FDCPA.
The Seventh Circuit declared the holding unpersuasive, stating that the court’s reasoning rested on the faulty assumption that a debtor receiving the letter would (i) ignore the phrase “under certain circumstances” and (ii) misconstrue “may” to mean “will.”
The Seventh Circuit concluded that the FDCPA claims were properly dismissed because the language at issue was literally true and not misleading, even under the “unsophisticated consumer” standard. Accordingly, the Seventh Circuit affirmed the trial court’s dismissal of the plaintiffs’ claims.