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Proposed HEROES Act Poses Great Risks to Those Extending Credit or Attempting to Collect on a Debt

August 5, 2020


As the COVID-19 pandemic continues to cause harsh economic conditions throughout the United States, Congress is in the process of altering the legal landscape for creditors and debtors.  The House of Representative recently passed and sent to the Senate for consideration H.R. 6800, Health and Economic Recovery Omnibus Emergency Solutions (“HEROES”) Act.  Along with providing additional funds for the unemployed and small businesses, this massive $3 trillion 1,852 page bill contains provisions that will critically impact those extending credit to individuals, small businesses, and non-profits and those attempting to collect a debt from such a person or entity.  In short, most legal collection and enforcement efforts against covered entities and individuals will be stayed nationwide for the foreseeable future.  And should this bill become law, we anticipate that among the unintended consequences of the Act will be that many small businesses may face even greater challenges obtaining reasonable credit and payment terms going forward.

Since the start of the COVID-19 shutdowns, lenders and other creditors seeking to collect on debts owed and/or to enforce judgments and security interests have been hampered by a hodge-podge of state and local procedures restricting such measures.  Under the HEROES Act, those collection actions that have been allowed to proceed may actually grind to an indefinite halt.  The HEROES Act’s potential effects on both businesses and individual debtors will be addressed in turn.

The Basics of the Bill’s Collection Restrictions for Business Debts

The HEROES Act, as proposed, would amend The Fair Debt Collection Practices Act (15 U.S.C. 1692, et seq.) (“FDCPA”), by inserting a section entitled:  “§ 812B. Restrictions on collections of small business and nonprofit debt during a national disaster or emergency.”  This new section will prevent the overwhelming majority of collection actions against small businesses and nonprofits from the date of the law’s enactment until “120 days after the end of the incident period for the emergency declared on March 13, 2020, by the President under section 501 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act (42 U.S.C. 4121 et seq.) relating to the Coronavirus Disease 2019 (COVID-19) pandemic.”

This delay, called the “Covered Period,” figures to be a long pause.  While no one knows exactly when the President’s disaster declaration will end, we anticipate that the declaration will continue well into 2021.  Moreover, even after the declaration ends, creditors will still need to wait an additional four months before they can commence any of the collection activities barred under the HEROES Act.  The upshot of this legislative moratorium is that creditors may be stuck with large receivables that they cannot legally attempt to collect for at least a year.  And even once the HEROES Act’s moratorium ends, it is likely that creditors could face a court backlog of cases unseen in this nation’s history.

The proposed HEROES Act would expand the FDCPA’s definition of a “Debt Collector” to include a “creditor and any other person or entity that engages in the collection of debt, including the Federal Government and a State government, irrespective of whether the applicable debt is allegedly owed to or assigned to such creditor, person, or entity.”  Thus, even a company attempting to collect its own debt would suddenly be classified as a Debt Collector and may be required to follow the onerous restrictions and requirements that the FDCPA places on Debt Collectors.

The broad language of the HEROES Act’s restrictions applies to any person (a) “who offers or extends credit creating a debt or to whom a debt is owed;” or (b) “whom any obligation for payment is owed.”  The HEROES Act defines debt as “any obligation or alleged obligation that is or during the covered period becomes past due, … that arises out of a transaction with a nonprofit organization or small business.”

The HEROES Act contains two notable exceptions.  First, a mortgage loan is not covered in the definition of a debt.  Second, the restrictions do not apply to “an obligation arising out of a credit agreement entered into after the effective date” of the HEROES Act.  Thus, if after the HEROES Act becomes effective, (a) the debtor signs a new credit agreement and (b) the creditor lends new money or tender new goods to the debtor based on that new credit agreement, then the creditor will not be restricted by the provisions of the HEROES Act in collecting that new accumulated debt.

What Business Collection Activity Is Prohibited Under the Act?

The HEROES Act would bar various business collection conduct, including:

[E]nforc[ing] a security interest securing a debt through repossession, limitation of use, or foreclosure;

[C]ollect[ing] any debt, by way of garnishment, attachment, assignment, deduction, offset, or other seizure, from—

(i) wages, income, benefits, bank, prepaid or other asset accounts; or

(ii) any assets of, or other amounts due to, a small business or nonprofit organization;

[C]ommenc[ing] or continu[ing] an action to evict a small business or nonprofit organization from real or personal property for nonpayment; or

[T]hreat[ing] to take any of the foregoing actions.

As proposed, the HEROES Act would effectively stop the enforcement of any judgment against a covered business, even if the judgment was obtained before the Act’s effective date.

Arguably under the HEROES Act, creditors may be prevented from asserting mechanic’s liens against covered businesses and nonprofits.  Further, creditors may be forbidden from renewing existing liens, including UCC liens, as they expire due to state time limits.

Additionally, after the expiration of the Covered Period, the HEROES Act would bar creditors from adding to “any past due debt any interest on unpaid interest, higher rate of interest triggered by the nonpayment of the debt, or fee triggered prior to the expiration of the covered period by the nonpayment of the debt.”

The HEROES Act’s “threaten to take any of the foregoing actions” provision raises the important question of whether a creditor would be prohibited from even filing a lawsuit arising out of a transaction with the debtor.  In many jurisdictions, the entry of a judgment results in an attachment on the real property owned by the debtor in that jurisdiction.  The HEROES Act would explicitly prohibit an attachment or foreclosure on real property.  A lawsuit may therefore be deemed a “threat” to attach or foreclose on real property.  While the HEROES Act is silent about whether obtaining a judgment would violate the law, it does explicitly prohibit commencing or continuing an action to evict a small business or nonprofit.  As such, a statutory counterargument could be made that, if Congress had intended to bar a creditor from commencing or continuing a suit for a debt owed, it knew how to do so and determined not to impose such a prohibition.

What Businesses Are Protected by the Act?

The HEROES Act would protect a wide array of businesses from collections, including small businesses and almost all nonprofits organizations.  Specifically, the Heroes Act covers any “nonprofit organization” as that term is described in section 501(c)(3) of the Internal Revenue Code of 1986, that is exempt from taxation under section 501(a) of such Code (which would encompass most universities, schools, hospitals, religious organizations and charities).   All “small business” also fall within the amended parameters contemplated by the HEROES Act.

With respect to “small businesses,” the HEROES Act defines the term as having the same definition as the term “small business concern” in section 3 of the Small Business Act (“SBA”).  In general, a “small business concern” under the SBA, must meet a variety of criteria enumerated in the SBA.  Status as a “small business concern” under the SBA is also dependent upon the definition of “small” under industry size standards categorized using the North American Industry Classification System (NAICS) codes.  The industry size standards are generally based on the average number of employees over the previous year or average annual receipts over the past three years.  Creditors should take note that these standards vary from industry to industry and some businesses may still qualify as a “small business concern” (and, thus, a “small business” under the HEROES Act) despite having as many as 1,500 employees or up to approximately $40 million in average annual receipts depending upon the applicable industry.

Importantly, the SBA definition of a “small business concern” extends far beyond the typical mom-and-pop shop and includes a large segment of businesses operating in the United States.  In light of the complexities involved in identifying a “small business” under the HEROES Act, and before pursuing any collection activity against another business, creditors should seek assistance from legal counsel to determine whether a particular business is a “small business” protected by the Act.

Tolling the Statute of Limitations

The HEROES Act would toll “[a]ny applicable time limitations for exercising an action” against a small business or nonprofit for the duration of the Covered Period.  The HEROES Act, therefore, recognizes and attempts to protect creditors who are unable to timely pursue claims as a result of the HEROES Act’s restrictions.  This provision of the HEROES Act, however, raises the constitutional question of whether this Federal Act can modify a state’s statute of limitations period.  This question may need to be sorted out by the courts in coming years.

Penalties

Violations of the collection provisions of the proposed HEROES Act are subject to the penalties set forth in Section 813 of the FDCPA.  Under the FDCPA, the court may award a plaintiff any actual damages sustained by the plaintiff as a result of the violation, plus such additional damages as the court may allow, not to exceed $1,000.  In a class action suit, the court may award each named plaintiff their actual damages, plus, for all other class members without regard to a minimum individual recovery, up to the lesser of $500,000 or one percent (1%) of the net worth of the defendant creditor.  In addition to those potential damages, in any successful action to enforce the foregoing liability, the costs of the action and reasonable attorneys’ fees may be awarded.   While pursuing such claims may seem like a bonanza for plaintiff’s firms, under the unique Catch-22 of the HEROES Act, any judgment obtained against a “small business” could not be enforced and, arguably, may not even be commenced.

Equally Broad Protections for Consumer Debts Exist

The HEROES Act offers a variety of protections to individuals that parallel those offered to small businesses and nonprofits, including a proposed eviction moratorium.  The HEROES Act would add new section 812A to the FDCPA, entitled “Restrictions on collections of consumer debt during a national disaster or emergency.”  This section clarifies that the delay on collections on consumer debts will last as long as small business collections.  In other words, the Covered Period is the same.  Additionally, the statute offers identical, broad definitions for key terms: creditor, debt, and debt collector.  And here as well, the Act prohibits the same broad array of collection efforts, including wage garnishment, repossession, foreclosure, evictions, and discontinuation of utilities.

The HEROES Act also clarifies that, after the Covered Period ends and debt-collection protections expire, individuals will not be forced to repay those debts at an accelerated rate.  Specifically:

  • For individuals with debts arising from credits with a defined term, debt collectors must extend payment periods by one more than the number of missed payments during the Act’s enforcement. Notably, “the payments [must be] due in the same amounts and at the same intervals as the pre-existing payment schedule.”
  • Creditors must allow past-due debts arising from open end credit plans to be repaid in a manner that is no more onerous than the methods set forth in section 171(c) of the Truth in Lending Act.
  • For all other debts, the creditors must allow the individual to pay past-due balances in equal installments. The Act further establishes minimum time horizons for full repayment: (a) 12 months for balances $2,000 or less; (b) 24 months for balances between $2,001 and $5,000; and (c) 36 months for past due balances over $5,000.

Finally, the HEROES Act creates a “credit facility” for creditors and debt collectors who suffer losses caused by loan forbearance to consumers.  But companies seeking these loans will be subject to extra restrictions, including (a) the companies must grant automatic forbearance “upon the request of a consumer” and (b) they may not charge “fees, penalties, or interest (beyond the amounts scheduled or calculated as if the borrower made all contractual payments on time and in full under the terms of the loan contract) … to the borrower in connection with the forbearance.”  The exact requirements for obtaining these credit facilities and how such facilities will be rolled out are not spelled out in the Act and will require significant regulatory input and clarification.

Possible Impact on Creditors            

At first blush, the proposed restriction on collections efforts against small businesses and nonprofits under the HEROES Act appears to give these struggling businesses the needed breathing room to stabilize their operations and cash flow, and get back on their feet.  In practice, due to the proposed HEROES Act’s expansive effect, unclear definitions, parameters and duration, the Act’s long-term impact on small businesses and nonprofits may have the opposite effect.  In particular, other businesses (large and small) may hesitate doing business with such entities due to the increase credit risk posed by such transactions.

During the Covered Period, lenders, vendors and suppliers looking to do business with small businesses and/or nonprofits can no longer rely on the ordinary business terms and relationships that existed prior to the COVID-19 pandemic or even post-COVID-19 pandemic but before the effective date of the HEROES Act.  In order for post-HEROES Act lending, extensions of credit, and delivery of goods to fall outside the restrictions and prohibitions of the HEROES Act, new credit agreements must be entered into before the extension of credit or other business transaction with the small business or nonprofit.  Vendors and suppliers, without a new credit agreement, may consider, on a post-HEROES Act basis, providing goods or services to a small business or nonprofit on a cash in advance or a cash on delivery basis to protect themselves from being unable to collect from a small businesses or nonprofit that fails to timely perform or satisfy even post-HEROES Act debt obligations.  This will make an already bad credit situation even worse.  As the term “credit agreement” is not defined under the HEROES Act,  lenders, vendors, and suppliers, even if unsure as to whether or not a business is considered a “small business” or “nonprofit organization” under the HEROES Act, would be well served to memorialize further lending and extensions of credit in a new master credit agreement, evidencing the timing and the credit terms.

It is important to note that, under the proposed HEROES Act, pre-HEROES Act debt is NOT being forgiven.  It is merely being postponed.  As many lenders, vendors and suppliers will continue to do business with many small businesses and nonprofits, the Act’s standstill could (and likely will) lead to financial difficulties for these creditors themselves.  Moreover, these same creditor entities may or may not be protected from their own creditors by the HEROES Act.  If they are not protected, these lenders, vendors and suppliers could be faced with creditor workouts or bankruptcy decisions of their own.  Lenders, vendors and suppliers will be faced with important decisions of whether they want to continue to do business with business entities under these circumstances and should consult with counsel to fully understand their options.

The HEROES Act will most certainly impact, and in many instances negatively, key components of the bankruptcy system.  Indeed, without the need to file for bankruptcy protections, the proposed HEROES Act serves as a giant unsupervised automatic stay for tens of millions of individuals and businesses.  Not only would collection efforts be stayed under the HEROES Act, but creditors (now all classified as debt collectors) are likely prohibited from, among other things, commencing an involuntary bankruptcy proceeding against a small business or nonprofit organization that is in default on its payment obligations to such creditor on account of a pre-HEROES Act covered debt.  Instead, the creditor must stand by and wait until the Covered Period is over, in the hopes that the small business or nonprofit organization has stabilized itself and has the necessary cash flow to resume payments under the payment plans imposed by the HEROES Act.

Freedom to Prefer

The HEROES Act expressly provides that the “[n]othing in this section may be construed to prohibit a small business or nonprofit organization from voluntarily paying, in whole or in part, a debt,” and as such would allow small businesses and nonprofits to prefer one creditor over another during the Covered Period.  Unlike in a bankruptcy proceeding with a trustee’s avoidance powers to recover such preferential payments and redistribute them amongst the debtor entity’s creditors, due to the duration of the Covered Period, many, if not all of the payments made to preferred creditors during the Covered Period, would no longer be avoidable in a subsequent (and potentially certain) bankruptcy case or state court insolvency proceeding. In particular, such payments could not be recovered because the applicable look back period (usually 90 days) under the United States Bankruptcy Code and certain state laws will have expired.  Thus, unless the lookback period for preferential transfers is extended, preferential payments made by a small business or nonprofit to certain of their creditors during the Covered Period may ultimately be unrecoverable to the detriment of other creditors that were not paid and were faced with the restrictions of the HEROES Act.  Furthermore, given the broad definition of a “debt collector” under the HEROES Act, the Act could even prevent a trustee in an existing bankruptcy from commencing or continuing any preference or other avoidance action against a small business or nonprofit organization until such time as the Covered Period is over.

While affording small businesses and nonprofits with the necessary breathing room for the near future, the HEROES Act may do little more than delay the inevitable rush to the bankruptcy court that may still occur shortly after the Covered Period.  Unsecured lenders, vendors and suppliers who continue to do business with these small businesses and nonprofits may find that, even with a new credit agreement as discussed above, once the Covered Period is over, they stand in a very long line for payment with all of the other creditors of such small business  or nonprofit.  Absent a perfected lien or security interest, such unsecured lender/vendor/supplier will have no preferred status over other pre-HEROES Act creditors.

Montgomery McCracken is available to assist you or your business in understanding and addressing the challenges posed by changing legal requirements during the COVID-19 era.  Montgomery McCracken’s Bankruptcy and Financial Restructuring attorneys have experience representing both debtors and creditors regarding collections matters.  Visit the firm’s Coronavirus (COVID-19) Resource Center for more information and updates on this constantly evolving situation.