A creditor can be exposed to liability under the Fair Debt Collection Practices Act where it indicates that a law firm has been retained to collect its debts, but the law firm makes no genuine effort to collect those debts, the U.S. Court of Appeals for the Second Circuit held Wednesday.

A divided circuit panel held that liability can attach under the act’s “false name” exception to creditor immunity in the case of Mazzel v. The Money Store, 11-4525-cv.

The Money Store and its subsidiaries and affiliates, are creditors who had purchased mortgages from other lenders. It retained the law firm of Moss, Codilis, Stawiarski, Morris, Schneider & Prior LLP of Colorado to send debt collection letters to homeowners who had defaulted on their mortgages.

The plaintiffs were homeowners who claimed The Money Store had violated the Fair Debt Collection Practices Act,(FDCPA),15 U.S.C. §1692, and the Truth in Lending Act, (TILA),15 U.S.C. §1601, by sending deceptive letters.

Southern District Judge John Koeltl (See Profile) granted summary judgment for the defendants on the Truth in Lending claims and denied a motion to reconsider Judge John Sprizzo’s earlier dismissal of the FDCPA claim.

The plaintiffs appealed to the circuit, where oral argument was heard on Nov. 8, 2012 by Judges Robert Katzmann (See Profile), Debra Ann Livingston (See Profile) and Raymond Lohier (See Profile).

On Wednesday, all three judges held the district court was correct in finding that the defendants were not “creditors” for purposes of being accused of charging improper fees under the TILA, because The Money Store was an assignee of the plaintiffs’ notes.

But Katzmann and Lohier held that the lower court erred in its grant of summary judgment under the FDCPA because of the false name exception to the general rule that a creditor has immunity.

Under §1692a(6) of the FDCPA, the exception to creditor immunity exists where the creditor “in the process of collecting [its] own debts, uses any name other than [its] own which would indicate that a third person is collecting or attempting to collect such debts.”

Here, the plaintiffs charged that Moss Codilis was hired by The Money Store in 1997 to send out “breach” letters on its stationery that falsely indicated Moss Codilis had been retained to collect debts that The Money Store was in fact itself collecting.

The letters stated that “this law firm” has been “retained” in order to “collect a debt for our client.” The letters also stated that “this firm has been authorized by [The Money Store] to contact you” and “provide[] notice that you are in default” and they warn that a failure to resolve their default within 30 days would lead “our client” to accelerate the entire sum of both principal and interest and possibly pursue foreclosure.

Moss Codilis, which has since gone out of business, received $50, and later $35, for each breach letter mailed to defaulting debtors, but the firm played no other role in collecting the debts purchased by The Money Store—a fact the circuit said might expose The Money Store to liability. In all, the firm sent 88,937 letters and earned between $3 million and $4.5 million in fees.

“Where a creditor, in the process of collecting its own debts, hires a third party for the express purpose of representing to its debtors that the third party is collecting the creditor’s debts, and the third party engages in no bona fide efforts to collects those debts, the false name exception exposes the creditor to FDCPA liability,” Katzmann said.

He said that the two sides in the case disagreed over the level of Moss Codilis independence.

“Thus, we must decide whether The Money Store ‘used’ Moss Codilis’s name in order to suggest that Moss Codilis, rather than The Money Store, was ‘collecting’ the relevant debts,” he said. “We conclude that, resolving all factual disputes in plaintiffs’ favor, it did.”

Katzmann said the circuit had addressed the “false name” exception only once­—in Maquire v. Citicorp Retail Services, 147 F.3d 232 (2d Cir. 1998) and held that the standard was whether the “least sophisticated consumer would have the false impression that a third party was collecting the debt.”

But Maguire involved a situation where it was alleged that the creditor created the impression that a third party called “Debtor Assistance” was collecting the debt, the circuit has yet to address a situation presented by The Money Store, where the creditor used the name of an “actual non-affiliated third-party to collect its debts.”

The circuit majority, he said, was holding that, in determining whether a letter to a debtor indicates a third party is collecting or attempting to collect a debt for a creditor “The appropriate inquiry is whether the third party is making bona fide attempts to collect the debts of the creditor or whether it is merely operating as a ‘conduit’ for a collection process that the creditor controls.”

And that, he said, is an open question of fact that makes summary judgment inappropriate.

A jury, he said, “could find that Moss Codilis was not collecting The Money Store’s debts and instead acted as a mere ‘conduit’ for a collection process that The Money Store controlled. And if the breach letters falsely indicated that Moss Codilis was ‘collecting or attempting to collect’ The Money Store’s debts, The Money Store can be held liable under the FDCPA pursuant to the false name exception.”

Livingston dissented on the court’s FDCPA ruling, saying it “will prove vexing” over time because a creditor could be held liable “merely for hiring a debt collector whose practices are deemed inadequate in some respects.”

“The majority now interprets the FDCPA as imposing liability not just on those creditors who deceptively employ false names to collect their own debts, but also on those who take the unremarkable step of hiring a debt collector to collect their debts—so long as that debt collector is, in the majority’s view, insufficiently involved in ‘bona fide’ collection efforts,” Livingston said.

Solo practitioner Paul Grobman and Neal DeYoung of Sharma & DeYoung argued for the plaintiffs. Grobman said Wednesday the court had taken an important step.

“The decision is significant in that it makes a creditor liable in a situation in which it hires a law firm which appears to be taking collection action and has the authority to take legal action on behalf of the creditor but in actuality is more akin to almost a boiler room operation which simply sends out mass produced letters on attorney letterhead,” Grobman said. “That is inherently deceptive and if the creditor is not liable under these circumstances then there is not much of a deterrent to this kind of conduct.”

Daniel Pollack of McCarter & English argued for The Money Store defendants.

David Chizewer of Goldberg, Kohn, Bell, Black, Rosenbloom & Moritz in Chicago argued for Moss, Codilis.