08 December 2011

Tom Martino and Contact Law

A story on television news consumer advocate Tom Martino's bankruptcy case today illustrates a common scenario in debtor-creditor law. A debtor incurs a valid and enforceable debt to a creditor. The debtor default on a payment on that debt. The debtor and creditor enter into discussions regarding repayment. In those discussions, the debtor makes a proposal that, if accepted, would allow the creditor to mitigate their damages from a default on the debt, in whole or in part. The creditor rejects the proposal and sues.

In this context, when, if ever, can the creditor be denied a recovery for failing to mitigate damages?

Every creditor has a common law duty in a suit for breach of contract, which includes almost all debt collection cases, to take all reasonable steps to mitigate damages.

The classic mitigation case in a breach contract is one where a tenant breaches of lease and vacates. In that situation, assuming it is not reasonable for the landlord to refuse to rent the property to the substitute tenant based on the character of the substitute tenant (e.g. it might be reasonable to refuse to rent to a substitute tenant whose business is in violation of local zoning laws), the landlord is generally not entitled to recover from the original tenant the rent that could have been paid by the substitute tenant during the lease term, whether or not the landlord actually allows the substitute tenant to move into the property.

In general, however, mitigation of damages is a tricker matter when the contract is a simple contract to pay a fixed sum of money, with interest and certain fees, at one or more dates certain, that is not attached to any collateral, i.e. an unsecured loan.

Martino's argument is less textbook: "[Tom Martino] said his wife, Holly Martino, offered to pay the card in full if the company agreed to move the balance into her name, which FIA [the credit card company] refused."

Presumably, Martino is arguing not that his wife was offering immediate payment in cash of the credit card, but that she was offering to guarantee the debt in exchange for a release of the original debtor.

In hindsight, this surely would have been a good deal for the bank. Tom Martino's bankruptcy was triggered due to liability on business investments gone bad that his wife had no involvement in, so only he went bankrupt. A debt owed by his wife would still be valid, enforceable, and in all likelihood current today, notwithstanding the husband's bankruptcy, in which the credit card company is almost sure to take a huge loss, even if part of their balance can be recovered as pennies on the dollar like any other unsecured creditor, and perhaps on the theory that some of his purchases were "luxury purchases" that can't be discharged if made on the eve of bankruptcy.

On the other hand, usually, in a mitigation case, the debtor offers a way for the creditor to reduce the damages suffered by the creditor, but is not fully released. In the classic substitute tenant case, the original tenant still has liability for the full amount of the rent due that the substitute tenant does not pay, and often the substitute tenant will be paying less than the full rental amount owed by the original tenant. For example, if the original tenant has a lease with a rental payment of $2,000 a month, the proposed substitute tenant may be paying $1,600 a month, leaving the original tenant on the hook for the $400 a month balance for the remainder of the lease.

A promise to repay from a secondary earner in a family in exchange for a full release of the primarily liable primary earner in the family is not obviously a risk free proposition that will reduce the creditor's exposure, ex ante, so it may not be unreasonable for the lender to refuse to agree to that deal in order to mitigate its damages.

This isn't to say that mitigation arguments are never relevant in the case of unsecured loans. But, they are harder to establish.

No comments: