Debts Canceled by Bankruptcy Still Mar Consumer Credit Scores
By Jessica Silver-Greenberg
In the netherworld of consumer debt, there are zombies: bills that cannot be killed even by declaring personal bankruptcy.
Tens of thousands of Americans who went through bankruptcy are still haunted by debts long after — sometimes as long as a decade after — federal judges have extinguished the bills in court.
The problem, state and federal officials suspect, is that some of the nation’s biggest banks ignore bankruptcy court discharges, which render the debts void. Paying no heed to the courts, the banks keep the debts alive on credit reports, essentially forcing borrowers to make payments on bills that they do not legally owe.
The practice — a subtle but powerful tactic that effectively holds the credit report hostage until borrowers pay — potentially breathes new life into the pools of bad debt that are bought by financial firms.
Now lawyers with the United States Trustee Program, an arm of the Justice Department, are investigating JPMorgan Chase, Bank of America, Citigroup and Synchrony Financial, formerly known as GE Capital Retail Finance, suspecting the banks of violating federal bankruptcy law by ignoring the discharge injunction, say people briefed on the investigations.
The banks say that they comply with all federal laws in their collection and sale of debt.
Still, federal judges have started to raise alarms that some banks are threatening the foundations of bankruptcy.
Judge Robert D. Drain of the federal bankruptcy court in White Plains said in one opinion that debt buyers know that a bank “will refuse to correct the credit report to reflect the obligor’s bankruptcy discharge, which means that the debtor will feel significant added pressure to obtain a ‘clean’ report by paying the debt,” according to court documents.
For the debt buyers and the banks, the people briefed on the investigations said, it is a mutually beneficial arrangement: The banks typically send along any payments that they receive from borrowers to the debt buyers, which in turn, are more willing to buy portfolios of soured debts — including many that will wind up voided in bankruptcy — from the banks.
In bankruptcy, people undergo intense financial scrutiny — every bank account, bill and possession is assessed by the bankruptcy courts — to win the discharge injunction, which extinguishes certain debts and grants a fresh start. The heavy toll of personal bankruptcy, which can tarnish a credit report for a decade and put some loans out of reach, is worthless, bankruptcy judges say, if lenders ignore the discharge.
At the center of the investigation, the people briefed on it said, is the way banks report debts to the credit reporting agencies. Once a borrower voids a debt in bankruptcy, creditors are required to update credit reports to reflect that the debt is no longer owed, removing any notation of “past due” or “charged off.”
But the banks routinely fail to do that, according to the people briefed on the investigation, as well as interviews with more than three dozen borrowers who have discharged debts in bankruptcy and a review of bankruptcy records in seven states.
The errors are not clerical mistakes, but debt-collection tactics, current and former bankruptcy judges suspect. The banks refuse to fix the mistakes, the borrowers say, unless they pay for the purged debts. And many borrowers end up paying, given that they have so much at stake — the tarnished credit reports showing they still owe a debt can cost them a new loan, housing or a job. The Vogts, a couple in Denver, for example, paid JPMorgan $2,582 on a debt that was discharged in bankruptcy because they needed a clean credit report to get a mortgage.
There are many more who make payments on debts that they no longer legally owe, but never alert anyone because they do not realize the practice is illegal or cannot afford to litigate.
Humberto Soto, a 51-year-old unemployed hospital worker who went through bankruptcy in 2012, said he was almost one of those people who paid. In January, he was rejected for a Brooklyn apartment after the housing agency pulled his credit, which was tarnished by $6,411 on a Chase credit card, according to a letter from the agency, a copy of which was reviewed by The New York Times.
When he called JPMorgan, Mr. Soto said, he was told that the black mark would remain unless he paid. “It was either pay or lose the apartment,” he said. But after his bankruptcy lawyer explained the situation to the rental agency, Mr. Soto ultimately did not pay. (He got the apartment.)
JPMorgan and the three other banks declined to comment for this article, citing pending litigation in federal bankruptcy court in White Plains.
But the banks have offered defenses in court documents filed in conjunction with those lawsuits brought by Charles Juntikka, a bankruptcy lawyer in Manhattan, and George F. Carpinello, a partner with Boies, Schiller & Flexner. Those lawsuits — seeking class-action status on behalf of the borrowers — accuse the banks of bolstering the value of their debt by refusing to erase debts that were discharged in bankruptcy.
The banks have moved to throw out the lawsuits, arguing that they comply with the law and accurately report discharged debts to the credit agencies. Their lawyers have argued that the banks typically sell off debts to third-party debt buyers, and have no interest in recouping payments on the stale debts.
Some bankruptcy judges, however, have questioned whether the banks’ sale of the debts is precisely what the problem is.
Judge Drain, who is presiding over the cases, posited that the banks’ ability to sell the soured debts depends on ignoring the bankruptcy discharge in order to collect money from people who don’t have to legally pay it.
In July, the judge refused to throw out the lawsuit against JPMorgan, saying that the “complaint sets forth a cause of action that Chase is using the inaccuracy of its credit reporting on a systematic basis to further its business of selling debts and its buyer’s collection of such debt.”
During a hearing last year on a related case, transcripts show, Judge Drain said, “I might refer this, if the facts come out as counsel’s alleging, to the U.S. attorney,” for criminal prosecution.
Newly unsealed court documents reviewed by The Times illustrate how the banks handle payments from borrowers on stale debts, including those voided in bankruptcy. In contracts with debt buyers that were filed with the court, the banks outline the steps they will take when payments are made on charged-off debts.
In one contract between FIA Card Services, a subsidiary of Bank of America, and a debt buyer, the seller can keep any payments it receives 18 months or later after the sale. Before then, the contract shows, the lender will send any payments to the debt buyer.
Another contract between JPMorgan and a debt buyer allows the bank to keep a percentage — the exact amount is redacted in the court’s copy of the contract — of any payments sent in on the debts.
Those contracts shed light on the shadowy market of soured debts, including tens of billions of dollars that were voided in bankruptcy. Some banks sell off long overdue bills, which eventually wind up being extinguished in bankruptcy after the sale, for steeply discounted prices to debt buyers.
None of the banks specifically outline how much of their overdue loans are sold to debt buyers, but a review of publicly traded debts buyers like the PRA Group in Norfolk, Va., shows that the sums of bad debt bought and sold are vast. Since 1996 the company has bought more than 36 million accounts with a face value of $81.3 billion. Roughly 16 percent of those accounts — with a face value of $23.4 billion — are bankruptcy debts.
If the United States Trustee’s office determines the banks have violated bankruptcy law, say the people briefed on the investigations, they could audit the lenders and extract steep penalties.
The costs are more immediate for people like Bernadette Gatling, a 46-year-old hospital administrator whose credit report is still marred by Chase credit-card debts that were voided in bankruptcy three years ago. Since being laid off in March, Ms. Gatling said she has lost one job opportunity after another because potential employers pull her credit report.
“It’s just so unfair,” she said.