Recent news stories by The New York Times and NPR have brought much attention to a question that many creditors likely face on a regular basis: When a debt is sold to a debt buyer prior to the debtor entering bankruptcy, what must creditors report to credit bureaus following the debtor’s subsequent discharge in bankruptcy?
Bankruptcy court litigation involving credit reporting is not new to financial institutions. Such cases go back at least to the early 2000s. What has changed is how debt buying fits into the picture. “Debt buying” refers to the sale of debt by creditors or other debt owners to buyers that then attempt to collect the debt or sell it to other buyers, thereby reducing the losses that creditors incur in providing credit and permitting them to provide more credit at lower prices. The Structure and Practices of the Debt Buying Industry, 2013 WL419348 at *2 In a 2009 study of the debt collection industry, the Federal Trade Commission concluded that the “most significant change in the debt collection business in recent years has been the advent and growth of debt buying.” Id.
Debt buying can have implications in bankruptcy proceedings, and it is such implications that grabbed the media’s attention recently when several class action lawsuits involving debt buying were filed in bankruptcy courts. See, e.g., In re Haynes, No. 11-23212 (RDD), 2014 WL 3608891 (Bankr. S.D.N.Y. July 22, 2014) The news coverage, in turn, appears to have captured the public’s attention. This article highlights some of the legal issues that are central to the disputes that arise in this area of the law, with the aim of reinforcing creditors’ understanding of their legal obligations.
In bankruptcy, an individual debtor’s assets undergo either a liquidation (“Chapter 7”) or reorganization (“Chapter 13”) in order to provide the debtor a “fresh start” in a manner that is fair to creditors. Key to the debtor’s “fresh start” is the “discharge” that the debtor obtains through bankruptcy. Under Section 524(a) of Title 11 of the United States Code (the “Bankruptcy Code”), the discharge has the effect of voiding judgments of personal liability on many of the debts the debtor owed at the time of the filing of the bankruptcy, and of enjoining “the commencement or continuation of an action, the employment of process, or an act, to collect, recover or offset any such debt as a personal liability of the debtor.” Courts have interpreted the so-called “discharge injunction” broadly, and it can implicate creditors’ obligations under federal laws governing credit reporting. The interaction between the discharge injunction and credit reporting laws lies at the heart of the recent class action lawsuits that have been garnering public attention.
Among a creditor’s obligations under a body of federal law outside the Bankruptcy Code called the Fair Credit Reporting Act, is the duty, under the threat of federal or state investigation and monetary penalties, to “promptly notify” a consumer reporting agency if it determines that information about a person’s transactions that the creditor previously, and in the ordinary course of business, furnished the agency is no longer “complete and accurate”—and the creditor must provide the correct information. One such correction creditors are required to make is to notify credit bureaus when a debtor has received a bankruptcy “discharge.” Could the failure to do this constitute a violation of section 524’s discharge injunction?
Standing alone, likely not—remember, only when the creditor’s action constitutes an action to “collect, recover or offset” a discharged personal liability does the creditor run afoul of Section 524. In re McKenzie-Gilyard, 388 B.R. 474, 481 (Bankr. E.D.N.Y., 2007) If, on the other hand, the debtor can persuade a court that the creditor more likely that than not failed to update the information so as to coerce the debtor into personally paying the debt, the court may well conclude that the creditor violated the discharge injunction. But this begs the question this article began with: If a creditor’s reporting delinquency must have been for the purpose of collecting a discharged debt in order for the creditor to be deemed in contravention of the discharge injunction, how could a creditor that doesn’t even own the discharged debt ever be said to have broken this law?
That’s where the recent class action cases come into play. Plaintiffs in these cases allege the coercion theory of collection discussed above, but they go further, alleging that some creditors contract with debt buyers for a cut of any payments on discharged debts that the creditor receives and has to pass on to the new owner of the debt. A complaint representative of such cases was summarized well in a recent decision from the U.S. Bankruptcy Court for the Southern District of New York:
[The original creditor] adopt[s] a pattern and practice of failing and refusing to update credit information with regard to debts discharged in bankruptcy because it sells those debts and profits by the sale. [The original creditor] knows that if credit information is not updated, many class members will feel compelled to pay off the debt, even though it is discharged in bankruptcy. Thus, buyers of [the original creditor’s] debt know and are willing to pay more for the fact that they will be able to collect portions of [the original creditor’s] debt, despite the discharge of that debt in bankruptcy….[In addition, the original creditor] receives a percentage fee of the proceeds of each debt repaid to [the original creditor] and forwarded to the buyer of [the original creditor’s] debt. In re Haynes, No. 11-23212 (RDD), 2014 WL 360889 at *5 (Bankr. S.D.N.Y. 2014)
The New York court found that the plaintiffs had sufficiently alleged a violation of the discharge injunction to be allowed to proceed with a lawsuit. It is not unlikely that other courts would rule along the same lines if presented with similar facts.
The growth in the market for debt in recent years has presented new and potent means by which creditors might reduce losses on their loans, which as a result can enable them to offer more, cheaper credit in the marketplace. It is important for creditors to be aware of their legal obligations under the Fair Credit Reporting Act and Section 524 of the Bankruptcy Code, and to understand how those laws interact. Policies and procedures should be examined for compliance with legal obligations, and contracts with debt buyers and others should likewise be drafted with those obligations in mind.