Discharged Bankruptcy Debt Pursued by Collection Agencies
Can Debts Discharged in Bankruptcy Court "Spring Back" to Life?
Last updated: May 20, 2014
We read an article in an March 2012 article on American Banker where debts potentially forgiven by bankruptcy courts have been sold by Bank of America to junk debt buyer CACH, LLC. Based on letters from readers, this practice continues today. We'll summarize the main points for you in the next few paragraphs and add some additional information.
The sad, rather frightening thing is that many of these consumers are actually giving in and paying off debts they no longer owe. Business Week cites an example of a case of a North Carolina factory worker named Van Rathavongsa to illustrate how cancelled debts can "regain vitality". During his 2002 bankruptcy proceeding one of his numerous discharged debts was $9523 Rathavongsa owed to Capital One Financial.
This practice is not new. In a 2007 Business Week article, it was reported that Capital One continued to report a man's discharged debt to credit bureaus as a live balance. Ultimately in September 2003, when the man tried to close on a mortgage for a new home, the lender (Wachovia, now Wells Fargo) informed him that he would either have to pay his debt to Capital One or show proof from the credit-card company that it had been discharged.
Capital One had never revised the credit report, a failure that is not uncommon by creditors. Through his attorney, Rathavongsa attempted to get Capital One to correct his credit report, but finally gave in and paid Capital One the debt he no longer legally owed.
The factory worker then filed a motion in bankruptcy court in November 2003, claiming that Capital One had failed to update his credit report. U.S. Bankruptcy Judge A. Thomas Small agreed. Capital One, Small wrote in December, 2003, "most likely received notice" of Rathavongsa's bankruptcy filing, as indicated by the company's having ceased trying to collect the debt.
Because Capital One never responded to Rathavongsa's motion, the judge wrote, "the court can assume that Capital One filed the erroneous credit report for the purpose of pressuring Rathavongsa to pay a discharged debt." In February, 2004, the judge ordered the company to repay the $9,523, as well as $14,000 in fines and attorney's fees for its "cavalier attitude toward the debtor's motion."
Know Your Rights if Your Debt has Been Discharged in Bankruptcy Court
The law is quite clear as far as defining what the debtor can do if a creditor attempts to collect a discharged debt after the case is concluded. If a creditor attempts collection efforts on a discharged debt, the debtor can file a motion with the court, reporting the action and asking that the case be reopened to address the matter.
The bankruptcy court will often do so to ensure that the discharge is not violated. The discharge constitutes a permanent statutory injunction prohibiting creditors from taking any action, including the filing of a lawsuit, designed to collect a discharged debt. A creditor can be sanctioned by the court for violating the discharge injunction. The normal sanction for violating the discharge injunction is civil contempt, which is often punishable by a fine.
What is less clear is how to enforce the obligation that creditors have to inform credit bureaus that accounts that have been discharged by bankruptcy have a zero balance, as it is not currently included in any statute. The Fair Credit Reporting Act requires credit bureaus to ensure "maximum possible accuracy" of their reports. Unfortunately, the bureaus are allowed to rely on lenders to provide consumer's debt information. Given the ambiguity not surprisingly bankruptcy judges are divided on whether a creditor's failure to update a consumer's credit report should be considered an improper attempt to collect.
Why is it Happening if it is Illegal?
According the the Business Week article, since the 1990's firms that track and trade consumer debt have been expanding their portfolios to include accounts involved in bankruptcies, a now robust market. Although some of the trade in the bankruptcy paper involves collectible debt, much of the market now also includes billions in discharged debts, technically with no dollar value.
The Businsess Week article further states that owners of these cancelled liabilities "can revive their value in two main ways: by directly pressuring consumers to cough up cash or by gaming the credit system, as allegedly happened in the Rathavongsa case".
A second example provided by the article is the case of Belinda Hedge, who filed for protection from creditors in November 2005. In March 2006, the majority of her debt including several credit card accounts with Capital One totaling $2414, were discharged by the U.S. bankruptcy court in Tennessee.
Subsequent to the discharge, according to Hedge, Capital One and other debt collection agencies attempted to make contact with her over 140 times by telephone and mail to collect on one of the debts, a clear violation of the bankruptcy injunction. Despite providing the company and collectors court records from the bankruptcy, they continued to make contact. A Capital One spokeswoman attributed the collection efforts "to the lender's failure to update Hedge's credit report to reflect the discharge", stating that it will correct the error.
According to Brian Budsberg, a Tacoma Washington U.S. bankruptcy trustee, Ms. Hedge's experience is not uncommon, stating that "his impression is that the number of debtors alleging collection abuse is greater than it has ever been", adding that he has observed "an emboldened attitude by the collection arms of credit card companies and debt buyers". There has been a surge in the growth of businesses sometimes called Junk Debt Buyers or JDB's in recent years which includes the trading of discharged debts as well.
With Chapter 7 debt growing in our current economy, sales of Chapter 7 debt is growing as well. In order to be "successful" in the JDB market, companies must buy debt very inexpensively, even at a fraction of a cent, according to the Business Week article.
Update July 14, 2010 - Despite the illegality of going after these kinds of debts, the practice has not stopped. Currently, the FTC is working on new recommendations aimed at stopping creditors from going after uncollectible debts in court.
What To Do So You Avoid This Happening to You
Well, stay out of debt is a good start, but of course that is sometimes easier said than done. Know your rights if you file bankruptcy and succeed at having your debts discharged; creditors are notified by the court both when a consumer files bankruptcy, and again when a discharge is granted.