« Can Payday Lending Help? | Main | A $50 Fee There, a $75 Fee There, and Soon It Adds Up to Real Money »

How Much Do You Want for that Discharged Debt?

posted by Bob Lawless

Business Week just ran an article about the debt collectors who buy chapter 7 discharged debt. That's right. People pay good money for debts they can't legally collect. Why? It is because they expect to collect some of these debts, legally or not.

It would be perfectly legitimate to buy predischarge chapter 7 or chapter 13 debt and try to maximize collection within the bankruptcy process. The industry literature and web sites are very careful to avoid any statement that might hint illegal activities are occurring. Nevertheless, it all looks very fishy, and it strains credulity to believe that debt buyers are purchasing discharged chapter 7 debt with the expectation of recovering significant portions of that discharged debt. The Business Week article documents numerous instances where creditors or debt buyers were trying to collect discharged debt and failed to stop until hauled into the bankruptcy court.

To provide a little context, the discharge in the Bankruptcy Code is conceived as a court injunction. Stated plainly, the discharge in bankruptcy operates as a court order prohibiting any person from commencing or continuing any action "to collect, recover or offset" any debt subject to the discharge. Some debts, such as alimony or many tax debts, are excepted from the discharge, but these debts are not the debts that Business Week reports being bought and sold. Rather, it is garden-variety credit card and other retail debts that show up in the Business Week article. The language in the Bankruptcy Code is broad and reaches any act, no matter how small, that attempts to collect a debt. Violating the discharge injunction is like violating any other order of a court--the sanctions are potentially severe.

The Business Week article documents how discharged debts are sometimes still on credit reports. The Bankruptcy Code only prohibits "an act" to collect a debt. Is failure to remove information "an act?" Perhaps. The bankruptcy courts are split. Nonetheless, the Fair Credit Reporting Act (FCRA) obligations for a creditor to provide truthful information would seem to kick in and require the creditor to report the debt as discharge. The FTC has agreed with that interpretation of FCRA in the past.

One development that concerns me is the increased assertion of mandatory arbitration provisions in bankruptcy court. Although the bankruptcy law seems pretty clear and the sanctions severe, could a creditor or debt buyer try to maneuver a debtor into an arbitration where the decision maker might not be so sympathetic to the claim of a discharge? The answer clearly should be "no" and even an attempt to invoke an arbitration provision should subject the creditor or debt buyer to the same sanctions as they would face for an violation of the discharge injunction. Nevertheless, there is some loose language in some court opinions that creditors and debt buyers might seize upon to make the collection of discharged debt even more of a problem that it is already.

Hat tip to current student, James Thibodeau, and former student, David Fuller, for bringing the Business Week story to my attention.


As Congress looks to regulate credit cards, it presents a prime opportunity to stamp out this sort of illegal zombie debt. Perhaps banning federally insured institutions (or all institutions, as part of the Bankruptcy Power) from selling or otherwise transferring discharged debt would be a step in the right direction, especially if coupled with a private cause of action that (1) makes clear that arbitration agreements/class action waivers on the underlying debt do not apply to actions after its discharge and (2) sets damages as three times the amount of the debt attempting to be collected plus costs. Making transferors of discharged debt liable for the actions of the transferees (and then some) might dry up the source of discharged debt.

I found the Business Week article Friday morning, printed a copy of it and mailed a copy to a client who is experiencing almost this exact problem. A particular credit card company, that had already obtained a judgment against the creditor prior to bankruptcy, had their debt discharged. The problem? This large bank sold the debt to a collections company who is now trying to collect the debt (with some strange twists I cannot go into.) Either way, I found the article VERY interesting and am glad that I am not the only one who thought, back when the client brought this issue to our attention, that there should be a ban on a bank being able to sell discharged debt AT ALL. One 'stop this nonsense' letter has gone out to the creditor so we'll see if they make us file a complaint to get them to stop it.
(past Lawless student wishing he had stuck around to teach the M&A class...)

Billions of dollars in discharged debt is bought and sold every month. There are internet auction sites that advertise it, which I am sure will go underground after this article. The discharged debts are packaged into SPVs and securitized and sold to very private investors like mortgages. The problem with enforcing the discharge injunction in relation to these problems lies with whether or not credit reporting, by itself, is attempt to collect a debt. Some courts do not seem to understand that the creditors are laying a trap for the debtors. This business model relies on passive collections through the manipulation of the credit reporting system. They wait until the debtor needs credit to collect it. These are recapture points. Examples would be when the former debtor needs to refinance a home loan, buy a house, buy a car, or even get a job that requires no open charge-offs or current delinquent balances. The bureaus offer monitoring services that allow the bottom feeders to get immediate notice when the debtor is trying to obtain credit. This is just one of the dozens of schemes being used to collect discharged debt. If the bottom feeders can't get it collected through passive means, the debts are sold, again, down stream, to folks willing to take more risks to collect it. After a few sales, it is almost impossible to trace to the discharged account, the amounts and account numbers are nowhere close to what was on the schedules, and debts are re-aged. These debts keep coming back form the dead. It is truly zombie debt.

The creation of zombie debt by the sale and re-sale of uncollectibles is just another way to attempt to legalize loan sharking. Don't even think of going after who or what you think is mafia. For all of you smart people out there, mafia doesn't even exist. It only exists in the Hollywood sense. This zombie debt is deeper than the american-perceived organized crime. This is just a way to keep people enslaved and indebted. Indentured servitude at its greatest. Those who attempt to collect legally discharged debt should be prosecuted to the fullest extent of the law. The courts are in place to protect those who used them properly. The long arm of the court is now needed to erradicate the scum of the collections barrel. And, for the poor persons who are being harrassed, these people shouldn't need further legal assistance at cost to get the situation to stop, either.

This is an active area of litigation, so I am not free to comment at any great length on it. I will note that I am one of the contributors to the body of jurisprudence that holds that the mere reporting of the existence of a debt, without more, does not violate the discharge injunction.

The decision that reached that conclusion also emphasized the "without more" point. One issue that has arisen has to do with whether the "passive" reporting might result in an effort to collect a debt -- an issue that might depend on the way in which the debt is reported. To date, that issue has been discussed (and has been the subject of discovery) but has not yet been litigated. In other words, that shoe is still waiting to drop.

In order for passive collection scheme to work, the creditors must violate their absolute duty to update the account as required by 1681s-2(a). So, when a creditor received notice of the discharge, and fails to update, they are violating another Federal statute. One of the questions before the Torres Court, was whether or not the violation of that Federal Statute constitutes an attempt to collect a debt? No other bankruptcy court has had that issue before it, as yet.

With respect to debt collectors, I think the debtors bar has failed to illustrate to the courts that a debt collector can only report an account to a credit bureau, because it is attempting to collect a debt. They have no other legal reason to be reporting. If they got notice of the bankruptcy, they have no legal right to report that the account is still live with a balance due.
When they do it post-discharge, it should be a no brainer. On these cases there are clear FDCPA violations, so the Plaintiffs have easier avenues to deal with this, with lower burdens of proof.

The collection of discharged debt is one of the biggest problems facing consumers who have successfuly completed a Chapter 7 or 13 case. The primary objective of a consumer bankruptcy case is the Discharge. This disregard for compliance with the Discharge Injunction undermines the entire bankruptcy process and impairs the "fresh start." And, as others have noted, the value of a discharged debt is based in part on how the tradeline is reported by the three consumer credit reporting agencies. I have been involed in cases where the debt seller and debt buyer have agreed to "never change" the negative trade line. This conveant is called a "double lock-out" provision. These "double lock-out" covenants create "high value" discharged debts since you can keep collecting them over and over and over. And, in my view the "fuel" that has allowed this fire to burn with more intensity is securitization. The ability of debt buyers to securitize large pools of discharged debt has simply increased the demand for more claims, whether discharged in bankruptcy or by time. I have litigated discharge violations in the past year involving debt that was originated in 1977 and discharged in bankruptcy in 1981. This debt was almost as old as the number of years that I have practiced law (33 years). The Bankruptcy Courts must recognize the serious implications of this problem and help us stamp it out. The "we don't have jurisdiction" position adopted by some bankruptcy courts constitutes nothing more than giving these bottom-feeders a green light for fraud. It is time to turn the light on to a permanent "red."

You should make every attempt to pay your debts even if they have been discharged. It is perfectly understandable that someone wants to get paid for money owed, regardless of its discharge. The problem here is that bankruptcy laws favor the consumer and people who pay their debts end up paying more as companies have to recover their costs. Shareholder lose also.

PAY YOUR DEBTS!!! (and stop whining)

To Max Gardner III:

Even fully PAID accounts are resold again and never recognized as paid by ANY party. Fraud goes around and around - eventually, all suffer as the economy is dragged down. Sounds like you are a shareholder. Stop your whining, you cannot collect on fraud forever.



The signatures are below the comments. I think the comment to which you meant to respond was from "jumboloan." Max Gardner is a well-known consumer bankruptcy lawyer and, in his comment, bemoans the same practices you criticize.

The comments to this entry are closed.


Current Guests

Follow Us On Twitter

Like Us on Facebook

  • Like Us on Facebook

    By "Liking" us on Facebook, you will receive excerpts of our posts in your Facebook news feed. (If you change your mind, you can undo it later.) Note that this is different than "Liking" our Facebook page, although a "Like" in either place will get you Credit Slips post on your Facebook news feed.



  • As a public service, the University of Illinois College of Law operates Bankr-L, an e-mail list on which bankruptcy professionals can exchange information. Bankr-L is administered by one of the Credit Slips bloggers, Professor Robert M. Lawless of the University of Illinois. Although Bankr-L is a free service, membership is limited only to persons with a professional connection to the bankruptcy field (e.g., lawyer, accountant, academic, judge). To request a subscription on Bankr-L, click here to visit the page for the list and then click on the link for "Subscribe." After completing the information there, please also send an e-mail to Professor Lawless ([email protected]) with a short description of your professional connection to bankruptcy. A link to a URL with a professional bio or other identifying information would be great.