Badawi & de Fontenay Paper on EBITDA Definitions

I confess that, on its face, this did not strike me as the most exciting topic to read about (and that comes from someone who writes about the incredibly obscure world of sovereign debt contracts).  After all, who even knows what EBITDA definitions are?  Sounds like something from the tax or bankruptcy code.  But don’t let the topic be off putting.  This is a wonderfully interesting project; and elegantly executed (here).  By the way, EBITDA stands for earnings before interest, taxes, depreciation blah blah. Turns out it is especially important for young companies, where potential investors want to know about the cash flow being generated (Matt Levine has been writing about it recently in the context of the WeWork debacle - here). It is also very important because it generally ties into the covenants in the debt instrument and can impact whether or not the covenants are violated.

Using machine learning techniques, Adam and Elisabeth look at the EBITDA definitions in thousands of supposedly boilerplate debt contracts.  And they find a huge amount of variation in this supposedly boilerplate term; variation that can end up making a big difference to the parties involved. (For those interested, there is a nice prior study by Mark Weidemaier in the on how supposedly boilerplate dispute resolution terms in sovereign bonds are often not really all that close (here); and John Coyle’s recent work on choice-of-law provisions in corporate bonds is also along these lines (here))

The question that naturally arises here is whether the variation in these EBITDA definitions is the product of conscious and smart lawyering or just random variation that arises as contracts are copied and pasted over generations. (for more on this, see here (Anderson & Manns) and here (Anderson)). My understanding of the results is that these definitions are definitely not the product of random variation; instead, there seems to be a lot of sneaky lawyering to inflate the supposedly standard EBITDA measure.

Why is Netflix Listing its European Bonds on the Isle of Guernsey?

Netflix has long interested me as a company, not only because of shows like "Master of None" (Aziz Ansari and Alan Yang have delivered brilliantly), its darwinian management philosophy (very cool podcast on Planet Money), but because of its uncertain future. It is competing against rich giants like Amazon and Apple to deliver original content in a field that is getting increasingly crowded.  My guess is that it is having to spend more and more on content, but is unable to increase its prices very much. One solution for Netflix: borrow at a high interest rate from investors who are willing to bet on your future.  And that it has done, in spades. Most recently -- a few days ago -- it borrowed $1.6 billion (yes, billion). I was intrigued and trying to avoid doing my real work, so I went looking for its offering documents and while I didn't immediately find the current docs, I found the offering circular for the bond issue Netflix did a few months prior in Europe (Euro 1.3 billion) in an offering listed on the International Stock Exchange, which is an exchange licensed by the Bailiwick of Guernsey.  Yes, really. So, surely, at least some of you are asking the same questions I am. What? Where? Who?

Guernsey, for those of you who are clueless like I am, is a British Crown "dependency" (not sovereign, but not independent, and not quite like a former colony like the British Virgin Islands or Bermuda (they are "British Overseas Territories")). Basically, a cynic might say: Perfect for a tax haven. But it is the stock exchange that interested me, especially since it seems to have been quickly rising in popularity for US and EU companies over the last couple of years.

If I remember my basic corporate finance class (I don't), we were told that exchanges performed a monitoring and disciplinary role; they were "gatekeepers", as the fancy corporate types liked to say. So, is Netflix going all the way to the Isle of Guernsey to get extra special monitoring from the Channel Islanders? Curious, I went to the website for the Guernsey exchange, to see what it said. And it does say that it has wonderfully rigorous regulatory standards ("some of the highest regulatory standards globally"). But does it really?

Venezuelan Debt: Call a Spade a Spade

Adam Lerrick, of the American Enterprise Institute, has offered an intriguing approach to the Republic of Venezuela/PDVSA debt problem. Call a spade a spade. The distinction in the market between Republic of Venezuela and PDVSA bonds has always been artificial and the market has normally perceived it as such. Only recently have market participants begun trying to figure out which bonds -- PDVSA or Republic of Venezuela -- will be more likely candidates for a debt restructuring and therefore which should trade higher in the market.

PDVSA accounts for 95 percent for the foreign currency earnings of the entire country. Without PDVSA, there is no credit standing behind Republic bonds.  At base, there is only one public sector credit risk in the country and Lerrick invites us to acknowledge this fact.

He proposes that the Republic assume the indebtedness of PDVSA and proceed to restructure that debt as part of a generalized Republic debt workout. As part of this process -- and to discourage potential holdouts from the Republic's offer to exchange PDVSA bonds and promissory notes -- he suggests that the Government take back PDVSA's concession to lift and sell Venezuelan oil. This risk has always been prominently disclosed in the PDVSA offering documents and should not come as a surprise to anyone.

Lerrick's proposal adds to the growing list of suggestions for how a future Venezuelan debt restructuring (and there almost certainly will be such a debt restructuring) may be accomplished without holdout creditors devouring the process. No one wants to repeat the experience of Argentina.

Recently, in the context of trying to work out the knotty problem of how to restructure Venezuela’s promissory notes, Lee Buchheit and I made a similar suggestion along these lines. (our friends, Bob Lawless and Bob Scott, two gurus of this world of secured financing and contracts, were invaluable in helping us figure this structure out -- all blame for errors is ours, of course).

The structure we suggest differs from the Lerrick proposal mainly on the question of what should happen to the PDVSA oil assets, including receivables for the sale of oil.  We suggest that PDVSA pledge those assets to the Republic in consideration for the Republic's assumption of PDVSA bond/promissory note liabilities (as opposed to transferring title to the assets back to the Republic).  Such a pledge is expressly permitted by the terms of the PDVSA bonds and promissory notes and should operate to shield the assets from attachment by holdout creditors.

Could Giving the Rohingya Refugees a Debt Claim Ameliorate the Current Crisis?

From Joseph Blocher & Mitu Gulati

Just a couple of weeks ago, the plight of the Rohingya, a muslim minority group in Myanmar, who are being oppressed (to put it mildly–they have been called “the most friendless people in the world”) was front page news. But, as has often been the case with the plight of the Rohingya over the years, news of their plight quickly receded as other human drama and tragedy took over (hurricane in Puerto Rico, Las Vegas shooting, Catalan secession vote/violence, North Korean craziness etc.)

We realize that we are likely engaged in a pointless task.  But we want to plead for the condition of the Rohingya, and indeed other refugees, not to be forgotten so quickly. As a threshold matter, we recognize that our government cannot be depended on to care much (if at all) about the plight of oppressed groups that are as far away, foreign and poor as the Rohingya. In other words, the top down mechanism isn’t going to work. The question then is whether, assuming that the oppression in question is clear and cognizable, there is some other solution—something bottom up--that the international legal system could provide to oppressed groups who are forced into refugee status that does not depend on other governments, such as the U.S., having a self interest in intervening.

More on Madden

I have a more refined piece on the problems with the Madden fix bills in the American Banker.  See here for my previous thoughts. 

Guess Who's Supporting Predatory Lending?

Guess who’s sponsoring legislation to facilitate predatory lending? It’s not just the usual suspects from the GOP, but it looks like a number of centrist “New Democrats” are signing up to help predatory financial institutions evade consumer protections. 

Yup, you heard me right: Democrats. Ten years after the financial crisis, it seems like we’ve gone back to the mistakes of the Clinton years when centrist Democrats rode the financial deregulatory bandwagon. What I’m talking about is the McHenry-Meeks Madden “fix” bill, the “Protecting Consumers’ Access to Credit Act of 2017”. The bill effectively preempts state usury laws for non-bank finance companies like payday lenders in the name of ensuring access to credit, even if on extremely onerous terms.

Right now there's only one Democratic co-sponsor, but others seem to be preparing to join in. They shouldn't, and if they do sign onto this bill, it should only be in exchange for some solid consumer protections to substitute for the preempted state usury laws. This bill should be seen as a test of whether New Democrats "get it" about financial regulation. I'm hoping that they do. If not, perhaps its time to find some new Democrats.   

Plain Meaning Rolls On in Gorsuch's First [Credit Related] Opinion

It was not at all surprising that, for his first (traditionally unanimous) opinion, in Henson v. Santander, the new Justice Gorsuch took on the relatively simple and low-key issue of the definition of "debt collector" in the Fair Debt Collection Practices Act. It was also not surprising that he hewed quite closely to the approach of his predecessor in basing his decision on the "plain meaning" of the words in the statute, complete with grammatical analysis of past participles and participial adjectives (the example adduced, "burnt toast," might describe how the consumer protection industry will view this latest ruling). The FDCPA is as simple as it appears, the Court confirmed:  if you're collecting a (consumer) debt owed to someone else, then you're a debt collector; if you're collecting on a debt owed to you, for your own account, you're not a debt collector, even if, as in Santander's case, you bought the debt from the original creditor with the intention of collecting it for an arbitrage profit later. The notion that Congress did not foresee the debt buying industry and its explosive growth when it wrote the FDCPA in the 1960s, and it certainly would have wanted to constrain abusive collections practices by debt buyers as much as by debt collectors was ... wait for it ... a matter for the present Congress to clarify. You can almost see Scalia whispering in Gorsuch's (or his clerk's) ear as the opinion is drafted. Well, at least there's something to be said for predictability.

Do the Distressed Debt Traders Know About This?

N.C. Gen. Stat. § 23-46:  

It shall be unlawful for any individual, corporation, or firm or other association of persons, to solicit of any creditor any claim of such creditor in order that such individual, corporation, firm or association may represent such creditor or present or vote such claim, in any bankruptcy or insolvency proceeding, or in any action or proceeding for or growing out of the appointment of a receiver, or in any matter involving an assignment for the benefit of creditors.

John Oliver and Consumer Law YouTube Videos

I'm trying something new this year. My consumer bankruptcy policy seminar students will read many great articles by many wonderful academics on this blog, as well as others, but this year, their "reading" will also include a great deal of YouTube.

90% of the videos are John Oliver segments from his excellent show on HBO, Last Week Tonight. They cover particular "products" (student loans, credit reports, debt buying, payday loans, auto loans, retirement plans and financial advisors) and middle class issues (minimum wage, wage gap, wealth gap, paid family leave).

I thought Credit Slips readers might enjoy seeing them all in one place. Here they are in no particular order. Let me know if I've missed any!

Fabulous New Paper: Random Justice in Bankruptcy Trial Courts

I just read a terrific new paper by Gary Neustadter of Santa Clara University Law School, called "Randomly Distributed Trial Court Justice: A Case Study and Siren from the Consumer Bankruptcy World." It presents a monumental empirical study of a debt buyer's litigation campaign to pursue essentially identical contract and fraud claims against hundreds of secondary mortgagors in state courts, federal District Courts, and federal Bankruptcy Courts. The paths and outcomes of these materially identical cases are so different in so many surprising (and often disturbing) ways, the paper offers a really stunning look behind the curtain of our often arbitrary trial-level justice system. And Neustadter's telling of the story is gripping--I read the paper and most of its footnotes from beginning to end in one sitting, unable to put it down. The revelations in this paper are a gold mine for civil proceduralists generally and bankruptcy practitioners in particular. It offers a cautionary tale and useful playbook for lawyers (and perhaps judges) in how to make many aspects of our system more effective. Get it while it's hot!

Justice die image courtesy of Shutterstock

Big Win for CFPB on Debt Collection

Yesterday, Judge Amy Totenberg of the Northern District of Georgia issued a very cogent 70-page opinion in the case of the CFPB v. Frederick Hanna & Associates, a large collection law firm with offices in Georgia, Florida, and South Carolina. The opinion denies Hanna's motion to dismiss in its entirety, and almost completely agrees with the CFPB's legal theory. In doing so, the opinion deals a serious blow to the collection law firm business model.

A brief recap of the case if you haven't been following. A year ago, the CFPB filed suit against the Hanna law firm essentially attacking the big collection law firm business model. Among other things, the CFPB alleged that the firm operated "less like a law firm than a factory" and that attorneys were not "meaningfully involved" in the collection lawsuits they filed. As an example, the CFPB alleged that one attorney in the Hanna firm signed about 138,000 lawsuits between 2009-10. That's 189 lawsuits per day, 7 days a week, 52 weeks a year.

The second CFPB claim was that in filing most of its lawsuits on behalf of debt buyers, the law firm "knew or should have known that many of the[] affidavits [they filed] were executed by persons who lacked personal knowledge of the facts." The Bureau sued under both the Fair Debt Collection Practices Act (FDCPA) and the Consumer Financial Protection Act (CFPA) for what it alleges were false or misleading and unfair acts and practices.

The opinion allows the Bureau to proceed on all of these claims. Specifically, Judge Totenberg (who incidentally, is Nina Totenberg's sister) found that the Bureau could regulate collection attorneys under the CFPA (the first time any court considered this issue), that the "meaningful involvement doctrine" extends to activities in litigation, and that the Hanna firm might be liable for filing affidavits given to it by its clients if the CFPB can prove its allegations.

The last two points are huge because it means that collection attorneys will have to spend some time reviewing the collection cases they file. (How much time and what constitutes enough "involvement" is up in the air). Nonetheless, this completely up-ends the business model of at least some collection law firms. As Joann Needleman has pointed out at InsideARM, an interlocutory appeal is unlikely to succeed here, so look for the CFPB to file more cases (or enter into consent decrees) with more law firms.

Stale Debts in Bankruptcy

Should liability under the Fair Debt Collection Practices Act (FDCPA) lie against a creditor who submits a proof of claim past the statute of limitations in a consumer bankruptcy case?

That is the question the Supreme Court declined to review recently in LVNV Funding, LLC v. Crawford. In Crawford, the Eleventh Circuit applied the "least sophisticated consumer" standard to find liability for the debt buyer when it submitted a proof of claim in 2008 for a debt that was out of statute as of 2004. Other courts have held differently. In fact, just last month, district courts in Indiana and Pennsylvania dismissed FDCPA suits against debt buyers under essentially the same facts as Crawford. Other courts, including the Second Circuit, have seemingly held that FDCPA liability can never lie in a bankruptcy case.

Putting the merits of applying the FDCPA in a bankruptcy case aside, it seems to me that in this specific instance potential liability under the Act could serve very useful functions: namely efficiency and cost savings.

Are Some Banks Using Credit Reports to Help Collect Discharged Debts?

Last week, Adam pointed us to a NYT's story on "zombie debt" after bankruptcy. I did a bit more research into the story because I had a hard time understanding the problem from the article.

There are a few lawsuits that have been filed about this (I found ones against GE Capital/Synchrony, Bank of America/FIA Card Svcs, Citigroup, and Chase). The GE complaint alleges that the banks have a systematic practice of "selling and attempting to collect discharged debts and ... failing to update and correct credit information to credit reporting agencies to show that such debts are no longer due and owing because they have been discharged in bankruptcy." You can download the complaint in the GE case here.

More specifically, the allegations are that after a discharge, some creditors do not update their tradelines to a status of "in bankruptcy" and instead leave them as "charged-off." The credit report of a person in this situation would then say they have filed bankruptcy and obtained a discharge but you could not tell whether any individual debt has been discharged in that bankruptcy. The (non-binding) credit bureau reporting guidelines (METRO 2) specify that creditors should report accounts as "included in bankruptcy" once they receive a notice of discharge.

The complaint characterizes GE's argument as being that the FCRA does not require it to make this change, perhaps especially in particular after a debt has been sold and they no longer have an interest in it. (GE has not filed an answer yet, but it seems like this is one argument they might make from reading their other filings). That seems to me to be a wrong interpretation of the FCRA and the FTC's Furnisher Rule. It should also be a violation of the discharge injunction. As Judge Drain put it in an opinion denying a motion to compel arbitration:

One could argue that the reporting of a discharged debt as still outstanding when the credit report also shows that the debtor has been in bankruptcy is even a worse result, indicating to those who are considering providing credit in the future that the debtor has fallen into the category of the dishonest debtor who did not receive a discharge.

I am told that NPR's On Point will be doing a segment on this on Thursday at 10AM EST with one of the attorneys filing these cases. You can listen to the podcast here.

Note: post has been edited to correct the timing of the NPR program and to add the link to the podcast.

Fully Clothed CDS

Lots of questions about the Blackstone CDS trade that Bloomberg wrote a great piece on back in October, and that Jon Stewart has now brought (finally) out into the light.

In short, Blackstone buys CDS on a company's bond debt while giving the same company a new senior loan facility.  One provision of the loan facility is that the company promises to pay its bonds after the grace period – which constitutes a technical "failure to pay" under the ISDA credit definitions.

A few quick thoughts:

First, while the trade undoubtedly is valid by its strict contractual terms, I would not assume that it could not be challenged. Namely, if ever there was an opportunity to invoke the old implied covenant of good faith and fair dealing, it might be here. Normally the covenant is a last resort argument in finance transactions, but maybe, just maybe ...

Second, however, this is a relatively small trade and Blackstone's counterparties probably value Blackstone's overall business too much to litigate this one. But do future trades with Blackstone get priced with an eye to this trade? That is, will Blackstone pay in the long term?

And this is, of course, the very sort of manipulation that Skeel, Partnoy and your's truly predicted years ago.

GM, Chrysler and Ideologically Selective Bankruptcy Formalism

James Sherk and Todd Zywicki have an op-ed in the Wall Street Journal that kvetches about the unfairness of the Chrysler and GM bankruptcies.  As one might expect, their complaint centers upon the contention that the senior lienholders in Chrysler get 29 cents on the dollar, while the UAW VEBA received a superior treatment despite holding a general unsecured claim.  They also allege that the UAW didn't make serious concessions in the bankruptcies, and that GM unnecessarily assumed the UAW pension obligations of its major supplier and former subsidiary Delphi. All of this, Sherk and Zywicki calculate, cost taxpayers $23 billion unnecessarily.  

There are two problems with Sherk and Zywicki's argument. First, it plays fast and loose with the facts, and second, it makes a number of heroic assumptions.

American Banker: Chase Has Halted Credit Card Collection Suits

Yesterday, the American Banker reported that Chase has stopped filing lawsuits to collect consumer debtors. Moreover, they did it quietly and quickly. With concerns over sloppy procedures in debt collection, akin to the robo-signing problems in the mortgage industry, this news was quite interesting.

H/t to our reader who pointed me to the story.

Chase Amassing Lehman Claims

On Monday, JP Morgan Chase reported that it had purchased more than $60 million in claims from Raiffeisen Zentralbank Osterreich AG. In July Chase bought about $200 million in claims. And while Chase has sold some claims too -- back in May they sold a couple of big claims -- it appears that there are more and larger claims going to Chase, including some "partial" claim transfers, which should add a special something to the plan negotiations:  what debtor wouldn't like to find it has even more creditors post-petition?

And then there is the matter of how all these claims play into the ongoing litigation between Lehman and Chase . . . 

N.B.  Some of the August 30th transfers are docketed as transfers from Chase, but the underlying documents show that they are Chase purchases.

Private Funds and Bankruptcy

As the financial reform bills make their way through committee conference, I thought I would take this opportunity to reflect on the activities of private equity firms and hedge funds in bankruptcy. (For those of you interested in the bills’ efforts with respect to credit rating agencies, see my post here at Maryland’s new faculty blog.) Although the financial reform bills provide for some regulation of private funds (see here and here), some argue that the proposed measures are meaningless because of, among other things, exemptions and enforcement issues (see here and here). Others argue that even these measures hinder private funds’ business models (see here). Irrespective of your views on this debate, it is clear that the bills do not address the challenges posed by private funds in the distressed debt context.

Investing in distressed debt is not a new investment strategy, but private funds have been pursing it with increased vigor in recent years. And they have been doing so quite successfully. These funds generally yield above-market returns, and during the 1999-2004 economic bubble/burst, they averaged "double-digit returns, including 30 percent for the 2002 funds." The most recent recession has likewise provided ample opportunity for distressed debt investors. These opportunities are likely to continue for the next several years, as "U.S. companies have about $600bn . . . of leveraged loans to refinance . . . between 2011 and 2014."  (See here and here.)

Distressed debt investing generally involves a private fund purchasing the debt of a troubled company and then exploiting the leverage associated with that debt instrument when the company defaults or is about to default on the underlying obligation (see here and here). Some of these investors resemble pure traders and primarily seek to flip the debt for a quick return. Others are, however, using this investment strategy to influence corporate governance or make a control play for the company. (For data on investment strategies, see here.) These investors also are increasingly willing to extend postpetition loans (i.e., DIP financing) to troubled companies, often with the intent to credit bid the debt or otherwise convert it into equity to gain control of the company. As one commentator observed, "Investors in loan-to-own deals may earn an 18 percent return on the financing, plus get equity, compared with the potential for 12 percent returns and no equity on DIPs."

Now, I am not against private funds earning positive returns for their investors—that is of course the primary objective of for-profit endeavors. I also believe that these investors frequently provide much-needed liquidity to troubled companies; liquidity that otherwise would be unavailable and that can provide a second (or third, etc.) chance for the company to the benefit of all stakeholders. I am, however, concerned about the unlevel playing field on which these investors operate in many instances.

Congress to Outlaw Indiana Pension Funds

Not really, of course. But Felix Salmon does have an important new post about how, in the sovereign debt context, Congress is honestly considering preventing purchasers of distressed sovereign debt from collecting the full face amount of the debt. It is aimed at the "vulture funds" who buy distressed debt and then engage in aggressive collection tactics, often against countries that really have better uses for their money than defending lawsuits.

This is the sovereign equivalent of the Indiana Funds, who bought their Chrysler claims at a mere fraction of face value and then proceeded to make a fuss in the chapter 11 case. Indeed, they continue to do so, as their petition for cert. is still pending before the Supreme Court.

Vulture investors, foreign and domestic, can be a pain in the . . .  as we saw in the Chrysler case. But Congress' proposed legislation is a really bad idea. First of all, I don't know of you confine it to the sovereign debt context. They say they can do so, but is that going to pass with courts? Certainly if it applies to outstanding debt, there is a retroactivity/due process, takings, and perhaps even equal protection problem (why are some creditors subject to the act, but not others?).

And does Congress really want to kill the distressed debt market? Does this mean that whenever bond debt trades at below face value it implicitly trades without enforcement rights? That will do wonders for the high-yield market.  How much will you pay me for my unenforceable Ford bonds?

Paying transferred claims at full face value has been the law since at least Hamilton's first Report on Public Credit. I'd pause a bit before overruling a founding father, especially one who remains the one clearly good Treasury Secretary we've had.

Landing Claims from LandAmerica

A Richmond Times-Dispatch reporter, Emily Dooley, called me yesterday and clued me into an interesting story from the bankruptcy of LandAmerica, the Virginia based title insurance company that is in chapter 11. Her story is here, and Credit Slips readers will want to give it a look. It presents a twist on the usual story about bankruptcy claims trading.

LandAmerica had a subsidiary called LandAmerica 1031 Exchange Services, Inc., which would hold the cash earned from a real estate sale until it could be exchanged for reinvestment in property similar to the one sold. By reinvesting the cash in similar real property, U.S. tax law allows the seller to defer any tax owed from the sale profits. Continued rollovers could indefinitely defer the tax consequences. It's all governed by section 1031 of the U.S. Internal Revenue Code, which explains the name of the subsidiary.

How Much Do You Want for that Discharged Debt?

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.

Bankruptcy Claims Trading: Part II

I’ve greatly enjoyed my stint blogging at Credit Slips for the past two weeks. It’s given me new respect for the energy and commitment of the blogosphere community, and I’ve learned at least as much as I’ve taught. Bob Lawless has already posted a very kind goodbye, but before I go back to lurking, I have one last post to make, namely a follow-up to my general introduction to bankruptcy claims trading.

Claims trading, like any other investment, has risks. The question is what risks does one assume when one purchases a bankruptcy claim?

Bankruptcy Claims Trading: Part I

Let me turn to a true bankruptcy nerd topic tonight—corporate bankruptcy claims trading. Bankruptcy claims trading is the buying and selling of claims against a bankrupt corporate debtor. (Trading in consumer bankruptcy claims is an issue that has not been academically explored to the best of my knowledge.)

Bankruptcy claims trading is virtually unregulated in the U.S. Although claims trades can effect changes in corporate control, they are not subject to securities or mergers and acquisitions regulation. There is also little case law on bankruptcy claims trades; my next post will address a very recent decision in the Enron bankruptcy that is the most significant to date.

So who on earth would want to buy a bankruptcy claim?

Collecting Consumer Debts: Talk to the FTC

In the nearly  year of Credit Slips' existence, posts on debt collection have provoked consistently strong responses and lots of interest. The Federal Trade Commission is all ears if any Credit Slips readers would like to share their perspectives on issues relating to collecting consumer debts. The deadline is June 6th, and comments may be submitted by mail or electronically. Here are the technical details. The public comments to date offer some scary stories about abusive debt collection practices and seem to be submitted by consumers with real-life experience with debt collection. Read them. The FTC clearly is interested in comments from lawyers on the front lines of debt collection, whether their clients are creditors or debtors. For our professor audience, note that FTC says that it also welcomes "original research, surveys, and academic papers regarding consumer debt collection issues" and these papers are due September 7, 2007.

The topics for comment that interest the FTC illustrate a range of trends in debt collection, and hint at the FTC's interest in redirecting its regulatory focus in certain areas. As I read the topics for comment, I repeatedly was struck by pessism about obtaining reliable information on these questions. The sad reality is that there simply is not a substantial body of serious academic research on debt collection. Most empirical research is about bankruptcy, in part because the court process facilitates data collection. Many of the inquiries would require corporate proprietary or industry association data to answer, such as "provide data illustrating trends in the number or percentage of accounts in collection with each of the following: (1) credit issuers; (2) collection agencies; (3) collection law firms; (4) debt buyers; and (5) other identifiable industry sub-groups." On the other hand, an optimist could read the topics for comment as a future research agenda, a list of possible news stories, a manisfesto for legislative action, depending on one's livelihood.

The (Belated) AALS Report

Contrary to popular belief, the regular Credit Slips bloggers are not being held for ransom by guest blogger Jack Ayer. When we set this up, Ayer kindly offered to start last week when law school academics tend to have their attention turned elsewhere. And, where else are law school professors the first week in January except the annual meeting of the Association of American Law Schools (a/k/a "the AALS") in Washington, DC? I had promised to report in from the event, but the Internet connection in my room did not want to work. Other than that and the small fire at 2:15 AM in the morning that caused an evacuation of my part of the building, the hotel was great.

For those fortunate enough never to have known the AALS meeting, a little background is in order. It meets over three and a half days. The first day is typically turned over to a plenary event that would be of interest to all--this year it was law school rankings--and the rest of the meeting is dominated by small section meetings organized by subject-matter specialty. For Credit Slips readers, the most germane section is the one on Creditors' and Debtors' Rights. (I've seen others refer to it as the Section on Debtors' and Creditors' Rights--all depends on your perspective.) There were four papers presented at the section meeting from Ed Morrison (Columbia), Robert Chapman (visitor, Baltimore), Cre Johnson (Ohio State), and Adam Feibelman (North Carolina). So what is on the minds of bankruptcy academics?

Differential Methods of Medical Debt Collection

Should medical debt be subject to different collection rules than debt owed to other creditors such as credit card issuers?  My answer to this has generally been "no," in part due to the fungibility of obligation. But even if states refrain from imposing differentially restrictive rules, various collection approaches are naturally generated through other means.  Specialty publications on collections have featured a variety of articles on the evolution of medical debt collection (thanks to Jason Kilborn and Nick Sexton for tips on some of the recent ones).  The stories in periodicals such as Collections & Credit Risk have been paying particular attention to the outright purchasing (as opposed to contingency collection) of medical debt from hospitals or other providers.  The stories in the collection industry publications convey the impression that medical providers impose more constraints on the collection techniques of debt buyers than the originators of other debts do because of the nature of the obligation and the localized nature of the business and resulting public relations issues.   Thus, less litigation, prohibitions on resale of the debt, etc.  Of course, some patients immediately use a credit card for the self pay portion of the debt.  If they don't pay, and if such bad credit debt gets sold, it will be sold as general consumer debt, presumably without these particular originator restrictions.  Medical providers still have incentives to encourage patients to use credit cards at the outset; bad medical debt portfolios are selling for only a few pennies on the dollar.  It is possible that some convergence could occur if buyers purchase newer accounts receivable, and then team up with lenders to provide financing options for patients. 

Empirical Evidence on Debt Trading

Katie Porter's earlier post on debt trading (which has gotten some attention at The Conglomerate) reminded me of some poking around that I had been doing. Trading claims in bankruptcy is huge, in the billions of dollars per year. Although Katie Porter's post was in the context of consumer bankruptcy, bankruptcy claims trading can have decisive effects in huge corporate reorganizations. A corporate debtor in financial distress may find itself no longer dealing with a lender interested in a long-term relationship but with a so-called "vulture investor" interested only in maximizing short-term profits. Of course, without the ability to resell a loan, the lender might not have made the loan in the first place. None of this is to say that bankruptcy claims trading is either good or bad, but we don't know much about it.

I was trying to see if one could get data on bankruptcy claims trading and trading in distressed debt generally. (And by "I," I mean by my extremely capable faculty assistant.) It turns out you can get such data, if you have thousands of dollars to pay for expensive data subscription services. With the other things on my plate, I could not justify the time and money to invest in such a research project, but it strikes me as a fruitful area for investigation. Because we have so few data, it's an empirical project where the researcher would have something to say no matter what the data showed. Even a paper with descriptive data would make a huge contribution.

Disciplining Debt Buyers

In the last several years, rumors have flown that a substantial fraction of the debt discharged in consumer bankruptcy cases is sold to a third-party after the bankruptcy. It is perfectly legal to sell debts. But why would someone buy debt that a debtor was under no legal obligation to pay? Aren't these debts worthless?

A recent action by the Federal Trade Commission gives an answer. Debtors sometimes pay debt that they do not owe. Debtors are either misled into thinking that they still owe these discharged debts or they pay up to get the debt buyers to quit harassing them. The complaint in US v. Whitewing Financial Group alleges that after purchasing the debts (often for a few cents on the dollar), the debt buyer would contact debtors and threaten to take legal action if the debt was not paid. The bankruptcy discharge is essentially an injunction that prevents the collection of the discharged debts. This alleged threat then would be an "action that could not legally be taken," which violates the Fair Debt Collection Practices Act. A consent judgment was entered to resolve the dispute. More details are available from the FTC news release about the case.

In an ironic twist, all but $30,000 of the $150,000 civil penalty was suspended based on the defendants' alleged inability to pay. As the comments to a recent post by Elizabeth Warren at TPM Cafe demonstrate, debt collection is apparently a hard way to make a buck. This must be especially true when you aren't actually owed the money you are trying to collect!