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Courts Crack Down On ‘Zombie’ Debts

shoppers in zombie costumes and makeup ascending stairs at an Apple store
photo by Jayel Aheram

I recently called American Express, not long after my father-in-law died, to cancel his credit card.

After offering her sympathies, the customer service representative began reading from a script that she told me she was required to deliver. Her speech made it perfectly clear that the outstanding balance on the card was an obligation of my father-in-law’s estate. She politely inquired whether I knew who was, or would be, appointed as his executor. No other party, including my wife or me, was obliged to repay the balance, she told me. I thanked her, told her that I understood that this was not a legal obligation of anyone else, but noted that the balance would be paid in full and on time.

That’s how a debt that is unenforceable - or at least unenforceable against the party in question - ought to be handled. AmEx did everything right.

A death is not exactly the same as a bankruptcy. The decedent’s obligations survive, at least to the extent that his or her estate has the resources to pay them. In bankruptcy, on the other hand, most obligations are reduced or discharged. Once handled, these obligations ought never to be an issue again.

But some banks have found a lucrative niche in selling off this legally worthless debt to collection agencies that seem to have few scruples against trying to profit by harassing or shaming debtors - or their heirs - into paying money they don’t legally owe.

One of the levers they have used has been to keep these discharged debts on customers’ credit reports as though they were still actively owed. Last fall, The New York Times reported on a Justice Department investigation into several banks allegedly engaging in this practice, including Bank of America and JPMorgan Chase.

The problem at hand was “zombie” charges: debts which should have been wiped out by bankruptcy but that banks left on credit reports, essentially forcing debtors to make payments on bills even after their legal obligation has been removed. For borrowers who tried to fight the banks, setbacks in the form of employer credit checks and difficulty securing new loans sometimes dogged them for years after they finished the bankruptcy process.

This practice, in effect, double-penalizes borrowers whose credit histories and FICO scores already reflect the fact that they have been in bankruptcy. It also does an end run around the bankruptcy code’s public policy objective of giving overwhelmed borrowers a financial fresh start, and of concurrently encouraging lenders to take prudent risks lest they see their debts compromised or wiped out in bankruptcy court.

The exception to this lender discipline? Education loans, which are virtually never dischargeable in bankruptcy. As you would expect, disciplined underwriting in education lending is therefore nonexistent.

The courts are now rightly stepping in to bring zombie charges to heel. Bank of America and Chase have agreed to update borrowers’ credit reports within three months to reflect the consumer debts discharged through bankruptcy, in response to lawsuits leveled against them in U.S. Bankruptcy Court in White Plains, New York. Citigroup and Synchrony Financial face similar challenges there, too. The Justice Department’s United States Trustee Program also continues to investigate whether banks have deliberately violated federal bankruptcy law, The Times reported.

This is not the first pressure courts have brought to bear on banks trying to induce Americans to repay debts for which they are no longer liable. In 2013, Judge Robert Drain of the Bankruptcy Court in New York ordered Bank of America to pay $10,000 each month as long as it continued to seek loan payments from a couple who had discharged their debt through bankruptcy. (Drain is also presiding over the current cases.)

Drain wrote, “[…] frankly, $10,000.00 a month plus attorney’s fees may not mean much to Bank of America, but at least it will send a message that other attorneys may pick up on.” The couple in the case not only had to hire a lawyer, but also had to reopen their bankruptcy case in order to legally fight the bank. Many borrowers end up simply paying the former lenders to make the problem go away so they can secure new homes or jobs.

Even as banks have agreed to change their practices, they have not admitted to any wrongdoing, arguing that they comply with the law and that they have no stake in recouping payments after they sell them off to third-party buyers. Several bankruptcy judges, however, have suggested that the banks’ ability to make money off such sales relies on the understanding that third parties will have leverage as long as the debts erroneously remain on borrowers’ credit reports. Drain went so far as to say, “I continue to believe there’s one reason, and one reason only, that Citibank refuses to change its policy,” which is “because it makes money off of it.”

Now that courts and regulators are cracking down, maybe this debt-collection scam will get closed down permanently. It certainly should. A lot of the legal abuse against bankers might eventually stop, if bankers would in turn stop looking for new and more annoying ways to abuse their customers.

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