Debt-buying industry and lax court review are burying defendants in defaults
His pro bono client’s life had been seized up in such fear that she pawned her wedding ring to feed the maw of a default judgment against her in Los Angeles County Superior Court, obtained by one of the nation’s biggest debt buyers.
It was too late to undo the judgment, but Benshoof sued the debt buyer, alleging that its repeated phone calls to the woman were harassing and illegal. The company turned over phone recordings in discovery that showed the calls weren’t as heated as the woman thought.
“I still think they crossed a line,” says Benshoof, a partner and big-firm commercial litigator in the Los Angeles office of Alston & Bird.
The debt buyer settled, discharging the debt of $5,000, which included interest on the original $3,500 loan, and gave back $2,600 the woman had managed to pay on the judgment.
But Benshoof remained curious. His client still insisted she’d never taken out a loan, though she once might have co-signed one. The bank that originated the loan and later sold the debt happened to be a client of his firm, so Benshoof called and asked about it, providing her name and Social Security number. The bank had no record of her involvement in any debt.
“It was one of several eye-opening experiences for me in this case,” Benshoof says. “I felt naive. How could the court have entered a judgment?”
He looked deeper into this head-scratcher. The only evidence provided in discovery was a spreadsheet with little more than his client’s name and some dollar figures. And he found that no judge had given so much as a side glance at the debt buyer’s lawsuit. A clerk simply processed the creditor’s claim based on a document stating little more than this person owes us this much, and the fact that she was served with the suit, then entering judgment after it went unchallenged. (Benshoof’s client had never heard of the company pursuing her and considered the various contacts junk mail or spam.)
California’s courts were relying on an antiquated law reaching back to the 1800s, when merchants kept so-called books of account—handwritten ledgers with amounts owed—and those spare records sufficed in a smaller world. Now with about 80,000 such cases each year in Los Angeles alone, that law helped move things along.
Critics put it more harshly: “Most courts nationwide have some version of that limited-evidence requirement and have allowed themselves to become co-opted and thus part of the problem,” says Peter Holland, who recently returned to his full-time practice in Annapolis, Maryland, after running the consumer protection clinic at the University of Maryland School of Law for five years.
LOTS OF LOSERS
Studies have shown that many people sued by debt buyers lose through default judgments, typically from simply not responding. When they do challenge the complaint, those without lawyers almost always lose, often because of a lack of sophistication in answering or asking questions on paper or in a face-off with a debt-collection lawyer.
The debt-buying industry has understandably taken advantage of this and put an unprecedented burden on the nation’s courts—state venues, usually small claims or others of nonrecord jurisdiction. The huge influx of debt-collection cases that started in about 2006 came at a time when the courts were beginning to face declining budgets and becoming resource-strapped. The caseloads have dropped some, but they remain much higher than before the onset of debt-buyer litigation.
In New York, for example, more than 300,000 debt-collection suits were filed yearly from 2006 to ‘08, with the lion’s share in New York City. That deluge dropped to just under 200,000 in 2011, then leveled off to a bit more than 100,000 a year, according to research by the New Economy Project, a public interest group working at the community level.
Numbers are declining somewhat as giant bulges of debt lawsuits from the worst, early years of the financial crisis have worked their way through the snake’s gullet. Less credit card debt is for sale because consumer credit tightened after the economic siege took hold in 2008. But a lot of debt is still sold, and the industry is consolidating, with bigger companies acquiring smaller ones.
THE BIG 3
The debt-buying industry plays a legitimate role in righting the economy, providing some compensation (pennies on the dollar) to banks and other lenders that discharge unpaid debts and sell them. And it is huge, having become so in less than 15 years.
The biggest firm is Encore Capital Group, based in San Diego; it is the parent of Midland Funding, the company that pursues payment. Encore last year surpassed $1 billion in revenues, a 39 percent increase over 2013, spurred by major acquisitions, among them Asset Acceptance for $200 million and the United Kingdom debt buyer Cabot Credit Management for $177 million.
Next largest is Portfolio Recovery Associates, based in Norfolk, Virginia. In 2014, PRA reported revenue of $881 million and acquired Aktiv Kapital, a Norway-based debt buyer.
Encore, PRA and Asta Funding are the three biggest publicly traded debt buyers. The top five together purchase more than 80 percent of all credit card debt sold in this country, according to the worldwide trade association Debt Buyers Association International, which represents more than 575 companies and is based in Sacramento, California. (Because other firms are privately held, the other two top firms could not be determined.)
All have been tagged for widely publicized problems concerning abuses, including lawsuits filed with little or no documentation of the debt or its assignment to a buyer; mistaken identity in pursuing payment; suing for time-barred debts; and seeking high amounts in fees and interest for which there is no proof or accounting.
In July, the industry was stunned by a broad enforcement agreement JPMorgan Chase entered into with the Consumer Financial Protection Bureau and the attorneys general of 47 states. And in September, the agency hit at the industry’s heart, issuing a similarly sweeping order against the Encore Capital Group and Portfolio Recovery Associates.
JPMorgan Chase, a major seller of debt, admitted that a significant number of its own 538,000 collections suits filed between 2009 and 2013 were questionable or seriously flawed. Some of them had already been settled, paid in full or discharged in bankruptcy—based solely on robo-signed affidavits made with little or no review of pertinent documents (more than 150,000 times, the CFPB said)—or otherwise already found to be unenforceable.
“The evidence showed fundamental flaws in debt sales,” says Claudia Wilner, a staff attorney with the National Center for Law and Economic Justice in New York City. “These are not old cases. This is up to 2014, so it’s very recent. Debt buyers are trying to convince regulators that they’re legitimate and all is above board, but we know there still are many mistakes and inaccuracies.”
The CFPB’s subsequent order against the debt buyers says Encore must refund as much as $42 million to consumers for misrepresenting that it could sue on time-barred debt, or telling courts a debt was assumed because it hadn’t been disputed. PRA must refund $19 million for wrongly saying a lawyer had reviewed a debt, for collectors saying they were calling on behalf of lawyers and for improperly getting payments or judgments on time-barred debts.
Also, both companies must cease collection on similar judgments and drop pending lawsuits in such cases, as well as adhere to a laundry list of reforms concerning proof and verification of debts.
The two debt buyers admitted no wrongdoing, but they did not challenge the order.
What seems the harshest penalty in the CFPB agreement and orders is the prohibition on reselling debt, a common practice in an industry with big and small companies. Some debt buyers work portfolios to a certain extent and then sell the uncollected remains to others down the food chain. Debt buyers often resell accounts that don’t pan out, passing them along to others for even lesser amounts. Those collectors, in turn, might work longer or wring harder to get money from the portfolios.
But JPMorgan already has virtually ended debt sales, PRA has never resold debt and Encore stopped doing so about 10 years ago, says Jan Stieger, executive director of DBA International, the trade association of companies involved in debt buying.
“The effect on the small and medium-size companies is devastating,” Stieger says. “They can’t buy [volume] from the big banks, and the industry could become less competitive because only the big five or 10 buyers might survive.”
Smaller companies can be better for consumers, Stieger asserts, because they work niche areas and often are closer to the debtors geographically—and they can be more flexible.
Chase, which once was a major seller of debt to debt buyers and also collected on some itself, agreed to cease collections on the more than half a million accounts and to notify debt buyers that they cannot resell any debts the bank sold to them. The bank also must pay at least $125 million in penalties and compensation to consumers.
NEW RULES COMING
The CFPB’s actions presaged what the agency will do when it issues comprehensive rules regulating debt collection and debt buying, which are expected in 2016—after an unusually long comment period that began in November 2013. The agency’s demands include requirements for detailed debt verification at every stage of buying and selling to prevent the data degradation that has been prevalent.
In effect, if strictures find their way into the new CFPB rules, debt sellers would no longer be able to sell portfolios with contracts declaring there are no warranties for accuracy, which almost always is boilerplate at each sale down the line.
“Talk about a business killer,” says Joann Needleman, president of the National Association of Retail Collection Attorneys and senior counsel in the Philadelphia office of Clark Hill. “It would be like having responsibility for a car accident after you sold the car. But the point here is that it was Chase that sold bad data.”
While abuses have lessened more recently—perhaps from a mix of changes in the industry, increasing scrutiny by courts and greater availability of proof of debts through improved, digitized records—they have not stopped, according to consumer lawyers working in the trenches.
Last year Annapolis lawyer Holland published an analysis of 4,400 debt-buyer cases in his state over a two-year period from 2009 to 2010, which he titled “Junk Justice.” It showed that more than 99 percent of judgments against defendants were obtained without trial, with fewer than 2 percent of defendants represented by a lawyer—and that those who had one fared much better.
Follow-up data shows that continues to be the script, Holland says. Nationwide, the mere appearance of a lawyer for the defendant still typically leads to a nonsuit, reinforcing critics’ claims that default judgments are the goal of a business model relying on scant documentation.
The industry pushes back on that one. “The last thing a debt buyer wants to do is file suit and seek judgment,” says Stieger of DBA International. “They want to work out a payment plan. It’s expensive to sue. We sue the ‘won’t pays,’ not the ‘can’t pays.’ “
“She’s right,” says Simon Sandoval-Moshenberg, a Falls Church, Virginia, lawyer who has represented more than 30 consumers in debt-collection cases, mostly in Fairfax County. “I thought default judgments were their No. 1 goal, but I started looking at their financials and they make more by what comes in over the phones; then, next is litigation.”
Sandoval-Moshenberg has countersued some debt buyers in federal court, including the nation’s biggest, Midland Funding. In Paz v. Midland Funding in the U.S. District Court for the Eastern District of Virginia in Alexandria, for example, his complaint dissected the problem with robo-signed affidavits and offered up extensive research into how the debt buyers worked the Fairfax County General District Court.
Midland sued 20 other consumers along with Leoncio Paz on the same day in September 2013; Paz was the only one represented by a lawyer. Of the others, four were “not found” and thus not served; three were voluntarily dismissed before trial, likely for agreeing to make payments; and default judgments were sought against the other 13. Three were granted, 10 were dismissed without prejudice for insufficient documentation. When Sandoval-Moshenberg subpoenaed Midland’s records, the company nonsuited.
The federal case was settled confidentially.
ONE COURT’S BEST PRACTICES
In 2008, the Fairfax County General District Court (small claims civil division) addressed due process issues raised by the spate of debt-buyer suits, adopting “best practices” for default judgments, primarily requiring more documentary proof. It is the largest jurisdiction in the state, part of the Washington, D.C., metro area, and debt buyers file thousands of cases there each year.
“We had started talking about our gatekeeping role and needing more documentation,” says General District Court Judge Lisa Mayne. “The law is clear that a judge can’t grant a default when there’s no valid claim.
“Now some are attaching basically every credit card bill from beginning to end of the account, which is a real storage issue for us,” says Mayne, who in private practice had represented banks in debt collections before the debt-buying industry grew huge and when local lawyers represented original creditors. “Thus pleadings are huge.” So the court recently set a 10-page limit, with copy on both front and back.
Astoundingly, Mayne has presided over just two debt-collection trials in her 10 years on the bench. Many cases end in default judgments and, Mayne says, “if a defendant shows up for trial, I’d say it’s generally nonsuited, and if they ask for a bill of particulars and supporting documents, they’re mostly nonsuited, rarely tried.”
Publicly traded debt buyers’ financial statements indicate that litigation is becoming more and more necessary, while at the same time the courts might be less hospitable. In its 10-K annual report for 2014 filed with the U.S. Securities and Exchange Commission, SquareTwo Financial Corp., whose debt-collection arm is Cach, noted that: “As our industry has increased its use of legal collection efforts significantly over the last several years, we have witnessed the imposition of enhanced evidentiary requirements in excess of those required for claims brought by other entities other than debt purchasers, and more consumer-friendly behavior from judges and courts in various jurisdictions.”
In San Antonio, Texas, for example, PRA was sanctioned by a nonlawyer justice of the peace last December. The judge dismissed its case with prejudice for improperly embedding questions in its initial petition that, if answered affirmatively by an unsuspecting defendant, would prove up its case. That practice ended in 2013 under new legislation that otherwise was debt-buyer friendly.
Carla Sanchez-Adams, a staff attorney with Texas RioGrande Legal Aid, says she informed the judge that Portfolio Recovery Associates files thousands of petitions around the state and knew better.
“After the case closed, they sent my client a letter demanding payment, and I had her write back telling them the case was dismissed with prejudice, and attaching the final order,” Sanchez-Adams says. “Their disputes department replied that she had offered no new facts and must pay. I might be suing them.”
A PRA spokeswoman says the firm’s policy is to not comment on litigation.
Texas is one of several states, including Arizona, Arkansas and Tennessee, that in recent years have made it easier for debt buyers to collect or have protected already friendly situations, according to Lisa Stifler, policy counsel for the Center for Responsible Lending in Durham, North Carolina.
That state took the national lead against debt-buyer litigation practices in 2009, enacting a statute requiring more documentation and “reasonable verification” of a debt. Recently, though, opponents—including industry lobbyists—began pushing a bill to reverse the law, ironically saying the state needed to get in line with the rest of the country.
“From our perspective, North Carolina was out in front in terms of passing a law that helped curtail some of the abuses or problems,” says Kevin Anderson, senior deputy attorney general in the North Carolina Department of Justice. “What we’re seeing now is that other states are taking or considering similar action. So we don’t think bringing us back in line with states that haven’t enacted laws that serve as well to protect consumers is the way to go.”
Indeed, some significant efforts are going even further than North Carolina’s.
Benshoof, the Los Angeles litigator, didn’t walk away after gaining some benefit for the pre-screened pro bono client sent to him by Public Counsel, the public interest law firm of the Los Angeles County and Beverly Hills bar associations. He still works on the underlying issue that puzzled him so, joining with California’s attorney general and others in an ongoing effort to prevent abuses in the suddenly huge, multibillion-dollar industry built mostly on credit card debt stemming from the Great Recession.
California, through legislation, and New York, through rules issued by the state’s chief judge, have taken the strongest steps among an increasing number of states seeking to curtail abuses in debt-buyer cases. Most of the efforts focus on the ease of getting default judgments and the need for more documented proof of debt—more than the spreadsheet Benshoof saw.
California enacted the Fair Debt Buying Practices Act in 2013. In a hearing during the bill’s markup, the chair of the state assembly’s Committee on Banking and Finance noted in a prepared statement that “California’s courts are swamped with debt-collection lawsuits at a time that could not be worse, given recent court closures and the fiscal crisis facing our judicial system.”
The legislation, in effect, overturned a 2012 decision by the Appellate Division of the Los Angeles County Superior Court in HSBC Bank Nevada v. Aguilar that upheld the “books of account” evidence. One of the bill’s co-sponsors, state Sen. Lou Correa, was wrongly identified and targeted for someone else’s $4,000 debt, subjected to a default judgment and faced a court order to garnish his wages.
The new law was phased in, taking into account the fact that debt buyers had already purchased inventory that might be voided by the new requirements. It applies to debt sold or resold after Jan. 1, 2014.
“We negotiated that bill for three years with the attorney general [a sponsor of the legislation] and we ended up supporting it,” says Stieger of DBA International. “It reached that place where it provided consumer protection without being so onerous that you couldn’t collect on a debt.”
Benshoof, however, can’t live with how it is playing out so far. He has notified some courts that his firm’s own unscientific survey of their dockets indicates one early problem: When filing complaints, debt buyers aren’t disclosing when the debt was purchased, thus possibly triggering the new statute’s more rigorous scrutiny.
“We also believe that clerks still are processing default judgments, and they shouldn’t be because there is still too much reliance on affidavits and not enough information is disclosed,” Benshoof says. The law’s more comprehensive and detailed requirements for proof would go unmet if that happens, he explains, adding that he believes the law’s attempt to get beyond the old common-law book-of-accounts standard requires judicial determinations.
Full implementation of its comprehensive scope might require significant case-by-case scrutiny from judges, thus increasing their load. But Benshoof has proposed a fix, and he says some courts are considering it. His firm developed a checklist of facts, based on requirements in the statute, that clerks could use to winnow cases filed by debt buyers without wandering beyond their ministerial function and encroaching on a judicial one.
The forms would ask debt buyers a series of questions that otherwise would require a judge’s purview to ascertain the validity of, for example, balance at charge-off (when the creditor declares the debt is unlikely to be collected), along with an accounting of any fees or interest; date of default or last payment; charge-off creditor’s name and address, and the account number; names and addresses of all previous purchasers of the debt; and attachment of the original contract or similar evidence of the consumer’s agreement to the debt.
“I’ve gotten good feedback from some judges,” Benshoof says.
NEW YORK RULES
On the heels of California’s legislation, New York Chief Judge Jonathan Lippman announced adoption of Unified Court System rules in September 2014 to stem unwarranted default judgments in debt-buyer cases, saying the judiciary “has an obligation to prevent inequitable debt-collection practices in the courts.”
The rules are similar to California’s statute. Debt buyers filing lawsuits must provide affidavits—by individuals with personal knowledge of the accounts—from original creditors and all subsequent buyers, and they must attach copies of key documents. They must affirm that the debt is not time-barred and give the court an additional notice of the lawsuit that the court then will send to the defendant where the process was served. If that notice is undeliverable, there can be no default judgment.
As in California, the rules for default judgments were phased in for debt buyers. They initially applied to debt purchased from an original creditor on or after Oct. 1, 2014, and in July applied in all debt-buyer cases no matter when the debt was acquired. The new rules closely follow those issued last December by New York’s Department of Financial Services.
“We can live with it,” says Needleman, president of NARCA, which along with DBA International represented the interests of debt collectors and debt buyers in working with the department.
“I’m not so sure,” says Benshoof, who has reviewed New York’s new procedures and checklist. He believes a deeper-diving checklist is needed. “Clerks aren’t trained in evaluating evidence. Judges are.”
The New York court system disagrees. The form affidavits, says spokesman David Bookstaver, “require plaintiffs to allege a whole litany of essential facts … and append various types of documentary proof,” adding that “clerks have been trained concerning the rules and mandated affidavits.”
Documentation is key to much of the change. Part of the problem (before increased digitization of data in recent years) was the added cost for debt buyers when they asked for more documentation. The greater the effort on the seller’s part, the higher the price. So the transfer of records was minimal, and many courts didn’t mind.
Now, says Stieger, “documentation is leaps and bounds better, vastly improved since 2008 and 2009. A lot of what the industry is accused of, being bad for this or that, is not the way things are done now.”
Yet the courts sometimes need to catch up technologically. New York, for example, still relies heavily on paper files and folders.
“There has been a huge backlog as far as putting newly filed documents into folders is concerned, and that’s a problem for consumers and litigants,” says Carolyn Coffey, supervising attorney at MFY Legal Services, which provides free representation to underserved residents of New York City.
MFY sent interns to courts around the city to review applications for default judgments filed after the new law went into effect. “We were not able to look at a single one because they are so far behind in filing them,” Coffey says. “They’re in stacks on desks and counters.”
Faced with pushback by courts and others, as well as headline horror stories, the debt-buying industry has worked to improve its methods and practices, as well as its image.
All 575 or so members of DBA International must be certified by March 2016 through a training program to ensure compliance with state and federal rules and laws on matters such as documentation and handling complaints. To qualify, a company must have a compliance officer (often the owner) who takes 24 hours of continuing education credits in ethics and issues, and another 24 hours every two years.
“It’s not just about doing it right but having a culture of doing it right,” Stieger says of training aimed at the higher-ups. They also must agree to third-party audits of their adherence to the program. “It establishes the outside looking in, and not just saying members are compliant.”
Stieger, DBA’s top staffer since 2011, who before that held the same position for 10 years with the California Association of Collectors, adds, “We believe in appropriate consumer protections—no harassment, no abuse—but we don’t want barriers put up that are essentially and arbitrarily to prevent collection of legitimate debt.”
The details still are being worked out. The CFPB is expected to draw a number of bright lines when it releases comprehensive new rules concerning debt buying and debt collecting.
But the testing ground, Benshoof believes, will be through common law, state by state.
This article originally appeared in the November 2015 issue of the ABA Journal with this headline: “The Debt Buyers: Lax court review and a ravenous industry are burying defendants in defaults.”