In the netherworld of consumer debt, there are zombies: bills that cannot be killed even by declaring personal bankruptcy.
Tens of thousands of Americans who went through bankruptcy are still haunted by debts long after — sometimes as long as a decade after — federal judges have extinguished the bills in court.
The problem, state and federal officials suspect, is that some of the nation's biggest banks ignore bankruptcy court discharges, which render the debts void. Paying no heed to the courts, the banks keep the debts alive on credit reports, essentially forcing borrowers to make payments on bills that they do not legally owe.
The practice — a subtle but powerful tactic that effectively holds the credit report hostage until borrowers pay — potentially breathes new life into the pools of bad debt that are bought by financial firms.
Now lawyers with the U.S. Trustee Program, an arm of the Justice Department, are investigating JPMorgan Chase, Bank of America, Citigroup and Synchrony Financial, formerly known as GE Capital Retail Finance, suspecting the banks of violating federal bankruptcy law by ignoring the discharge injunction, say people briefed on the investigations who asked not to be identified by the New York Times.
The banks say that they comply with all federal laws in their collection and sale of debt.
Still, federal judges have started to raise alarms that some banks are threatening the foundations of bankruptcy.
Judge Robert D. Drain of the federal bankruptcy court in White Plains, N.Y., said in one opinion that debt buyers know that a bank "will refuse to correct the credit report to reflect the obligor's bankruptcy discharge, which means that the debtor will feel significant added pressure to obtain a 'clean' report by paying the debt," according to court documents.
For the debt buyers and the banks, the people briefed on the investigations said, it is a mutually beneficial arrangement: The banks typically send along any payments that they receive from borrowers to the debt buyers, which, in turn, are more willing to buy portfolios of soured debts — including many that will wind up voided in bankruptcy — from the banks.
In bankruptcy, people undergo intense financial scrutiny — every bank account, bill and possession is assessed by the bankruptcy courts — to win the discharge injunction, which extinguishes certain debts and grants a fresh start. The heavy toll of personal bankruptcy, which can tarnish a credit report for a decade and put some loans out of reach, is worthless, bankruptcy judges say, if lenders ignore the discharge.
At the center of the investigation, the people briefed on it said, is the way banks report debts to credit reporting agencies. Once a borrower voids a debt in bankruptcy, creditors are required to update credit reports to reflect that the debt is no longer owed, removing any notation of "past due" or "charged off."
But the banks routinely fail to do that, according to the people briefed on the investigation. The errors are not clerical mistakes, but debt-collection tactics, current and former bankruptcy judges suspect. The banks refuse to fix the mistakes, the borrowers say, unless they pay for the purged debts. And many borrowers end up paying, given that they have so much at stake — the tarnished credit reports showing they still owe a debt can cost them a new loan, housing or a job. The Vogts, a couple in Denver, for example, paid JPMorgan $2,582 on a debt that was discharged in bankruptcy because they needed a clean credit report to get a mortgage.
JPMorgan and the three other banks declined to comment for this report.
If the United States Trustee's office determines the banks have violated bankruptcy law, say the people briefed on the investigations, they could audit the lenders and extract steep penalties.
The costs are more immediate for people like Bernadette Gatling, a 46-year-old hospital administrator whose credit report is still marred by Chase credit card debts that were voided in bankruptcy three years ago. Since being laid off in March, Gatling said she has lost one job opportunity after another because potential employers pull her credit report.
"It's just so unfair," she said.