Last year JPMorgan Chase & Co took New York resident Shady Gergis to court over a few thousand dollars in allegedly unpaid credit card debt.
The facts of the suit were banal, but Chase's case landed in the courtroom of Noach Dear, a Brooklyn, New York civil court judge with a reputation for being tough on collections efforts. Taking no chances, Chase hired pricey white-shoe law firm Alston & Bird to face off against the self-represented Gergis.
In June, Judge Dear threw Chase's suit out. The judge described as "robo testimony" the statements of the bank's document custodian — a 17-year Chase veteran — and made it clear that he believed Chase had failed to present evidence to support the accuracy of its own records.
The case received little attention and ultimately could prove to be merely a populist fluke. Of course, that's what many observers first said when judges began dismissing home foreclosure suits over problems with affidavits and recordkeeping — a trend that eventually mushroomed into the nationwide robo-signing mortgage scandal.
Now, a growing number of judges, state attorneys general, federal agencies, consumer attorneys and academics are concluding that banks may be susceptible to similar claims in other areas of consumer lending, including the credit card market. If banks prove unsuccessful in defending themselves from claims that their records are shoddy, they run the risk of inviting a new regulatory crackdown and legal battles over the validity of claims involving tens of billions of dollars in unsecured debt.
Under normal circumstances, the handling of delinquent consumer loans is fairly straightforward. When consumers fail to pay off such debts, banks write down the balance and try to recoup whatever they can by bringing collections suits against debtors themselves or by selling rights to the debt to specialized collection agencies. The individual debts amount to only a few thousand dollars per consumer on average, but the total sums at issue are large; last year, market leaders Bank of America and Chase each charged off $7 billion in credit card debt.
One silver lining for banks is that they have not been the main focus of documentation dispute so far. Instead, consumer advocates and courts have directed their harshest barbs at the third parties who acquire rights to delinquent credit card accounts and then seek to turn a profit collecting from consumers.
The risks that brand-name banks will themselves get caught up in the dispute appear to be rising, however. As American Banker reported earlier this month, JPMorgan Chase stopped filing collection suits last April amid growing evidence of internal documentation problems. With the template for challenging collection procedures already established in the mortgage market, a broad attack on banks' debt collection practices in other areas of consumer lending could expand rapidly.
"If I were a collector of consumer debt, I'd look at my entire process from start to finish for whether there's an argument to be made that the process is not verifiable," says Christopher Willis, an Atlanta attorney for Ballard Spahr LLP, which specializes in defending banks in consumer lending cases. "I think there is substantial danger."
For banks, the documentation issues pose threats on several fronts. If consumer advocates manage to hobble the ability of collections agencies to win cout judgments against consumers, it would likely reduce what they're willing to pay banks for defaulted receivables. Such bum debt typically sells for only pennies on the dollar, but those pennies add up to billions of dollars.
More aggressive defenses in court and more rigorous rules regarding unscrupulous practices in the second-hand debt market could also complicate and raise the cost of banks' own debt-collection efforts. Another risk is that highly publicized cases of poor documentation and plaintiffs' victories in court could encourage other borrowers to pose legal challenges or simply stop paying.
Missing Records, Unprovable Cases
Willis emphasizes that for banks reviewing documentation practices is purely a prudent risk-management measure; there is no reason to believe the courts will find that substantive documentation failings are widespread, he says.
Consumer advocates argue otherwise, at least for outside debt collection agencies. When banks sell delinquent loans to such firms, its transfer is accompanied by proof of how the debt was created, critics say.
"Banks actually keep pretty crummy records," says Peter Holland, a University of Maryland law school professor who focuses on consumer debt.
No less than the Association of Credit and Collection Officials, an industry trade group, has admitted as much. "[D]ocumentation is often unattainable for a variety of reasons, the most important of which is the creditor no longer has the information or did not have it when selling an account," the association wrote in a 2011 letter to the rules committee of Maryland's Court of Appeals. "Greater discussion is needed to identify the type of proof sufficient to seek a judgment."
Without access to the original creditor's business records and procedures, collections agents cannot truthfully attest to the validity of the debt they're seeking to collect. What's more, unlike in the case of home, when the original amount borrowed is rarely in dispute, there are numerous instances in the public record of debt collectors filing suits involving bogus claims for other types of consumer debt.
"The person [filing an affidavit] doesn't have personal knowledge of the records, even though he says he does," says Charles Debaulm, an attorney for the National Consumer Law Center who has litigated robo-signing involving mortgages and other types of consumer debt. When challenged by a competent consumer defense attorney, "the debt [collections agency] buyer will simply dismiss the suit."
What has worked in the favor or creditors is the fact that defendants rarely show up in court, enabling creditors to win default judgments in most circumstances. However, when lawyers have put up a defense in such suits, they boast of winning the overwhelming majority of even contested cases.
Michelle Weinberg, a Supervisory Attorney at the Legal Assistance Foundation of Metropolitan Chicago, says she's taken on nearly 100 consumer debt cases over the last decade and lost only one.
"Debt buyers know they cannot prove [their claims] if there's someone making proper legal objections on the other side," she says.
Similarly, law students at the University of Maryland's consumer protection clinic claim a nearly undefeated record defending debt collection suits, says Holland, the law professor there who manages their efforts. The clinic's only loss was in a case in which it opposed Chase directly rather than a collections agency.
"Getting judges to focus on the lack of proof in debt buyer cases has taken awhile," Holland says. "But often the exact same kinds of problems exist in the original creditor cases."
Holland and other consumer advocates have been making a market lately defending such cases in important venues. Missouri's Supreme Court threw out a credit card debt judgment Jan. 17. In doing so it sided with the defendant, who argued debt collector CACH LLC could not claim as its own business records originally created by now defunct Washington Mutual. The ruling appears to indicate that debt buyers will have a much harder time making cases in the courts in Missouri. Appellate courts in Texas, Pennsylvania, Illinois, and Wisconsin have raised similar objections over the past few years.
ACA, the trade association for the collections industry, concedes that there may be room for improvement in legal documentation. "We've always said that the debt buying industry is relatively new," says David Cherner, head of the group's state lobbying efforts. "A lot of banks and credit card companies are beginning to make documents digital so they can transfer. I think over time this problem is going to resolve itself."
A Template for Bank Trouble
False documentation has already gotten third-party collectors of credit card debt into legal trouble that is reminiscent of bank's robo-signing woes. An employee for Asta funding testified that she churned out affidavits every 13 seconds. An employee at Collect America (now known as SquareTwo Financial) stated in a deposition that if a debtor's file said the moon was made out of green cheese he would formally vouch for it. A third firm, Portfolio Recovery Associates, had to promise it would stop using affidavits signed by Martha Kunkle, a woman who had been dead 15 years. Amazingly, it was subsequently caught using Kunkle's name again.
"What was true with mortgage foreclosures is true here," says Thomas Donnelly, a law professor at Chicago's Loyola University and a part-time Cook County judge. "The system itself, the way it's set up, is rife with the possibility that things could go wrong."
Some consumer advocates, says Ballard Spahr's Willis, would like to "put personal knowledge and review requirements on affidavits that would make it essentially impossible to do any large volume of collection activity … The possibility that consumer attorneys or regulators will hold banks responsible for third-party collection failures may be a greater danger."
In an untested but plausible worst-case legal scenario for banks, they could be forced to defend themselves against charges that they knowingly sold poorly documented accounts to outside agencies and are therefore responsible for their worst abuses, attorneys say. One theory laid out in the Oklahoma Bar Journal last month has banks facing civil or criminal charges under the Racketeer Influenced and Corrupt Organizations Act for selling dubious accounts to entities that file false documentation.
Early Legal Trouble
Even if RICO suits are not forthcoming, the decades-long tussle between consumer advocates and the collections industry appears to be tilting in favor of the former.
Ballard Spahr's Michael Waldron, who has spent several years trying to contain the regulatory fallout from mortgage robo-signing, says that the industry needs to adjust to an environment of regulatory and judicial skepticism.
"Gone are the days when the collector or the servicer was given deference," Waldron says. "I'd hang my reputation on there being several iterations of this in asset classes besides mortgages. The issue is how consumers are treated as assets are serviced and what the process looks like once the consumer goes into default and the stakes are higher."
A review of New York state cases indicates a vanguard of judges has become increasingly wary about documentation issues. In Chase v. Cardello, Rochester County Judge Philip Straniere lambasted Chase in 2010 for trying to execute the "bulk" transfer of credit card debt to "an unlicensed, out of state debt collector" without attempting to notify borrowers.
In a separate ruling the same year, Straniere found problems extended to Chase's own collection efforts and dismissed 150 Chase collection cases that relied on dubious affidavits. The documents "appeared to be signed in large numbers by only a few individuals," the judge wrote in an opinion first cited last year by the Wall Street Journal.
Other judges in the state have cited Straniere's rulings in Chase cases.
If there is a bright side to consumer debt documentation concerns it's that banks have a relatively straightforward way address them, says Waldron. It involves getting their systems for handling defaulted credit cards up to the standards regulators are now demanding for mortgages.
"At the end of the day, the mortgage industry is the most heavily regulated out there," Waldron says. "There's always been more stringent requirements around collecting money for someone's home."
Upgrades would no doubt increase costs, but based on the changes Waldron's seen in the mortgage market, they're bearable, he says.
"It's a different number crunch than what the industry has historically been used to but people will figure it out," says Waldron.