Banks using credit scores to recoup bankruptcy-discharged debt

Going through bankruptcy as an individual is designed to be unpleasant. A personal bankruptcy generally has a dramatic negative impact on a credit report and can put some loans out of grasp for up to a decade. The financial tool is designed this way to ensure that it is only used as a last-ditch resort by those who are so far in debt that a fresh start is the only option.

According to a new report from The New York Times’ Dealbook, however, some banks are using credit reporting procedures that, at best, cause significant accidental harm to already vulnerable bankruptcy filers. At worst, these procedures represent a cynical attempt to force these people to pay off debts that they no longer legally owe.

Trapped in debt
What is occurring, the news source reported, is this: Despite a legal obligation to update borrowers’ credit reports to reflect the discharge of debts after a bankruptcy filing, banks like JPMorgan routinely fail to do so. Borrowers interviewed by the Times said that the banks would refuse to fix the “mistakes” unless they paid the balances of the discharged debts. Because of what depends on maintaining a good credit score – homeownership, the ability to obtain loans, consideration for jobs and more – many of these former borrowers do pay.

Unfortunately, despite this practice being illegal, those who have recently filed for protection under Chapter 7 of the bankruptcy law do not tend to be aware of this fact. Even those who might be aware of such a practice’s illegality are not likely to be in a financial position to mount a serious legal challenge.

Dealbook reported that several current and former bankruptcy judges suspect that these “errors” in the banks’ reporting are not clerical mistakes at all, but debt-collection tactics. The banks in question have moved to throw out a recent class action lawsuit on behalf of these borrowers, arguing in part that they have no interest in recouping payments on these debts because they typically sell them off to third-party collectors anyway. However, U.S. Bankruptcy Judge Robert Drain, who is presiding over the case, pointed out that the banks’ ability to sell these stale or discharged debts is dependent upon their willingness to ignore their discharge under bankruptcy law.

Using this logic, Drain denied the motion to dismiss, according to court documents.

“I believe the complaint sets forth a cause of action that Chase is using the inaccuracy of its credit reporting on a systematic basis to further its business of selling debt and its buyer’s collection of such debt,” Drain wrote in his opinion