The “discharge injunction” of Section 524 of the Bankruptcy Code is one of the most, if not the most, important features of United States bankruptcy law. Debtors in bankruptcy must complete detailed paperwork regarding their assets and liabilities and either turn over their non-exempt assets to a bankruptcy trustee or execute a payment plan that repays all or a portion of their debt. In return, individual debtors who comply with their obligations under the Bankruptcy Code receive a discharge of their pre-bankruptcy debts, unless those debts are among those that Congress has deemed non-dischargeable (e.g., most student loans, tax obligations, and other such debts). This discharge is enforced by the “discharge injunction,” a prohibition upon any attempt to collect a discharged debt. Creditors who violate the discharge injunction are subject to severe sanctions, including compensatory damages and the attorney’s fees a debtor incurs in remedying the violation of the injunction.
Often, it is easy to tell when the injunction has been violated, such as when a creditor sues a debtor to recover a discharged debt. However, whether a creditor has actively engaged in an effort to collect a debt is sometimes unclear and nothing epitomizes that ambiguity more than the listing of a debt on a credit report.
Under the Fair Crediting Reporting Act, a creditor not only has a duty to provide accurate information to a credit reporting agency but must also correct any information it later discovers is inaccurate. Thus, if a debt is discharged, a creditor should correct its report to account for that fact.
However, sometimes even after a debt has been discharged in bankruptcy, a creditor will fail or refuse to inform credit reporting agencies of the discharge. Most courts to consider the issue do not deem this failure to correct as a violation in and of itself, but instead will find a violation of the injunction where the failure to correct is part of an attempt to collect on the debt. Bankruptcy courts in Kentucky have ruled similarly. Because the listing of an unpaid debt on a credit report can have severe consequences for a discharged debtor, many debtors feel compelled to pay erroneously reported debts, thereby losing the protection of the discharge, which was their entire purpose in filing for bankruptcy in the first place.
Courts have begun to crack down on creditors who fail to update credit reports, particularly large financial institutions. As recently reported in The New York Times, in July, the Bankruptcy Court for the Southern District of New York denied a motion to dismiss filed by Chase Bank USA, N.A. in Haynes v. Chase Bank USA, N.A. This case is a class action lawsuit alleging a systematic violation of the discharge injunction based on Chase’s refusal to correct the plaintiffs’ credit reports by showing that their debts had been discharged. In its motion to dismiss, Chase claimed that it had sold the debt instruments at issue in the case and therefore it could not attempt to collect a debt from the plaintiffs.
The Court rejected that argument for two reasons. First, the plaintiffs had alleged Chase actually kept a percentage of any recoveries on the debt they had sold and therefore it did directly profit from the failure to update the plaintiffs’ credit reports. Second, and more interestingly, the Court found Chase profited indirectly by failing to update the debtors’ credit reports, because it could sell the debts to buyers for a higher value. Thus, the Court found the plaintiffs adequately
“set 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”.
The holding in Haynes has significant ramifications for individual debtors and the financial institutions that lend to them. For debtors, the Haynes case sets forth a framework for them to fight back against creditors that refuse to update debtors’ credit reports. For creditors, the decision presents the risk of liability for failure to correct credit reports, even where the creditor has sold the debt at issue to a third party.
Finally, the reasoning in Haynes diminishes the value of the debt-buying industry as a whole. In today’s economy, the debt-buying industry is a multi-billion dollar business. Buyers of debt often purchase it in portfolios consisting of hundreds or thousands of debt obligations. If any of those debtors had, or later have, their debts discharged in bankruptcy, and the creditors selling the debt do not note the discharge on their credit reports, then the creditors could be liable for violation of the discharge injunction if the debt buyer later takes action to collect on the debt. Indeed, under the logic of Haynes, a pervasive failure to correct credit reports could be deemed an effort to profit from discharged debt in violation of the discharge injunction. Penalties for such violations can be significant, particularly if a class of injured plaintiffs brings claims for violations against a creditor.
While the interplay between credit reports and the discharge injunction is still being sketched out, both creditors and debtors need to be aware of their rights and obligations with respect to discharged debts. In counseling debtors, attorneys need to make clients aware that they do not have to pay discharged debts, and they can rely on the Haynes precedent in fighting attempts to collect them. Counsel for creditors need to advise their clients to be vigilant in monitoring their debt obligations and to make reasonable efforts to update their debtors’ credit reports whenever debts are discharged in bankruptcy.