The Return of Debtor's Prison

Collection agencies use the criminal justice system to pocket credit card debts.

According to Michael Klozotsky, managing editor of the trade publication insideARM.com, debt collectors contact consumers approximately four billion times a year. With so many contacts, there are bound to be complaints. In 2009, the Federal Trade Commission (FTC) received 88,190 consumer complaints about third-party debt collectors. More than 2,500 of these involved collectors who used threats of violence, or actual violence, while plying their trade. Another 11,505 involved false threats of arrest or property seizure. Approximately zero involved one of the more egregious aspects of debt collection: the way the industry outsources collection efforts to the civil court system, using taxpayer money and government force to strong-arm nickels from low-level deadbeats.

"In 2007, third party collection agencies returned over $40 billion to original creditors via collection efforts," Klozotsky tells me. He's making a case for the virtues of debt collection, and this is his most persuasive talking point: Those recovered billions increase the availability of credit to all consumers and help keep interest rates in check.

But the persistent phone calls and dunning letters that collection agencies deploy on debtors only pack so much punch. More and more, creditors are retaining the services of attorneys to file lawsuits on their behalf in civil court. At an FTC roundtable in 2009, Ira Leibsker, a Chicago collection attorney, estimated that there were "probably tens of millions of lawsuits" underway at that time. That same year, a single company, Encore Capital Group, filed 375,000 suits in the United States. According to "Debt Deception," a report published by the Legal Aid Society and several other advocacy organizations in May 2010, the 26 largest debt buyers in New York City filed 457,322 lawsuits from January 2006 through July 2008.

This huge infusion of cases exposes thousands of individuals to a process that overwhelmingly favors plaintiffs. Indeed, in debt collection cases, you're basically guilty until proven innocent.

Part of the problem stems from the way the debt buying industry has evolved over the last 20 years. As recently as the early 1990s, many credit card issuers made little effort to collect on their past-due accounts. If a cardholder missed a payment or two, in-house collection efforts would generally follow. But when a cardholder hadn't made a payment in 180 days, issuers tended to "charge off" the delinquent account against earnings, settle for the tax break, and pursue collection efforts no further.

Now there are companies that purchase portfolios of delinquent debt for pennies on the dollar, then attempt to collect. According to "Debt Machine," a report produced by the National Consumer Law Center, debt buyers bought receivables worth $6 billion in face value in 1993. By 2005, that number had grown to $110 billion. Debts migrate from seller to buyer, often with very little information attached to them. "What they're buying is a spreadsheet full of data: names, addresses, account numbers, and balances," says Fred W. Schwinn, an attorney at Consumer Law Center, Inc. in San Jose, California. Applications, original contracts, transaction histories—plaintiffs don't need any of these documents to file a lawsuit. "You don't have to attach assignment documents of any kind," says Schwinn. "You just say, 'I bought an account [with a balance of] $10,000. This person owes me the money.' You file the complaint, you get service on the defendant, and the courts will grant a judgement on that."

In the bulk of these cases, defendants don't show up and the judge simply issues default judgments against them. In many instances, they fail to show because they're hoping haplessly to avoid paying debts they owe. In others, they simply don't know they're being sued. "I get people in our office every week who say, 'My paycheck just got garnished and I've never been served for anything,'" says Schwinn. "Come to find out, they were substitute-served at an address they haven't lived at in three or four years. The processor knocks on the door and asks for So-and-So, and the person says, 'I never heard of that person.' And the processor just drops the paperwork on the porch and walks away."

In the early years of America, "debt was an inescapable fact of life," the historian Bruce H. Mann writes in Republic of Debtors, his 2002 account of how the new nation reconciled its ideals of "republican independence" with the pervasive indebtedness that plagued its citizens. Over time, he shows, insolvency shifted in meaning "from sin to risk, from moral failure to economic failure," and bankruptcy laws and the eventual abolition of debtor's prisons offered the insolvent a chance to free themselves from past failures and misfortunes.

While this shift in meaning applied more to commercial debts than personal ones, we see its echo in today's statutes of limitations on credit card debts. Simply put, America doesn't want you to stay in debt forever. While statutes of limitations differ from state to state, more than half give creditors just three to five years to sue debtors for non-payment. If they miss that window, a debtor is under no legal obligation to repay
his debt.

If a creditor sues and obtains a judgment, however, any ideals of republican independence, fresh starts, and forgiveness quickly go out the window. In California, for example, judgments are enforceable for 10 years, then renewable for another 10 years, then renewable after that under certain conditions. Interest accrues at 10 percent per annum, wages can be garnished, bank accounts frozen, property seized. A debt originally incurred by someone whose name is similar to yours can become a lifelong commitment, simply because you ignored a few letters from a company whose name you didn't recognize that said you owed it money. That's a worst-case scenario, but as cases get rubber-stamped by judges and clerks auto-piloting their way through the daily deluge of lawsuits, it happens.

Then there's an unfortunate fellow in Kenney, Illinois. In January, a judge sentenced him to "indefinite incarceration" until he paid $300 toward a debt he owed to a lumber yard. Originally reported in the Minneapolis Star Tribune, the case is an extreme example of a practice that, while rare, is apparently happening more frequently—the Star Tribune reports that the "use of arrest warrants against debtors has jumped 60 percent over the past four years, with 845 cases [in Minnesota] in 2009."

When a judge issues a judgment against a debtor, the debtor is supposed to complete a financial disclosure form that will provide the information a creditor needs to collect his debt. If the debtor fails to do this, the creditor can obtain a court order compelling the debtor to show up in court to explain why he hasn't. If the debtor fails to show up for this hearing, a judge can issue a contempt of court order and a warrant for the person's arrest.

It's the same process the court system uses to imprison individuals who fall behind on child support. In the mid-1990s, a hospital in Illinois started employing the tactic as well. Over the last decade, at least four people around the country have actually been arrested and at least briefly detained for their failure to pay library fines. Debtors have also been arrested and jailed in Arkansas, Arizona, Illinois, Indiana, Massachusetts, Washington, Florida, and New Jersey. 

While the official charge is contempt of court, judges sometimes set the bail to the exact amount the debtor owes. When he pays it, it can go straight to the creditor's coffers. At a time when the federal government has spent hundreds of billions of dollars to bail out big business, it's a travesty that state and local governments are using the full force of their power to shake down private citizens on behalf of debt collectors—especially when many of those debts have been acquired for less than it costs to incarcerate a small-time deadbeat for a long afternoon, much less indefinitely. 

Contributing Editor Greg Beato ([e-mail]) writes from San Francisco. Follow him on Twitter @GregBeato.