Sears to plead guilty and pay $60 million in credit-card reaffirmation fraud
By Lynda Edwards • Bankrate.com

A subsidiary of Sears, Roebuck and Co. will plead guilty to criminal fraud and pay a fine of $60 million for illegally pursuing debts from bankrupt credit-card customers, the giant retailer announced Tuesday.

In a plea agreement with the federal government, Sears Bankruptcy Recovery Management Services will admit guilt to one count of bankruptcy fraud for failing to file before a bankruptcy judge the debt-collection, or reaffirmation, agreements signed by credit-card customers who sought Chapter 7 protection.

Sears, based in Hoffman Estates, Ill., already has paid more than $180 million in restitution to about 188,000 debtors and paid $40 million in civil fines to 50 state attorneys general in connection with the scheme.

The agreement between Sears and the U.S. Attorney is subject to court approval. A hearing date has not yet been set.

The resolution of the United States Attorney's investigation will conclude the last in a series of legal actions surrounding Sears' failure to file some reaffirmation agreements  the company reached with Chapter 7 bankruptcy debtors.

Bankruptcy law loophole
Reaffirmation is really a loophole in bankruptcy law. A consumer files for bankruptcy because his survival supposedly depends on the court wiping out his debts. Designed as a last resort, it's a financial salvage attempt tinged with shame.

Chapter 7 bankruptcy releases the filer from all debt after he sells his belongings to pay what debts he can. (Some property, such as a house, is exempt and can't be seized and sold). But a creditor can convince the bankruptcy filer to "reaffirm," agreeing to pay an unsecured debt such as a credit card, rather than letting the court wipe it out. Creditors are required by law to submit reaffirmations to the debtor's bankruptcy court for approval. The debtor then has 60 days, during which he can change his mind and withdraw it.

Legally, a debtor cannot be forced to reaffirm, and judges rarely approve reaffirmation agreements, bankruptcy experts say. But that isn't always what creditors tell bankruptcy filers. In October, the Senate passed a bill protecting Chapter 7 reaffirmations. Banking lobbyists spent $40 million on a campaign to push the legislation and block a House proposal to outlaw them. President Clinton sought language curbing misinformation and bullying by creditors.

In 1997, Sears, Federated Department Stores and GE Capital settled multimillion-dollar class-action lawsuits of consumers who claimed they had been tricked or bullied into reaffirming credit card debts. Sears officials issued a statement this week that says, in part, the agreement has yet to be approved by a judge. A federal investigation found that Sears failed to file reaffirmations for court approval between 1992 and 1997. Still, banks argue that reaffirmation prevents greedy yuppies from using bankruptcy to bail out on frivolous bills -- and running up costs for all card holders.

But consumer advocates paint an equally compelling picture of bankrupt debtors they most often see victimized by reaffirmation. Trapped in a world of back-breaking jobs, rust-bucket cars, taped glasses, permanent coughs and limps, with bosses who fire them on five minutes' notice, they reaffirm debts because they don't understand their legal rights. A debtor often reaffirms a car loan, fearing the repo man. Or he envisions a store manager invading his home to grab a half-paid-for refrigerator charged on his card.

Reaffirmation can ruin a fresh start
Attorney Tobey Daluz has a unique perspective on the controversy. She represents big, unsecured corporate creditors for her white-shoe Philadelphia law firm and advises bankrupt indigents pro bono at the Consumer Bankruptcy Assistance Project. "Don't be panicked into thinking reaffirmation will save you," she advises frantic debtors. "The reality of bankruptcy is some hard years but, unless you reaffirm, also the chance at a fresh start."

In most states, if a filer is current in his payments, his car can not be repossessed when he files bankruptcy. As for the fridge scenario, it's illegal for a creditor to enter a debtor's home without permission. A filer can return property on which he owes money and make no further payments. If the payments equal the current market value of an item that's been charged, the bankruptcy court often categorizes it as exempt property that the filer gets to keep. (How much property is protected by exemption varies according to state law.)

The debtors suing Sears claimed they were lied to about these rights and threatened. On April 9, 1997, Sears agreed to reimburse an estimated 325,000 credit card reaffirmations plus finance charges and late fees, 8 percent interest and a $100 gift certificate to each debtor involved. Sears was to pay $240,000 to state programs educating bankrupt consumers about their rights, and tell credit bureaus to correct negative reports related to debtors who fell behind in reaffirmation agreements.

A debtor who reaffirms may be heeding the axiom of financial columnists; the cure for a bad credit rating is to incur one more debt then pay it off in installments. Credit bureaus note bankruptcies for 10 years. Is reaffirming a fix for that black mark? Visa USA is airing radio ads in 20 cities warning card holders that bankruptcy makes it harder to get a job, rent an apartment or even buy insurance.

"... it's a terrible idea to reaffirm"
The ads urge overextended customers to visit the nonprofit, nonpartisan National Foundation for Consumer Credit for guidance. "Well, I don't know if this is what Visa wants to hear, but in the vast majority of cases it's a terrible idea for a bankrupt filer to reaffirm," says foundation education director Barbara Morgan. "It doesn't make much difference to credit bureaus that we can tell. It defeats bankruptcy's purpose of wiping the slate clean for a fresh start."

Morgan adds: "The only example I can think of when reaffirmation might be useful to the debtor is if he travels on business constantly and his company refuses to prepay his rental car and hotel so he needs a card for that."

Chapter 7 bankruptcy was intended for the low-income or jobless debtor. Individuals earning a living wage file Chapter 13 bankruptcy, meaning they pay most of their debts from their wages in 3 years to 5 years under court supervision.

Despite our nation's low unemployment and job growth statistics, the American Bankers Association found that 70 percent of bankruptcies now filed are Chapter 7, in which credit card debt need never be paid. "Reaffirmation law does protect the industry from affluent debtors abusing Chapter 7 to avoid paying bills," says MasterCard senior vice president William Binzel. "There are debtors filing Chapter 7 earning incomes high enough for them to be in Chapter 13 repayment plans."

A good deal for creditors -- even when it's illegal
And reaffirmation is lucrative for creditors, even in the Sears disaster. Sears told the Securities and Exchange Commission it probably collected as much as $400 million via dubious reaffirmations.

Bank card companies trotted out examples of selfish, deadbeat yuppies when the National Bankruptcy Review Commission examined reaffirmation last year. Commission member Judge Edith Jones, an appellate judge on the Fifth Circuit in New Orleans, recalls the weird case of Orange Beach, an Alabama resort where "a lot of people accumulated huge card debt because they said a man must own a great bass boat and a Jet Ski ... to hold his head high."

Congress appointed the nine commission members -- judges, attorneys and one accountant -- to draft a proposed revision of national bankruptcy law. But reaffirmation had the buttoned-down professionals screaming insults at each other and (in one bad breakfast meeting) coming close to a pastry fight, some sources say. The commission finally approved a proposal to ban reaffirmation in Chapter 7 bankruptcies by a 5-to-4 vote. Judge Jones, an appellate judge on the Fifth Circuit in Houston, wrote the vehement dissenting opinion.

Are the bankrupt victims -- or victimizers
Visa USA calculates that 1.4 million personal bankruptcies in 1997 cost the American economy $44 billion. Visa and MasterCard International are lobbying for Congressional bill HR 3146, which forces bankrupt filers with the median national income ($51,000 for a family of four) into Chapter 13 repayment and protects Chapter 7 reaffirmations. "It's a myth that people filing bankruptcy with big credit card debt are poor," Judge Jones says. "I don't believe being poor automatically makes a person a victim. There's a boom in bankruptcy due to a lack of responsibility, more than lack of income."

But consumer counselors wonder whether journalists, political leaders and financial executives shaping national financial policy have any idea about what living on a low, or even averag,e income is now like. "We're seeing a lot of people like that with big medical bills on their cards, especially with an aging population and employers cutting out, or charging more, for health insurance," says Morgan of the National Foundation for Consumer Credit.

"The other huge trend we've noticed is the fallout from corporate downsizing is still forcing more people into bankruptcy," she adds. "Former middle managers who were grossing $50,000 now get $15,000 managing a McDonald's or running a business out of their basements." For low wage earners, the card is for emergencies in lives that are perpetual crises. Surgery, car and roof repairs, lawyers' fees all go on the card. "The media says there's an economic boom, so they think they'll find a job that will pay off debts. Those jobs and new life aren't coming."

The Consumer Federation of America's research found that the average personal bankruptcy filer is single with an after-tax income of $19,500 and $7,000 in credit card debt. During the bankruptcy commission hearings, banks marshaled heinous examples of credit hogs in this income bracket; brats who charged their student loans, then filed for bankruptcy and the woman who ran up $400 in manicurists' bills to feel better about a job demotion. But when there is so little disposable income, workers mainly use credit cards for emergencies -- surgery, IRS audits and blown car gaskets send them running for their credit cards.

A winning bet for credit card companies
Letting a low-wage customer bloat his debt seems a horrible gamble for credit card companies. Yet the results prove otherwise; last year credit card companies collected $70 billion in interest and late fees while losing $20 billion in unpaid charges. (The Consumer Federation found no evidence that the skyrocketing bankruptcy rate prompted banks to raise credit card fees for good customers.) "It is hypocritical of these creditors to complain they need bankruptcy relief," a federation report declared. It recommends "publicly shaming" banks that extend crushing debts.

A move to outlaw Chapter 7 reaffirmations
For those who doubt that public shaming would elicit more than a shrug, Rep. Jerry Nadler (D-NY) has introduced HR 3146, a bill that would fine creditors who extend debt past 40 percent of a card holder's gross income, and would outlaw reaffirmations in Chapter 7.

"The well-advised, high rolling -------s will always be able to manipulate the bankruptcy system," says David Lachmann, the House Judiciary Committee aide who helped Nadler draft the proposed legislation. "This would protect the poor hard-working schnook who actually has a sense of shame about bankruptcy. He's the one who can be strong-armed into reaffirmation rather than owe money on his washing machine."

Reaffirmation triggers a host of class and cultural hot buttons as the economy plunges into uncharted waters. "The closest analogy I can think of is welfare reform," Judge Jones says. "And bankruptcy reaffirmation may outpace that in terms of urgency and volatility."

-- Posted: Feb. 11, 1999