Personal Finance

Feds crack down on debt collection 'factory'

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Old debt doesn't always go away. Collection companies buy it for pennies on the dollar, hoping to make a profit by collecting the uncollectable. But some of these firms use illegal and abusive tactics to get the job done.

Earlier this week, the Consumer Financial Protection Bureau announced it had filed a lawsuit against Frederick J. Hanna & Associates, a Georgia-based law firm it accuses of operating a "factory" that churned out more than 350,000 debt collection lawsuits since 2009.

According to the CFPB complaint, these lawsuits were filed without taking even the basic checks to determine whether the people they sued actually owed the debts.

The company denies all of the allegations. In a statement, managing partner Joseph Cooling said that the firm "takes great pride in its commitment to compliance with all consumer protection laws."

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Consumer advocates tell CNBC they deal with so-called debt collection "lawsuit mills" on a regular basis.

"Frankly, it's a business model for these debt-buying companies and the law firms that represent them," said Claudia Wilner, senior staff attorney with the New Economy Project, an advocacy group in New York.

"The debt buyers find it very lucrative to file a lot of lawsuits at once, without doing a lot of work," said Margo Saunders, staff attorney with the National Consumer Law Center. "They're making so much money by violating the law, there's little reason for them to comply."

The law firms using this mass production technique get an electronic spreadsheet from the creditor—typically a bank or credit card company—that lists a person's name, address, Social Security number and amount owed. They have automated systems, similar to a mail-merge process, that prepare hundreds or thousands of complaints at once.

"They're basically robo-signed and there's no real checks going on to ensure that what they're alleging is accurate and has a factual basis," Wilner said.

Last month, a U.S. District Court judge in New Jersey ruled that a debt collector had violated the law when it sued Daniel Bock in order to collect an old credit card debt. The filing process relied almost entirely on automation and non-attorneys. Judge Kevin McNulty said there is nothing wrong with that, but in his ruling he wrote:

"… it is possible for reasonable people to disagree as to what constitutes reasonable attorney review. But whatever reasonable attorney review may be, a four-second scan is not it."

Critics say the companies that crank out lawsuits this way hope for default judgments that allow them to garnish people's wages and freeze their bank accounts. They realize many people never receive a notice about the lawsuit—and even if they do, they often don't know how to respond.

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The collections industry defends itself

Mark Schiffman, vice president of public affairs for The Association of Credit and Collection Professionals (ACA International), defends the industry and calls the criticism unfair.

"This is not an industry that has run amuck, he said. "The vast majority of these agencies are following the rules and those who break the law need to be held accountable."

Schiffman told CNBC that the industry is vehemently pro-consumer. The real problem, he said, is how much unpaid debt there is in the U.S. right now.

In a soon-to-be released report, ACA International found that there are 1 billion active collection accounts worth $756 billion.

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The CFPB is considering new rules for the debt collection industry. Consumer advocates would like to see the agency require every company involved in selling, buying, or collecting debts to ensure the integrity and accuracy of the information used in the process. They hope that if these companies are held liable for inaccurate or unverifiable information, it will clean up the industry.

ACA International supports such a "clarification" about what collectors need to do. Schiffman said the industry only wants to collect what is rightfully owed.

What to do if you get notice of a debt collection lawsuit

Don't ignore it. It won't go away. Contact your lawyer. If you don't have one or can't afford one, see if you can get help from a legal aid attorney.

"Simply filing a response that denies the complaint will force the debt buyer to prove the case and typically they cannot," explained NCLC's Margot Saunders. "And don't take anything said in a verbal conversation as a promise, it must be in writing."

Here are some resources that may be helpful:

—By CNBC contributor Herb Weisbaum. Follow him on Facebook and Twitter @TheConsumerman or visit The ConsumerMan website.