Consumer Protection in Outsourcing:
Liability of Data Processor for Consumer's Loss of Credit due to Erroneous Debt Collection Procedures

© 2005 William B. Bierce.  All rights reserved.

    In the course of processing data relating to an account receivable, the accounts receivable department of a service provider, or an outsourced debt collector, could make a mistake that costs a consumer his good credit rating and deprives him of access to consumer financing.  What liability does a creditor have when it assigns the unpaid debt to a debt collection agency that erroneously pursues credit-harming activities?  In a May 2005 court decision, a consumer alleged theories of defamation, negligence, gross negligence and punitive damages for an alleged violation of New York State common law. 

    The court found that, as to a company having a direct relationship with the consumer, the Federal Debt Collection Practices Act, 15 U.S.C.§ 1692 et seq. ("FDCPA") did not apply. 

    Only one claim survived a motion to dismiss for failure to state a claim.  The case underscores basic principles in liability relating to outsourcing of debt collection, finance and accounting ("F&A") services and customer relationship management ("CRM"). 

    Background.   An ambulance service transported an accident victim to a hospital.  The ambulance service allegedly failed to correctly note the accident victim's address at the time of his admission to the hospital.  The ambulance service issued several invoices to an erroneous address.  The accident victim failed to pay.  He claimed that, despite never having received any invoices, the ambulance service was liable when its debt collection service, an independent contractor, allegedly reported the accident victim's debt to the three credit reporting agencies as being "seriously past due date/ assigned to attorney for collection, or credit grantor's internal collection department." 

    The ambulance service failed to send any invoices to the accident victim's insurer, even though it had the insurer's address.  Once it turned the case over to the debt collector, the ambulance company never telephoned the accident victim, even though it had the correct phone number.

    As a result of the debt collector's actions, the accident victim alleged that he "received denials and reductions of credit from several services, all based upon credit reports containing the [debt collector's] bad debt allegation."

    Legal Issues in Debt Collection: Liability of the Creditor and the Creditor's Debt Collector

    FDCPA.  A provider of goods and services to customers is not liable directly under the FDCPA for its own efforts to collect debts from its customers.  The FDCPA applies to debt collectors, not to creditors.  15 U.S.C. 1692a(6).  Accordingly, the accident victim alleged violations of state common law of torts.

    Defamation of Credit.  Consumer claims of defamation must include certain basic elements under New York common law.  To state a valid claim for defamation of credit, the victim must plead the following elements:

1. a false and defamatory statement of and concerning the plaintiffs was uttered by the defendants;

2. the defendant published such statement to a third party;

3. the defendant was at fault; and

4. the plaintiffs were injured as a result of such faulty action. 

    The consumer whose credit is injured due to a debt collector's reliance upon an erroneous collection record does not have a claim for defamation of credit.   To state a claim against his creditor, the consumer must allege that the creditor published a false and defamatory statement.   Where the creditor's debt collector made false statements to credit agencies, the creditor was held not liable (even though the debt collector was also an agent for collection).  Witherwax v. Transcare Inc.,__ N.Y.S. 3d __,  NYLJ May 5, 2005, p. 19, cols. 1-4, at col. 2 (N.Y. Co. Supreme Ct. 2005) (Justice Shafer).   In that case, the creditor did not instruct the debt collector to "go after" (or otherwise discriminate against) the consumer because he does not pay his bills.   The only statement made by the creditor to the creditor was in relaying the existence of the debt.

    Further, under the common law principle of defamation, the doctrine of qualified privilege allows certain statements that would otherwise be defamatory.  New York courts recognize "[i]t is an established rule that communications made by one person to another upon a subject in which both have an interest are protected by a qualified privilege."  Witherwax, id, citing Brennan v. Granite Equip. Leasing Corp., 60 A.D.2d 877 (2nd Dept. 1978).

    Negligence.  The definition of a claim of negligence is basic to common law torts.  To state a valid claim for negligence, the victim must show:

1. the defendant owed him a duty, or obligation, recognized by law;

2. the defendant breached that duty;

3. a "reasonably close causal connection between [defendant's] conduct and the resulting injury; and

4. loss or damage resulting from that breach.  Witherwax, id., citing McCarthy v. Olin Corp., 119 F.3d 148, 156 (2nd Cir. 1997); Becker v. Schwartz, 46 NY2d 401 (1978). 

    A consumer states a valid claim of negligence against his creditor where he alleges that the creditor negligently furnishes its debt collector, an independent contractor acting as the creditor's agent, with erroneous information knowing that the agent would rely on and use that information in pursuit of the creditor's claim against the consumer.

    Vicarious Liability for Negligence.  The consumer may have a cause of action against his creditor for the negligence of the creditor's independent debt collector.  "Engaging an outside entity to collect a debt does not excuse [Transcare, the ambulance service] from the wrongful acts of its agent committed during the course and scope of its agency."  Witherwax, at p. 19, col. 3, citing Parlato v. Equitable Life Assurance Soc. of New York, 749 NYS2d 216 (1st Dept. 2002). 

    Damages in Negligence.  A consumer makes a sufficient claim of negligence when he alleges damage to his credit reports and alleged emotional distress and embarrassment resulting from the reduction and/or freezing of his credit lines.  Witherwax, id.

    Gross Negligence.  To state a claim for gross negligence, the injured party must not only allege the elements of negligence.   In addition, the injured party must claim and show that the defendant recklessly disregarded the facts.  See Credit Alliance Corp. v. Arthur Andersen & Co., 65 NY2d 536 (1985), cited in Witherwax, id.   Generally, recklessness implies a disregard for the truth or falsity of the statement and the existence of legally protected interests of the plaintiff.

    Punitive Damages.   While there is no independent cause of action for punitive damages.   "Punitive damages are not recoverable for ordinary negligence, as their purpose is not to remedy private wrongs [between the injured party and the wrongdoer], but to vindicate public rights.  Rocanova v. Equitable Life Assur. Society of U.S., 83 NY2d 603 (1994), cited in Witherwax, id., at p. 19, col. 4.  Punitive damages are awarded to protect society, punish criminal acts or hold the wrongdoer as an example to others of conduct harmful to society.  "A private party seeking to recover punitive damages must not only demonstrate egregious tortious conduct by which he or she was aggrieved, but also that such conduct was part of similar conduct aimed at the public generally."  Witherwax, id.

    Lessons for Outsourcing.  

    In most cases, outsourcing will be subject to the common law principles of torts and agency.

1. The service provider's errors can potentially injure the rights of others with whom the enterprise customer has legally protected business relationships.  The service provider may be treated as an agent of the enterprise customer, causing the enterprise customer to be liable for the service provider's conduct that may be actionable as negligence, gross negligence or defamation.

2. The outsourcing contract should carefully allocate responsibility of the service provider and the enterprise customer for violations of the rights of third parties and, indeed, liability for punitive damages. 

3. The interactions between the service provider and the enterprise customer are susceptible of making each of them liable in tort to a protected class of consumers.   The outsourcing contract should identify the roles and responsibilities of the service provider and the enterprise customer in relation to such protected classes.

Further reading

    Liability of Service Providers
    Lawyer's Role
    Debt Collection Services

Posted:    May 10, 2005