A "Downward Spiral"

More than any single problem, lenders and credit bureaus are on the lookout for trends that suggest borrowers are heading for trouble. They believe that, if they see broader signs of a “downward spiral,” they can make better decisions about granting credit…or how to respond when a borrower asks for help. Credit bureaus are constantly modifying their reports in an effort to spot trouble sooner.

What constitutes a downward spiral? The March 2000 Massachusetts federal court decision AT&T Universal Card Services v. Edmund Dietzal offers one answer. In March 1998, Dietzel filed for personal bankruptcy to discharge his many debts. AT&T promptly sued, arguing that $4,144 Dietzel had charged on a credit card it issued to him shouldn’t be wiped out because he’d committed fraud.

The case turned on one question: Was Dietzel a credit card scammer who had no intention of repaying AT&T? Or was he simply a guy with money problems whose downward spiral AT&T would have noticed if it had been paying closer attention?

In his bankruptcy filing, Dietzel listed 100 percent ownership interest in a house in Dedham, Massachusetts, valued at $190,000. He also listed personal property that included: $250 in cash spread around several bank accounts; “furnishings” with a value of $2,000; and two automobiles, a 1997 Dodge Caravan and a 1997 Nissan Altima with values of $16,500 and $18,000, respectively. He claimed exemption for the house and personal property—which means he wanted to keep those things.

Among his listed debts were: two mortgages on the Dedham house totaling about $165,000; secured car loans equal to the full claimed value of his two vehicles; and nonsecured consumer loans—including the balance on the AT&T card—totaling $53,589. These nonsecured loans were almost all credit card debts, with the exception of about $6,000 in student loans and some medical bills.

Dietzel listed monthly income (from a part-time job and a small pension) of $1,400. His wife earned about $1,700 a month; together, they had three dependent children, ages 10, 14 and 16. In all, the Dietzel household’s expenses exceeded its income by about $2,000 a month.

At trial, Dietzel admitted he’d kept only a small debt balance on his AT&T card for most of the time that he’d had it. Through early 1997, he maintained a balance of less than $20. Then, in the late summer, he started using the AT&T card for small purchases and a number of cash advances.

Dietzel had been using credit cards heavily to finance his middle-class life-style since he’d lost his government job in late 1995. In February 1997, he consolidated this credit card debt—about $43,000, at that point—into the second mortgage on the Dedham house.

But the borrowing continued. In May 1997, Dietzel took a cash advance of $5,000 on a Compuserv Visa card; in June, he charged $2,000 for three round trip airline tickets to England and took cash advances totaling $800; in July, he took a $5,000 cash advance from Household Finance Company. That month, he took two of his children to England to visit a personal friend who was ill.

About that time, Dietzel’s personal life was getting less stable. His wife moved out of the Dedham house for several months; the separation resulted in household expenses of at least $6,000.

From late 1996 through early 1998, Dietzel used cash advances from some credit cards to make payments on others. He explained:

I think I was able to make all the payments because if payments came due and I didn’t have enough money, I would just use a credit card to pay the other credit cards.

In this manner, he ran up over $40,000 in new credit card debt in the 13 months after he took out the second mortgage.

Through this period, Dietzel held several jobs, including a promising position with a courier company called Minute Man Deliveries. But none of the jobs lasted; the delivery job ended after he got into a fight with a customer. Instead, in early 1997, he got a part-time job delivering The Boston Herald.

Should AT&T have seen Dietzel’s troubles coming? Ronald Lewis, AT&T’s bankruptcy specialist, testified that Dietzel’s credit history didn’t raise any red flags. He’d opened the account with AT&T in 1992; the account was subject to periodic review, which resulted in scores that were always “at a very good level.” But Lewis explained how credit card kiting would effect the “scoring” or mathematical assessment of risk associated with the account:

It would maintain it at a good level. Kiting is basically the movement of money from one or more credit cards to other credit cards, and unfortunately, what happens until the bottom falls out, it creates a false illusion on the Credit Bureau that the individual has financial stability because everything is being paid as agreed. It completely masks any way to determine that there’s a problem....

Lewis noted that Dietzel contacted AT&T in August 1997 to explain that his August payment would be late because he broke his leg on vacation (an event Dietzel later admitted never happened).

After that contact—and an indirect contact for authorization for the October 1997 cash advance in the amount of $2,000—there was no direct contact between Dietzel and AT&T.

Dietzel made a last, partial payment on the account in November 1997. In early January 1998, AT&T began contacting him, seeking payment. He declared bankruptcy a few weeks later.

The trial court pointed out that, in order to prove fraud on Dietzel’s part, AT&T had to establish the following elements:

1. that Dietzel made a representation;
2. that Dietzel knew the representation was false at the time he made it;
3. that Dietzel made the representation with actual intent to deceive AT&T;
4. that AT&T justifiably relied on the representations; and
5. that AT&T sustained a loss caused by the false representation.

Of course, it’s not fraud simply to make a minimum payment with a cash advance from another credit card. This action must also be coupled with a lack of intent to repay the debt. Courts can infer this lack of intent to repay from a list of factors, including:

• the length of time between the charges made and the filing of bankruptcy;
• whether an attorney has been consulted concerning the filing of bankruptcy before the charges were made;
• the number of charges made;
• the amount of the charges;
• financial sophistication of the debtor;
• whether or not the debtor was employed; and
• whether the purchases were made for luxuries or necessities.

According to the court, “the correct focus...is whether in good faith he intended to keep his promise.” AT&T argued that Dietzel didn’t. And the court admitted:

[His] Schedules and Statement of Financial Affairs are replete with errors and omissions. …Additionally, he lied to AT&T about breaking his leg to obtain an extension of time within which to make the August payment on his credit card.

But this wasn’t enough. The court said Dietzel’s untruths weren’t substantive and material to AT&T’s complaint. AT&T had to establish that his representations were false when made and were made with the intention of deceiving it. On these matters, the court concluded:

At the time [Dietzel] obtained the cash advances, his financial condition was not good, but it was much better than it had been…. Although the total amount outstanding on [his] AT&T card exceeded [his] credit limit at the time he filed his bankruptcy petition this was in part due to finance charges as opposed to substantial charges over his credit limit.

The court concluded that AT&T had failed prove that Dietzel had intended to defraud it at the time he obtained cash advances. In other words, it should have been paying closer attention. The monies Dietzel owed on the AT&T credit card were discharged as part of his bankruptcy.

Next: Beware of Cash Advances