One question that is continually posed in this business is whether a cash flow investor has the legal right to access a person’s credit file prior to purchasing a debt instrument.
The rights of consumers are protected under The Federal Fair Credit Reporting Act (“Act”). Originally passed by Congress in 1970 and substantially overhauled in 1997, the Act regulates acceptable practices with respect to credit information, which is gathered and sold by Consumer Reporting Agencies. The Act is enforced by the Federal Trade Commission and carries stiff penalties for noncompliance ranging from monetary fines to imprisonment.
The Act protects a consumer’s rights in a variety of ways. First, it limits the permissible purposes for which a consumer credit report may be obtained and used. Second, it provides the consumer the right to receive full disclosure of items contained in the file, dispute information believed to be erroneous, and to include a statement explaining any controversy. Third, it limits the length of time during which adverse information may be reported on an individual (typically seven years on most adverse ratings and ten years on bankruptcy proceedings). Fourth, it requires that the consumer be informed when a credit report has contributed to the denial of credit.
The purchase of most debt instruments includes a review of the payer’s credit history by the investor prior to funding to assist in determining the likelihood of timely repayment. If the transaction involves the party making payments it is fairly simple to obtain their written permission to pull a credit report. However, in our business, it is more likely that the debt instrument already exists and the primary contact is with the person desiring to sell their payments rather than the payer. Is it acceptable to pull credit on the payer without first obtaining their written permission?
One of the definitions of permissible purposes (604a3E) states that a Credit Reporting Agency may furnish a consumer report to a person that “intends to use the information, as a potential investor or servicer, or current insure in connection with a valuation of, or an assessment of the credit or prepayment risks associated with,an existing credit obligation.” In our business there is an existing debt from the payer to the seller and the information is being evaluated by a potential investor to determine whether to pursue the investment.
While the right of an investor to access an existing payer’s credit file falls under the definition of permissible purposes, there are still areas for careful observation. It is prudent to only pull credit once a preliminary agreement has been reached with the seller. This could be in the form of your signed option/purchase agreement or as simple as a one sentence authorization from the seller. This serves to evidence your position as a “potential investor”. If you were dealing with a simultaneous transaction where the obligation or debt had not yet been created (such as a pending real estate sale, business sale, or a factoring relationship), it is advisable to first have the seller obtain the proposed payer’s written permission since both parties are motivated to complete the transaction. Caution should also be exercised in the number of investors a seller or broker submits the transaction to for review. A multitude of inquires is reflected on a credit report which has the potential to substantially lower a consumer’s credit score.
It is essential to remember that permissible users of credit reports are still required to employ confidentiality to protect a consumer’s right of privacy. Given this requirement, a cash flow professional is generally precluded from discussing information contained in the credit report unless that person is a joint user meaning they too have legally obtained a credit report. Sensible users will carefully avoid violating not only confidentiality but also being considered a Credit Reporting Agency by disseminating the information.
Hopefully this serves to clarify some of the implications of the Act on our industry. As always, it is advisable to consult with a qualified attorney, or for more information and a complete copy of the Act contact the FTC at 202-326-2222 or browse the web at www.ftc.gov, www.wdia.com or www.acc-u-data.com.