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A Collection Scandal at Sears, Roebuck & Company Source: O’Rourke, J.S. IV (2013). Management Communication 5th edition, Pearson Publishing (pp. 69-71). It was just 8:30 a.m on a Sunday morning. While most of Chicago was either still asleep or out retrieving the morning paper, Arthur C. Martinez was meeting with a dozen of his company’s top executives at their headquarters building in suburban Hoffman Estates. For a few moments, the room grew quiet as Martinez tried to digest what he had just been told. Lawyers for Sears, Roebuck & Company were explaining how employees had secretly violated federal law for nearly a decade. Martinez couldn’t believe what he was hearing: Sears attorneys and credit employees, according to a bankruptcy judge in Boston, had for years been dunning delinquent credit card holders who had filed for – and had been granted – bankruptcy protection. The newspapers and cable television news channels didn’t have the story yet, but it would only be a matter of hours before they would. The company that Martinez, a former Saks Fifth Avenue executive, had struggled to turn around would quickly be mired in the worst legal and ethics scandal in its 111-year history. The United States Department of Justice was already considering not only civil penalties, but also criminal prosecution. Worse, this wasn’t simply a rogue operation or an honest misinterpretation of the law: Sears appeared to have been violating the rights of many of its customers systematically and intentionally. The company, the lawyers were suggesting, may even have put the illegal practice into its procedures manual. How could such wrongdoing have gone unchecked for years? Martinez wanted to know. “Not one phone call about this? Ever?” he demanded. According to at least one participant in the meeting, it was a “sickening moment.” A “Half-Billion Dollar” Handwritten Letter As an extensive investigation would later reveal, Sears struggled – first to understand and then to deal with criminal charges and an ethical lapse that would cost the company nearly $500 million. According to Sears’ senior vice president Ron culp, the collection scheme began to unravel in November 1996, when Francis Latanowich, a disabled security guard, hand wrote a letter on a yellow legal pad, begging the Boston Bankruptcy Court to reopen his case. Although Judge Carol Kenner had wiped out his debts, Sears later asked Latanowich to repay the $1,161 he owed for a TV, an auto battery, and some other merchandise. But the monthly payment, he wrote, “is keeping food off the table for my kids.” Sears, it turned out, had mailed Latanowich an offer. In return for $28 a month on his account, the company wouldn’t repossess the goods he had bought with a Sears charge card before he went bankrupt. The practice of urging debtors to sign such deals, called reaffirmations, is legal and relatively widespread in the retail credit business, but many judges view them as unethical practices that keep people from getting a fresh start. Moreover, every signed reaffirmation must be filed with the court so a judge can review whether the debtor can handle the new payment. 2 Sears, Roebuck & Company hadn’t filed this one with the court and Judge Kenner wanted to know why not. At a January 29, 1997 hearing, a Boston attorney working for Sears offered a convoluted technical excuse for not filing. Kenner’s response: “Baloney.” According to Newsweek magazine, there were hints from prior cases that Sears, both praised and feared nationwide as the most aggressive pursuer of reaffirmations, wasn’t filing many of them with the court. If true, the company was using unenforceable agreements to collect debts that legally no longer existed. Judge Kenner pushed Sears for a list of such cases. Sears’ response, delivered reluctantly in mid-March by a credit manager, was shocking: The company had apparently ignored the law nearly 2,800 times in Massachusetts alone. Martinez and his senior team could only imagine what the company was up to in the other 49 states. Soaring Personal Bankruptcies Between 1994 and 1998, personal bankruptcies in the United States rose from 780,000 to more than 1.3 million, leaving many retailers and credit card issuers awash in bad debt. Sears, as the nation’s second-largest retailer was in a particularly vulnerable position. That year, the company earned 50% of its operating income from credit, including charge cards held by more than 63 million households with Sears credit cards. The problem, as Martinez would come to discover, was that too many of those new cardholders barely qualified for credit. In its zeal to attract new business, Sears became a lender to its riskiest customers. As the number of bankruptcies rose nationwide, so did the number of unpaid accounts at Sears. By 1997, more than one-third of all personal bankruptcies in the United States included Sears as a creditor. Companies heavily dependent on income from their credit cards chose to aggressively pursue bad debts, and Sears was just one of many to do so. The list included such prominent creditors as Federated Department Stores, the May Company, G.E. Capital, Discover Card, and AT&T. As Martinez would also come to discover, the problem was neither isolated nor small. During the previous five years, some 512,000 customers had signed reaffirmation agreements with Sears, pledging to repay debts that totaled $412 million. Martinez suspected that his company’s transformation from an exhausted, defeatist bureaucracy into “An aggressive can-do company” had an unanticipated consequence: Managers simply wouldn’t send bad news up the chain of command. A culture of aggressively pursuing bad debts while filtering out bad news from top management had become part of the company’s culture and official policy, Michael Levin, chief of Sears’ law department, explained to his CEO that at least one outside law firm had told someone in the company that Sears’ policy was questionable. But word of the alert, which might have triggered a broader investigation within the company, somehow never worked its way up through the bureaucracy. Martinez leaned back and motioned to his executive assistant, “Call a meeting of the Phoenix Team,” he said. “Eight o’clock tomorrow.” That would mean 200 of Sears, Roebuck & 3 Company’s top executives would get the bad news directly from their CEO. It would also signal the start of Sears’ response to the charges. Martinez then turned to Ron Culp, Sear’ senior vice president for public relations and government affairs, and Bill Giffen, vice president for ethics and business policy. “Give me your best thinking,” he said. “Tell me what you think we should do.”

Discussion Question: Even though the reaffirmation agreements are perfectly legal and enforceable, if properly filed with the courts, is it ethical to try to extract money from people who have legally declared bankruptcy? What ethical obligations do those people in bankruptcy have toward companies who lent them credit, such as Sears?

Answer 1

In my opinion, It was wrong of Sears to extract money from them since the courts had already exempted them. Bankrupt people should present a statement showing their status to companies like Sears to prevent cases of being illegally changed. Moreover, they should not accept credit services since they know they cannot pay off their debts.

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