The recent recession tarnished the credit histories of thousands of Americans and spurred an uptick in personal bankruptcies. That focused public attention on whether it is fair in such a climate to screen job applicants based on their credit reports. Several legislatures said no and passed laws restricting the practice. The Equal Employment Opportunity Commission (EEOC) took a renewed interest, too, contending that the use of credit reports can have a disparate impact on minority applicants.

Because of that political climate, employment lawyers are taking a cautious approach to the 3rd Circuit’s Dec. 15, 2010, opinion in Rea v. Federated Investors, which upheld an employer’s right to reject a job applicant based on a previous bankruptcy.

“This is an issue that is garnering a lot of attention from advocacy groups and legislatures in terms of how to protect folks with bad credit in the workplace,” says Rod Fliegel, a shareholder at Littler Mendelson. “The most important point is that even though the court says for companies doing business in [the 3rd Circuit] it is OK to screen employees based on bankruptcy, there are other governors on how you collect and use that information.”

The plaintiff in the case, Dean Rea, applied for a job as a project manager with Federated Investors in 2009 through the placement firm Infinity Tech Services. After an interview, it appeared Federated would offer Rea a job, contingent on a third-party background check. Infinity later informed Rea that the company refused to hire him because of his 2002 bankruptcy.

Rea contended that Section 525 of the Bankruptcy Code prohibits private employers from discriminating in hiring based on a bankruptcy. But the 3rd Circuit panel, the first federal appeals court to rule on the question, agreed with several lower courts that the code affords no such protection for people seeking jobs with private employers. While the code specifies that government employers may not “deny employment to, terminate the employment of, or discriminate against, a person that is or has been a debtor,” the court noted that language covering private employers requires only that they not “terminate the employment of, or discriminate with respect to employment against, an individual who is or has been a debtor.” In other words, the court held that Congress specifically intended to allow private employers to consider bankruptcy filings in hiring decisions, while forbidding government employers from doing so.

Limited Victory

While the decision was a win for employers, there are several caveats. It only applies to hiring decisions, not to any other employment decisions. Private employers are still prohibited from discriminating against existing employees based on bankruptcy filings.

For multistate employers, it is important to know that four states–Washington, Hawaii, Oregon and Illinois–have passed laws prohibiting the use of credit history information in hiring, unless it is specifically job related. Similar bills are pending in other states.

Additionally, employers using credit-check screening face scrutiny from the EEOC, which for several years has warned that the practice could violate Title VII’s provisions against discrimination in hiring unless the employer can show a business necessity. In October 2010, the commission held hearings on the topic. And it is starting to put its muscle behind Title VII cases alleging that type of discrimination.

Just a few days after the Rea decision, the EEOC filed a nationwide race discrimination case in the Federal District Court for the Northern District of Ohio. EEOC v. Kaplan Higher Education Corp. alleges disparate impact based on use of credit reports.

In a statement, Kaplan said it checks credit histories on employees whose responsibilities include financial matters. “This is not unusual,” the company said. “As many as 60 percent of Society of Human Resource Management members consult credit reports in the hiring, promotion or dismissal of employees.”

The Kaplan suit follows a 2009 EEOC case against Freeman, in which the EEOC accused the convention and corporate events marketing company of discriminating against blacks, Hispanics and males by routinely rejecting job applicants based on their criminal background records and credit histories. EEOC v. Freeman is still pending in the Federal District Court for the District of Maryland.

“The EEOC has made it very clear of late that it is not happy with employers who have a blanket policy of doing credit checks or criminal background checks and making decisions without considering job relatedness and any disparate impact these policies might have,” says John McDonald, a partner at Reed Smith.

Cover Your Bases

Fliegel says some companies are receiving broad EEOC requests for information that may signal more litigation ahead. Private plaintiffs are also starting to assert discrimination based on the use of pre-hiring credit checks. For example, a class action filed in the Southern District of Florida in November 2010, Loudy Appolon v. University of Miami, alleges the plaintiff’s Title VII rights were violated when the university rescinded a job offer as a medical collector based on her credit history.

McDonald says this increased liability makes it important for employers to carefully consider which job categories justify using credit checks. He suggests including sensitive responsibilities in job descriptions, and using credit checks as a trigger for a discussion with the applicant about how his credit was tarnished, rather than rejecting him outright.

Fliegel adds that in-house lawyers should review background-screening providers and contracts, which procurement personnel focused on pricing often handle. “If you go with the cheapest contract, it may be great on the cost savings side, but it may create exposure to all sorts of legal risks that supersede those cost savings,” he says.