When the Federal Trade Commission banned upfront fees for debt settlement firms, a funny thing happened: More law firms suddenly began offering debt settlement services — and charging upfront fees.
Despite a 2010 federal rule that banned charging upfront fees for helping consumers to negotiate their way out of debt, law firms have now teamed up with debt settlement operators to get around restrictions — and to keep on charging hefty upfront fees.
State and federal law enforcement agencies and industry observers say the new “service” they offer is just another fee-harvesting gimmick — this time aided by local attorneys aligned with large national law firms.
“Consumers are still paying large fees,” says Doug Davis, an assistant attorney general for the state of West Virginia. Critics say fees aren’t the only problem with the lawyer-led debt settlement services. Consumers who sign up for debt settlement help through an attorney, they say, are sometimes led to believe they are getting legal representation if they are sued by creditors.
“They think things are being taken care of,” says Davis. “Then, they get the knock on the door from the deputy sheriff saying, ‘You’ve been sued.’ They thought they were paying for a lawyer to handle all of this and of course they’re not. They’ve got to pay more fees if they want representation.”
Davis adds: “If they wanted anything more than an initial consultation, they had to pay for it. All the fees that they’ve been paying prior to that basically just disappeared.”
West Virginia is one of several states filing suits against national law firms and local attorneys engaged in debt settlement work.
According to court documents, the large firms conduct mass marketing on the Internet and through email, attracting customers with promises of paying half of what they owe on their debts. The companies refer clients to local attorneys who sign off on debt settlement plans that involve debtors paying 10 percent to 20 percent of the amount they owe in debts to the attorney in upfront fees.
Clients are instructed to break all contact with credit card companies and stop paying their bills. No debt negotiation is attempted until the client pays the entire upfront fee in monthly installments. This can take one to two years or more — and during that time, the consumer’s already bad credit rating gets worse and creditors often file suit to collect what’s owed.
States filing suit
Law firms that are sued by state attorneys claim they are exempt from restrictions on upfront fees because they are practicing law and offer legal advice about bankruptcy and other matters in addition to debt settlement. That, they say, is part of attorney-client services and is not covered by the ban on upfront fees.
North Carolina’s attorney general, Roy Cooper, won a consent decree in January 2012, in a lawsuit filed against one of the law firms, The Consumer Law Group. The Florida company agreed to refund or not collect $1.2 million in fees to North Carolina residents and cease debt relief operations in the state.
Illinois Attorney General Lisa Madigan filed suit in 2011 against another major national law firm, Legal Helpers Debt Resolution Inc., claiming it violated that state’s law against collecting upfront fees for debt settlement. Madigan asserts in a press release that Legal Helpers “served as a front” to sign up potential clients and that the actual “debt settlement service was contracted out to nonlawyer, third-party companies.”
Legal Helpers later sued Madigan claiming the attorney general went beyond her authority in attempting to police the firm’s practice of law. Neither Consumer Law Group nor Legal Helpers responded to requests for interviews for this article.
FTC: No upfront debt settlement fees
After nationwide complaints about customers shelling out thousands of dollars in fees paid up front for these services and never getting the results they hoped for, the Federal Trade Commission amended the Telemarketing Sales Rules. As of October 2010, for-profit debt settlers that used the telephone to market their services could collect fees only after they had negotiated an actual settlement. Several states across the country, including Illinois, North Carolina and West Virginia, also have state consumer laws banning collection of upfront fees for debt relief services.
As many predicted, the federal rule chased many debt settlers out of business starting in late 2010. It also had another effect: Tempting companies to look for loopholes and create new business practices to evade state and federal restrictions.
Some companies have switched to Web-based marketing because the federal rules apply to companies that use the telephone in marketing their services. Regulators say, even if they use the Internet, the rules apply if they use the telephone at any point to communicate with a client. Other companies are using paralegals or “runners” — people who contact potential clients in person and direct them to a brick-and-mortar location to sign up for services.
“We’ve seen outfits trying to sell other products that they could charge for that aren’t covered in the law, things like bankruptcy services, bankruptcy form preparation and bankruptcy counseling,” says Davis. “Before October 2010, they had nothing to do with bankruptcy, but in November 2010, they all became bankruptcy experts.
“Yet, they still go about the debt settlement activity and try to secure debt settlement for consumers.”
No one has been able to provide an estimate of how many debt settlement firms are currently operating around the country or the number of law firms involved in debt relief services. The debt settlement trade organization, the American Fair Credit Council (formerly known as The Association of Settlement Companies) says it only accepts members who agree to abide by the FTC’s no-advance fee rules. The trade group’s board voted against allowing law firms that rely on attorney exemptions to debt relief statutes to join the organization, according to Robby Birnbaum, the group’s president.
Davis says the attorney-model of debt settlement existed before the new telemarketing rule took effect; it has increased dramatically since the restrictions took effect.
Debt settlement industry in flux
Since October 2010, the debt settlement industry has been in flux. Among the developments:
- Debt relief operators have been quick to relocate or revamp their services to avoid breaking the letter of the law. “As soon as, on a case-by-case basis, a state attorney general or the FTC has taken some action in closing down individual companies, they re-emerge as another entity under another guise,” notes William Binzel, counsel for the National Foundation for Credit Counseling, an association of nonprofit credit counselors.
- More state attorney generals are going after debt relief and debt settlement companies and filing suit alleging violation of state consumer protection laws.
- State bar associations and professional licensing agencies are also cracking down on lawyers who violate ethical standards by collecting fees for services they never provide or “robo-signing” debt settlement contracts. Attorneys have been disciplined in Illinois, Connecticut and Florida. According to the American Bar Association, attorneys are bound by the codes of ethics and standards of their state bar associations and courts. Accepting money from clients without providing services or mishandling client funds can be grounds for disbarment or suspension.
- Debt settlement firms that are trying to operate in accordance with the state and FTC rules are confounded that the law firms are luring customers under false pretenses — by touting the fact that they are law firms but failing to represent clients when debtors are sued by creditors.
- The new federal consumer watchdog agency — the Consumer Financial Protection Bureau (CFPB) — has launched with authority over both the nonprofit credit counselors who provide debt management plans to help consumers pay off their debts in full and the for-profit debt settlers. However, the CFPB has no authority to regulate attorneys engaging in the legitimate practice of law.
Several people acknowledge that not all law firms engaging in debt settlement negotiations are suspect.
“There are definitely legitimate debt settlement companies out there that tend to be smaller scale local offices,” says Charles Phelan, publisher and founder of Manchester Publishing Company Inc., and a 15-year debt settlement industry veteran.
“I in no way object to a consumer sitting down with an attorney. That is a representation situation. That can make sense if the consumer can afford the fees.”
Phelan adds: “What does not make sense is when it is designed to lull the consumer into a false sense of security by thinking they are going to have an attorney who is going to represent them in court … It’s a gigantic red flag that the companies sign you up on the basis that you’re getting an attorney on your side, but if you get sued, you’re on your own … The consumer is left holding the bag.”
Phelan says that when creditors see that debtors are represented by some of the well-known legal companies and debt settlers, they refuse to negotiate a settlement. Phelan calls it the “footprint” problem.
“They are leaving a clear footprint that they are involved and that tips off the creditor. It’s definitely a handicap for the consumer. Creditors say, ‘Wait a minute. If you can afford to pay those guys 15 percent on the front end, you can afford to pay us.'”
Consternation for the industry
The so-called “attorney model” is also “causing a lot of consternation among the companies that are following the FTC rule and among state legislators and regulators,” says David Leuthold, CEO of Century Negotiations, a debt settlement company that says it follows the FTC rules.
“A good number of them just don’t see these law firm models as legitimate law firms. They just see them as a way around the FTC,” Leuthold adds.
Evan Zullow, an attorney with the FTC in Washington, D.C., says the agency is aware of the increase in attorney involvement in debt settlement.
Zullow points out that the federal rule does not exclude attorneys from the ban on upfront fees for debt settlement. “Attorneys are not exempt simply because they are attorneys,” Zullow says, adding that includes debt settlers who are partnering with law firms to evade the federal restrictions. “Just tacking on to a law firm is unlikely to bring you into compliance with the law.”
Although the CFPB has not specifically indicated how it will crack down on the industry, the FTC’s Zullow says his office is closely working with the new bureau. The CFPB — which is also charged with overseeing credit card regulation, payday lenders, debt collectors and a host of other financial services — may not have time to go after debt settlement in the near future, says Binzel from the credit counseling group. “I don’t perceive the regulation of debt settlement is one of their immediate priorities,” he says. “It’s just that they have so many other really pressing issues that they are trying to address.”
A CFPB spokeswoman said the bureau is “closely coordinating with the Federal Trade Commission.” The CFPB has enforcement powers over the telemarketing sales regulations. The agency also has broader powers under the Consumer Financial Protection Act of 2010 to write new laws regulating financial services products, including debt settlement.
The telemarketing rule and increased public awareness of the problems associated with debt settlement have helped reduce the number of federal actions taken against operators. In 2011, for instance, there were only six FTC cases against debt relief companies — down significantly from the 35 cases and investigations handled over the past several years. Says Zullow: “The rule has done a lot to curb deceptive and other abusive practices.”
Abuses continue for existing customers?
Industry observers say even though the federal telemarketing rule took effect in October 2010, consumers who had already signed up with debt settlers before that date are still stuck in contracts that allow upfront fees. They were not grandfathered in to the protections and are still turning to consumer credit counseling agencies when they give up on debt settlement.
“There are still people who are coming to agencies who either signed up for debt settlement on the Internet or under the attorney model and who paid substantial upfront fees and got little or nothing,” says Binzel, from the credit counseling association.
Nonprofit credit counseling programs offer debt management plans. Clients pay the full amount of the principal that they owe. Creditors may agree to waive fees and reduce interest rates while in the plan, which typically takes five years. Any payments on the debt start as soon as the client is enrolled — rather than waiting until they have enough saved up to make a lump payment offer.
The latest iteration of the debt settlement business model is making more people wonder if contracting with a third-party debt settler works at all anymore — or if consumers shouldn’t just attempt to work out payment deals on their own.
Why not do it yourself?
“Debt settlement, even if there is no advance fee, is usually not in the consumer’s best interest,” says Josh Frank, a researcher for the Center for Responsible Lending. The center is conducting ongoing research on the dollars and sense of debt settlement. His advice to consumers: Steer clear of debt settlement. “They’re usually better off with other options, including doing it on their own.”
The AFCC debt settlement trade group president defended his industry in an e-mailed statement: “AFCC members provide debt relief services to consumers who are in desperate need of financial help and get amazingly good results for those consumers,” wrote Birnbaum, who is also a partner in a Florida law firm that represents the settlement firms sued by Illinois and North Carolina. “Hundreds of thousands of families have been helped by AFCC members through some of the toughest times in their lives, and while consumers have a lot of lawful debt relief options to choose from, AFCC continues to be a leader in consumer protection and lawful settlements.”