Consumer Credit Counseling

The consumer-credit-counseling industry originated in the early twentieth century in the form of debt adjusters (also known as debt poolers, debt consolidators, debt managers, or debt pro-raters). This first generation of credit counselors consisted of profit-seeking enterprises that communicated with a consumer’s creditors to persuade them to accept partial payment in full satisfaction of the consumer’s obligations. If the creditors agreed, the debt adjuster would collect a monthly payment from the consumer and forward appropriate portions of it to each of the creditors. They often charged hefty fees, leaving little for distribution to the creditors. Instances of deceptive advertising and theft of clients’ funds were numerous enough that, starting in the 1950s, legislatures in more than half the states outlawed the business (e.g., N.Y. Gen. Bus. Law §§ 455-457). Of the remaining states, approximately two thirds opted for a regulatory approach, requiring licenses, imposing requirements on how the businesses operate, and restricting troublesome practices (e.g., Mich. Comp. Laws Ann. §§ 451.451-.465 (repealed in 1976 and replaced by §§ 451.411-.437)).

Many states exempted not-for-profit organizations from these statutes, enabling nonprofits to render counseling services free of regulation. This led to the growth, starting in the 1950s, of the second generation of credit counselors. The growth of these non-profits was fueled by the National Foundation for Consumer Credit (NFCC) (later renamed the National Foundation for Credit Counseling), which was created by retailers and banks that issued credit cards. These creditors supported the formation of credit-counseling agencies as a means of helping consumers in financial difficulty gain control of their finances and pay their credit-card debts. The objectives were full repayment of debt and the avoidance of bankruptcy.

The counseling agencies provided community education, met individually with consumers, helped them develop or improve budgeting skills, and, when appropriate, enrolled them in debt-management plans (DMP’s). To establish a DMP, the agency negotiated with each of the consumer’s unsecured creditors to obtain concessions from them, in the form of some combination of reduced interest rate, waiver of default or delinquency fees, and monthly payments in an amount less than the contractual minimum. Thereafter, the consumer made monthly payments to the agency and the agency disbursed a pro-rata amount to each of the participating creditors. The creditors supported the counseling agencies by returning to them a percentage—often 15% of the payments they received. The NFCC called this contribution the creditor’s “fair share.” The agencies also sometimes received charitable contributions from other sources and imposed modest fees on the consumer. As of 2005, this second generation of counseling agencies continues to operate.

Consumer advocates generally acknowledged the educational and budgeting benefits that the counseling agencies provided, but were critical—or at least skeptical—of their overall usefulness. They perceived the agencies as debt collectors for the credit-card industry and were critical of the limited range of advice the agencies provided. The last thing a card issuer wanted to see was a consumer filing a petition in bankruptcy. Formed and supported primarily by the credit-card industry, most counseling agencies never recommended bankruptcy, and many never even mentioned it as a possibility. E.g., Gardner, Consumer Credit Counseling Services: The Need for Reform and Some Proposals for Change, 13 Advancing the Consumer Interest 30 (2001).

The late 1980s and 1990s saw a dramatic increase in credit-card debt as consumers’ income rose and card issuers relaxed their standards of creditworthiness. The increase in the amount of debt was accompanied by an increase in the amount of debt in default and an increased opportunity for credit-counseling agencies. Many new entities arose, unaffiliated with the NFCC. They formed competing trade associations, e.g., the Association of Independent Consumer Credit Counseling Agencies (AICCCA) and the American Association of Debt Management Organizations (AADMO)). These new entities—the third generation—rely heavily on advertising and telemarketing, and many conduct their business with consumers entirely by telephone or over the Internet. Perhaps because of their aggressive marketing and innovative business methods, their share of the counseling market grew from approximately 20% in 1996 to approximately 80% in 2001. For the most part, their focus is on the creation of DMP’s, not on counseling and education. Indeed, at many entities counseling and education have fallen entirely by the wayside.

Since many states prohibit for-profit debt-management businesses, and since card issuers have limited their fair-share payments to nonprofit entities, members of this third generation of agencies are organized as nonprofit entities. Many of them, however, have not operated as charitable or educational institutions. Instead, they have uncritically enrolled all their customers in DMP’s, and they have charged fees much higher than the fees charged by the agencies affiliated with the NFCC. At the traditional level of the creditors’ fair share contribution, and with the educational function stripped away, many of these entities have generated revenues much larger than needed to provide debt-management services. They have disbursed these excess revenues in the form of generous compensation to affiliated entities that provide back-office services. They also have paid salaries for the principal executives that are out of line with the salaries paid by other kinds of non-profit entities of comparable size. (For a description of three different models for channeling funds to related entities, see Staff Report, Profiteering in a Non- Profit Industry: Abusive Practices in Credit Counseling (Permanent Subcommittee on Investigations of the Senate Governmental Affairs Committee) (S. Rep. 109-55 April 2005), available at http://hsgac.senate.gov/index.cfm).

Meanwhile, in the 1990s credit card issuers saw that their fair-share payments to counseling agencies had increased to the extent that those payments approximated the amounts they were paying for all their other collection activities combined. In addition, they discerned that some of the counseling agencies were accumulating large surpluses and were enrolling in DMP’s consumers whom the creditors believed could pay their debts without the concessions the creditors had been giving. They responded by reducing the concessions they were willing to make to consumers and by reducing the amounts they were willing to pay the counseling agencies. Some card issuers have stopped supporting the agencies altogether, and on average the amount returned to the agencies has dropped from more than 12% to less than 8%. This decrease has adversely affected the ability of counseling agencies to provide individual counseling and community education. Some major card issuers have abandoned the fair-share approach altogether and have developed proprietary models for compensating counseling agencies depending on such factors as the profiles of the debtors being served by an agency, the agency’s record with the creditor, and the agency’s advertising and business practices.

An objective of credit-counseling agencies, whether or not they provide reasonable educational services, is to enable consumers to repay their debts in full. There is, however, another segment of the industry—the fourth generation—whose members do not have this objective at all. These entities are known as debt-settlement companies, and they formed trade associations of their own (merged in 2004 into the United States Organizations for Bankruptcy Alternatives (USOBA)). Instead of helping the consumer pay his or her creditors in full, they attempt to persuade creditors to settle for less than the full amount of the consumer’s debt, writing off the rest. Thus they represent a revival of the first generation of counseling agencies. Unlike their forebears, however, they do not negotiate with the creditors in advance of establishing a plan for dealing with the consumer’s debts. Instead, they encourage the consumer to default on the debts and to make monthly payments to them or to a savings account of the consumer. When those payments reach a target percentage of the debt owed to one of the creditors, the agency submits an offer to that creditor (on the consumer’s behalf) to settle the debt for the amount in hand. During the period when the funds are accumulating, the creditors receive nothing. As a result the creditors impose additional finance charges and delinquency fees, and they may undertake collection activity, including litigation.

Reports of abuses by credit-counseling agencies and debt-settlement companies and injury to consumers have appeared with increasing frequency in numerous media outlets. Reports of two prominent consumer organizations (Consumer Federation of America and the National Consumer Law Center) have documented the situation. (See CFA & NCLC, Credit Counseling in Crisis: The Impact on Consumers of Funding Cuts, Higher Fees and Aggressive New Market Entrants (2003); NCLC, Credit Counseling in Crisis Update: Poor Compliance and Weak Enforcement Undermine Laws Governing Credit Counseling Agencies (2004); NCLC, An Investigation of Debt Settlement Companies: An Unsettling Business for Consumers (2005), all available at http://www.nclc.org). The problems include:

deception concerning the nature of, the need for, the benefits of, and the cost of debtmanagement plans to help consumers deal with their debt;
excessive cost to consumers; and
self-dealing and other conduct by agencies to evade limitations in the Internal Revenue Code.
In January 2003 the Executive Committee of the Conference authorized the appointment of a drafting committee to develop a uniform law that would address the problems that have developed and enable the states to take a common approach to regulation of the counseling industry. A uniform approach is particularly important because the great majority of agencies operate in multiple states and would otherwise be subject to multiple and sometimes conflicting requirements.

History of the Draft
When it first authorized this project, the Executive Committee focused on the segment of the industry that counsels consumers and forms debt-management plans to assist them pay their debts in full. It did not contemplate entities engaged in debt settlement. At the 2004 Annual Meeting, the Conference authorized the Drafting Committee to include debt-settlement companies within the scope of the Act. It also directed the Drafting Committee to draft the Act in such a way that states could authorize for-profit entities to provide debt-management services. The definition of “debt-management services” encompasses both credit counseling and debt settlement. With very few exceptions, the provisions of the Act apply equally to both types of debt-management services and the entities that provide them. The Act is neutral on the question whether for-profit entities should be permitted to provide debt-management services. Each state must decide whether to permit for-profit entities to provide credit-counseling services, debt-settlement services, or both. The state’s decision is implemented by language in sections 4, 5, and 9. Each of these sections contains bracketed language and instructions on which language to adopt to implement the state’s policy concerning for-profit entities.

Bankruptcy Code Amendments
Shortly before the last meeting of the Drafting Committee, Congress enacted revisions to the Bankruptcy Code. These revisions are likely to increase the demand for the services of entities that provide debt-management services.

Section 109(h) of the Code requires a debtor who wishes to file under Chapter 7 to provide certification that he or she has received from an approved nonprofit credit-counseling agency assistance in preparing a budget analysis and information about credit counseling. In addition, section 727(a)(11) establishes the completion of an instructional course concerning personal financial management as a prerequisite to obtaining a discharge. These two new provisions are likely to increase the demand for services from entities regulated by this Act. The Bankruptcy Code’s regulation of persons regulated by this Act is terse and consistent with it. Since the revised Bankruptcy Code will induce more consumers to seek the services of those who provide debt-management services, the revisions increase the urgency of the need for states to adopt a uniform law governing debt-management services.

Description of the Act
The purpose of the Act is to rein in the excesses while permitting credit-counseling agencies and debt-settlement companies to continue providing services that benefit consumers. The Conference has benefited from the participation of credit-counseling agencies (and their trade associations), debt-settlement companies (and their trade association), representatives of consumer organizations, and attorneys general. The Act represents an accommodation of the conflicting views of these interested entities. As may be expected, it leaves all of them satisfied with some decisions and dissatisfied with others.

The Act applies to “providers” of “debt-management services” that enter “agreements” with individuals for the purpose of creating “plans.” The definitions of the quoted terms are critical and appear in section 2, along with the definitions of several other terms. The Act speaks of “individuals,” as opposed to “consumers,” so that it applies to farmers and other individuals who are dealing with personal debt incurred in connection with their businesses. To provide debt-management services to a resident of the enacting state, a provider must obtain a certificate of registration from the administrator of the Act. To obtain a certificate, a provider must supply information about itself, must meet specified requirements of competency, must obtain insurance against employee dishonesty, and must post a surety bond to ensure its compliance with the Act. The requirements concerning registration appear in sections 4-14 and 22.

The Act establishes requirements for providers to meet in connection with their interaction with the individuals they serve. Section 17 prescribes steps to be taken before entering an agreement with an individual. Sections 19-24 and 28 govern the content of an agreement, including limitations on the fees that may be charged (§§ 23-24). Other provisions deal with the performance and termination of agreements (§§ 25, 26, 28) and miscellaneous other matters. The Act provides for enforcement both by a public authority and by private individuals. Sections 32-34 provide for public enforcement, including a rule-making power on the part of the administrator. Section 35 provides for private enforcement, including recovery of minimum, actual, and, in appropriate cases, punitive damages.

by Johnson Law Group