A state bill to regulate the burgeoning debt-settlement industry in California is moving closer to passage.
Sponsored by Assemblyman Ted Lieu, D-Torrance (Los Angeles County), AB350 is supported by the industry's two main trade groups, who say they want to weed out unscrupulous firms giving the business a bad name.
Two prominent consumer groups oppose the bill. "We think it's too soft," says Gail Hillebrand, a senior attorney with Consumers Union.
Unlike credit counseling services, which help consumers pay off their entire debt, settlement companies try to help them settle for less than the amount owed.
While some such companies do help disciplined consumers, critics say many collect steep up-front fees from cash-strapped people who get little or nothing in return because they or the companies don't uphold their end of the bargain.
Although programs vary, consumers typically enter a multiyear agreement. They stop making payments on their unsecured debt and start contributing to a savings account they control. When there is enough money in the account, the settlement company tries to talk creditors into settling accounts for a lump sum that is less than the amount owed.
Consumers usually pay firms a fee based on their debt going into the contract, not the amount extinguished. It is often 15 or 20 percent of the debt but can be higher. It is usually paid at the beginning or in the early months of the contract.
Typically, the process takes three years although some people finish it sooner. About half don't finish at all.
The consumer's credit rating often suffers from late payments and debts settled for less than the full amount. Also, canceled debt can be taxed as income.
The industry is enjoying robust growth. The explosion in unsecured debt, followed by the recession, has left a growing number of Americans unable to repay their obligations. Meanwhile, the Bankruptcy Act of 2005 has made it harder for consumers to file to discharge their debts in court.
Few regulations
Yet the business is largely unregulated. Only about a dozen states have laws governing debt settlement, although more states have bills pending.
Lieu, who is running for state attorney general, has been trying to regulate the industry in California for more than two years. His bill would require firms to be licensed and regulated by the Department of Corporations, provide extensive disclosures and cap fees at 5 percent of the consumer's debts up front and a total of 20 percent during the first half of the contract.
If consumers complete the program, and the amount they pay in settlements plus fees exceeds the debt brought into the program, the company must refund the difference. Consumers who don't complete the program are not eligible for any refund.
Consumers Union and the Center for Responsible Lending object mainly to the bill's fee structure and consumer-suitability requirements. They would like fees to be based on the debt waived, not the total. Lieu says that approach would discourage companies from working with smaller debtors.
Industry concerns
The industry objects because "this is a 36-month program. It's very labor intensive. For us not to get paid until the program is complete, that's a long time," says Wesley Young, legislative director for the Association of Settlement Companies. Moreover, he adds, "We don't want to be in the position where we become a creditor (of the client.) It's very difficult to get paid."
Caryn Becker, policy counsel with the Center for Responsible Lending, says her group would settle for a fee based on the debt brought into the program if it was 4 percent spread over the first six months and 18 percent (including the 4 percent) spread over the first three-quarters of the program.
Qualifying for program
The bill requires companies to make sure clients are "qualified" for the program by enrolling them. "We think that is too weak of a standard," Hillebrand says. "It could be like saying if you have a pulse you are qualified." Her group wants companies to make sure a consumer is "suitable," or able to benefit from the program.
Lieu's bill passed the Assembly 56-22. It passed the Senate banking committee 10-1 on Thursday and moves this week to the Senate judiciary committee. The full Senate could vote in August or September. If passed, the bill would not take effect until January 2012, although Lieu says he would consider moving that up to help today's stressed borrowers.
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