BILL ANALYSIS
AB 350
Page A
Date of Hearing: April 28, 2009
ASSEMBLY COMMITTEE ON JUDICIARY
Mike Feuer, Chair
AB 350 (Lieu) - As Amended: March 31, 2009
SUBJECT : CONSUMER DEBT NEGOTIATION COMPANIES
KEY ISSUE : SHOULD THE COMMITTEE PASS THIS BILL AS A WORK IN
PROGRESS WHILE THE AUTHOR CONTINUES HIS GOOD FAITH EFFORTS TO
REACH CONSENSUS WITH CONSUMER GROUPS REGARDING APPROPRIATE
REGULATION OF THE EXPANDING DEBT SETTLEMENT INDUSTRY?
FISCAL EFFECT : As currently in print this bill is keyed fiscal.
SYNOPSIS
This bill, co-sponsored by two trade association of the debt
settlement services industry, provides for the regulation and
licensure by the Department of Corporations (DOC) of entities
that offer to represent consumers for the purpose of negotiating
reduction in the amount of debt owed to creditors for a fee.
This bill continues several years of notable effort by the
author to implement a comprehensive enforcement scheme to
provide helpful clarity to the industry and appropriate consumer
protection. Although consumer groups remain opposed to certain
provisions in the bill, the author and sponsor have engaged in
serious discussions through the Committee to reduce areas of
concern and seek consensus on outstanding issues noted in the
analysis.
SUMMARY : Provides for regulation and licensure by the
Department of Corporations (DOC) of entities that provide "debt
settlement" (i.e., negotiation) services. Specifically, this
bill as currently in print:
1)Defines "debt settlement services" as services provided as an
intermediary between an individual and one or more creditors
of the individual for obtaining concessions on behalf of the
debtor.
2)Provides that no person shall provide debt settlement services
to an individual who resides in this state unless the provider
is licensed, but exempts specified persons and companies from
licensing.
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3)Requires licensees to obtain a license renewal on an annual
basis.
4)Requires a licensee to maintain evidence of a surety bond or
minimum coverage of insurance in an amount specified by the
commissioner.
5)Requires the application to contain specified information
regarding the applicant.
6)Requires the approval or denial of an initial license within
60 days of submission of a complete application. If an
application is denied the applicant may appeal and request a
hearing pursuant to the California Administrative Procedure
Act.
7)Allows the DOC to conduct investigations and otherwise enforce
the licensing provisions.
8)Requires certain disclosures and other information prior to or
in the consumer contract and allows a consumer or the provider
to cancel the contract in certain situations within specified
time periods.
9)Allows a maximum set-up fee and provides a maximum total of
all fees charged by the provider and a specified period during
which the fees may be spread unless accelerated.
10)Requires a provider to notify the individual within three
business days after learning of a creditor's decision to cease
final negotiation with the provider.
11)Requires a provider to furnish specified information to the
consumer if a creditor has agreed to accept as payment in full
an amount less than the principal amount of debt owed by the
individual.
12)Requires a provider to maintain records of each individual
for whom it provides services for a specified period.
13)Prohibits certain acts and representations by providers,
including specified advertisements.
14)Requires each provider to establish an internal formal
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complaint policy that creates a process for the provider to
receive, review, and address or resolve formal complaints
internally and requires that the file of complaints be
available to the commissioner upon request.
15)Provides for public and private enforcement, including a
private cause of action for specified wrongs.
16)Specifies an operative date of July 1, 2011.
EXISTING LAW provides, under the Check Sellers, Bill Payers and
Proraters Law, for licensing and regulation by DOC of proraters
- i.e., persons who receive money from a debtor for the purpose
of distributing the money among the debtor's creditors in full
or partial payment of the debtor's obligations. (Financial Code
12000 et seq.)
COMMENTS : This bill reflects the author's laudable continuing
efforts to establish a new set of rules to clearly govern the
burgeoning "debt settlement" industry, which offers to negotiate
unsecured consumer debt with an individual's creditors for a
fee. As with prior measures, this bill is jointly sponsored by
two industry trade associations, who state that consumer debt
settlement is a relatively new industry in need of an
appropriate regulatory scheme to provide certainty for the
industry and protection for consumers. This bill is one of many
being pursued by the industry in various states. The sponsors
note that the number of companies offering debt negotiation
services has expanded rapidly in recent years in response to the
increasing level of consumer debt - an observation confirmed by
media reports that revolving debt (overwhelmingly from credit
cards) reached a record high of $943.5 billion last December,
and the annual growth rate of this debt has increased steadily
since 2007. The amount of this debt that is delinquent also
appears to be on the rise. (See New York Times, Debt Relief Can
Cause Headaches of Its Own (Feb. 9, 2009).) The sponsors state
that their service has "proven to be a valuable and successful
alternative to bankruptcy."
As explained in more detail below, the author and sponsors have
engaged in important and productive discussions with consumer
advocates after this bill was reported out of the Assembly
Banking & Finance Committee. These discussions are continuing
in an effort to resolve the considerable remaining issues,
listed below. While the opposition has indicated it would
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prefer to see the bill remain in the Committee as a two-year
measure, it is the author's desire that the bill advance in
order to meet legislative deadlines while negotiations proceed.
History of Prior Legislative Efforts. Last year the Committee
passed the author's AB 2611 as a work-in-progress, with the
understanding that further amendments would be taken and the
bill might need to return to the Committee. That measure was a
follow-up to the author's 2007 effort, AB 69, which was
ultimately amended for another purpose. Last year AB 2611 was
likewise held in the Senate Banking Committee. At the end of
the last session, however, the debt settlement provisions of AB
2611 were amended into SB 1678 (Florez), which subsequently
failed passage in the Senate Banking Committee. This bill now
returns to the Committee in substantially the same form. As
discussed below, the bill continues to be a developing proposal,
with a number of outstanding questions dividing the sponsors and
consumer opponents.
Background On The Debt Settlement Industry . Debt settlement
companies represent consumers for a fee in an attempt to
negotiate with creditors to settle for less than the full amount
of a consumer's debt. According to the sponsors, the industry
is designed so that providers do not hold or manage the client's
money. Rather, they encourage consumers to accumulate savings
over time while they approach creditors and attempt to work out
a reduced payment acceptable to both sides in full satisfaction
of the debt, to be paid from the consumer's accumulated savings.
Debt Negotiation Services Have Generated Controversy . The
Assembly Banking & Finance Committee reports that the industry
has been marked by a history of bad actors that have typically
encouraged customers to default on debts while they collect
payments from the consumer from the customer's savings account,
which is intended to be available to eventually leverage
lump-sum settlement for an amount less than what is owed.
However, this approach often leads creditors to impose
additional finance charges and delinquency fees and further
collection activity, including litigation. Perhaps even more
serious than advising consumers not to pay their debts is the
failure of many debt settlement companies to assist consumers
with the consequences. The Banking & Finance Committee analysis
states, "It should not surprise anyone that a consumer that
stops paying credit card debt is likely to face debt collection
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harassment and in many cases collection lawsuits. In fact, debt
settlement company advertisements play heavily on these themes,
in many cases sounding much more like companies that stop
collection harassment rather than settle debts. Many companies
highlight stopping collection calls as the first item in a list
of company services."
The Banking & Finance Committee states:
The Federal Trade Commission (FTC) summarized these
problems in its May 2004 lawsuit against National Consumer
Council (NCC) and affiliates. According to allegations in
this lawsuit, "Consumers find out, only after enrolling in
defendants' debt negotiation process that: a) even after
they execute powers of attorney authorizing defendants to
represent them in dealing with creditors, they are still
called, harassed, and sued by their creditors for
collection of their outstanding debts; b) it is not
realistic for them to successfully complete the program or
eliminate their debts because of intervening creditor
collection efforts ; c) they will continue to accrue late
fees, penalties, and interest on their debt during the time
they are enrolled in the debt negotiation process, even
though they are making monthly payments to defendants; d)
their creditors may raise the interest rates applicable to
their debt because, while they are enrolled in the debt
negotiation program, the creditors are not receiving the
consumers' minimum monthly debt payments; and e) defendants
will not reach a settlement, if at all, with the consumer's
creditors, and in fact typically will not even contact the
creditors, until after the consumer has deposited enough
money into his NCC trust account to make a lump sum payoff
to the creditors, which often does not occur until many
months after the consumer has enrolled in the program."
In its lawsuit against Better Budget, the FTC alleged that
rather than negotiating with creditors, the defendant in
numerous instances failed to contact creditors and debt
collectors. Consumers enrolled in the program were still
contacted by creditors.
A New York Times article last week describes the recent growth
of the business, and some of the continuing controversy.
As many as 2,000 settlement companies operate in the United
States, triple the number of a few years ago. Settlement
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ads offering financial salvation blanket radio and
late-night television.
Consumers who turn to these companies sometimes get help
from them, personal finance experts say, but that is not
the typical experience. More often, they say, a settlement
company collects a large fee, often 15 percent of the total
debt, and accomplishes little or nothing on the consumer's
behalf. State attorneys general are being flooded with
complaints about settlement companies and other forms of
debt relief. In North Carolina, complaints doubled last
year, while in Florida they tripled, spokeswomen for the
state attorneys general said. In Oregon, complaints have
quadrupled since 2006.
Debt settlement companies claim they help both creditor and
consumer by bridging the abyss between them. "There is
overwhelming demand for this service," said Robby H.
Birnbaum, a lawyer who is a board member of the Association
of Settlement Companies, a trade group. "People want to
avoid bankruptcy, and this is their last resort."
In practice, however, the debt settlement firms frequently
manage to please no one. An executive of the American
Bankers Association, representing the credit card industry
at a recent forum, labeled debt settlement companies "very
harmful" to both creditor and consumer. Even debt
collectors are upset, saying the settlement companies
prevent them from collecting.
The premise of debt settlement is simple: A consumer stops
trying to pay even the minimum on his cards. Instead, he
accumulates money in an account that the settlement company
promises to use to strike a bargain with creditors.
Confronted with the certainty of some money now versus the
possibility of no money later, the card company settles for
40 cents on the dollar or less.
Even if the goal makes sense, achieving it can be
difficult.
Once the consumer stops paying the minimums, the card
companies increase efforts to collect. Their fees and
interest charges do not stop. They may sue. The
consumer's credit score falls through the floor. Long
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before making any attempt at a deal with creditors, the
settlement companies take a fee. (New York Times, Debt
Settlers Offer Promises But Little Help (April 20, 2009.))
Disagreement Regarding Application of Existing "Prorater's Law"
to Debt Settlement Companies. Existing law regulates "Bill
Payers and Proraters" (the "Prorater's Law"), providing for
licensing and regulation by the Department of Corporations of
proraters - i.e., persons who receive money from a debtor for
the purpose of distributing the money among the debtor's
creditors in full or partial payment of the debtor's
obligations. (Financial Code 12000 et seq.) According to the
Assembly Banking & Finance Committee analysis, the DOC has
issued orders for many debt settlement companies to comply with
the Prorater's Law. However, some industry participants have
argued that because they do not directly control the consumer's
money they are not proraters as defined in law. Indeed, the
sponsors of this bill categorically state: "Currently there is
no law governing the operation of debt settlement companies."
Under the Prorater's Law, the definition of "prorater" is: "A
person who, for compensation, engages in whole or in part in the
business of receiving money or evidences thereof for the purpose
of distributing the money or evidences thereof among creditors
in payment or partial payment of the obligations of the debtor."
(Fin. Code section 12002.1.) The sponsors contend that because
their member companies do not handle or control the consumer's
money they are not proraters under this definition.
The Assembly Banking & Finance Committee analysis reports that
recent litigation sheds some light on this debate. In
Nationwide Asset Services, Inc v. California Department of
Corporations, a company filed suit against the DOC arising out
of the DOC's issuance of a cease and defrain order for operating
as a prorater without a license. In issuing its order, DOC
concluded that under the Proraters Law the receipt of money can
be actual or constructive, a finding that the court upheld. The
sponsors of this bill claim that they do not operate the same
business model as Nationwide, but that the decision in the
Nationwide case could be applied to them because there is no
alternative to the current Proraters Law.
The sponsors of this bill contend that there are several
differences between the existing law pertaining to proraters and
debt settlers, with a common theme that the Prorater's Law is
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drafted to regulate the relationship between a prorater as an
entity that receives money from a debtor for the purposes of
distributing it to the creditors of a debtor. Debt settlers,
the sponsors contend, act as an agent on behalf of a debtor for
the purpose of obtaining a reduction in the debt without
controlling the debtor's money. According to the sponsors, many
provisions of the Prorater's Law either conflicts with or are
not ideal given the fundamental difference between the two
industries. "For example, it is unnecessary for a DS company to
provide an audited financial statement annually as required in
Section 12304, whereas it is very appropriate for a prorater
that maintains a trust account for a debtor. Another example is
the posting of fees in Section 12309. This is clearly aimed at
'brick and mortar' business and does not fit with current
practices in the DS industry."
ARGUMENTS IN OPPOSITION : Consumers Union opposes the bill,
arguing as follows:
This measure would replace the fee restrictions that now
apply to debt settlement services under the current
Proraters law, Financial Code Section 12000, et seq., with
much higher fee caps. It would also create a new licensing
scheme and impose certain new restrictions on the conduct
of debt settlement companies. In addition to raising the
allowable fees, the bill undermines a critical, if not
always fully complied with, provision of current law -that
a debt settlement service is not entitled to fees beyond an
initial $50 origination fee and a percentage of 10% to 12%
of the funds that are actually paid to the creditor.
Financial Code section 12314. Under current law, the
service must pay the creditor (that is, settle the debt) to
earn a percentage fee. Under AB 350, consumers would owe
the debt settlement service up to 20% of the amount of the
original debt as a fee even if that debt is never
successfully negotiated and paid.
Debt settlement services are in the business of contracting
with consumers for the consumer to save their own money
and, when the consumer has saved enough, negotiating with
the consumer's creditors to settle debts. These services
were recently included in a list of five "financial traps"
and "costly come-ons" in the March issue of Consumer
Reports, Financial Traps are Flourishing, Tough Times Have
Bred Five Costly Come Ons: High Fee Debt Settlement . In
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that article, Consumer Reports noted evidence that few
consumers actually benefit from these programs. People in
financial distress are unlikely to be able to save enough
of their own money for the settlement company to use to
negotiate their debts, and the debts even can continue to
grow during the savings period due to interest and
penalties. Consumer Reports said: "But in a May 2004 case
against debt-settlement services brought by the Federal
Trade Commission, a court found that less than 2 percent of
consumers enrolled in the defendants' debt-negotiation
programs, 638 out of 44,844, completed them."
AB 350 offers a detailed licensing scheme and conduct
restrictions, but it authorizes much higher fees than
current law and permits those fees to be charged whether or
not the debt is in fact actually settled. Under AB 350,
unlike under current law, it would be legal for the
consumer to get stuck with a fee of up to 20 % of the debt
even if the debt is never in fact successfully settled by
the service.
Also in opposition are the Consumer Federation of America and
National Consumer Law Center, who write:
Our organizations are taking the unusual step of weighing
in on state legislation because it would be very harmful to
increase the amount of money that settlement firms can
charge upfront for a service that is already quite
dangerous for many consumers. The essential promise made
by debt settlement firms to the public - that they can
settle most debts for significantly less than what is owed
- is often fraudulent. Some of our specific concerns with
debt settlement firms include:
Settlement firms often mislead consumers about the
likelihood of a settlement. Evidence from debt settlement
investigations indicate that a large number of consumers
never complete a debt settlement program. One North
Carolina assistant attorney general estimates that 80
percent of consumers drop out of debt settlement plans
within the first year. A receivers' report on the
California-based National Consumers Council, a purported
non-profit debt settlement organization that was shut down
by the FTC in 2004, found that only 1.4 percent of NCC
customers settled with all their creditors. 43 percent of
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their clients cancelled the program after incurring fees of
64 percent of the amount remitted to NCC.
Unlike credit counseling agencies, settlement firms cannot
guarantee to consumers that the creditor will agree to a
reduced payment if certain conditions are met. In fact,
some creditors insist that they won't negotiate with
settlement firms at all, or that they will initiate a
collections action if they learn that a debt settlement
company is negotiating on behalf of a consumer.
Settlement firms often mislead consumers about the effect
of the settlement process on debt collection and their
credit worthiness. Withholding payment to settle multiple
debts is a very long process. Meanwhile, additional fees
and interest rates continue to build up, creditors continue
to try to collect on unpaid debts, and consumers' credit
worthiness continues to deteriorate. Some firms still
advise consumers not to pay debts, either implicitly or
explicitly. Others firms say they never tell consumers not
to pay their debts but only accept clients who have already
done so. Moreover, many settlement firms have not followed
through with promises that they will stop collection calls.
In fact, under the Fair Debt Collection Practices Act,
consumers can only request that third party collection
efforts stop, not collection attempts by a credit card
company or other creditor on its own behalf.
Settlement firms charge such high fees that consumers often
don't end up saving much to make settlement offers, which
is why so many drop out of settlement programs. Debt
settlement firms typically require consumers to pay fees of
between 14 and 20 percent upfront (and as high as 30
percent) before they receive a settlement. It is often not
made clear to consumers that a hefty portion of the
payments they make in the first year will go to the firm,
not to their reserve fund or creditors. Many firms also
charge monthly fees to maintain accounts as well as a
"settlement fee" of between 15 and 30 percent of the amount
of debt that has been forgiven.
As a result of high fees, consumers targeted by debt
settlement companies are generally the least likely to
benefit. Some firms will work only with insolvent consumers
who are unemployed or those in a hardship situation. Many
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have minimum debt requirements of $10,000 to $12,000.
Consumers facing serious hardship with very high debts are,
of course, the least likely to be able to afford the hefty
payments that are charged. Settlement firms also appear to
make no distinction, as a good attorney would, between
consumers in these hardship situations who are vulnerable
to legal judgments to collect and those who are not.
It is unclear what professional services most debt
settlement companies offer to assist debtors while they
save money to pay for a settlement. Serious negotiation
with creditors cannot commence until a significant
settlement amount is saved, which could take years once
high fees are paid. A persistent complaint by consumers is
that settlement companies do not contact creditors at all
in some cases.
Though current California law is far from perfect, it does
provide that the debt settlement service must pay the
creditor (that is, settle the debt) to earn a percentage
fee. By contrast, under AB 350, consumers would owe the
debt settlement service up to 20% of the amount of the
original debt as a fee even if that debt is never
successfully negotiated and paid. This bill takes the law
in precisely the wrong direction, and we therefore urge you
to oppose it.
Outstanding Questions Requiring Further Discussions . The author
and sponsors have committed to continue their substantial
efforts to work with the Committee to resolve a number of
outstanding issues as the bill advances. Among the more
significant issues are the following:
What is an appropriate fee cap and fee collection period that
will not undermine the licensing mandate and yet still protect
consumers against the potential for unscrupulous operators?
What if any financial incentives can be established to promote
successful performance by both providers and consumers?
If debt settlement companies act as agents of consumers for the
purpose of attempting to negotiate debt reduction, is it not
appropriate to recognize that they may have a fiduciary
obligation to their customers, as agents, lawyers, brokers and
other financial professionals have?
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What if any constraints (e.g., suitability factors), should
appropriately be placed on the type of customers that are taken
on by debt settlement providers?
Because the debt settlement industry frequently relies on "lead
generators" to refer prospective customers, what if any
regulation should be placed on the activities of lead generators
and the payment of referral fees?
Should debt settlement companies operated by or affiliated with
financial institutions and/or bill payers be exempt from
regulation?
What background information should be required of applicants,
including other names used in other jurisdictions, and the
criminal and civil history of the company and its controlling
officials, and what if any prior conduct should the DOC be
allowed or required to consider when deciding whether to issue
or renew a license?
What representations should a provider be allowed to or
prohibited from making?
What financial arrangements may a provider have with consumers?
What information should a debt settlement company be required to
provide before a consumer commits to a contract?
What information, documents or transactions are appropriate to
communicate solely by email?
When and what information should be provided in languages other
than English?
What is an appropriate cancellation period and what if any fees
should be returned to the consumer who exercises a right to
cancel or otherwise terminate the contract?
Should private arbitration of disputes be allowed unless it is
voluntary and knowing given concerns that private judging can
impose significant consumer fees, takes place in secret, is
conducted without due-process and other rules designed to ensure
fairness, raises concerns about alleged "repeat-player" bias and
effectively undermines any statutory or other legal protection
because arbitrators are not required to apply either the law or
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facts in order to impose a binding decision that is essentially
shielded from judicial review?
Should consumers be required to participate in a company's
internal complaint process or have their remedies contingent on
the result of that process?
What is an appropriate statute of limitations and what remedies
are adequate to ensure robust compliance and enforcement?
By what methods should providers be required to obtain and
document consumer assent to the transfer of funds?
Should debt settlements be permitted where the consumer
continues to owe funds on that debt subject to "balloon
payments"?
Should debt settlement companies be required to provide a
consumer with evidence of full satisfaction of debt settlements
they obtain?
Should debt settlement companies be liable only for certain
violations committed "willfully" rather than the more common
"intentional" standard?
Because this would be a new licensing scheme, what information
and reports should be provided to policy makers and regulators
to ensure that the measure achieves its desired goals?
REGISTERED SUPPORT / OPPOSITION :
Support
The Association of Settlement Companies (co-sponsor)
United States Organization for Bankruptcy Alternatives
(co-sponsor)
AFSCME
Freedom Financial Network
Opposition
Center for Responsible Lending
Consumer Federation of America
Consumers Union
National Consumer Law Center
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Analysis Prepared by : Kevin G. Baker / JUD. / (916) 319-2334