BILL ANALYSIS
SENATE COMMITTEE ON BANKING, FINANCE,
AND INSURANCE
Senator Ronald Calderon, Chair
SB 1188 (Wright) Hearing Date: April 7, 2010
As Amended:March 25, 2010
Fiscal: Yes
Urgency: No
SUMMARY Would, effective January 1, 2012, add a new division
to the Financial Code related to debt settlement organizations,
as specified, and would give the Department of Corporations
limited regulatory authority over companies engaging in debt
settlement.
DIGEST
Existing law
1. Provides for the Check Sellers, Bill Payers, and Proraters Law
(Proraters Law; Financial Code Section 12000 et seq),
administered by the Department of Corporations (DOC), which
defines a prorater as 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
among creditors in payment or partial payment of the obligations
of the debtor (Section 12002.1);
2. Limits the fees that may be charged by a prorater, or by any
other person for the prorater's services, to an origination fee
of up to $50, plus 12% of the first $3,000 distributed by the
prorater to the creditors of a debtor; 11% of the next $2,000;
and 10% of any of the remaining payments, except for payments
made on recurrent obligations, as defined (Section 12314);
3. Defines recurrent obligations for purposes of the
aforementioned fee cap as current rent payments, current utility
payments, current telephone bills, current alimony payments,
current monthly insurance premium payments, and first lien
mortgage payments, and authorizes a fee not to exceed $4 per
disbursement on recurrent obligations consisting of current rent
payments or first lien mortgage payments, and not to exceed $1
on other recurring obligations (Section 12314);
SB 1188 (Wright), Page 2
4. Provides that when a debtor has not canceled or defaulted on
the performance of his or her contract with the prorater within
12 months after engaging in the contract with the prorater, the
prorater must refund the origination fee (Section 12314);
5. Provides that if a prorater contracts for, receives, or makes
any charge in excess of the maximum allowed under the Check
Sellers, Bill Payers, or Proraters Law, except as the result of
an accidental and bona fide error, the prorater's contract with
the debtor is void, and the prorater is required to return to
the debtor all charges received from the debtor (Section 12316);
6. Provides for administrative penalties of up to $2,500 per
violation of the Check Sellers, Bill Payers, and Proraters Law,
and states that any licensee or person who willfully violates
any provision of the law, or any rule or order adopted pursuant
to the law, is liable for a civil penalty of up to $10,000,
enforceable by the Commissioner of Corporations (Section 12105).
This bill
1. Would define "debt settlement services" or "services" as
acting as an intermediary between an individual and one or
more of the individual's creditors in order to obtain
concessions for that individual's unsecured debts, but
without holding or disbursing funds to the individual's
creditors, for a fee to be paid by the individual;
2. Would provide that it is unlawful for a person to provide
debt settlement services unless it obtains and maintains
insurance coverage for employee dishonesty, depositor
forgery, and computer fraud, in an amount not less than
$100,000, and with a deductible of no greater than 10% of
the face amount of the policy. Each person providing debt
settlement services would have to provide a copy of its
policy to any party upon request, and would have to file a
form establishing proof of the required insurance coverage
with the Commissioner of Corporations;
3. Would require a debt settlement organization to enter into
a written contract with an individual, which is signed and
dated by the individual, and given to the individual upon
the contract's consummation, before the debt settlement
organization may provide debt settlement services to that
SB 1188 (Wright), Page 3
individual. The contract would be required to include the
following information:
a. A full and detailed description of the debt
settlement services to be performed and the estimated
date by which, or length of time in which, they will be
performed;
b. All terms and conditions of payment, including the
estimated total of all payments to be made by the
individual;
c. The organization's principal business address and
the name and address of its agent in the state who is
authorized to receive service of process;
d. A clear and conspicuous statement in boldface type,
in immediate proximity to the space reserved for the
individual's signature, which states, "You may cancel
this contract within 5 business days after the date the
contract is signed." The organization is also required
to give a separate document to the individual titled,
"Notice of Right to Cancel," whose language is specified
in the bill;
4. Would establish the following rules with respect to fees
that are allowable and prohibited by a debt settlement
organization:
a. A debt settlement organization would be prohibited
from collecting any fees, until after settlement of an
account with the individual's creditor is agreed upon,
and documentation memorializing the funding of the
settlement is executed;
b. Settlement fees and other monetary settlement
charges may not exceed 30% of the difference between the
debt principal and the concession agreed upon with the
individual's creditor;
c. No fee or other charge may be imposed, either
directly or indirectly, on an individual for debt
settlement services, until the individual agrees in
writing to the fees or charges and to the plan negotiated
by the debt settlement organization;
SB 1188 (Wright), Page 4
d. In the event that a multiple pay settlement is
negotiated (i.e., a settlement that will be paid in
installments), the debt settlement organization may only
collect a fee based on the amount of the multiple
installment payment, at the time that installment payment
is made;
5. Would prohibit a debt settlement organization from doing
any of the following:
a. Making or using any false or misleading
representations or omitting any material fact in the
offer or sale of services offered, or engaging in any
fraudulent, false, misleading, unconscionable, unfair, or
deceptive act or practice in connection with the offer or
sale of any of its services;
b. Providing services to an individual without
executing a written contract;
c. Failing to provide copies of all contracts and other
documents the individual is required to sign; and,
d. Failing to obtain insurance coverage or failing to
make that coverage information available for public
inspection;
6. Would exempt a debt settlement organization from the
provisions of the Prorater's Law, except to the extent the
organization is performing services and activities governed
under that law;
7. Would exempt the following entities and their employees
from its provisions, when the entities or employees are
engaged in the regular course of their business or
profession: a person licensed to practice law in
California, a licensed public accountant or certified public
accountant; a depository institution; any subsidiary or
affiliate of a bank holding company; Fannie Mae; Freddie
Mac; any consumer reporting agency; any title insurer,
escrow company, or other person that provides bill paying
services, if the person does not provide debt settlement
services; and any person who engages in debt adjustment to
adjust the indebtedness owed to that person. Would also
exempt from the bill's provisions a family member of an
individual who negotiates concessions, with or without
SB 1188 (Wright), Page 5
compensation, from the creditor's of that individual;
8. Would provide that a violation of the bill is an act of
unfair competition within the meaning of Business and
Professions Code Section 17200 et seq., and would authorize
any individual injured by a violation of the bill to bring
an action to enjoin and restrain any violation and to
recover damages.
COMMENTS
1. Purpose of the bill To provide a regulatory scheme other
than the Prorater's Law, under which debt settlement
services may be provided in California.
2. Background The business model of debt settlement service
providers involves working on behalf of individuals behind
on their debts, and helping these debtors negotiate
reductions in the amounts owed to their creditors. A
customer who signs up with a debt settlement services
provider is commonly instructed to put money aside in a bank
account, and add money to that bank account each month.
Because creditors typically want assurances that an
individual will pay his/her settled debts, the debt
settlement service providers use the existence of money in
the bank account as leverage, when they seek out the
consumer's creditors to negotiate a reduction in the amount
the consumer owes.
Once a reduction in a person's debts is negotiated by a debt
settlement service provider, one of several business models
is followed. Some providers direct the negotiated amount to
the creditor, using a power of attorney granted to the debt
settlement provider by the debtor (though reportedly, this
practice has fallen out of favor in recent years). Other
providers notify the debtor about the negotiated amount, and
the debtor is responsible for sending money to the creditor.
Still other providers work with a third party financial
institution, which facilitates the transfer of money from
the debtor's account to a creditor. Alternate business
models are also possible.
According to the representatives of the debt settlement
industry, the average amount of consumer debt brought into a
debt settlement program ranges from $20,000 to $30,000.
Most debt settlement programs are set up to last three
SB 1188 (Wright), Page 6
years, although about half the people who complete their
programs finish those programs in 24 months or less.
Although estimates of the percentage of customers who finish
their programs vary (consumer groups claim percentage
completion rates as low as 2%), industry representatives
assert that about half of all customers complete their
programs. The remainder drop out at some time before
completion.
The fees charged by providers vary. Some providers charge
front-end fees and collect the remainder of their fees over
a subsequent period of 12 months or less. Others providers
charge flat fees, which are collected over the first half of
the total enrollment period. Still others charge relatively
small monthly fees (or no monthly fees at all), and then
charge the consumer a percentage of the money they are able
to save the consumer, upon completion of the program. These
fee models have been described by the Federal Trade
Commission as the "front-end fee model," "flat fee model,"
and "back-end fee model," respectively.
The diversity in business models among debt settlement providers
has resulted in a fragmentation of the industry, and in the
legislation its members have advocated in the recent past.
One segment of the industry, represented by The Association
of Debt Settlement Companies (TASC) and United States
Organizations for Bankruptcy Alternatives (USOBA) has
promoted a licensing scheme administered by DOC, as an
alternative to the Prorater's Law. Under the model
preferred by TASC and USOBA (see AB 350, Lieu, from the
2009-10 Legislative Session), debt settlement providers may
charge up front fees of up to 5% and total fees of up to 20%
of the debt a consumer brings into a debt settlement
program. This Committee passed AB 350 on a vote of 10-0 in
July, 2009. AB 350 is currently awaiting a hearing in the
Senate Judiciary Committee.
More recently, the American Coalition of Companies Organized to
Reduce Debt (ACCORD) presented the Legislature with an
alternative debt settlement model that bans advance fees,
but allows fees of up to 30% to be charged once debts are
settled. Unlike TASC and USOBA, ACCORD does not propose
licensing of debt settlement providers; instead, ACCORD
would like to establish a series of allowable and prohibited
actions, and to authorize individuals injured by a violation
of its rules to bring an action to recover damages. SB 1188
SB 1188 (Wright), Page 7
contains ACCORD's proposal.
A limited comparison of the two measures is provided immediately
below:
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| | SB 1188 (Wright) | AB 350 (Lieu) |
|---------------------+---------------------+---------------------|
|Coverage |Companies that |Companies that |
| |attempt to settle |attempt to settle |
| |all types of |all types of |
| |unsecured debts |unsecured debts for |
| | |individuals who |
| | |reside in California |
|---------------------+---------------------+---------------------|
|Licensing scheme |No license |A license issued by |
| |necessary. Debt |DOC would be |
| |settlement companies |necessary to engage |
| |would have to comply |in debt settlement |
| |with the |services in the |
| |requirements of the |state. |
| |bill, but would not | |
| |be required to | |
| |obtain a license in | |
| |order to do business | |
| |in the state. | |
|---------------------+---------------------+---------------------|
|Law to be |DOC would review |DOC |
|administered by |compliance with | |
| |insurance | |
| |requirements. | |
|---------------------+---------------------+---------------------|
|Fees |No up front fees |Fees capped at 20% |
|allowed/prohibited |would be allowed. |of the amount of |
| |Companies could |debt brought into a |
| |collect fees of up |debt settlement |
| |to 30% of the amount |program, including a |
| |of debt settled. |set-up (up-front) |
| | |fee of 5%. Fees |
| | |plus settlements |
| | |could not exceed the |
| | |amount of debt |
| | |brought into the |
| | |program. |
|---------------------+---------------------+---------------------|
|Interaction with |Debt settlement |Licensed debt |
SB 1188 (Wright), Page 8
|Prorater's Law |organizations would |settlement companies |
| |be exempt from the |would be exempt from |
| |Prorater's Law, |the Prorater's Law. |
| |except to the extent | |
| |the organization is | |
| |performing services | |
| |and activities | |
| |governed under that | |
| |law. | |
|---------------------+---------------------+---------------------|
|Companies exempted |Attorneys and |Attorneys and |
|from the bill |certified public |certified public |
| |accountants when |accountants when |
| |rendering services |rendering services |
| |in the course of |in the course of |
| |their practice; a |their practice; a |
| |family member of an |family member of an |
| |individual that |individual that |
| |negotiates financial |negotiates financial |
| |concessions from the |concessions from the |
| |individual's |individual's |
| |creditors; |creditors; judicial |
| |depository |officers; persons |
| |institutions, bank |acting under a court |
| |holding company |order or |
| |subsidiaries and |administrative |
| |affiliates, Fannie |order; assignees |
| |Mae, Freddie Mac, |acting for the |
| |title insurers, |benefit of |
| |escrow companies, or |creditors; |
| |other persons that |financial |
| |provide bill-paying |institutions |
| |services, if those |licensed under state |
| |persons do not |or federal law; |
| |provide debt |persons licensed or |
| |settlement services, |registered to |
| |and persons who |originate loans |
| |engage in debt |secured by real |
| |adjustment |property; title |
| | |insurers, escrow |
| | |companies, or other |
| | |persons that provide |
| | |bill-paying |
| | |services, if those |
| | |persons do not |
| | |provide debt |
SB 1188 (Wright), Page 9
| | |settlement services; |
| | |and financial |
| | |planning services |
| | |providers, as |
| | |specified |
|---------------------+---------------------+---------------------|
|Remedies for |Authorizes persons |Authorizes DOC, law |
|violations of the |injured by a |enforcement |
|law |violation of the law |agencies, and |
| |to bring a private |individuals to bring |
| |right of action |actions against |
| |against violators. |violators, and |
| | |subjects violators |
| | |to administrative, |
| | |civil, and criminal |
| | |penalties for |
| | |failure to comply |
| | |with the law. |
-----------------------------------------------------------------
3. FTC Proposed Regulations In August 2009, the Federal Trade
Commission (FTC) issued a draft proposal to regulate the
sale of debt relief services (Federal Register Volume 74,
No. 159, Wednesday, August 19, 2009, pp. 41998-42024). The
FTC's proposal would define the term debt relief service,
ensure that, regardless of the medium through which such
services are initially advertised, telemarketing
transactions involving debt relief services are subject to
the proposed rule, mandate certain disclosures and prohibit
misrepresentations in the telemarketing of debt relief
services, and prohibit any entity from requesting or
receiving payment for debt relief services, until those
services have been fully performed and documented to the
consumer. Written comments on the FTC's proposal were due
by October 9, 2009. To date, the FTC has not issued its
final rule. Those familiar with the FTC's review of debt
relief services believe the rule will be issued sometime
during 2010, but are unsure of its timing.
If enacted in anything approaching its proposed form, the FTC's
debt relief rules will significantly impact the debt
settlement services policy debate in California. As
proposed, the FTC's rule would apply to credit counseling,
debt management plans, debt settlement, and debt negotiation
(i.e., it would be broader than either SB 1188 or AB 350).
The rule would apply to all inbound debt relief calls to
SB 1188 (Wright), Page 10
debt relief service providers. Thus, even if a debt relief
provider uses a third party to solicit potential customers
via print, electronic, or broadcast media, that provider
would be covered by the FTC rule, once a potential customer
contacts the debt relief provider for more information about
their services via an inbound phone call.
Under the proposed rule, no up-front fees could be collected.
"Telemarketers of debt relief services" (i.e., those who
receive inbound phone calls regarding their debt relief
services) would have to disclose a significant amount of
information to prospective debt services customers, intended
to fully inform them about the way(s) in which the program
will work, the likely length of the program, the potential
impact of the customer's participation in the program on
his/her credit score and tax liability, and the possibility
that debt collection efforts may continue to be directed
toward the customer, even after he or she enters a debt
services relief program. The proposed rule also contains
language intended to prohibit telemarketers of debt relief
services from making misrepresentations regarding any
material aspect of the services they provide.
4. Licensing disputes: The FTC proposal must also be
considered in the context of an ongoing debate regarding the
extent to which for-profit debt settlement service providers
should be licensed, and under which law.
The FTC proposal neither requires nor prohibits the licensure of
debt relief providers. In California, there has been a
long-standing disagreement between DOC and the debt
settlement industry over whether debt settlement providers
must be licensed under the Prorater's Law.
DOC's enforcement staff believe that for-profit debt settlement
service providers should be licensed under the Proraters
Law, and has taken enforcement action against some debt
settlement service providers who have failed to obtain
licenses as proraters. Some members of the debt settlement
services industry maintain that, because they do not
physically hold money for debtors, nor control debtors'
assets, they do not fall under the definition of a prorater
under the Check Sellers, Bill Payers, and Proraters Law, and
need not obtain a prorater's license. Instead, they assert
that they need a separate licensing law. Toward that end,
TASC and USOBA sponsored AB 69 (Lieu), AB 2611 (Lieu), and
SB 1188 (Wright), Page 11
SB 1678 (Florez) during the prior Legislative Session, and
are sponsoring AB 350 (Lieu) this year.
Despite a variety of court cases on the subject, the ongoing
debate over whether, under what circumstances, and under
which law, debt settlement services providers should be
licensed has continued. This bill provides a limited
exemption from the Prorater's Law. AB 350 provides an
express exemption from the Prorater's Law.
5. Support The American Coalition of Companies Organized to
Reduce Debt (ACCORD) is sponsoring SB 1188, to create a more
consumer-oriented model for the debt negotiation industry to
follow in California.
6. Opposition Consumers Union (CU) and the Center for
Responsible Lending (CRL) have endorsed the concept,
embodied in SB 1188, that consumers should be charged for
debt settlement services, only after their debt is
eliminated. "Consumers should not be required to pay for
services before they are provided. This general rule is
amplified in the case of debt settlement services where the
evidence shows that often, payment before performance
translates into payment without performance, and, typically,
more consumers lose than win."
CU and CRL submitted very similar letters of opposition, stating
that, while SB 1188 adopts the right structure for debt
settlement fees, the bill sets the fee cap too high. Both
organizations cite the California Prorater's Law cap of 10%
to 12% and a Maine law that limits fees to $75 up-front and
15% of savings.
CU also expresses concern that SB 1188 permits fees to be
collected on installment plan payments, regardless of
whether a customer completes the installment plan. CU is
also concerned that the bill triggers the fee obligation
upon documentation "memorializing funding of a settlement,"
rather than upon a completed settlement, with a full release
of the debt.
Both groups advocate for additional consumer protections, beyond
those proposed in SB 1188. In addition to the fee cap cited
above, these groups would like to see an ability for a
customer to leave his or her debt settlement program at any
time, without owing future fees; a requirement that debt
SB 1188 (Wright), Page 12
settlement companies sign up customers only if the debt
settlement program is suitable for the customer and there is
evidence that the customer can make the expected savings
payments; a requirement that a contract be void if the debt
settlement provider fails to comply with certain statutory
requirements; strong conduct prohibitions and rules
regarding advertising disclosures; and a restriction on
unsubstantiated claims of savings.
CU's and CRL's letters of opposition sidestep the issue of
whether these groups believe that debt settlement firms
should require licenses in order to do business in
California. However, the organizations offered the author
six pages of amendments, which do not include a licensing
scheme, and stated that they would remove their opposition
to the bill, if it is amended consistent with the language
they provided.
The Coalition for Quality Credit Counseling (CQCC) shares the
concerns of CU and CRL regarding the fee cap proposed in SB
1188. Like CU and CRL, CQCC favors the "no advance fee"
approach in SB 1188, but believes that the proposed 30% cap
should be lowered. CQCC cites the Prorater's Law cap of
between 10% and 12% and references a cap of 5% in federal
legislation expected to be introduced during the current
Congress by Charles Schumer. Much of CQCC's opposition
letter urges the California Legislature to follow the
approach of the soon-to-be-introduced Schumer legislation.
Like CU and CRL, CQCC attached proposed language to its
opposition letter, and stated that it would remove its
opposition, if SB 1188 is substantially amended. Among the
concerns expressed by CQCC in its letter of opposition: The
bill's definition of debt settlement services and settlement
accounts should be changed. The bill fails to elaborate on
any of the details that must be contained in the written
contract it requires.
CQCC urges the California legislature to perform a thorough
analysis of the proposed FTC regulations and the proposed
federal legislation and move toward a more comprehensive
approach, while looking at stronger consumer protections and
licensing provisions.
The Association of Settlement Companies (TASC), a national trade
association of the debt settlement industry, is
co-sponsoring a competing debt settlement measure, AB 350
SB 1188 (Wright), Page 13
(Lieu). TASC is opposed to SB 1188, because it believes
that the bill, if enacted, would place numerous California
debt settlement companies out of business.
TASC observes that SB 1188 contains a series of rules related to
the operation of debt settlement companies, which TASC does
not oppose, but which the organization believes are less
protective of consumers than the rules contained in AB 350
(Lieu). TASC's primary concern with SB 1188 is the bill's
proposal to ban the collection of advance fees. "While on
the surface that may seem like a laudable goal, such a fee
structure is most often not in the best interest of
consumers and is rarely feasible for the industry that has
been operating for years in California utilizing a different
fee structure." TASC notes that it does not oppose some
form of a contingency model as an alternative for consumers,
and is intending to ask that Assemblyman Lieu amend AB 350
to allow for both the "flat fee" and "contingency
fee/percentage of savings" model fee structures.
The United States Organizations for Bankruptcy Alternatives
(USOBA), another debt settlement industry trade group, and
the other co-sponsor of AB 350, also opposes SB 1188. USOBA
states that, "unlike AB 350, SB 1188 unfairly penalizes a
large segment of the industry by requiring the use of a fee
structure that is unproven and not always in the best
interest of the consumer." Like TASC, USOBA also believes
that SB 1188 lacks the meaningful consumer protections
contained in AB 350.
7. Questions
a. Should the state adopt a law intended to
govern the activities of debt settlement services
providers before the proposed FTC regulations are
finalized?
b. Should a state law intended to govern the
activities of debt settlement services providers
require that those providers be licensed? Or, should
the state enact a series of required and prohibited
actions by companies that meet the definition of a
debt settlement services provider, and leave
enforcement of the law to the courts?
8. Prior and Related Legislation
SB 1188 (Wright), Page 14
a. AB 350 (Lieu), 2009-10 Legislative Session:
Would enact the Debt Settlement Services Act,
administered by DOC, and operative January 1, 2012.
Would provide a similar regulatory scheme for debt
settlement service providers as the one proposed in AB
2611 (Lieu) and SB 1678 (Florez) from the 2007-08
Legislative Session, but contained several amendments
to address technical concerns raised regarding the
earlier bills. Passed the Senate Banking, Finance &
Insurance Committee; currently pending in the Senate
Judiciary Committee.
b. AB 2611 (Lieu) and SB 1678 (Florez), 2007-08
Legislative Session: Contained debt settlement
provisions similar to those contained in AB 69. Died
in the Senate Banking, Finance & Insurance Committee;
c. AB 69 (Lieu), 2007-08 Legislative Session:
Would have enacted two separate regulatory schemes,
one tailored to the licensure of debt settlement
service providers, and the other tailored to the
licensure of debt management providers. Language
amended out;
d. AB 535 (Calderon), 2005-06 Legislative
Session: Would have enacted a law regulating
nonprofit credit counselors and increased the fees
that could be charged by these licensees, relative to
the fees allowed of nonprofit community service
organizations under the Check Sellers, Bill Payers,
and Proraters Law. Vetoed by the Governor;
e. AB 403 (Correa), Chapter 360, Statutes of
2004: Increased the fees that may be charged by a
nonprofit community service organization to their
current levels and added additional components to the
best practices that nonprofit community service
organizations must adopt, in order to qualify for an
exemption from the Check Sellers, Bill Payers, and
Proraters Law;
f. AB 2293 (Liu), Chapter 779, Statutes of 2002:
Revised the provisions of the Check Sellers, Bill
Payers, and Proraters Law authorizing an exemption for
nonprofit community service organizations, provided
SB 1188 (Wright), Page 15
they meet certain requirements; authorized the
commissioner to investigate violations of the Check
Sellers, Bill Payers, and Proraters Law; imposed
various civil penalties for violations of that law;
and required DOC to conduct a study of the consumer
credit counseling industry in California.
SB 1188 (Wright), Page 16
POSITIONS
Support
American Coalition of Companies Organized to Reduce Debt
(sponsor)
Oppose
Center for Responsible Lending
Coalition for Quality Credit Counseling
Consumers Union
The Association of Debt Settlement Companies
United States Organizations for Bankruptcy Alternatives
Consultant: Eileen Newhall (916) 651-4102