California on Verge of Passing Debt Settlement Law That Protects Consumers

California is getting ready to pass AB-1405 titled “Fair Debt Settlement Practices Act.”

Ironically, a number of settlement companies are located in California, Irvine in particular.

Unless something magical happens the bill will pass.

As it stands today, the bill has some serious consequences for settlement companies.

This can be of no surprise to an industry that has grossly failed to police itself and as is always a result, it forces regulators to act in the absence of self-regulation.

I challenge anyone that states any trade association or group has acted to police members’ activities. In fact, the summary of the bill from the Senate Committee on Banking and Financial Institutions specifically calls out one trade group in its opposition.

The Committee analysis states the law will not only cover settlement providers but also payment processors.

Payment processors are defined as entities as “accepting, maintaining, holding, or distributing funds, on behalf of a consumer for the purpose of facilitating debt settlement services.”

The Act also “Prohibits a debt settlement provider from engaging in false, deceptive, or misleading acts or practices when providing debt settlement services.” That could be problematic given the statements made on settlement websites and by representatives, including lead generators.

Here is a big change that will irritate many settlement companies and cause them to lose sales. The Act “Requires a debt settlement provider to provide a disclosure to a consumer at least three days prior to execution of a debt settlement contract. The disclosure contains warnings about the risks related to debt settlement services, including that there is no guarantee the consumer’s debts will be reduced or settled, that the consumer’s credit score may be negatively impacted, and other specified disclosures.”

A commonsense feature of the proposed Act would prohibit “a debt settlement contract to be entered into by a consumer who is not already allegedly legally responsible for all the debt that will be enrolled in the debt settlement services.”

And then, once the contract is activated, the Act would allow a consumer to terminate the contract, “at any time without a fee or penalty and establishes obligations of a debt settlement provider and payment processor related to facilitating the of returning of funds in the settlement account to the consumer.”

Bill Carves Out Niche for Credit Counseling and Some Attorneys

The proposed law would exempt credit counseling groups and some attorneys from being covered. The Act states:

“This title does not apply to any of the following:

(a) Any person, or the person’s authorized agent, doing business under license and authority of the Commissioner of Financial Protection and Innovation under Divisions 1.1 (commencing with Section 1000), 2 (commencing with Section 5000), and 5 (commencing with Section 14000) of the Financial Code or under any law of this state or of the United States relating to banks or credit unions.

(b) Any nonprofit business organization that is certified as tax-exempt by the Internal Revenue Service and that does not receive compensation from the consumer for providing debt settlement services.

(c) Attorneys and law firms that meet all of the following criteria:

  1. The attorney or law firm does not charge for services regulated by this title.
  2. The fees and disbursements are not charges or costs shared, directly or indirectly, with a debt settlement provider.
  3. Any of the following is true:
    • The attorney or law firm is retained by a consumer for the purpose of legal representation in consumer debt litigation.
    • The attorney or law firm provides debt settlement services pursuant to representation by retainer for a debt collection matter that does not involve consumer debt.
    • The attorney or law firm is retained by the consumer primarily for purposes other than the settlement of consumer debt.

(d) A merchant-owned credit or creditors association, or a member-owned, member-controlled, or member-directed association whose principal function is that of servicing the community as a reporting agency.”

The Big Horrors

The section that is most likely to the new form of settlement companies that claim to purchase enrolled debts or make or broker loans to consumers is this section.

“Prohibits a debt settlement provider and a payment processor from engaging in unfair, abusive, or deceptive acts or practices, which includes but is not limited to the following:

a) Offering to lend money or credit, or purchase an enrolled debt.

b) Offering any compensation to any person for referring any prospective consumer to the debt settlement provider.

c) Accepting any compensation from any person other than the consumer in connection with debt settlement services.”

Did you catch that, no referral fees can be paid. That will impact lead generators.

Settlement Companies Should Not be Able to Make or Broker Loans

The analysis of the Act provides a deep dive into the issue of settlement companies fronting as loan brokers.

“Many of the workability issues with this bill have been addressed in recent author’s amendments or in committee amendments proposed in Comment #10 below, but an important policy question remains for the Committee’s consideration. Recent discussions with opponents and sponsors of the bill have focused on whether debt settlement providers should be allowed to also make or broker loans. For historical context, the Proraters Law, which was enacted in 1957, includes a prohibition on lending, likely motivated by concerns around conflicts of interest. The author and sponsor of the bill share those concerns and have included a similar prohibition in this bill.

Permitting a company to provide both debt settlement services and lending or brokering activities may place consumers at risk of being steered toward a service that is more profitable for the company, but less beneficial and/or more risky for the consumer. Take, for example, a consumer who responds to an advertisement from a debt relief company about a debt consolidation loan. The consumer has multiple credit lines outstanding with varying interest rates and monthly payments, and they would like to pay off all of those lines by taking out a consolidation loan with a fixed monthly payment and lower overall financing costs. When the consumer engages with the debt relief company, they are convinced to enroll in a debt settlement program instead, even if their financial circumstances would have qualified them for a consolidation loan. In this example, the consumer is now exposed to the risks described in Comment 3) above, including significant damage to their credit score and the risk that additional fees and penalties on unsettled credit lines will wipe away any savings realized on settled lines.

Some debt settlement companies serving California consumers are currently engaged in the making or brokering of loans. When these companies interact with consumers, they receive important personal information about the financial situations of the consumer that can be used to determine which service to recommend to the consumer. These companies also know about the likely profitability of a consumer taking out a consolidation loan vs. entering into debt settlement services vs. first entering into debt settlement and then converting to a loan.

With inadequate legal protections in place today, the state is simply hoping that these companies will place the interests of consumers over their own business interests in recommending products and services.

If the Committee agrees with the author that debt settlement providers should not be permitted to make or broker loans, then no additional amendments to the bill are necessary. On the other hand, if the Committee believes that a blanket prohibition is too burdensome on industry, the bill may be amended to require that debt settlement providers that also make or broker loans shall be held to a fiduciary standard. The establishment of a fiduciary relationship between the debt settlement provider and the consumer would partially alleviate concerns related to steering and conflicts of interest, but would be more difficult to enforce than a straight prohibition. On the other hand, the debt settlement industry may prefer an elevated standard related to their obligations to consumers, rather than the full prohibition.”

American Fair Credit Council (AFCC) Objects

The Committee listened to the representative of the settlement industry, the AFCC. The analysis states the AFCC submitted an “oppose unless amended” letter that had the following key points.

“AFCC identifies the following areas of concern with the bill:

  • The 3-day cooling off period between the time the contract is provided to the consumer and the time when the contract can be executed.
  • The 5-day delay from the time of contract execution to the time of its effective date.
  • The provision establishing that a contract is considered cancelled five days after notification of cancellation is mailed by the consumer, rather than upon receipt.
  • The prohibition on paying for referrals (e.g., lead generation).
  • The requirement to deliver a monthly accounting statement with transactions dating back to the start of the contract.

Committee Listens

The Committee listened to objections from the settlement industry companies and payment processors and suggested the following amendments:

  • Delete the provision that delays the effective date of a contract until five days after execution, and replace with a prohibition for a debt settlement provider to contact a consumer’s creditor until five days after contract execution.
  • Clarify that the monthly statement provided by the payment processor is limited to transactions occurring in the previous month, rather than all transactions since the outset of the contract. Make historical records available upon a consumer’s request.
  • Require a payment processor to be licensed pursuant to the Money Transmission Act or expressly exempt from licensure.
  • Make a contract cancellation effective seven days from the date of mailing, if sent by non-certified mail, rather than on the fifth day.
  • Delete the requirement that a payment processor engage in certain communications with a consumer upon notice of contract cancellation, and instead require the payment processor to close the account and deliver the balance in the settlement account within seven days.
  • Delete the exemption for the services of a certified public accountant from the bill.
  • Various technical and clarifying changes.

Interesting Supporter

The Financial Counseling Association of America is on record of supporting the bill if amended.

Opponents to the bill are listed as:

  • American Fair Credit Council (AFCC)
  • CA Black Chamber of Commerce
  • Finxera, INC.
  • Consumer Debt Relief Initiative Resource
  • Thurman Legal

Listed supporters of the bill are:

  • AARP California
  • Bet Tzedek
  • California Asset Building Coalition
  • California Association for Micro Enterprise Opportunity (CAMEO)
  • California Association of Collectors, Inc.
  • California Low-income Consumer Coalition
  • Consumer Federation of California
  • East Bay Community Law Center
  • Freefrom
  • Hope for All: Helping Others Prosper Economically
  • Legal Aid of Marin
  • National Consumer Law Center
  • New Economics for Women
  • OneMain Financial
  • Public Counsel
  • Public Law Center
  • University of California Irvine, Consumer Law Clinic
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