{"id":9472,"date":"2008-07-21T13:29:00","date_gmt":"2008-07-21T18:29:00","guid":{"rendered":"http:\/\/blogs.law.harvard.edu\/ethicalesq\/2008\/07\/21\/doubts-over-debt-negotiation-fees\/"},"modified":"2011-08-05T14:53:24","modified_gmt":"2011-08-05T18:53:24","slug":"doubts-over-debt-negotiation-fees","status":"publish","type":"post","link":"https:\/\/archive.blogs.harvard.edu\/ethicalesq\/2008\/07\/21\/doubts-over-debt-negotiation-fees\/","title":{"rendered":"doubts over debt negotiation fees"},"content":{"rendered":"

follow-up<\/strong><\/em> (June 19, 2010): See today’s New York Times <\/em>article, “Peddling Relief, Industry Puts Debtors in a Deeper Hole<\/a>” (reg. needed)<\/p>\n

\"\"<\/a> O<\/strong><\/em>ur mention<\/a> last month of an upcoming FTC Debt Settlement Workshop<\/a> attracted some “comment spam<\/a>” from NetDebt<\/a><\/strong><\/em>, a for-profit company that “negotiates” with creditors in an attempt to reduce your overall debt. NetDebt calls itself a “100% online debt settlement solution” and emphasizes the participation of lawyers in providing its services (nonetheless, you apparently never meet your lawyers). They claim that “In some cases, your total debt will be cut in half.”<\/p>\n

I first heard of NetDebt on June 9th, when they tried<\/a> to plant a link from f\/k\/a<\/em> to their affiliated weblog<\/a>, in order to increase NetDebt’s online profile. When the Comment showed up for “moderation,” my response was: “I just looked at your ‘NetDebt’ web site and have many questions about your services \u2014 especially the fees. Until I get a chance to review it more fully, I do not want a link from this weblog to yours, and have removed your URL.”<\/p>\n

Having now looked more deeply into NetDebt, I want to present my continuing concerns about their fees — which are 15% of the amount of debt you bring to their program (regardless of results or the number of creditors it must deal with), plus a “small” monthly service fee of $50.<\/p>\n

\"\" For example<\/em>, the so-called “flat” 15 % fee would be $1500 if you have $10,000 of debt in the program; $3000 for $20,000 of debt; $6000 in fees for a $40,000 debt load. The $50 monthly service fee quickly adds up, too, and would add another $2700, if you stay in their program the full 54 months.)<\/p><\/blockquote>\n

Although many debt negotiators make no mention of the cost of their services at their websites, it appears that similar percentage-based fees have become common among debt settlement firms. (See, for example here<\/a> and there<\/a>) update<\/strong><\/em> (July 25, 2008): As discussed below, in response to this posting, Charles Phelan has written an extensive”History of Debt Settlement Fees<\/a>” at The ZipDebt Blog<\/em> (July 25, 2008).<\/p>\n

Despite the traditional lawyer reluctance<\/a> to talk about excessive fees, I hope that legal ethics counsel or professors, other lawyers, and consumer advocates will help us determine if or when such fees are “reasonable” or appropriate for lawyers to charge. At a time when many in the legal profession are promoting the use of “alternative” and “value-based” fees instead of hourly billing — while offering so little guidance<\/a> on how to make the switch in an ethically-responsible manner — it would be especially useful to hear what standards or criteria they believe should be applied to prevent excessive fees under our professional and fiduciary principles. My assumption is that “what the market may bear” is not<\/em> an appropriate test for protecting consumers — especially unsophisticated ones in dire economic straits — from unreasonably high legal fees. [Consumers can get some tips for protecting themselves in our post “understanding and reducing attorney fees<\/a>“.]<\/p>\n

T<\/em><\/strong>here are many voices on the internet warning about “debt settlement scams” and the money wasted due to the high fees. [For example, this post<\/a> at the ZipDebt Blog<\/em>, and this article<\/a>.] An article from SmartMoney.com<\/em>, “Debt Settlement Could Cost More Than You Think<\/a>” (June 20, 2007), gives an excellent summary. SmartMoney<\/em> says, “Debt settlement is, in fact, a perfectly legal solution for consumers who are in deep and seeking an alternative to bankruptcy. But having a debt-settlement company do the legwork for you is fraught with risk, not to mention outrageous fees.”<\/p>\n

Still, unless the purveyors are engaged in actual fraud or deception, regulators can’t do much about non-lawyers charging excessive fees for a questionable service that exploits desperate people, beyond providing information and warnings. However, the legal profession can<\/em> hold lawyers to a higher standard and should<\/em> require lawyers engaged in debt settlement to charge only reasonable fees. As with many similar easy-money schemes, my guess is that the services would not be offered by members of the Bar, if only a fair price could be charged.<\/p><\/blockquote>\n<\/blockquote>\n

<\/p>\n

\"\" B<\/em><\/strong>ackground: The f\/k\/a<\/em> Gang has been skeptical for over a decade about the value of “debt reduction” services: Although there may be exceptions, in general, they appear to be overpriced, to be marketed with unrealistic claims, to use questionable tactics in gaining negotiation leverage (i.e.<\/em>, telling clients to stop making all payments to creditors), and to downplay the harm their tactics can cause to the credit rating of many of their clients. In addition, I believe that a significant number of consumers with large credit card debt are fully capable of “negotiating” directly with their creditors (that is, writing or calling to explain their financial situation and haggle for a reduction in the total debt owed), instead of using a debt settlement firm.<\/p>\n

A<\/strong><\/em>s TrueCredit.com<\/a> (sponsored by the credit bureau TransUnion) notes: “Everything that an agency can do, you have the power to do on your own. You can reduce your debts, negotiate settlements and improve your credit score from the comfort of your own home. Plus, with do-it-yourself credit improvement, all your money goes directly to the debts and you can avoid the practices that damage your credit.” In addition, see ZipDebt.com<\/em><\/a>, which provides information<\/a> to help consumers engage in successful do-it-yourself debt settlement (including a free, 32-page e-brochure<\/a>), and says “debt settlement” is nothing more than haggling, and can be successfully accomplished by “average, everyday, ordinary people.”<\/p>\n

Useful information and Do It Yourself assistance for solving debt problems can also be found at Nolo.com<\/em><\/a>, including a calculator<\/a> to determine how long it will take to pay off a particular amount of credit card debt.<\/p><\/blockquote>\n<\/blockquote>\n

The lax response of bar discipline committees to misconduct by debt-reduction lawyers in Upstate New York was, in fact, an important part of this weblog’s very first post<\/a> in May 2003, and it received more detailed attention several times thereafter, including the posting “Blame bar counsel for the Andrew Capoccia Scandal<\/a>” (March 8, 2005).<\/p>\n

\n

Note<\/em>: I’ve never been a bankruptcy or debt collection lawyer, or a credit counselor, nor worked for or with one. My concern is that of a consumer and a client advocate, not a provider of a rival form of legal and credit-related services. I had originally looked into “debt negotiation” when chronic health problems forced me to close my law and mediation practice, and I accrued significant debt over the next few years of disability. Seeing their debt-reduction advertising campaign, I approached the Capoccia Law Firm, to explore ways to avoid bankruptcy (which I was able to do on my own, without using such debt-settlement services).<\/p><\/blockquote>\n

L<\/em><\/strong>et me be clear: I have absolutely no reason to think NetDebt is engaging in Capoccia-style theft and fraud. However, long before I learned that Andrew Capoccia was actually stealing his clients’ money instead of using it to pay off their debts, I worried that lawyers and others touting “debt reduction” services such as his might be using questionable tactics and charging excessive fees. A decade later, objective observers and consumer advocates continue to have similar concerns about debt negotiation services. See, e.g.<\/em>, “Debt Relief: Beware the Frauds<\/a>” (AARP Magazine<\/em>, May 2007); the Federal Trade Commission’s Debt Settlement Workshop<\/a> and petition in FTC v. Edge Solutions<\/em><\/a>; and “Beware Debt Elimination Scams<\/a>: Costly Bogus Schemes Won\u2019t Cancel or Reduce Credit Card Balances” by George Daleiden (Feb. 18, 2008; see Scam #2).\u00a0 update<\/em><\/strong> (Oct. 29, 2008): See our posting “FTC smites debt negotiation firms<\/a>.” And (May 9, 2009): See “ATTORNEY GENERAL CUOMO ANNOUNCES NATIONWIDE INVESTIGATION INTO DEBT SETTLEMENT INDUSTRY<\/a>: Subpoenas Fourteen Debt Settlement Companies and One Law Firm in Connection with Probe” (Press Release, NYS AG, May 7, 2009);\u00a0 and “Cuomo subpoenas debt settlement companies<\/a>” (Newsday<\/em>, by John Riley, May 7, 2009, which discusses the Allegro Law Firm<\/a>); and Consumer Reports<\/em><\/a> (March 2009), on high-fee debt settlement as a “financial trap”.<\/p><\/blockquote>\n

\"noloShark\"<\/a> Like NetDebt, Andrew Capoccia claimed to be able to reduce your debt levels dramatically, without putting you in bankruptcy. See, e.g<\/em>., this 1999 ad<\/a> (which ironically featured an image of a vicious shark), and this earlier TBED ad<\/a>.<\/p>\n

Capoccia charged what he called a \u201csmall part\u201d of the savings (25 to 27%). His massive advertising campaign was aimed at people with significant unsecured debt, who wanted to avoid bankruptcy \u2014 and<\/em> who had enough money to afford his fees. Capoccia took his fees upfront, before starting “negotiation” with creditors. Negotiation amounted to sending form letters and making phone calls requesting a large reduction in the client’s debt, while withholding payments and hinting at bankruptcy to increase leverage over creditors.<\/p>\n

\n

Note<\/em>: As one debt collection lawyer has pointed out<\/a>, bankruptcy is not as threatening to creditors as it was a decade ago, due to the new creditor-friendly bankruptcy laws<\/a>, which went into effect in October 2005 and which require debtors who can afford to pay off their debt to set up a plan to do so. Thus, a creditor does not usually have to worry it will be “left with nothing.” Instead, the new bankruptcy law generally means “that a debt will be extended out over a longer period of time than the creditor would normally accept with little or no interest being paid.” Despite this change, one debt settlement author insists<\/a> that “The negotiation leverage is still there, because the creditor has no way to know in advance whether your case would be a Chapter 7 or a Chapter 13 bankruptcy.” As a former mediator, I think a creditor is likely to gain a pretty good idea of the debtor’s situation in any real<\/em> “negotiation.” I agree, however, that the new bankruptcy laws do not remove all incentives for creditors to negotiate a reduced balance.<\/p><\/blockquote>\n<\/blockquote>\n

\"SlicingThePie\"<\/em> The Capoccia fee was a “reverse contingency fee<\/em>” (based on savings achieved, rather than moneys won, for the client). His fee was taken upfront and was determined by an optimistically-forecasted percentage of debt-reduction savings, with the contingency fee set at 25 to 27% of such projected savings. He clearly wanted potential clients to conclude that the percentage was a bargain, after comparing it to the “standard” one-third (or more) taken by personal injury lawyers in Upstate New York.<\/p>\n

\n

S<\/strong><\/em>uch fees were excessive, I argued at the time (and continue to believe), because there was little risk<\/a> that Capoccia would not be adequately compensated for his efforts (which involved little if any real lawyering). For example, when I met with him, he bragged — lawyer-to-lawyer, while trying to hire me, once he heard I had worked a decade for the FTC — about how easy it was to get huge reductions from creditors. By taking the fee upfront, Capoccia also removed the risk that he would not be able to collect his fee once it was actually earned. [NetDebt’s fees and related practices are discussed in detail below.]<\/p><\/blockquote>\n<\/blockquote>\n

Also like NetDebt and similar services, Capoccia had his debt reduction clients first stop making all payments to their creditors (to increase the pressure to settle for less than the full amount due), thus immediately ruining the credit status the client was trying to salvage.<\/p>\n

\"\" H<\/strong><\/em>ere’s how NetDebt describes its services in its FAQ<\/a>::<\/p>\n

\n

“What does “debt settlement” mean? The term ‘debt settlement’ means negotiating with a creditor to reduce the amount of a delinquent debt down to a lower amount, that the debtor can then pay in order to fully satisfy (or pay off) the debt. The primary benefits of this strategy are to help you become debt free sooner, pay your debts on terms structured to your specific budget, avoid bankruptcy, and pay less than you would by making the minimum monthly payments.”<\/p>\n

. . . “Once you enroll in the program, you will immediately stop paying your creditors, and instead start putting your monthly payments into a Trust Account that is established by the law firm. From that point on, the attorneys take over everything. Since your creditors will not be receiving monthly payments, your accounts will become past due, but in a controlled environment.”<\/p>\n

. . . Once there is sufficient funds in your account, the lawyers will settle with the first creditor, and that process will continue until [you settle all accounts and your balance is zero].<\/p><\/blockquote>\n<\/blockquote>\n

As for their fees, NetDebt’s FAQ says:<\/p>\n

1. What does this cost me? <\/strong>\"\"<\/strong>+ service fees <\/strong><\/em>
\n<\/strong><\/p>\n

“Although we are a free online resource and do not charge you anything for our services, the law firm does charge a retainer equal to 15% of the debts that you include in the program, plus a small monthly service fee. Please remember that all program fees are included in your monthly payment and are not due in advance. <\/em>In addition, they will not start until you execute the Legal Services Agreement which will be sent to you upon completion of your online enrollment.”<\/p>\n

[I later learned that the “small monthly fee” is $50 per month, and that you may take no more than 15 months to pay the retainer, although you can be in their program for up to 54 months; also, negotiation will not start with your creditors until you have accrued enough money in a savings account to pay off the first creditor in a lump sum.]<\/p>\n<\/blockquote>\n

If you visit NetDebt’s website<\/a>, you will be invited to use the NetDebt Savings Calculator<\/em> to see how much money they can save you. I tried several debt amounts, and was told each time that it would cost me 12 to 13 times as much to pay off my debt on my own than if I used NetDebt. However, in tiny font at the foot of the display, I discovered that some fairly stringent and possibly unrealistic assumptions were made to show how much you’d save using NetDebt:<\/p>\n

\n

\"\" The total debt payment figure if you don’t use NetDebt is based on your making only the minimum monthly payment of 2% to your creditor, at the high annual interest rate of 21%. The lower-payment figure using NetDebt is based on their achieving the full 50% reduction in your overall debt, without counting accrued interest or penalties.\u00a0 Furthermore, while the savings comparison does count the lawyer’s fee you will pay, but does not take into account the $50 monthly service fee, the fact that interest and penalties will indeed keep accruing on your account until it is paid in full, or the likelihood that the IRS will consider any reduction in your debt to be taxable income.<\/p><\/blockquote>\n<\/blockquote>\n

NetDebt discourages the use of bankruptcy, saying it should only be used “as a LAST RESORT; \t\t\t\t\tpursued ONLY after all other debt relief remedies have been explored.” In FAQ<\/a> #6, NetDebt tells you further that, “A \t\t\t\t\tbankruptcy filing is a very detrimental entry on your credit history, and can remain \t\t\t\t\ton your credit reports from 7 to 10 years after the bankruptcy filling has been \t\t\t\t\tdischarged.” However:<\/p>\n

Although FAQ #4 acknowledges, “In the short-term, your credit rating will reflect that you are not current on your debt \t\t\t\t\tpayments which in most cases will negatively affect your credit,” it does not <\/em>tell you that being past due “causes a record of late payments on your credit report that can damage your credit score for 7 years” (per TransUnion<\/a>).<\/p><\/blockquote>\n

To learn more about NetDebt’s services and fees, I spoke with one of their service reps [“Ryan”] using their online Chat feature. I asked if I could see the Legal Services Agreement that a NetDebt client would sign with the participating law firm, but was told I could only do so “at the end of the application process. At that time you can choose to accept the agreement or decline.” (I decided not to go through a full “pretend” application process in order to see the Agreement.)<\/p>\n

\"\" Here are excerpts of my chat with NetDebt’s service representative, Ryan:<\/p>\n