October 26, 2012

Debt Settlement Companies Rip Off Consumers

It’s a debtor’s nightmare: you pay a company to help you pay off what you owe, but the company rips you – and 78,000 other people – off for thousands of dollars each, then makes empty promises to give all of you a refund. You and the other victims file a class action lawsuit and fight for four years to recoup what you’re owed, and in the end all you get is $185.

But that’s exactly what happened to consumers in California who paid fees to debt settlement companies, including Freedom Debt Relief (FDR), to help them consolidate and pay off their debts.

A class action against FDR and other companies was recently settled in federal court in California for $1.9 million. This may sound like a lot, but because of an intervening U.S. Supreme Court opinion the class was forced to accept an amount that was much lower than it might have been.

And that’s par for the course when it comes to debt settlement these days.

Class Action Forced into Arbitration

California regulates the fees such companies can charge consumers. In this case, says San Antonio, Texas, lawyer Tom Crosley, whose firm represented the plaintiffs, “the fees FDR charged for its ‘debt settlement services’ significantly exceeded” the limits of California’s law that covers “proraters”– companies that pay bills on behalf of others.

“We filed a class action to seek to disgorge the excessive fees and refund them to the class of approx 78,000 affected individuals,” Crosley says. The case had been certified as a class action, and settlement talks were underway.

But in the meantime, the Supreme Court ruled on another case that muddied the waters. While that case wasn’t directly related, it impacted whether the case against FDR could be brought as a class action. Unfortunately for the victims of FDR’s scam, the judge was forced to grant the defendants’ motion to compel arbitration and decertify the class. That meant that the victims lost their right to have their cases heard in a court of law; instead, all 78, 000 of them had to negotiate with FDR through a third party – chosen by FDR – if they wanted to be compensated.

Arbitration is a form of negotiation that takes place outside the courts and is normally binding on the parties that agree to participate. Many forms you sign as a consumer subject to you binding arbitration should a disagreement pop up between you and the company you’re contracting with – over anything from bank transactions to buying a cell phone.

“In [Concepcion], the Supreme Court held, by a 5-4 majority, that pro-arbitration and anti-class action provisions in consumer contracts were valid,” Crosley explains, “even though the laws or court decisions of many states, including California, had held that such provisions were unenforceable because they denied consumers any realistic access to the courts …. I mean, really, who can afford to hire a lawyer to litigate an overcharge of a few hundred dollars?” Crosley asks.

A Bad Situation Gets Worse

The class action “settlement” with FDR highlights a problem that more and more consumers are facing.

“America’s most deeply indebted consumers are now falling victim to a major new threat: so-called ‘debt settlement’ schemes that promise to make clients ‘debt free’ in a relatively short period of time,” according to a recent consumer alert from the National Association of Consumer Bankruptcy Attorneys (NACBA). “Unfortunately, most consumers who
pursue debt settlement services find themselves facing not relief but even steeper financial
losses.”

According to the NACBA, red flags that consumers should take heed of when dealing with debt-settlement firms include:

Creditors won’t negotiate to reduce the balance owed unless you’ve already defaulted. To hook you, debt settlement companies will tell you to stop making monthly payments.

Creditors may refuse to settle, and debt settlement companies can’t guarantee that they will. Don’t fall for that promise.

Tax liability can be an unexpected circumstance if you are able to settle your debts, but you may not be informed of this. Cancellation of debt is normally considered taxable income by the IRS.

In the FDR case, the corporate defendants won the ultimate debt relief game this time: They owed 78,000 people anywhere from $200 to $3,000 each but only had to pay $185 a head. That’s not a bad day at the office.

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