Charles Phelan

Sometimes I feel like the “Lone Ranger” here at ZipDebt, shouting from the rooftops about why consumers should not pay 15% of their debt to third-party settlement companies. Regular ZipDebt readers already know my position on the front-loaded fee structure currently used by about 99% of debt settlement companies. My post from April 3, 2006 discussed some of the problems associated with the “15% upfront” model.

Now, attorney and longtime consumer advocate David Giacalone has written an excellent piece on the subject of debt negotiation fees. Although I’m sure his post will not win him many fans in the settlement industry, I for one greatly appreciate his effort. David is focusing on one example of a company that uses the “attorney model” for debt settlement. And while his article pertains to the questionable ethics of attorneys who charge a flat percentage of enrolled debt, it’s certainly a problem throughout the entire debt reduction industry, whether or not the firm in question is attorney-based. So I felt it would be worthwhile to discuss some of the history of the fee models used in the industry.

Consumer debt settlement evolved in the 1990s from a pre-existing model that went by various names, but was usually called “business debt arbitration.” Companies would often choose names that made them sound like a law firm, even though most were not law firms. So, “Howard, Fine, and Howard” (with apologies to the Three Stooges) would set up shop as business debt “arbitrators.” The fee model in vogue at that time was to charge a 1% retainer as a deposit, based on the amount of debt to be negotiated, with the primary fee handled on a contingency basis, and set at 25% of the savings achieved in the negotiation.

When I first started negotiating consumer debt in 1997, this is the model that I employed, and I even credited the 1% deposit against future fees earned. So the concept was based on 100% contingency. Most of the people I worked with were happy with this fee structure, since it provided some assurance that they would see results before having to pay any significant amount in fees.

Flash forward to 2000, as I became part of a company that was attempting to roll out debt settlement services on a nationwide basis. We entered the large scale market with essentially the same fee model, except that we charged 2% instead of 1%, and the 2% figure was now treated as an “administrative fee” rather than a simple retainer to be credited against future fees earned. However, the core of the approach was still intact, with the primary fee being based on 25% of the savings achieved in the negotiations.

The reason for the change from 1% retainer to 2% administrative fee was simple enough. It’s one thing to run a small individual practice, quite another matter to grow a large company with payroll, overhead, and marketing expenses. Within a matter of months, the 2% was adjusted upward to 3%, but at that time there were still no monthly fees charged to the consumer. Again, the reason for the jump was not greed, but rather marketing exigencies.

Speaking of marketing, therein lies the problem! In 2000-2001, it was possible to purchase a database of consumers who had “opted in” to receive email on the subject of financial assistance. In those days, we could send 5,000 email messages to well-targeted recipients for a cost of about $1,000, and expect a steady flow of “leads” to the sales floor. A single blast of 5,000 email messages normally returned between 60-80 responses from interested, motivated consumers. And it was usually possible to enroll about 15% of those respondents. So we could expect to bring aboard 10 or 12 new clients for every 5,000 emails sent. That translates to an “acquisition cost” of $80 to $100 per new client based on the $1,000 cost to do the mailing. This does not take into account sales commissions or other payroll expenses, but represents a very healthy acquisition cost in terms of advertising dollars expended.

To make reasonable financial forecasts, we operated on the assumption that our overall settlement percentage would average 40% (which it did for several years, until it slowly crept up to the current industry average of approximately 50%). So we expected to save the client 60% before fees were applied. Taking 25% of the expected savings of 60% yielded an assumed fee equivalent to 15% of the starting balances. (Starting to sound familiar yet?) With the average enrolled client at a level of $30,000 of debt, that meant a forecast of $4,500 in negotiation fees, plus another $900 in administrative fees (based on the 3% admin fee), for a total of $5,400 in fees to be collected over the life of the program. That’s a very healthy potential income off a $100 marketing acquisition cost.

Another way to look at the above figures is that we could generate a “lead” (in the form of an interested consumer) for approximately $12 to $16 each. However, this happy state of affairs only lasted for a matter of months, and since 2001 lead costs have been climbing ever upward. Today, an “exclusive live transfer” lead can cost up to $90 each! And leads of lesser quality (generated through a few million website “lead form” traps set up by dozens of lead brokers) can still cost $30-$50 apiece. Closing ratios on these lesser quality leads are typically around 5-7%, further eroding the ROI on marketing expenditures and inflating the acquisition cost of a new client.

One of the key reasons for the upward spiral in lead costs is based on the law of supply and demand. In 2000-2001, there were at most a small handful of such debt companies in existence, so there were only a few of us “fishing” in a very large pond. However, the debt settlement industry was (and still is) a mostly unregulated industry. So there were (and still are) very few barriers to entry. With no clear standards, no licensing requirements, and no minimum financial standard (performance bonds, etc.), anyone could set up shop and call themselves an “expert debt negotiator.” Many did. Within 1-2 years, there were dozens of copycat companies, all basically cloning the existing business model. With more and more people fishing in the same pond (although still a very large pond), the mounting competition for “fresh hot leads” drove the cost higher and higher.

When you are attempting to enroll 400-500 new clients per month, the original fee model means that you must have very deep pockets in order to get to the “back end” stream of income generated from negotiation fees. Enter the monthly “service fee,” which started out around $29/month and climbed from there. So now there were three separate fees in place, the 3% administrative fee (which other companies quickly bumped to 4%, 5%, even 8%, etc.), PLUS the monthly service fee (now typically $40-$50/month, or more), PLUS the negotiation fee of 25% of the savings.

I was present at one of the first trade conferences held by the debt settlement industry. At the conference, the CEO of one of the newer large-scale settlement companies gave a presentation in which he discussed the fee model his firm was implementing. Gone was the negotiation fee based on 25% of savings. It was replaced with 15% of the total enrolled debt as a FLAT FEE, to be paid by the client over the first 14 months of the program. I was stunned. In my estimation, this front-loading of the program fee removed the single most valuable aspect of the program from the consumer’s perspective – namely, that the fees were based results achieved. No results, no fee. Instead, the fees were now charged in advance of having accomplished anything at all for the client. This, of course, was wonderful for the debt settlement company, but a horrendously bad deal for the customer. In effect, the settlement company had now become just another creditor, elbowing out of the way the client’s legitimate creditors, and grabbing up front most of the money that should properly have gone toward settlements.

Within a matter of months, this new fee structure spread throughout the industry like an extremely contagious virus. Today, I estimate that about 99% of settlement companies charge fees based on the front-loaded model.

So that is how the magic 15% flat fee came to be the industry standard. It has no bearing whatsoever on the amount of actual work involved in negotiating debts. As David Giacalone points out in his piece, there is very little actual legal work involved, so it makes no more sense for a law firm to charge a flat 15% of the enrolled debt than it does for a non-attorney settlement firm. And a fee of 15% of the enrolled debt certainly makes no sense at all from the consumer’s perspective. It is merely an artifact of the manner in which the industry itself has evolved. If you think about it, it’s not even remotely logical. If a person has $30,000 of debt spread over 5 credit card accounts, the fee is $4,500. If the debt load is $100,000, also over 5 accounts, now the fee jumps to $15,000. Is it any more work for settlement firm to negotiate 5 larger accounts versus 5 smaller ones? No. But it makes even less sense for the consumer to be forced to pay this fee IN ADVANCE of any meaningful service being performed.

For the past two months, I’ve been working nights and weekends to write and record the 2008 version of my debt training course. It’s hard to believe, but it’s been 4 years since I published the original version of the course in 2004. I had been bridging the gap with a written update, but even the update was in need of an update!

The reason is because the business of debt settlement is continually evolving, and it’s necessary to change tactics from time to time. Also, when I first launched this program back in 2004, I had just made the shift from 3rd-party debt settlement to teaching the do-it-yourself approach. Over the past 4 years, I’ve coached HUNDREDS of clients to successfully negotiate and settle their own debts, and quite frankly, I’ve learned a lot during that time about how to teach this process to people.

So the brand new 2008 version of the course reflects all that hard-earned knowledge and insight. The course has been expanded from 5 hours of audio material on 5 CDs to just under 8 hours of content on 7 audio CDs. The Workbook has also been expanded, and I’ve included some additional new material on the CD-ROM. The bottom line is that the original course has been getting rave reviews for 4 years, but the new course is even better yet!

If you’ve been thinking about ordering this program, but held off because you weren’t sure the material was up-to-date, now’s the time! I plan to increase my offering price in July, probably by July 15th (maybe sooner), but the old pricing is still in effect until I announce the changes via the main website pages. So order now before the price goes up!

Here’s a list of the revised Table of Contents for the audio material:

CD1—New Perspectives on Debt
Track 1—Introduction
Track 2—The Great American Debt Explosion
Track 3—The Hidden Cost of Debt
Track 4—The 10-20-70 Plan

CD2—Choosing the Right Debt Program
Track 5—Know Your Options (Part I)
Track 6—Know Your Options (Part II)
Track 7—The Debt Settlement Strategy
Track 8—How to Choose the Right Debt Solution

CD3—Debt Settlement Basics
Track 9—Understanding the Collection Process
Track 10—Why DIY Debt Settlement Makes Sense Today
Track 11—Why You’ve Been Brainwashed About Credit
Track 12—Let’s Get Real about Debt Settlement

CD4—Before You Get Started
Track 13—Different Types of Creditors
Track 14—Important Strategic Considerations
Track 15—Four Things You Must Do
Track 16—Common Tactical Questions

CD5—How to Settle Your Debts (with Original Creditors)
Track 17—What to Do for the First 90 Days
Track 18—Original Creditor Phone Calls
Track 19—Your First Settlements
Track 20—Documentation & Transactions

CD6—How to Settle Your Debts (with Third Parties)
Track 21—Handling Collection Agency Calls
Track 22—Understanding Third-Party Tactics
Track 23—Dealing with Collection Attorneys
Track 24—Settling with Debt Purchasers

CD7—Completing the Process
Track 25—Negotiation Tips & Tactics
Track 26—What to Do After the Settlement
Track 27—Debt Settlement & Income Taxes
Track 28—Recovering Good Credit

I’m fed up with the sales practices of the majority of debt settlement companies. Every day I talk to consumers who seek my advice after talking to settlement companies. Some of the stuff they were told makes me wonder what planet these company executives are living on. Don’t they know that settlement companies are getting shut down left and right by regulatory authorities? The Attorney General in Florida seems to be “shooting fish in a barrel” at the moment. Four settlement operations have been taken down in Florida just in the last few months.

So I’m inspired to offer some helpful “advice” to the owners and managers of settlement companies. (WARNING: What follows is satire, as in “irony,” as in “I’m joking.”)

20 Tips for Running A Successful Debt Settlement Operation

1. Start your settlement company with no prior experience in financial services, and never having negotiated settlements for anyone. Who cares if you have experience? You’re going to outsource the “back-end” to a settlement processing operation anyway.

2. Don’t bother joining any industry associations or attending any trade conferences so you can stay informed on regulatory changes and acceptable industry standards and practices. Just add a bunch of fake logos and seals at the bottom of your website so you look credible, and save all that monthly dues expense.

3. Hire a bunch of sales “closers” and pay them straight commission so they will sign up anyone and everyone with a credit card debt, whether or not debt settlement is a good fit for their situation. Call them “debt consultants” so the consumers think they are talking to experts.

4. Generate leads by buying an auto-dialer and calling consumers across the nation. Don’t worry about the Do-Not-Call Registry maintained by the Federal Trade Commission. That can’t possibly apply to pre-recorded messages from a financial services firm that has had no prior business relationship with the consumer.

5. Saturate local TV and radio stations with ads that say, “Save your credit! Settle your debts for pennies on the dollar. Guaranteed. Call 1-800-CON-GAME.”

6. Tell consumers that going through a debt settlement program will greatly improve their credit score and not have any negative effect whatsoever.

7. Tell your customers that “this is a bank supported program,” and that the creditors are really patient and have no problem waiting four years to get paid.

8. Assure new customers that it’s fine to “max out” their credit cards with cash advances before they start the program. You’re fee is based on the size of the debt load, so you might as well have the enrolled debt be as large as possible.

9. Charge as much as you can get away with without losing business to competitors. Take at least 15% of the debt up front, and insist that the client pay every dime of your fee before you obtain a single settlement for them. If they drop out because of creditor pressure or legal problems, that’s less work you’ll need to do on the back-end anyway.

10. When a prospect tells your sales rep they are thinking about bankruptcy, train your reps to helpfully explain that “bankruptcy is no longer an option since they changed the law in 2005.”

11. Make sure you have at least 1,000 clients before you spend any money on building your customer service department. Don’t worry about all those frantic customer calls and complaints meanwhile. They don’t have any money saved up for settlements yet anyway because they are still paying off your fee.

12. When a prospect balks at your suggestion they stop paying their bills and pay you instead, have your reps patiently explain that the banks really don’t care. They have insurance and tax breaks that will cover the loss anyway.

13. Promise your clients that you’ll stop all the collection calls by sending out your Power-of-Attorney along with cease communication notices to every creditor on the list. When this causes immediate placement with collection attorneys, pretend that this is the first time a creditor has ever reacted harshly to such a notice.

14. Assure your clients that there is no possibility they might get sued by a creditor. When a client does get sued, tell them to just ignore it because the creditor won’t be able to collect when they get a judgment anyway.

15. When a client calls and asks for a refund, refuse and be completely rude about it, or better yet, just don’t bother returning their phone calls. How dare anyone ask for their money back anyway? It’s past the 3-day recission clause in the contract, so tough luck.

16. When the Better Business Bureau starts sending you inquiries based on the complaints they are receiving, just ignore them. You’re not a member anyway, so who cares?

17. Don’t bother determining which states it’s legal to offer settlement services in. There’s no Federal law that applies, so it’s ok to offer your service in all 50 states, right?

18. To sign up the maximum number of people, let your reps enroll people into programs up to 89 months in duration. Ignore the fact that this is 3 years longer than the Statute of Limitations in most states.

19. Have your clients save up for settlements by sending their money to a bank account that you have access to. That way, when you run short of operating capital, you can just make up the shortfall by borrowing money from your clients.

20. Finally, don’t keep any accounting records and shred everything so if you do get a visit from the Attorney General, they won’t be able to prove you’ve done anything wrong.

Follow the above helpful tips faithfully, and you too can join the legions of entrepreneurs who have learned to successfully exploit the financially distressed American consumer! You deserve your piece of the action. What are you waiting for?

“With all the recent problems in the financial sector, is it getting easier to settle with the banks?” I’ve been hearing this type of question a lot lately. The past year or so has seen an avalanche of economic problems, beginning with the downturn in the real estate market, the subprime mortgage fiasco, the banking credit crunch, liquidity problems, the Fed shoring up the economy with multiple interest rate reductions, the bailout of Bear-Stearns (the fifth-largest investment banking firm on Wall Street), and so on. It’s logical for consumers considering debt settlement to wonder if all this grim news is “softening up” the credit card banks for better settlement deals.

The answer is, well, “no and yes.” No, because overall, it’s really just “business-as-usual” in the settlement industry. I personally have seen no drastic changes in settlement practices as a consequence of recent economic problems faced by the banks. You have to remember that we’re talking about huge companies, and they do not change direction quickly or easily. If you’re in a small sailboat, it’s pretty easy to turn and start tacking in another direction. However, if you’re in a massive oil tanker, it takes a long time to safely change direction. (Just ask the guy who piloted the Exxon Valdez into the coast of Alaska.)

On the other hand, some creditors have softened up a little, so that’s the “yes” part of the answer. But it’s important to understand that the banking industry is not one big monolithic enterprise. Different creditors behave differently. So while some of the banks seem to be slightly easier to settle with lately, others have gone in the other direction and stiffened their resistance to losses. Generally, this all translates to somewhat lower settlement percentages with some banks, and somewhat higher percentages with others. So overall, nothing much has changed from my own perspective, where I deal day-in and day-out with a wide range of consumer debt obligations.

Bottom line: It’s still the same game as it ever was, and consumers should not count on “extra” help from the banks they’re trying to settle debts with. As time goes by, current economic conditions may yet have a deeper effect on settlement practices, but so far there has not been much of a noticeable difference.

Regular readers of the ZipDebt Blog know that I routinely warn consumers about the notorious “debt elimination scam.” This is the type of program where the promoters claim that you never actually borrowed any money on those credit cards, because … wait for it … your signature on the credit card application is worth exactly as much money as the credit limit extended to you.

Essentially, the core of the argument made by these people is that credit card debt is not *real* money. Yet they are usually more than happy to accept payment of their huge fee ($2,500 minimum, and usually a *lot* more) by having you take a big cash advance against one of your credit cards with no plan to repay it. That’s fraud, of course, but they don’t seem to mind one little bit.

I write today about a “new” variation on this debt elimination scam. I put “new” in quotes because this latest crop of con-artists are promoting it as such, yet it’s really been around for a very long time. The twist on the debt elimination scam is one where the company *takes over the debt obligation itself*! They make the claim that through contractual law procedure, they can use the banks’ own contracts to assume your debt liability and then deploy their arsenal of secret legal tactics to force the bank to discharge the obligation. Presto! Like magic, your debt is erased.

It’s all still based on the bogus “no money lent” argument that has been rejected repeatedly by the courts, and warned against by the Office of the Comptroller of Currency. Let’s see. Who should you believe? The “network marketing” sales agent trying to make a buck off you, or an agency that is part of the Federal Government? Tough call, right?

Anyway, this new variant on the debt elimination scam is all wrapped up in legal-sounding jargon and packaged into a very convincing sales pitch. But the notion of altering the terms of the contract is not new at all. It’s been around for years and it’s called “novation.” Novation is nothing more than the substitution of a new contract for an old contract, often involving a change of parties to the transaction. Another relevant legal term is “assignment,” where contractual rights are transferred outright from one party to another.

The problem for the scammers is that novation requires that all parties to the contract must consent to the novation. And the banks have language in their agreements that precludes “assignment” of the debt to another party in the way that the debt elimination folks want. So how do they get the bank to agree to such a change? By using a technique called “accord and satisfaction.”

The way it works (in theory) is that you send the bank a payment with “restricted endorsement” language. That’s where you write a bunch of legal mumbo-jumbo on the back of the check, which basically says, “If you cash this, you agree to all these modified terms.” The theory is that this creates a brand new contract. The thinking is that the bank will not catch this, since they process so many thousands of checks every day. So the idea is to “fool” the bank into accepting the new terms. Supposedly, you can build into the “new contract” all kinds of clauses that work in your favor.

Accord & satisfaction, of and by itself, is not actually a scam. It is a legitimate legal concept often used to settle contractual disputes between parties. But the way it’s employed by “debt elimination” scammers is definitely bogus. Most states have their own version of legislation that protects creditors from such nonsense. In California, for example, you have to send such a notice in the form of a letter, and it must be sent to the corporate correspondence address, and NOT to a regular high-volume payment center. Further, the creditor has up to 90 days to reject such a payment and return it due to an unacceptable restriction on the endorsement. So you cannot legitimately smoke this by a creditor and expect any success thereby. Here is a link to the relevant California Code on accord and satisfaction.

There was a debt company called Briggs & Baker that got shut down by regulatory authorities for routinely practicing this type of scam. Here is the FTC press release that discusses official action against this pair of thieves. It reads a lot like some of the complaints against debt settlement companies, but this outfit was basically practicing the “accord and satisfaction” trick, obviously with very little success. It’s only a matter of time before the outfit peddling this latest incarnation of the debt elimination scam gets a visit from their friendly state Attorney General’s office or a legal team from the Federal Trade Commission. Let’s hope it happens sooner rather than later!

Continuing our discussion on “Crazy Stuff Collectors Say,” in this post I’ll deal with a common statement made by collectors.

In the first post in this series, I wrote about the myth of “bankruptcy insurance,” where the collector attempts to convince the debtor that the creditor actually *prefers* they just go ahead and file bankruptcy, rather than agreeing to a settlement, because the creditor supposedly has insurance that will cover bankruptcy-related losses. It’s a load of hogwash, of course, and there is no such thing as bankruptcy insurance. The purpose of the false statement is to reach into the debtor’s head and remove the perceived leverage that comes with the right to file bankruptcy.

Along the same lines, there is another similar statement frequently made by collectors. I first heard this one many years ago, when I was trying to settle a debt on behalf of a client. I explained the client would be forced into bankruptcy if they could not achieve settlements across the board with their creditors. The collector proceeded to tell me that he would “race” my client to the filing, file a lawsuit, and get a judgment before the client could file for bankruptcy. So they would have their judgment and the client would need to pay up anyway. I nearly fell out of my chair laughing. When I recovered, I informed the collector he needed to go back for additional training. What he was attempting to do was use a technique on a professional negotiator that no pro would fall for.

Lately, I’ve had clients report similar statements made by debt collectors. When the debtor explains they are seeking to avoid bankruptcy by using settlement as an alternative, the collector makes the claim that they will quickly get a judgment and then the debtor will be on the hook even if they filed bankruptcy. They try to convey the impression that once a judgment is recorded, an unsecured debt becomes like a secured debt that cannot be dismissed in a bankruptcy.

Nothing could be further from the truth. The bottom line is very simple: Bankruptcy trumps civil judgments, period.

In fact, one of the main reasons people file bankruptcy is to put a stop to civil lawsuits by creditors, or to stop active wage garnishments! It doesn’t matter whether the bankruptcy is filed before or after the judgment is recorded. The bankruptcy attorney has to take the correct steps to overturn garnishments or liens that are in-force, but assuming the attorney does his or her job correctly, then the bankruptcy will include all judgments and put a stop to any in-process lawsuits. Further, the bankruptcy MUST include such judgments, because a bankrupt debtor doesn’t get to favor some creditors over others, and judgment creditors do not have priority over other creditors who have not sued.

So here again, we have a common pattern of debt collectors purposely misleading debtors in an effort to gain the psychological advantage in the negotiation. Don’t be fooled.

Creditors do NOT want you to file bankruptcy. That’s why thousands of settlements take place every day in this country. Further, collection agencies REALLY don’t want to see you go bankrupt, because any commission they might make will vanish at that point. Remember you DO have leverage in these negotiations. Don’t let a collector trick you into thinking otherwise.