If you're struggling to pay your unsecured debts, you might be considering hiring a debt settlement company to help you negotiate with your creditors. Maybe you've noticed an advertisement for debt negotiation services on the internet, radio, or television or heard about a debt settlement company through social media.
But all too often, for-profit companies that provide this kind of "help" settling debts are scammers who offer little or no assistance once you've agreed to pay them. You might even end up in a worse position than before you hired the company.
To protect consumers from shady debt settlement companies, California passed a new debt settlement law. The California Fair Debt Settlement Practices Act (AB 1405) (Cal. Civ. Code § 1788.300 and following) provides protections if you decide to hire a debt settlement company, such as:
Still, even with all these protections under California law, in almost all cases, you'd be better off working directly with your creditors or getting help from a reputable lawyer rather than hiring a debt settlement company.
A debt settlement company acts as an intermediary between a debtor and one or more unsecured creditors, like credit card companies. These companies offer so-called "debt negotiation," "debt reduction," or "debt relief" services with the goal of obtaining a settlement in which the debtor pays less than the total amount of the debt.
Some companies claim they can reduce your debts by half or more. To get this kind of reduction, the company will tell you to make payments to it rather than your creditors. (Or the company might have you open a savings account in your name and deposit a monthly amount there rather than paying your creditors.) Once enough money is available, based on the debt settlement company's opinion, the company negotiates lump-sum settlements with your creditors. The company or an affiliated payment processor pays the creditors—and often themselves—with money from the account.
Generally, you have to pay the debt settlement company a percentage, around 15% to 25%, of the amount you save through settlement (or your total enrolled debt) as compensation. You might also have to pay a monthly fee and other fees, like a set-up fee.
It can take two to four years to complete the debt settlement process. During this time, your credit reports will show more and more late payments and probably charge offs and accounts sent to collection agencies. Because you haven't reached an agreement with your creditors to stop making payments, they might sue you or take other steps to collect from you.
Also, late penalties and interest will continue to accrue, so your debts will get bigger. Taking these additional charges into account, along with the fees you'll have to pay to a debt settlement company, you could end up worse off financially than before you start the settlement process—even if the company manages to settle some of your debts.
If, after considering all of these downsides, you're still thinking about using a debt settlement company's services, the California Fair Debt Settlement Practices Act can protect you in the process.
Governor Gavin Newsom signed the California Fair Debt Settlement Practices Act into law on October 4, 2021. Effective January 1, 2022, this law sets certain requirements and prohibitions for debt settlement companies and related payment processing services.
Here are some of the law's most important provisions.
California's Fair Debt Settlement Practices Act prohibits debt settlement providers and payment processors from engaging in unfair, abusive, or deceptive acts or practices when providing debt settlement services or payment processing activities. (Cal. Civ. Code § 1788.302).
For instance, a debt settlement provider or payment processor can't offer to lend you money or extend credit to you, or purchase a debt you've enrolled in a debt settlement program. (Cal. Civ. Code § 1788.302).
Under the law, a debt settlement provider can't engage in false, deceptive, or misleading acts or practices. So, it can't make false, deceptive, or misleading statements about its services or omit information when trying to sell its services to you or when providing settlement services. (Cal. Civ. Code § 1788.302).
The law also prohibits the company from directly posting, or indirectly causing to be posted, an online review or ranking on an internet website if the debt settlement provider provides anything of value in exchange for a good review or rank. (Cal. Civ. Code § 1788.302).
California's new debt settlement law requires debt settlement companies to give the following disclosures no less than three calendar days before you sign a contract with them.
The debt settlement provider must also disclose:
In addition, the debt settlement company must give you a copy of the proposed written contract no less than three calendar days before you sign the contract. (Cal. Civ. Code § 1788.302).
The company also has to provide you with a copy of the signed contract immediately after receiving it. (Cal. Civ. Code § 1788.302).
California's Fair Debt Settlement Practices Act requires each contract between a consumer and a debt settlement provider to include:
Also, the contract can't require a compulsory agreement with any other party. A debt settlement provider may require that you get a dedicated settlement account and provide a list of preferred vendors. But a payment processor that receives compensation from you for its services must supply its own contract to you. (Cal. Civ. Code § 1788.302).
A debt settlement company can't collect a fee until they've reached a settlement agreement, you've agreed to the settlement, and you've made at least one payment to the creditor as a result of the agreement. (Cal. Civ. Code § 1788.302).
The California Fair Debt Settlement Practices Act requires debt settlement providers to provide monthly accounting statements, including the fees collected from a settlement account, among other things. Debt settlement companies also have to provide an accounting statement on or before the fifth business day after a consumer requests one. (Cal. Civ. Code § 1788.302).
Payment processors, too, must provide monthly statements, including the amounts deposited in and withdrawn from a settlement account and other information. It must also provide an accounting statement on or before the fifth business day after a consumer requests one. (Cal. Civ. Code § 1788.302).
The debt settlement provider can't communicate with any of your creditors until five calendar days after you sign a contract for debt settlement services. (Cal. Civ. Code § 1788.302). You can cancel the contract during this time, before the company even starts dealing with your creditors.
Also, you may terminate a contract for debt settlement services at any time without a fee or penalty of any sort by notifying the debt settlement provider in writing, electronically, or orally. The termination is effective immediately when you give the notice either electronically or orally. If you give a cancellation notice by mail, the contract terminates upon receipt if the notice is sent via certified mail. The notice is effective seven calendar days from the date of mailing if you send the notice by noncertified mail. (Cal. Civ. Code § 1788.302).
Once the notice is effective, the debt settlement company must immediately cancel the contract and notify the payment processor. After getting a notice of cancellation from you or a debt settlement provider, the payment processor must stop accumulating service fees, close the settlement account, and deliver the balance of the settlement account to you within seven days. (Cal. Civ. Code § 1788.302).
The law also requires the debt settlement company to immediately forward to you any notice of a lawsuit or settlement agreement that the company negotiated. (Cal. Civ. Code § 1788.302).
Under California's new debt settlement law, you can bring a civil action if a debt settlement company or payment processor violates the law. If you win the suit, you can get statutory damages of no less than $1,000, but not more than $5,000, actual damages, injunctive relief, and other relief as the court deems proper, including costs and reasonable attorneys' fees. However, if you file a lawsuit in bad faith, you'll have to pay the company's attorneys' fees. (Cal. Civ. Code § 1788.305).
The statute of limitations for bringing a suit is four years after the latter of the following dates:
The debt settlement company or payment processor can't ask you to waive your right under this law. (Cal. Civ. Code § 1788.306).
Even if a debt settlement provider manages to reduce some of your debts, you'll have to pay a lot for services you could do yourself or would be better off paying to a lawyer.
You can negotiate with your creditors yourself (for free). If you're sure you want to settle your debts rather than filing bankruptcy or pursuing another option—and your creditors aren't already suing you—you might not need a lawyer. You might be able to negotiate better settlements than a debt settlement company or maybe even a lawyer could.
But if you need help with the negotiations, are being sued, or want to learn about other options, like filing for bankruptcy, it's best to consult with an attorney.
If you decide to hire a lawyer to help you in the debt settlement process, you need to make sure you're hiring a legitimate law firm and not a debt settlement company fronting as one. And be sure to avoid firms that share fees with a debt settlement provider. These arrangements give the company an appearance of legitimacy, but the lawyers have little or nothing to do with you, your creditors, or the debt settlement process.
Attorneys that operate debt settlement companies or share fees with one must comply with California's debt settlement law. To be exempt from the California Fair Debt Settlement Practices Act, lawyers and law firms can't charge for services regulated by this law or, directly or indirectly, share fees and disbursements with a debt settlement provider. To be exempt from the law, lawyers and law firms also must:
If you want to learn more about different alternatives for dealing with your debts, like filing for bankruptcy, talk to a bankruptcy lawyer. To find out more about settling your debts or how to deal with a collections lawsuit, speak to a reputable debt settlement attorney. Many bankruptcy attorneys and debt relief attorneys offer free consultations and will quote you a fee after evaluating your circumstances.
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