A New Role for U.S. Trustees Approval of Credit Counseling Services

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Jun 1999

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Major bankruptcy reform legislation pending in Congress (H.R. 833 and S. 625) contains credit

counseling provisions. If enacted, these provisions would establish new duties for the U.S. Trustee

Program (USTP),<a href="#2">2</a> including the duty to "approve" credit counseling services for use by individual

debtors who wish to file for bankruptcy. This article discusses the new duties for debtors and U.S.

Trustees as set forth in H.R. 833. It includes background information on credit counseling services

and debt repayment plans. It also highlights issues raised by this new area of responsibility for the

USTP.

<h3>What Is a Credit Counseling Service?</h3>

One need only peruse any metropolitan telephone directory to discover the wide

spectrum of organizations that advertise credit counseling services. Credit

counseling services are available from nonprofit organizations, for-profit

organizations, schools, churches, legal-aid organizations and attorneys, among

other providers.

HR. 833 does not define "credit counseling service." For purposes of this article, "credit counseling service" means an

organization that exists and functions to serve its consumer debtor clients and their creditors by attempting to resolve debts

through the formulation of individual debt repayment plans. The credit counseling service seeks, when possible, reduction

of the amount of debt and reduction or elimination of fees and charges accrued on the debtor's accounts. The debt

repayment plan provides for payment to creditors over a period of time, during which creditors withhold enforcement of

their claims. Generally, clients are expected to stop using their credit cards and to refrain from applying for any new credit

during the term of the repayment plan. The purpose of the plan is to settle the client's debts and repay creditors.

<h3>New Duties for Debtors and U.S. Trustees</h3>

Notice of Alternatives

As set forth in H.R. 833, an individual who wishes to file a bankruptcy case would receive written notice of alternatives

containing: (1) a brief description of chapters 7, 11, 12 and 13 and the general purpose, benefits and costs of proceeding

under each chapter; (2) a brief description of services that may be available from a credit counseling service; (3) warnings

about penalties for concealment of assets and false oaths or statements; and (4) notice of the possibility of an audit.<a href="#3">3</a> Unless

the court ordered otherwise, an individual debtor (or debtor's attorney or bankruptcy petition preparer) would have to file a

certificate with the court to show that the debtor received and read the notice of alternatives. If the debtor failed to file a

certificate within 45 days after filing the bankruptcy petition, the case would be dismissed automatically on the 46th day.<a href="#4">4</a>

Credit Counseling Requirement

Under H.R. 833, individuals who wish to file a bankruptcy petition would be required to undergo credit counseling through

an approved credit counseling service within 90 days before filing the bankruptcy petition.<a href="#5">5</a> The requirement would be fully

waived only if the U.S. Trustee determined that the approved credit counseling services for a district were not reasonably

able to provide adequate services for the additional individuals who would otherwise seek such services.<a href="#6">6</a> U.S. Trustees

would annually review any such determination.

Under H.R. 833, if certain exceptions or exigent circumstances applied, a debtor would be permitted to file the bankruptcy

petition first and then undergo credit counseling within 30 days post-petition.<a href="#7">7</a> In either case, a debtor would have to file

with the bankruptcy court a certificate of compliance from the credit counseling service and a copy of the debt repayment

plan, if any, developed through that service.<a href="#8">8</a> Automatic dismissal would not occur if a debtor failed to file a certificate

from a credit counseling service pre- or post-petition. Instead, the U.S. Trustee or a party in interest could move to dismiss

the case under <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. §707(a), §1112(b), §1208(c)</a> or §1307(c), based on the debtor's ineligibility under §109(h).

The credit counseling provision would require debtors to participate in an individual or group briefing that outlines

opportunities for available credit counseling and helps them perform an initial "budget analysis." Although the term

"budget analysis" is not defined in H.R. 833, it appears to contemplate an analysis of the debtor's income and expenses,

including all secured and unsecured debts and considering the debtor's available disposable income, to determine whether

the debtor can pay creditors through a debt repayment plan without imposing undue hardship on the debtor or the debtor's

dependents.

The U.S. Trustees would have responsibility for approving credit counseling services. Approved services would be

included on a list provided to debtors and maintained by the bankruptcy clerk for each judicial district.<a href="#9">9</a> Only the listed

agencies would be authorized to provide the certificates of compliance that debtors must file with the bankruptcy court. The

credit counseling provisions would take effect 180 days after the date of enactment of the Act.<a href="#10">10</a>

<h3>How Do Credit Counseling Services Operate?</h3>

The USTP has been working to become acquainted with the nature and operations of credit counseling services in

anticipation of the need to develop criteria for approval of those services that are equipped to render good service. The

USTP has met with representatives of nonprofit credit counseling organizations and with executives of large, multi-state

agencies to learn about their policies and practices. Staff have also examined the great variety of state laws applicable to

credit counseling services.

During this process it became apparent that the prototypical credit counseling service is part of a highly fragmented and

competitive industry. The industry's many organizations and autonomous units have diverse operational policies and

methods, charge different fees, and offer services of varying quality. While most of the providers declare similar core

purposes--to extend and work out payment programs for individuals overloaded with debt--and most appear to serve their

clients effectively, they depend almost entirely for their income not upon the debtors they serve but upon the creditors they

pay. The organizations receive funds from creditors in the form of a negotiated percentage fee based on payments

transmitted to the creditors through clients' debt repayment plans. This negotiated percentage fee is known in the industry

as a "fair share" and may range from 0 to 15 percent of the payments. Nonprofit organizations may also charge their debtor

clients small fees that are characterized as "donations."

There are several national associations that encompass most of the nonprofit segment of the industry, but have no

regulatory powers. There are also numerous independent nonprofit providers--among them large-volume, multi-state

organizations that operate through toll-free telephone numbers or the Internet, rather than through face-to-face consultations

with debtors in local offices. It is estimated that more than 1,450 nonprofit credit counseling services operate in the United

States.

Although the members of these associations may comply voluntarily with the associations' internal standards, they are

generally unregulated by state laws or regulations. Most states exempt nonprofit credit counseling services from their laws

governing credit counseling providers. Several states have no laws at all governing the operation of credit counseling

services. Only a few states<a href="#11">11</a> have laws applicable to both nonprofit and for-profit credit counseling services that provide for

oversight and licensing or registration of such services.

For-profit credit counseling organizations generally fall within the purview of a majority of states' applicable laws and

regulations, but the quality and type of services they provide are variable. In some cases, the fees they charge clients are

higher than those charged by nonprofit groups.

</blockquote>

The pre-bankruptcy filing requirement of credit counseling is a new concept in bankruptcy law,

creating new responsibilities for debtors and U.S. Trustees.

<hr>

<h3>Debt Repayment Plans</h3>

Nonprofit credit counseling services offer a variety of services that may include counseling, debt repayment plans and

education. Typically, when an individual contacts a nonprofit credit counseling service to inquire about a debt repayment

plan, he or she will be asked to provide information to a credit counselor. This may take place in person, through a toll-free

telephone number, by fax transmission, by mail or over the Internet. Such information may include personal data, gross and

net monthly income from salary, income from other sources, assets, monthly living expenses, housing data, a list of

creditors, a list of debt obligations, and account and payment data. This information is used to evaluate the client's financial

situation to determine whether a debt repayment plan is a viable option. Some providers require clients to sign an

agreement and other authorization forms. Credit counseling services may be free to the client or may involve a monthly fee.

If a debt repayment plan is developed, it is likely to provide a payment schedule tailored to the client's needs and ability to

repay. The plan may include reduced payments to creditors and reduced or waived finance charges, late fees and

over-the-limit fees. Each month, the client transmits a payment to the credit counseling service, which in turn transmits

payments to creditors. While most creditors pay a "fair share" to the credit counseling service, each creditor credits the

client's account with 100 percent of the payments. Clients may receive regular reports on the status of their accounts.

Significantly, most credit counseling services handle only unsecured debt, so clients must continue to make payments to

secured creditors and other creditors not included in the repayment plan.

Most creditors do not stop charging interest during a debt repayment plan. In addition, creditors may close or suspend a

client's line of credit, including credit card accounts, during a plan. Some repayment plans permit the client to maintain one

credit card, but almost all plans require the client to agree not to apply for any credit or incur any more debt during the plan.

Creditors may report to a credit reporting agency that a client is not paying as originally agreed, even though the creditors

have accepted a reduced payment through a debt repayment plan. A debt repayment plan that appears on a credit report

could have a negative impact on a client's ability to obtain credit, rent an apartment or find employment in the future. This

negative information may remain on a credit report for seven years, whereas a bankruptcy case appears on the report for 10

years.

When a client completes repayment under a plan, some creditors will re-establish the client's credit, based on his or her

ability to pay and payment history under the plan. Some credit counseling services try to help clients re-establish credit. It is

not uncommon for a debt repayment plan to take four years or longer to complete.

The USTP has been advised that clients typically have an 80 percent debt-to-income ratio when they seek credit counseling

from a nonprofit organization. About one third of all clients opt to develop a debt repayment plan. Out of that one third,

approximately 50 percent of the clients who begin debt repayment plans complete their plans, while the remaining 50

percent generally drop out within six months to one year. By comparison, approximately 35 percent of all chapter 13

debtors complete reorganization plans, with the balance of the cases being dismissed or converted.

Another one-third of all clients who seek nonprofit credit counseling are able to work out their finances without a debt

repayment plan. About 23 percent of all clients need to take some other type of action, such as seek part-time employment

or address substance abuse. Approximately 10 percent of all clients who seek nonprofit credit counseling file for

bankruptcy.

<h3>Standards for Approval</h3>

If pre-bankruptcy consumer counseling requirements are enacted, the USTP will develop standards for the approval of

credit counseling services throughout the country. It is anticipated that the approval process will involve an application,

which relies not only upon the applicant's disclosures, but also upon verifications from other sources whenever possible.

This design seeks to maintain the integrity of the assessment process while limiting the work required of field offices,

particularly given the uncertainty over whether Congress will provide funding for this additional responsibility.

The U.S. Trustees will apply the USTP standards to select and approve credit counseling agencies for listing in each

judicial district within their regions. Approval of a credit counseling agency will not mean that the U.S. Trustee warrants

the quality of the agency's services or the success of its work. Rather, approval will mean that the credit counseling agency

meets the minimum standards for operational integrity established by the USTP.

Given that financially distressed people are very vulnerable and are often targets for scams and unscrupulous operators, the

challenge in developing new standards will be to ensure that, to the extent possible, individuals are not directed to

inappropriate services. The credit counseling industry handles approximately $6 billion annually, more than the amount

distributed from chapter 7 and chapter 13 bankruptcy cases combined. Credit counseling services function as fiduciaries

because they handle and hold, for periods of time, substantial funds belonging to others. They are necessarily high-risk

operations, as the possibility of defalcations is clearly present. The standards for approval must provide for full protection

of monies that belong either to debtors or creditors while those funds are in the possession and control of credit counseling

services.

To ensure operational integrity, the standards for approval are expected to require the credit counseling agency to use trust

accounts or other such means to preserve and safeguard funds, engage in regular oversight and monitoring of all receipts

and distributions of client deposits, and obtain regular audits of the accounts from outside auditors. Of particular concern is

how credit counseling agencies cover possible losses through fidelity bonds or insurance. Further, it is likely that the

standards will address the need for agencies to make periodic status reports to clients about payments to creditors. They

may also require an agency to make certain disclosures to clients, including whether the agency is funded from the

creditors' "fair share." General quality of performance of credit counseling services will also be addressed in the criteria for

approval. In addition, the standards will address the need for each agency to provide training for credit counselors and have

experience in the credit counseling business.

To retain the USTP's approval, credit counseling services will be required periodically to demonstrate continued

compliance with the USTP's minimum standards and policies. Credit counseling services that do not meet the criteria will

be removed from the approved list provided to debtors. The procedures and standards for approval and concomitant

removal of agencies will be set forth in an administrative rule to be adopted.

<h3>Conclusion</h3>

The implementation of a pre-bankruptcy filing requirement of credit counseling for debtors, a new role for U.S. Trustees,

and standards for approval of credit counseling services depends upon the enactment of bankruptcy reform legislation that

contains the credit counseling provisions. The pre-bankruptcy filing requirement of credit counseling is a new concept in

bankruptcy law, creating new responsibilities for debtors and U.S. Trustees. Under H.R. 833, credit counseling services

would, in effect, become the "gatekeepers" of the bankruptcy system because individuals would be ineligible to file for

bankruptcy unless they first obtained a certificate from a credit counseling service approved by a U.S. Trustee.

The USTP is working to ensure that debtors are referred to credit counseling services that are dependable, responsible,

skilled in their work and responsive to both debtors and creditors. The goal will be to design a system that ensures that the

counselors who are approved will function with ongoing integrity and success. With that goal in mind, a system can be

structured that fulfills the intent of Congress and the needs of debtors, creditors, the bankruptcy courts, the U.S. Trustees

and all parties interested in the bankruptcy process.<hr>

<h3>Footnotes</h3>

<a name="1">1</a> Attorney, Office of the General Counsel, Executive Office for U.S. Trustees, U.S. Department of Justice. The views

expressed in this article are those of the author and do not necessarily represent the views of, and should not be attributed

to, the U.S. Department of Justice or the U.S. Trustee Program. <a href="#1a">Return to article</a>

<a name="2">2</a> The USTP is a component of the U.S. Department of Justice. The USTP acts in the public interest to promote the

efficiency and to protect and preserve the integrity of the bankruptcy system. It works to secure the just, speedy and

economical resolution of bankruptcy cases, monitors the conduct of parties and takes action to ensure compliance with

applicable laws and procedures, identifies and investigates bankruptcy fraud and abuse, and oversees administrative

functions in bankruptcy cases. <a href="#2a">Return to article</a>

<a name="3">3</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…. 833, §103 amends 11 U.S.C. §342(b)</a> to require individual debtors to be given a notice of alternatives. <a href="#3a">Return to

article</a>

<a name="4">4</a> H.R. 833, §603(b) amends 11 U.S.C. §521(a)(1)(B)(iii)(I), (II) to require the filing of a certificate regarding the notice of

alternatives. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…. 833, §604 amends 11 U.S.C. §521(b)(1)</a> to provide for automatic dismissal of a case for failure to timely

file schedules or provide information as required by <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. §521(a)(1)</a> by day 45 post-petition. <a href="#4a">Return to article</a>

<a name="5">5</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…. 833, §302(a) amends 11 U.S.C. §109(h)(1)</a> to restrict who may be an individual debtor with primarily consumer

debts, in all chapters, to one that has received credit counseling including, at a minimum, participation in an individual or

group briefing that outlined the opportunities for available credit counseling and assisted that individual in performing an

initial budget analysis, through a credit counseling service approved by the U.S. Trustee, within 90 days pre-petition.

<a href="#5a">Return to article</a>

<a name="6">6</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…. 833, §302(a) amends 11 U.S.C. §109(h)(2)</a>. <a href="#6a">Return to article</a>

<a name="7">7</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…. 833, §302(a) amends 11 U.S.C. §109(h)(3)</a> to provide for exceptions to the pre-filing credit counseling requirement.

The exceptions include (1) the debtor certifies that exigent circumstances merit a waiver; (2) debtor was unable to obtain

services within five days; and (3) debtor submits a certification that is satisfactory to the court. An exemption ceases to

apply 30 days after filing a petition and the debtor is required to undergo credit counseling post-petition. <a href="#7a">Return to article</a>

<a name="8">8</a> H.R. 833, §302(d) <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… 11 U.S.C. §521(d)</a>. <a href="#8a">Return to article</a>

<a name="9">9</a> H.R. 833, §302(e) <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… 11 U.S.C. §111(a)</a>. <a href="#9a">Return to article</a>

<a name="10">10</a> H.R. 833, §1201. <a href="#10a">Return to article</a>

<a name="11">11</a> States that have laws applicable to nonprofit credit counseling services include Illinois, Iowa, New Jersey, Oregon, Rhode

Island, Utah and Virginia. <a href="#11a">Return to article</a>

Journal Authors

Sue Ann Slates

Journal Date

Tuesday, June 1, 1999 - 12:00