The legality of the debt settlement industry

By Douglas A. Crowder, Esq.

Copyright © 2002. All Rights Reserved

The purpose of this article is not to summarize the various state laws regarding the debt settlement industry, but rather to analyze the reported court decisions regarding the power of the states to regulate the industry.

While there may be many definitions of "debt settlement" and "debt negotiation," a workable yet comprehensive definition is that used by the Federal Trade Commission: the business of receiving, in exchange for consideration, a debtor’s money for the purpose of distribution among creditors in payment or partial payment of the debtor’s obligations; or acting as an intermediary between a debtor and his creditors for the purpose of settling, negotiating, or in any way altering the terms of payment of any debt of the debtor.

Debt settlement, also referred to as debt adjusting, has been recognized as constituting a lawful business, in the absence of a valid statute prohibiting it. Further, debt settlement agencies have been likened to collection agencies. While the primary function of collection agencies is to assist creditors in collecting claims from their debtors, the function of debt-adjusting agencies is to help financially distressed debtors settle their obligations by the modification of their indebtedness through the services of an intermediary [15 Am.Jur.2d, Collection and Credit Agencies, Sec. 20]

There are few reported court decisions regarding the validity of state laws, which prohibit or limit the business of debt settlement.

In at least one case, a court ruled that such a law was unconstitutional. In Commonwealth v. Stone (1959) 191 Pa Super 117, 155 A2d 453, the defendant was prosecuted for violation of a statute making it a misdemeanor to engage in the business of budget planning. The court observed that budget planning is necessitated by the purchase of goods on the installment plan, a practice which results in families overextending themselves and finding it impossible to pay for items bought on credit. The court further reasoned that if a creditor may turn his claim over to a collection agency and thereby relieve himself of the stress and strain of collecting a debt, there was no sound reason for discriminating against the debtor by prohibiting him from using a budget planner.

However, the United States Supreme Court in Ferguson v. Skrupa (1963) 372 U.S. 726, 10L.Ed.2d.93, 83 S.Ct. 1028 rejected a challenge to a Kansas statute making it a misdemeanor for anyone to engage in the business of debt adjusting except as incident to the practice of law.

Similarly, a Massachusetts statute which expressly stated that the debt adjusting business constituted the practice of law was upheld against the contention that it interfered with the purely judicial function to determine who may practice law. Home Budget Services, Inc. v. Boston Bar Association (1957) 335 Mass 228, 139 N.E.2d 387. The same result was reached in the New Jersey case of American Budget Corp. v. Furman (1961) 67 NJ Super 134, 170 A.2d 63.

An Ohio statute forbidding any person to engage in the business of debt pooling unless licensed was held to be valid, and not to violate the federal or state constitutions. State ex rel. Clark v. Brown, 1 Ohio St. 2d 121, 30 Ohio Op. 2d 478, 205 N.E.2d 377 (1965).

It appears that while most courts will uphold the validity of state statutes forbidding debt settlement, such laws will be strictly construed. For example, in American Mortg. Assistance v. State, 570 So.2d 203 (La.Ct.App.5thCir. 1990), writ denied, 573 So.2d 1133 (La. 1991), it was held that a Louisiana statute prohibiting debt adjusting did not apply to a North Carolina partnership which analyzed debtors income and expenses and recommended resolution by one of several courses of action, where no periodic payments were made and the partnership did not distribute clients’ money to creditors.

In summary, debt settlement is a lawful, valid business unless it is expressly prohibited by statute. While there is at least one reported decision striking down a state law prohibiting debt settlement, most courts have ruled that such laws are constitutional. It does seem that such laws will be strictly construed.