WASHINGTON – Consumers struggling to recover from debt have another weapon to protect themselves from predatory credit-counseling agencies masquerading as nonprofits, according to an opinion published last week in Maryland federal District Court.
U.S. District Judge Peter J. Messitte ruled in a class-action suit that credit-counseling agencies may be subject to a federal law protecting consumers from deceptive practices.
According to the decision in Polacsek v. Debticated, credit-counseling agencies — or CCAs — may fall under the 1996 Credit Repair Organizations Act, which established strict guidelines for so-called “credit-repair organizations,” but exempted nonprofits.
“This is a great victory for consumers that have been mistreated by CCAs,” said Garrett M. Smith, a lawyer representing the plaintiffs in the class-action lawsuit.
The act prohibits credit-repair organizations — which negotiate with clients’ creditors to cut debt and lower monthly payments, interest rates and late fees — from charging fees for service “before such service is fully performed.” Organizations that violate the act may be held liable for actual damages, meaning all fees would have to be returned.
“For consumers who are in debt, we’re talking hundreds of dollars at stake,” Smith said.
The decision gives a new means of relief to consumers who believe they have been defrauded by credit-counseling services, Smith said. Specifically, Messitte ruled that nonprofit credit-counseling services that actually operate as for-profit ventures risk having to pay restitution to their clients.
“What this means is that nonprofit credit-counseling agencies have to act like nonprofits,” Smith said. “If they don’t, they’ll have to pass all of those fees back to the consumer.”
The credit-counseling industry has been rife with fraud because of a lack of oversight, said Greg Duncan, another lawyer who represented the class of consumers. In many cases, counseling services were pocketing hidden start-up fees — billed as “voluntary contributions” — that consumers thought were going toward their debt.
“This industry wasn’t regulated before,” Duncan said. “They were charging horrendous up-front fees before they did any work. They’d keep the first payment — your voluntary contribution to their favorite charity: themselves.”
In Polacsek, start-up fees averaged $300 and ranged as high as $1,000, Duncan said.
The decision affects consumers filing for bankruptcy, Smith said. Under the new bankruptcy law that went into effect in October, debtors must complete courses with nonprofit budget and credit counseling agencies within 180 days before filing.
“Everyone who goes into Chapter 13 is going to have to look at the CCA,” Smith said. “(This ruling) supports the integrity of the system.”
Chapter 13 is a type of bankruptcy filing for individuals who want to repay debt and retain major assets.
Nonprofit organizations hold a special status in the credit industry. Most credit card companies and some states require consumers to use nonprofit counselors, Smith said, and a high percentage of all counseling services call themselves nonprofit.
But a dichotomy often exists between actions and words in the nonprofit realm, said Jack Ayer, a scholar at the American Bankruptcy Institute in Arlington, Va.
“We do a lot of business in this country with nonprofits that aren’t acting like nonprofits,” Ayer said. “For some reason, it’s a pretty good marketing device to call yourself a nonprofit.”
The Polacsek case echoed a federal appellate court ruling last May in Boston. In Zimmerman v. Cambridge Credit, a 1st U.S. Circuit Court of Appeals judge found the act could apply to fraudulent nonprofit credit counselors. The case was returned to District Court and is pending, said Smith, who is also representing the Zimmerman plaintiffs.
The Polacsek opinion was signed Nov. 23 but not posted to the court’s Web site until Feb. 9. Court spokeswoman Renee Kelly said it was up to Messitte’s discretion to withhold publication.
In the opinion, Messitte wrote that Debticated, a credit-counseling agency run by University of Maryland, College Park alumnus Andris Pukke, qualified as a credit-repair organization and thus fell under the credit-repair act. Debticated advertised itself as a nonprofit, but it and 10 other agencies funneled consumer fees to a for-profit processing business called DebtWorks. DebtWorks, also owned by Pukke, posted gross revenues of more than $53 million in 2002.
Such practices led Maryland lawmakers to pass the Maryland Debt Services Management Act in 2003. The act required credit-counseling firms to obtain a two-year license and limited set-up fees to $50.
Pukke, of Newport Beach, Calif., agreed Jan. 9 to pay up to $35 million to settle a $172 million suit with the Federal Trade Commission. About 420,000 plaintiffs will receive money from the settlement, including 12,750 Maryland residents, Smith said. The agreement absolved Pukke of any wrongdoing.
The Internal Revenue Service, which has tax liens on all of Pukke’s real estate, has filed for an extension to consider whether to seek Pukke’s assets or let them be distributed to the consumers in the suit, Smith said. The IRS has until Feb. 22 to file a claim.
So far, the court-appointed receiver collecting Pukke’s assets has gathered between $15 million and $20 million, Smith said. The receiver is seeking to claim up to $15 million more in “questionable” assets.
Duncan said the expanded scope of the credit-repair act should deter credit-counseling agencies from slamming consumers with unfair start-up fees.
“I’m hopeful they will restructure their fees,” he said, “to be more in line with what a person who is in debt should be paying.”