Debt Settlement: New Laws and a Better Approach

Posted in Debt Free In 30

debt settlement, laws, consumer proposal

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More details also available in our report on Will the New Debt Settlement Laws Protect Consumers?

Why is the new law important for Ontario consumers?

Before now, there really were no rules governing debt settlement companies in Ontario, which meant that they could charge large up-front fees, only to refer the client to a bankruptcy trustee once legal action was taken by a creditor.  The process has already started and on January 1st, 2015 the Collection Agency Act was renamed the Collection and Debt Settlement Services Act.

Today I sit down with trustee in bankruptcy and co-founder of Hoyes Michalos, Ted Michalos to talk about the new legislation and what it means for consumers.

So why is this important? We often hear that clients are afraid to seek help from a trustee in bankruptcy because of the stereotypes and misconceptions about the process. Debt settlement companies feed off this fear by placing ads claiming to be able to settle their debts for pennies on the dollar, while avoiding bankruptcy. Unfortunately, more often than not, these informal debt settlement companies fail, hurting the consumer both emotionally and financially. The new debt settlement legislation attempts to protect consumers from these abuses.

We're not pro or anti debt settlement and in some cases it can be a good option. It is not for us to say that every debt settlement company is not reputable. What we address today is how, and if, the legislation levels the playing field and what other options debtors have to settle and eliminate their debt.

Story time with Ted: Fred's story

Like many Canadian consumers, Fred just couldn't get ahead of his debts and the collection calls were beginning to pile up. Fred saw an ad that boasted "avoid bankruptcy and reduce your debt by 70%!" So, Fred called the number and they offered him a debt settlement plan.

The Plan: Fred owed $50,000 and they were going to settle for $15,000.  Payments each month would be $500 for 30 months plus a fee of $3,000 to the settlement company. So in total Fred was expected to pay $500 a month for 36 months.

The Catch: Since the debt settlement company wants to be paid up-front Fred's first six month payments of $500 a month, were actually paying for the company's fees and not going toward his debt at all. Two months in, Fred received a notice from a creditor that they were taking legal action against him for non-payment. When confronting the debt settlement company, they advised him that he needed to seek legal protection in a consumer proposal or a personal bankruptcy. This after Fred had already paid the debt settlement company $1,000 in fees, for nothing.

The Take-Away: The old debt settlement rules (or lack thereof) meant that companies could charge big fees, and in most cases, not really accomplish anything on behalf of the consumer.  In fact, the Canadian Bankers Association has said that only about 10% of deals that banks receive from debt settlement companies, are actually accepted. If Fred had gone directly to a trustee in bankruptcy, he could have avoided up-front fees (all first consultations are free), and he would have received immediate legal protection through a stay of proceedings.

What's included in the new debt settlement legislation?

  1. No big up-front fees (with the exception of a $50 administrative fee for each account outstanding). Previously, companies could charge thousands in fees (consider Fred's story) before ever attempting to make a deal with the creditors.
  2. Because the debt settlement company can only charge fees as a payment is made, that likely means the deal has been agreed to by the creditors before any payments are made by the debtor.
  3. Fees have been capped.  The debt settlement company is only entitled to 15% of each payment or alternatively, 10% of the total if you're settling using a lump sum payment.

Ted's predictions

So what will this new law mean for Canadian consumers? Ted explains that,

this is a good first step because it immediately cause[s] a number of people who I think [are] less than reputable, to rethink their whole business model. They [can't] charge fees up-front so it [is] time for them to get out of the business.

Ted also predicts that although it will change the way that they do business, those in the debt settlement industry will morph into other agencies not regulated under this new law, including debt consultants and debt coaches; leading to repeat problems under a different guise.

Consumer proposal versus debt settlement plan

If you're facing overwhelming debt, don't be fooled by the quick fixes that some companies claim to be able to provide. If you want to deal with your debt, but avoid bankruptcy, a consumer proposal could be the right answer.  A consumer proposal can only be filed by a federally licensed trustee in bankruptcy and as soon as you sign the paperwork, you are legally protected from creditors who may be threatening to garnishee your wages or sue you for non-payment.  Ted explains that

under the Bankruptcy and Insolvency Act, you file a consumer proposal, you get an automatic stay if proceedings, which means no legal actions can continue or be commenced against you until we figure out what's happening with the proposal.

Unlike a debt settlement plan, a consumer proposal is legally binding and regulated by the Federal government under The Office of the Superintendent of Bankruptcy,

so you're not out of pocket for somebody that's hopefully going to make a deal for you. You know the deals in place and you're protected under the law.

Read the full transcript here.

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