The reform measures that took effect Oct. 17 will make it harder for filers to wipe away unsecured debt by steering more of them toward Chapter 13-instead of Chapter 7-which requires them to repay at least some obligations.
But consumers wishing to declare bankruptcy must first undergo credit counseling within 180 days of filing and finish debtoreducation courses before exiting the courts.
Critics contend the extra step will add more time to the pre-filing phase and increase the cost for those who can least afford it. Moreover, they say the requirement could create a windfall for the service providers, some of which already are being investigated by the Internal Revenue Service.
Nathalie Martin, a professor at the University of New Mexico School of Law and resident scholar for the American Bankruptcy Institute in Washington, D.C., said she finds the provision troubling.
"I am very concerned," she said. "It's somewhat ironic that this is even in the bill given the history of these organizations. Frankly, there have been many more prob- lems with the credit-counseling industry than with the [bankruptcy] attorneys."
The IRS told the Washington Post earlier this month that it probably would revoke the tax-exempt status of about 20 creditcounseling firms, which account for half the industry's revenue.
The agency began auditing 40 firms more than two years ago after hundreds of consumers complained about deceptive business practices, including high fees, high-pressure tactics and inadequate educational services, the Post said.
The IRS is concerned that many of the not-for-profit counselors have been misusing their tax-exempt status, by pressuring consumers to enroll in debt-management plans with fees funneled to for-profit companies controlled by the firms' executives.
"I have to send my clients to these people, and I don't even know who they are," local bankruptcy lawyer Mark Zuckerberg said. "I don't want to send my clients somewhere where they're going to get ripped off."
The Justice Department's U.S. Trustee Office, which oversees the nation's bankruptcy courts, is compiling a list of firms it will approve to provide the education and counseling required by the new law.
The office so far has approved 41 applications out of nearly 200. Credit counselors must be tax-exempt, but debtor-education providers don't have to be. Most are charging roughly $50 for the services, which must be offered at a "reasonable fee." Both credit-counseling and debtoreducation courses can be offered in person, over the Internet or by telephone, and last about 90 minutes each.
Leslie Linfield operates the Institute for Financial Literacy in Portland, Maine, and is one of seven firms so far that can offer debtor education in the Southern District of Indiana.
By requiring debtors to receive credit counseling, the law creates a conflict of interest, she said. Although Linfield said she does not receive fees from the creditcard industry, many of her national competitors do when they recover funds for the companies. The credit counselors may steer debtors away from bankruptcy in an attempt to profit from the bill, she said.
"There is a concern that a billion-dollar industry has been created, because of the mandatory credit-counseling requirement," Linfield said, "and that an industry under scrutiny by the IRS has suddenly been handed a brand-new profit center."
Susan Keating, president and CEO of the National Foundation for Credit Counseling, admitted that some within the industry have taken advantage of consumers. The NFCC, based in Bethesda, Md., has 115 members and has worked with federal lawmakers to weed out the rogue agencies, she said.
"We are painfully aware that our profession has seen a group of new entrants that really do not deliver services with the clients' needs as the primary consideration," Keating said. "They're really bad apples and have abused the label of notfor-profits."
Keating dismissed the conflict-of-interest issue, saying consumer counselors receive funding from a number of sources, including financial institutions. Ethical questions may arise, however, if an agency pushes a product without considering the debtor's needs, she said.
The NFCC did not lobby for the new law but supports the counseling provisions. Just as individuals undergoing surgery need to understand the risks and benefits, Keating said, so do consumers considering bankruptcy. If they choose that route, debtoreducation courses will help them avoid further financial trouble, she said.
Momentive Consumer Credit Counseling Service, a locally based not-for-profit that has counseled clients since 1965, has applied in the Southern District of Indiana to provide both credit-counseling and debtor-education services. The $50 it plans to charge, if approved, may not even cover expenses to provide the education, said Connie Russell, president of Momentive.
The tougher regulations created a stampede of filers before the Oct. 17 changes. Nationally, quarterly filings for the period from April through June were the highest in U.S. history, at 467,333-up 11 percent from the same quarter a year ago, according to the ABI.
Yet, some consumers contemplating bankruptcy remain in the dark about the new law. Visitors to Zuckerberg's downtown office are surprised to learn what they need to do to complete the process.
"Their reaction is, 'I gotta do what?'" Zuckerberg said. "When you get pulled over for speeding, you don't want to go to defensive driving class, but you do it. And if you want to get out of bankruptcy, you'll complete the classes."