Critics say that the new counseling requirement, part of the law that takes effect on Monday, increases the risk that people will be improperly steered away from the courts and into debt management plans, for which the counseling agency often receives part of any debts repaid.
"Lots of people see the opportunity to make lots of money off the backs of consumer debtors, and that should make people extremely cautious about this," said Karen Gross, a New York Law School professor and president of the Coalition for Consumer Bankruptcy Debtor Education.
The counseling agencies, which will receive no additional government aid under the new law, are increasingly reliant on funds from the credit industry. And the industry has pledged $10 million to the agencies for this year, possibly more.
The agencies maintain that they balance the competing interests of debtors and creditors and have worked with the lending industry for decades. But the aggressive practices of some counseling providers have been questioned by Congress and scrutinized by the Federal Trade Commission and the Internal Revenue Service. Indeed, I.R.S. officials say they will propose revoking the nonprofit status of at least 20 agencies by the end of the year.
Credit counseling industry officials say their services can help consumers make informed decisions about their finances.
William P. Binzel, chief counsel of the National Foundation for Credit Counseling, an industry group, compared a counseling session to a medical briefing before surgery. The agencies must present a range of alternatives, he said, just as a doctor must explain the procedure and its potential outcomes.
Yet now, finding a credit counselor's office may be harder than finding the right health care provider. While more than two million people are expected to seek counseling next year as a prerequisite to filing for bankruptcy protection, there are only 50 or so agencies approved so far - and there may be fewer if the I.R.S. carries out its proposal. In many parts of the country, from entire states to major cities like Nashville, counseling is expected to be available only by phone or over the Internet - at least until the government approves more agencies.
"On the surface, the notion that people should consider their alternatives is not a bad theory," Ms. Gross said. But "the way the system is structured suggests that will not happen."
The credit counseling requirement is part of the amended bankruptcy act that changes the balance of power between debtors and creditors. Intended to make it harder for individual Americans to wipe out their debts, the law requires a thorough review of whether people can pay off at least some of their credit card bills and other debts. It will also ask debtors to pull together more paperwork, increasing the time and legal costs of filing. In anticipation, there has been a recent surge of bankruptcy filings by people seeking relief under the 26-year-old bankruptcy rules that are about to expire.
Yet it has been the seemingly innocuous mandate for credit counseling that has stirred up some of the greatest concerns of the consumer advocates and bankruptcy lawyers.
The law will require that within six months of filing for bankruptcy protection, consumers receive a counseling session, averaging 90 minutes, that can be delivered in person, by telephone or online. It will also require a similar financial education session after a consumer files.
The sessions are expected to cost up to $50, though some may cost almost twice that. The fees can be waived for debtors who are deemed "not reasonably able" to pay.
Debtor advocates say the two sessions will essentially create a business overnight for the credit counseling agencies, which previously delivered shorter and less comprehensive briefings free. Industry executives estimate that six million people sought the advice of credit counselors last year.
The new law's counseling requirement would add people contemplating bankruptcy - perhaps two million more, according to bankruptcy specialists. (The counseling and debtor education requirements for Hurricane Katrina victims in Louisiana and southern Mississippi have been temporarily waived.)
Government administrators have taken steps to increase the chances that fees will be low and consumers protected. Since early July, reviewers at the Justice Department have been scrutinizing the more than 350 applications to provide counseling and debtor education services in every state but Alabama and North Carolina, where court administrators handle that task. Yet only within the last few weeks have the bulk of the counseling agencies been granted approval for now - and all of those will be reviewed in six months.
Officials at the I.R.S. say the agency will be extremely vigilant. "We have more than 40 examinations ongoing as we speak and have plans for a total of 60 examinations to date," said Steven T. Miller, the I.R.S. official responsible for overseeing tax-exempt nonprofit organizations. "We have found problems."
Even the most thorough reviews, though, may have little effect in trying to eliminate the conflicts between consumers' interests and creditors' interests that have existed in the counseling industry since its inception in the 1960's.
Indeed, the first credit counseling firms were started by the credit industry itself. With the help of banks and other creditors, former industry executives opened local counseling centers to help people create budgets, manage their debts and generally avoid bankruptcy.
But in addition to dispensing advice, the agencies offered and administered debt repayment plans. Instead of making payments to several creditors, a client could send one payment a month to the agency, which would then distribute the money to the creditors. Not only did clients find this arrangement more manageable, but they often also received lower interest rates by enrolling in the plans.
To compensate the agencies, the creditors gave them a share of each payment, generally 12 percent to 15 percent through the 1980's since those debts might otherwise have been discharged in bankruptcy. The debt management plans became an increasingly popular and central feature of credit counseling, rather than a program offered on the side.
Bankruptcy lawyers, who stand to lose business if the number of filers declines, have assailed the payment structure as a disingenuous and tax-evasive form of debt collection.
"For just about every credit counselor," said Charles W. Juntikka, a New York City bankruptcy lawyer, "I can give you a client who paid for years, and the debt didn't even go down," adding that close to a third of his 2,200 clients enrolled in a debt management plan that did not work. "They failed because they didn't have enough money for food or rent," Mr. Juntikka said.
In addition, some agencies are suspected of charging excessive fees for debt management, on top of collecting payments from creditors.
Even as more consumers have been steered into debt management programs, creditor financing of these has dropped off in recent years. But in an interesting twist, the new counseling requirement could increase the agencies' reliance on creditor funds.
When Congress passed the bankruptcy law, it did not provide any money to subsidize the counseling sessions and stipulated that the agencies limit their fees. But credit counseling industry officials say $50 will not cover the cost of a face-to-face 90-minute briefing.
Industry leaders contend that virtually all credit counseling agencies will need to offer other services like the debt management program, even if counseling is the only service required by law, and will also require the delivery of more services over the Internet.
The counseling requirement has sent the agencies scrambling for more money. And so far, the credit industry has been a major source of funds. Susan C. Keating, chief executive of the National Foundation for Credit Counseling, said that at least 16 major creditors, working through the Financial Services Roundtable, an industry lobbying group, have pledged at least $10 million over the next two and a half months and agreed to additional funds next year. The grants would be used to recruit and train counselors, install telephones and offset other costs.
"Funding is a challenge and is going to be a challenge," said Ms. Keating, adding that members of the foundation were also seeking money from other groups. "Even though that grant is substantial, it is not going to cover the current costs."
While counseling agencies strongly deny that the money colors their advice, they acknowledge there is a perception that it could be tainted. And in some cases, they encourage or require that the ties be disclosed.
"We have attempted to be more consumer advocates than we have been creditor advocates," said David Jones, president of the Association of Independent Consumer Credit Counseling Agencies, another industry group.
But given the potential for conflict, consumer advocates and bankruptcy lawyers are concerned that the government has focused too much on ensuring stringent approval standards and not enough on the advice the agencies will provide. They warn of a lack of precise standards in how the counselors will advise consumers - whether, for instance, they will treat bankruptcy as a real option or as something to be avoided at all costs.
"There's nothing wrong with budgeting and discussing alternatives," said Deanne Loonin of the National Consumer Law Center, "but they're not lawyers, they're not trained in bankruptcy law, they don't really know what the consequences are."
Under Chapter 7, 12, 13, and some 11 proceedings, a trustee is appointed to supervise the assets of the debtor. A bankruptcy proceeding can either be entered into voluntarily by a debtor or initiated by creditors. After a bankruptcy proceeding is filed, creditors, for the most part, may not seek to collect their debts outside of the proceeding. The debtor is not allowed to transfer property that has been declared part of the estate subject to proceedings. Furthermore, certain pre-proceeding transfers of property, secured interests, and liens may be delayed or invalidated. Various provisions of the Bankruptcy Code also establish the priority of creditors' interests.
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