Free Rider Problem Explained: Why Debt Settlement In California Often Backfires In The Long Run

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In this article, you can discover…

• The background behind the “free rider problem” in debt settlement programs.
• How this problem can impact settlements with creditors.
• How an experienced bankruptcy attorney can help you avoid these pitfalls.

What Is The “Free Rider Problem” In Debt Settlement?

I mentioned this problem in our last succession of questions, so answering it again is, I suppose, a bit pleonastic. If you have, let’s say, 10 creditors and you’re trying to negotiate with each one individually (whether you’re doing it directly or through some intermediary) you might come across a creditor that says, “No, I’m not going to go along with this program. You pay me in full and let the other guys take the bath.”

That can corrupt the whole process because other creditors might demand the same treatment, thus torpedoing the process. Of course, you don’t have to discuss the problem child with other creditors.

But if you’re asking creditors to reduce the debt that you have to them, they will probably ask what other debts you have and how you’re addressing them. Therefore, if you have a recalcitrant creditor, you may be unsuccessful in negotiating with the other creditors.

How Does It Affect Debtors Negotiating With Multiple Creditors?

How much you disclose to the other creditors about the entire creditor body is entirely up to you. My sense is, it’s probably good to keep your cards close to your vest.

This really only comes up when you’ve got a large enough debt that the creditor wants hard evidence to show that the entire creditor body is getting the same treatment. If the creditor concludes that its getting the short end of the stick, it probably will not accept your proposal.

Why Do Some Creditors Refuse To Settle When Others Agree?

One reason a creditor may refuse to settle is if you have assets you can liquidate. Suppose you’re trying debt settlement rather than bankruptcy, and a creditor sees you have $300,000 of equity in your home, and let’s say you owe the creditor $20,000. The creditor may insist that you take out a HELOC and pay the debt in full.

Another reason might be that the creditor looks at your paystubs and concludes that with proper budgeting you could pay the debt in full.

Yet another reason might be that the creditor has already filed suit. The creditor has had to pay an attorney, pay the filing fee on the complaint. At this point, the creditor is in no mood to start reducing the balance that you owe.

What Legal Leverage Does Bankruptcy Provide That Debt Settlement Lacks?

Bankruptcy is filed under federal law. That means that you have the Federal Government behind you when you go into bankruptcy. If a creditor violates bankruptcy law, you may be able to get sanctions against the creditor, and sometimes those sanctions can be really quite large. You may also be able to get costs and attorney’s fees. That’s a powerful cudgel that is unavailable in debt settlement.

Why Does The Free Rider Problem Cause So Many Plans To Fail In Orange County?

On the one hand, the free rider problem doesn’t exist in bankruptcy because you have the power of the Federal Government to force the creditors to go along with what the plan says.

On the other hand in a debt settlement program, the free rider problem – which I have already discussed above – can destroy the entire process.

Are Certain Types Of Creditors More Likely To Refuse To Negotiate?

Well, I suppose the loan shark types are more likely to refuse to negotiate. They’re the kind that used to speak like Don Corleone.

Ultimately, you have to convince the person on the other side of the table that it’s in his best interest to do what you’re proposing. You must appeal to the self-interest of the person with whom you’re speaking. If you can show the creditor that your proposal is the very best outcome it can get, it will probably it.

Although loan sharks are not as easy to deal with, once you file the bankruptcy, they generally will obey the law.

Something that’s really become a problem of late for business debtors is what are called MCAs (Merchant Cash Advances). These take the concept of loan shark to an absurd level. They present themselves as not borrowing money, but instead buying your future business profits.

If you have a small business, and you’re considering getting an MCAs, don’t do it. Go lie down. Let the feeling pass. Or maybe become addicted to heroin: It’s much safer than getting involved with those people.

The recovery that they get is phenomenal, and it’s fairly regular that I get calls from small business owners saying, “My business is going under because they take every penny that’s going into the till. I can’t make a profit.”

Those guys are not going to negotiate. They even put up a pretty big fight in the Bankruptcy Court. So as much as possible, avoid MCAs.

What Role Do Debt Collection Agencies Play In This Dilemma?

Debt collection agencies might be a little bit of a misnomer. A debt collection agency is an agency a creditor hires for a fee to collect the debt. There are some debt collection agencies, but most of the time they’re debt purchasers.

For example, let’s say you owe $10,000 to ABC Bank. ABC Bank is not in the business of collecting debt. It is in the business of lending money, and then having you remit the payments along with the interest. Suppose you haven’t been paying. ABC Bank may call Dewey, Cheatem, and Howe down the street, and offer to sell the debt. Dewey might buy the debt for $500. Even though they only paid $500, they are entitled to collect $10,000.

Dewey’s first communication is usually upbeat. They’ll offer to settle for, say, $7,500, and insist that you pay the offered amount in full within 30 days. If that doesn’t produce payment, they’ll rachet up the tone. They will also call you many times a day – because they care about you: Not.

Eventually, if you don’t pony up the money, they’ll sue you. They’ll get a judgment against you, use that to garnish wages, seize money out of bank accounts, and put liens against assets that you may have. You might find it useful to contact a bankruptcy attorney before these things happen.

If the underlying debt is dischargeable in bankruptcy, then the fact that somebody else owns the debt doesn’t change that fact. It’s still dischargeable.

But in practical terms, both debt collectors and debt purchasers go through the same motions that Dewey, Cheatem, and Howe does. They try to collect directly from you. If that doesn’t work, they sue you, get a judgment against you, garnish your wages, levy funds out of your bank account, and record liens against your assets.

How Can A Bankruptcy Attorney Help Me Avoid This Trap Entirely?

First, by filing a Chapter 7 bankruptcy petition – if you’re eligible – you can get rid of the debts in one fell swoop. That works if your income is sufficiently low, in a way that can be made precise.

Second, if you’re income is too high to do a Chapter 7, we can put you into a Chapter 13. You’ll enter a repayment plan that’s administered by the Bankruptcy Court, and is designed to be manageable. The plan is set up for success. It’s NOT: “I’m going to be living under a bridge, and I’ll get one hot meal a day: A bowl of steam.”

If your income is too high to do a Chapter 7, and your debts are too large to do a Chapter 13, we’ll put you into a Chapter 11. Since Chapter 11 is a quantum leap more complicated than the other two chapters, it’s concomitantly more expensive; so it’s the last stop on the bankruptcy train.

However, in each chapter you have a global way to deal with all of your creditors. All of your debts get taken care of, whether it’s in a Chapter 7, Chapter 13, or Chapter 11.

Classic Disclaimer

If you are not in California and you’re watching these videos, terrific. I’m very pleased that you find them useful. Unfortunately, I can’t give you legal advice. It is against the law. I am only licensed to practice law in the State of California. If I give you legal advice, and you’re in another State, I can be prosecuted because I will have committed a crime. So, don’t call me and ask for legal advice if you’re not in California.

If you are in California, then I need to put an additional disclaimer. I only take cases in Los Angeles County and Orange County; and I will take Chapter 7 and Chapter 11 cases in Riverside and San Bernardino Counties.

If you’re in one of those counties I serve, please give me a call. Let’s chat. But if you’re not in one of those counties, I’m not going to spend any time with you. Enjoy the videos. I’m pleased that you find them helpful, and maybe they can guide you. But you need to get an attorney in your own area if you’re not in the Central District of California.

Anyway, I hope that you find them useful, regardless of where you are.

Still Have Questions? Ready To Get Started?

For more information on free rider problems during debt settlement, an initial consultation is your best next step. Get the information and legal answers you are seeking by calling (562) 777-9159 today.