Many companies that have been successful with consumer debt counseling have moved into servicing commercial debt. Commercial debt is defined as an obligation arising from a business-to-business transaction.


Credit grantors know that with very few exceptions a Chapter 11 bankrupt debtor coverts the Chapter 11 to a Chapter 7 liquidation. This is because the debtor’s business model did not change after the initial Chapter 11 filing. Thus, the conditions that created the bankruptcy continued rendering it impossible for the debtor to successfully emerge from the Chapter 11. Commercial debt counseling companies face the same problem, which is why a full payout seldom occurs. The reason for this is that the counseling service does not change the flaws in the debtor’s business model. Fees that are siphoned off by debt counseling services reduce the available revenue pool for creditors. The debtor company goes out of business – with a lesser return to creditors.


A debt counseling company’s involvement ratifies “insolvency.”  The sole reason for “counseling” is because obligations are not being met as they mature.


Under our judicial system creditors are entitled to the same rights and legal remedies “at,” “after” and “during” insolvency. The most common fraudulent act committed by a debt counseling service is that the debtor pledges all unencumbered assets to the debt counseling company as collateral towards the debt restructuring agreement. This fraudulent act prevents litigating creditors from bypassing the process and thus deprives creditors from legal remedies that they are entitled to. The granting of a secured interest to the debt counseling company lacks a 2-way flow of adequate consideration. Assets are pledged in exchange for a yet-to-be-performed service, which serves nothing more than an illegal obstacle preventing creditors from pursuing their legal remedies that existed prior to the entry of the debt counseling service.


In a recent case decision in the Judicial District of Waterbury CT, Case #CV03-0181042S, the Judge’s “Memorandum of Decision” found that the practice of assigning unencumbered assets to the debt counseling service hindered and defrauded creditors in violation of the Uniform Fraudulent Transfer Act. The debtor’s actions with the debt counseling service constituted a fraudulent transfer of assets at a time when the debtor company was deemed insolvent. Further, the court ruled there was no way to determine if fair consideration was provided because there was no evidence as to the value of the security or value of the service to be performed by the debt counseling service. By taking a security interest in all of the unencumbered debtor assets, the debt counseling service attempts to “guarantee” its success.

The Financing Statement and Security Agreement are filed before the debtor’s creditors are approached. When the counseling service contacts creditors it makes it clear that the creditors must go along with the debt reduction plan because if they do not, they cannot pursue their legal remedies to judgment because the debt counseling company has already secured all of the remaining assets of the debtor company.


The Court in its ruling stated the transfer of the security interest was not made in full or in partial satisfaction of any indebtedness to the debt counseling company. Further, the unperformed service did not amount to value for the purpose of supplying consideration for the transfer of assets.


The debt counseling companies promote in marketing materials that the underlying purpose of the debtor granting a security interest to them is to frustrate the efforts of legitimate creditors who want to pursue their legal remedies. These debt counseling companies in their advertising proclaim that their method renders the debtor “judgment proof.”


Another case ruling in the state of Indiana in the Marion County Superior Court, Cause #49D13-0309-CC-1567, the Court ruled in the same manner giving the same reasons as the previously mentioned case in Connecticut. In this case, part of the Uniform Fraudulent Transfer Act that was quoted was, “A transfer made or an obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor’s claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation:


(1)    With actual intent to hinder, delay or defraud any creditor of the debtor; or

(2)    Without receiving a reasonably equivalent value in exchange for the transfer or obligation and the debtor:

Was engaged or about to be engaged in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or

Intended to incur or believe or reasonably should have believed that the debtor would incur debts beyond the debtor’s ability to pay as debts became due.


Value and consideration are considered one and the same. The Court ruled that there was not an equivalent 2-way consideration flow when unencumbered assets were pledged as security to the debt counseling company. In addition, when the debtor did assign the unencumbered assets to the debt counseling company, the debtor was already insolvent.


The Court went on to clarify that the assets transferred to the debt restructuring companies occurred with the express purpose of hindering or delaying the efforts of creditors to realize the possibility of satisfying such claims from the debtor’s assets. Transactions by which the debtor seeks to place its property beyond the reach of creditors are precisely the transactions to which the Uniform Fraudulent Transfer Act targets. Credit counseling companies that take a secured interest create a security position as a means to shield the debtor’s assets from creditors while promoting that this action “serves to benefit creditors.” The Court ruled that in reality the actions of the debt counseling company did not result in more favorable results with creditors. The bottom line is that the involvement of debt restructuring companies in itself is not illegal; however, the line is crossed when such actions shield assets from creditors. According to the Court “adequate consideration was lacking” when the transfer of unencumbered assets were pledged to the debt counseling company.


In the Findings of Fact and Conclusions of Law in the Indiana case, the Judge noted that the debt counseling company retained an excessive amount of fees, which diminished and diluted the overall revenue pool available to creditors.


It is the opinion of Williams & Williams, Inc. that if approached by a debt counseling company the debtor with the overdue balance should be placed for collection. Creditors should not participate in any type of debt restructuring proposed by commercial debt counseling service companies.


We welcome your comments and feedback concerning this subject.


Joseph H. Williams