07/20/2011 08:53 am ET Updated Sep 19, 2011

Borrower Nightmares: Small town teacher seeks help for big debt, ends up in bankruptcy

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Retired schoolteacher Mary Linville looked around the dinner table and smiled. It was an evening late in November 2008, and she was surrounded by friends who had come to unwind after the hectic Thanksgiving holiday. To her left sat her husband, and to her right were friends from church with whom she often went horseback riding. Her son Jamie, a county sheriff's deputy, sat across from her.

The dinner at Linville's middle-class home in the rural West Virginia town of Alkol was interrupted by a knock on the door. One of her son's co-workers, armed and wearing his badge, stood awkwardly at the door and served Linville with a lawsuit filed by Discover for failing to pay off her credit card.

The court summons alarmed Linville, who seven months earlier had hired what she calls a "debt settlement firm" that promised to cut her $72,000 debt in half by negotiating repayments to creditors. Instead, Linville became one of many Americans who have found themselves even deeper in debt after seeking help through debt settlement services, an industry the new Consumer Financial Protection Bureau aims to regulate.

More than 500,000 Americans with about $15 billion of debt are currently enrolled in debt settlement programs, said Andrew Housser, executive board member of the American Fair Credit Council. The industry group represents about 45 debt settlement companies which together handle about $2 billion in consumer debt.

"People in debt have several options," Housser said. "They can file bankruptcy, seek debt settlement, or do nothing. Debt settlement is appropriate for those people who have the desire to do something about their debt, who have the ability and willingness to slowly pay it off."

Seven months before that memorable November dinner, Linville had hired California-based Morgan Drexen, Inc. when a telemarketer called to advertise the firm's services.

Linville said the company told her it would charge her monthly installments of $771.25, and the initial payments would be applied toward Morgan Drexen's engagement fee of $4,101.53, and fees for maintaining Linville's checking account. In return, Morgan Drexen promised to deal with her creditors directly and settle her debt for less than half of the original amount, she said.

"I was so surprised, I had no idea I was in trouble," said Linville, 63, recalling the court summons that turned her financial world upside down. "I thought they were doing what they promised to be doing for me."

But Morgan Drexen did not deliver the promised services, Linville claims. Instead, the firm took -- and kept -- about $7,000 from her checking account but never paid a cent to Discover, Bank of America, Lowes and most other creditors, she said. Shortly before the Christmas holiday in 2008, she filed for personal bankruptcy.

'Head over heels' in debt

"By the time I realized what was going on, I was head over heels, way over my head in debt," Linville said. "I was falling behind in payments, and interest kept collecting. There was no way I could get caught up."

Linville, who taught elementary school for 36 years until she retired, complained to the West Virginia state attorney general, which filed a lawsuit against Morgan Drexen two months ago on behalf of her and other consumers.

The company describes itself on its website as a software and support service provider to 35 U.S. law firms. Morgan Drexen is "NOT a debt settlement company," wrote Raychel Harvey-Jones, vice president of media relations, in an email to iWatch News. "Morgan Drexen provides a platform where attorneys, clients and businesses can reach amicable solutions together. Clients and their attorneys use this platform in a variety of situations including bankruptcy, personal injury and resolution of claims by creditors."

While the company may not call itself a debt settlement company, the West Virginia attorney general and Linville allege that for all intents and purposes, it is. Defining exactly what constitutes a debt settlement company is one of the early challenges for the federal Consumer Financial Protection Bureau to tackle in regulating the industry.

Just last month, the bureau announced debt relief services were among a half-dozen high-priority areas it was targeting with its new powers under the Dodd-Frank financial reform law. As a first step, the Consumer Financial Protection Bureau said it must clarify which debt settlement companies are "a larger participant" in the industry.

"Statistics on the size of [the debt counseling and debt settlement] industries, as well as the size of other debt relief services, are not readily available. The CFPB will need to consider carefully how to define any debt relief provider market or markets included in an initial rule," the agency said in its announcement.

Linville is not alone in claiming that Morgan Drexen's work failed to bring results.

The Better Business Bureau, which said it has received some 217 customer complaints in the past three years about Morgan Drexen, gives the company an 'F" rating. Customers complained that as Morgan Drexen automatically deducted monthly fees from their bank accounts, the company failed to disclose where the funds were being held and debts remained unsettled, according to the BBB.

Loophole for lawyers

The debt settlement industry is a complicated one to regulate because it involves so many parties -- the creditor, the debt settlement provider, a consumer, and, in Morgan Drexen's case, lawyers who negotiate the debt.

According to Harvey-Jones' email, "1,000's of consumers have used MD [Morgan Drexen] supported attorneys to assist them with resolving their disputes with their creditors. MD has processed $266M of debt for just over $100M [in] over 72,000 settlements."

"The figures above speak for themselves. The attorney-based debt resolution program is successful," Harvey-Jones said.

The involvement of a lawyer in debt settlements is an important advantage for companies that promise to settle their clients' debts.

Just last fall, the U.S. Federal Trade Commission amended its telemarketing regulations to prohibit companies that sell debt settlement services over the telephone from collecting fees until a client's debt is settled. However, the rules allow ...

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