INDUSTRY WHITE PAPER April 2009
(Know Your DSC, and Other Guidelines for Responsible Settlement Fee Advance Providers)
Presented by DebtPayGateway, Inc.

Executive Summary
"Front-end" and "back-end Debt Settlement Companies (DSC), in some circumstances, need cash flow to survive. A Settlement Fee Advance (SFA) is a great tool to help the DSC better manage and grow their businesses. But, like any other powerful tool, if used incorrectly, it can do more harm than good. The Settlement Fee Advance is structured very similar to the "Business Cash Advance" in the payment processing industry. The payment industry allowed unscrupulous and predatory (funding) companies to destroy their clients' businesses with retrieval rates beyond their abilities to pay, increasing retrieval rates without permission, (dog piling) multiple business cash advances on top of one another, and even outright fraud.

As the Settlement Fee Advance industry matures, it will need to exhibit many of the traits demonstrated during the development of other innovations in the financial services industry. Early providers find a market niche and go about doing business. As their business models and practices gained acceptance, multiple providers will enter the market offering more money, lower rates and extending the market into less predictable DSC profiles. Although, as explained below, an SFA is not a loan or a financing.  If left unchecked, the SFA industry has the potential to follow the pattern of the payment processing industry and develop similar problems.

The challenge facing the Debt Settlement industry is simple: (Regulate ourselves, or someone is likely to do it for us.) DebtPayGateway believes that since it invented the Settlement Fee Advance it should set forth Best Practices for providing this novel financial product, and this White Paper is our invitation to the industry to begin that discussion. We believe that through Best Practices, the industry can ensure the healthy development of robust and ethical competition - and a level playing field safe for the DSCs, banks, consumer / debtor, processors and associations that are impacted by this industry.

What is a Settlement Fee Advance?
A Settlement Fee Advance (or SFA) involves the purchase of a portion of a DSC's future "Settlement Fees" ¹ at a discount. The purchase price paid by the SFA provider is a lump sum of cash delivered to the DSC for its use as working capital, "cashing-out" a partner, etc. No restriction on the use of proceeds should be placed upon the DSC by the SFA provider.

A common and popular way for the SFA provider to collect its purchased receivables is through (batch-splitting) and/or closely related variations through Automated Clearing House (ACH) transactions. In batch-splitting, the DSC directs its payment processor to forward an agreed upon, set percentage of the DSC's monthly Settlement Fee (post-credits, refunds, and other processor-related charges) revenue from consumer / debtors monthly Settlement Fees to the SFA provider's account.  ²

An SFA is not a loan - it is a purchase of a specified amount of Settlement Fees that have yet to occur. This distinction is more than semantics and goes straight to the benefits an SFA provides to DSCs. A DSC contracts for an SFA because, among other reasons, it doesn't have to have a fixed term and is not directly tied to specific itemized underlying consumer / debtor accounts. Rather, the SFA provider is entitled to receive a set percentage of its DSC client's monthly net settlement batch. This means that the dollar amount received by the SFA provider on a given processing day is based on the DSC's settlement fee volume.

On the other hand, these aspects of an SFA (viz., the SFA provider is only entitled to a set percentage of net settlement fees and the total amount of purchased future receivables is fixed) also make it a risky product for the SFA provider to deliver. If the DSC's future settlement fees are lower than the SFA provider projected, the provider's collection of the receivables it purchased will take longer than projected - a timing difference that may result in loss of income for the SFA provider. Moreover, the SFA provider will bear the loss if the DSC fails to generate future settlement fees sufficient to deliver the total amount of receivables sold to the SFA provider. For these reasons, responsible SFA providers are careful to set the terms of their transactions based on the particular profiles of their DSC clients. Any miscalculation in the DSC's profile, or unforeseen event (e.g. Federal Trade Commission action) can change the collection curve on the SFA transaction - often dramatically.

SFA providers usually require less paperwork than traditional capital sources, and can often go from application to completed funding in a week or less. Those SFA providers, like DebtPayGateway, who structure their transactions as (true sales) by DSC clients and not as loans, do not require personal collateral to secure the DSC's obligations. Some SFA providers, including DebtPayGateway, require the DSC to provide certain covenants (e.g., to not switch or split their payment processing, without the SFA provider's consent) and owners to provide guarantees of performance of those covenants.

A Call for Best Practices
DebtPayGateway believes that the SFA industry needs to develop a series of (Best Practices) for SFA Providers. These Best Practices will enable growth in our industry that is both fair and robust, benefiting all participants - from DSCs, to payment processors, to both "front-end" DSC salespeople and firms as well as "back-end" DSCs and SFA providers. Best Practices will provide market participants, banks, and associations with the benchmarks to distinguish between reputable and disreputable SFA providers using a common taxonomy. This ability to choose amongst SFA providers is certain to become more and more important as the industry grows and attracts greater scrutiny from the press and regulatory entities.

We call for the industry to establish standards against which industry participants may be measured. We have created this paper to begin the conversation that will lead to consensus. We invite open debate, comments and additions to our list of suggestions set forth below. We strongly urge everyone with a stake in the future of the SFA industry to participate in this discussion.

Best Practice Axiom #1 - Do Not Harm the DSC
1. Know Your DSC
Responsible funding means knowing your DSC and using commercially reasonable efforts to ensure that your funding does not harm the DSC's business. Every business has a maximum percentage of its gross revenues that it can afford to pay each month against any financial obligation the (Safe Retrieval Percentage). If the DSC has to pay more than that percentage, it risks going out of business. If the DSC goes out of business then the consumer / debtors who are relying on their DSC to perform the negotiation and settlement of their unsecured debt also lose.

We propose a Best Practice rule that calls upon SFA providers to know the margins of the DSC businesses they fund, and to establish internal Safe Retrieval Percentages for each DSC and adhere to that policy except pursuant to appropriate and documented exceptions.

Other areas that should be considered in establishing Safe Retrieval Percentages within each SFA provider include the following: (i) what percentage of DSCs actually use the SFA to advertise, market and otherwise grow their business within a year of entering into an SFA; (ii) what percentage of "front-end" DSCs actually increase the number of Debt Settlement Accounts and what percentage of "back-end" DSCs add more "front-end" DSC and hopefully add more Debt Settlement Accounts while future receivables are owed to the SFA provider; and (iii) what percentage of DSCs enter into one or more additional SFA transactions after the provider collects the total amount of receivables purchased in the first/previous SFA transaction?

2. Fix the Retrieval Percentage
Responsible funding means honoring your marketing and documented commitments to your DSC. One of the most severe breaches of this Best Practice is increasing the retrieval percentage without express consent of the DSC. SFA providers should not change the retrieval percentage in the event the DSC's future receivables are less than anticipated. We believe that this practice hurts DSCs and DebtPayGateway will not do it.

As described above, alignment between the DSC's settlement fee cash flow and the SFA provider's collection of its purchased receivables is the very essence of an SFA and its chief differentiator from other financial products in the marketplace. This feature makes it arguably one of the most cash flow friendly products available today. If SFA providers increase the retrieval percentage precisely when the DSC's settlement fee revenue drops, they endanger the DSC's business viability. The SFA product is priced to account for the unknowable timing of revenues, which is precisely the risk SFA providers must assume.

We propose a Best Practice rule that prohibits increasing the retrieval percentage with respect to any SFA, without a new, express, written consent from the DSC each time the SFA provider desires to increase the retrieval percentage (i.e., not just a blanket consent in the contract upfront). The consent form should clearly identify the new retrieval percentage and should be dated no more than five business days prior to application of the new retrieval percentage.

3. Provide Clear Disclosure of Fees
Fees, rates and automatic deductions and renewals are not necessarily evil. Unexpected fees, rate changes and contract renewals are. Contracts need to clearly specify these items, with bold print instead of the mousetype so common today. SFA providers must adequately disclose and explain them to their DSCs.

We propose a Best Practice rule that requires clear disclosure of all fees associated with an SFA. We believe the fee disclosure rules currently in place in the Debt Settlement industry are a good place to start the discussion of appropriate disclosure standards for SFA fees.

4. Establish DSC Service Standards and Issue Resolution Mechanisms
DSCs should be able to get assistance and answers when needed. SFA providers must operate with sound infrastructure to serve their client base, enhancing the overall professionalism of the industry.

We propose a Best Practice rule that requires SFA providers to establish (i) staffed DSC service desks, enabling DSCs to receive answers to their questions and problems within commercially reasonable times; (ii) issue resolution policies, with appropriate escalation procedures; (iii) quality control measures to ensure that the correct amounts are being deducted from the DSC's net settlement batches; and (iv) agreements and processes with payment processors and other persons involved to ensure that mistakes are corrected quickly.

Best Practice Axiom #2 - Do Not Harm the Industry
1. Represent the Product Accurately
If the SFA is structured as a purchase and sale transaction, then the product should be described accurately in a way that avoids confusion. A true sale transaction cannot have an interest rate or a principal balance and cannot involve repayment, late payment fees, payment guarantees, or any other indicia of a loan. These features must be absent from both the transaction itself as well as any marketing collateral or sales efforts. Mixing the features of a (true) SFA purchase and sale with
the features of a traditional loan confuses DSCs and invites regulatory scrutiny.

We propose a Best Practice rule that requires SFA providers to accurately describe their products in all communications, especially sales and marketing efforts directed at DSCs. This would involve using commercially reasonable efforts to cause independent sales channels to accurately describe such products.

2. Distinguish the SFA Sale
Just as the Card Associations and regulatory agencies have closely scrutinized and discouraged tying the sale of merchant processing to the sale of other products and services, we believe that the DSC community is best served by being able to similarly distinguish the relative merits of an SFA separate from related products or services. For this reason, it is important that the sale of SFAs remain distinct (i.e., separate documentation) from the sale of processing and related products and services.

We propose a Best Practice rule that requires SFA providers to use commercially reasonable efforts to distinguish (and to use commercially reasonable efforts to cause their independent sales channels to distinguish) the sale of SFAs from sales of any related products or services.

Summary
DSCs should want to work with SFA providers who abide by these Best Practices for obvious reasons. They will receive money that helps their businesses and build ongoing, professional relationships with SFA providers that can save them time and frustration. DSCs benefit because SFA providers that embody these Best Practices have satisfied, happier DSCs who will take advantage of more fundings over their lifetimes. More fundings means more revenue for all involved. The industry benefits because it builds a reputation within the regulatory community that it has the ability to self-regulate, advocate responsible funding practices, and minimize unscrupulous behaviors without the need for government intervention. If a SFA provider sets the retrieval percentage at a rate that the business cannot support, then it will be harmful. Or, if it increases the retrieval percentage when the card sales are not flowing as expected. Or if the DSC agreement is not free from hidden fees.

It is incumbent upon the industry to regulate itself to ensure that it moves forward responsibly. With 10 years of history behind it, DebtPayGateway's management has gained data, knowledge and perspective from the payment processing industry that can be used to promote Best Practices that help, not hurt DSCs, and others within the industry.

The purpose of this White Paper is to outline Best Practices that responsible Settlement Fee Advance providers can adopt, DSCs can judge providers against and the industry can promote. We offer this White Paper to start the discussion.

Footnotes:

1 The Uniform Debt Management Services Act (UDMSA) defines a Settlement Fee as a charge imposed on or paid by an individual in connection with a creditor’s assent to accept in full satisfaction of a debt an amount less than the principal amount of the debt.
2 Batch-splitting and substantially similar methods involve multiple benefits, as compared to other collection methods, including greater efficiency, lower costs, and more effective tools for managing risks and losses. By reducing the administrative burden and collection risk on the SFA provider, these methods enable providers to deliver less expensive capital to DSCs.