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How useful is debt counselling in bankruptcy?

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Iain Ramsay

http://www.kent.ac.uk/law/people/academic/Ramsay,_Iain.html

Several countries (Canada, US, Scotland)  now include debt counselling as part of the  individual bankruptcy process but evidence is limited as to its beneficial impact.

Many official inquiries have supported the integration of counselling in the debt enforcement system.  In the 1960s and 70s  counselling was justified  by the  perception of a debtor as needing assistance in managing her financial affairs and possibly having wider problems in coping with life.  The English Payne Committee (1970)  proposed a social service office for debtors as part of a state enforcement office based on ‘abundant evidence that many debtors incur and fail to pay their debts because they are inadequate personalities or irresponsible in managing their affairs… They need to be assisted to financial health and stability.” (para 1210) Social workers would ‘perform for financially incompetent or inadequate or irresponsible debtors, the functions which are discharged for more successful members of the community by bank managers, accountants or solicitors’ (1216).   The influential Brookings Commission study (1971) in the US  proposed that financial counselling should be available to all debtors after finding  that 31 percent of debtors attributed their problems to poor debt management,  and  the US Bankruptcy Commission(1973) proposed that access to bankruptcy should be dependent on a debtor receiving counseling by the new administrative  agency which would administer the bankruptcy process. The Bankruptcy Reform Act 1978 contained no formal requirement for counselling. The US National Bankruptcy Commission in the late 1990s endorsed the introduction of counseling on a voluntary basis.

Canada pioneered in 1992 the legislative  introduction of two counseling sessions during bankruptcy for individual bankrupts (see here).  The objective was to prevent repeat bankruptcies and to further rehabilitative goals of behavior modification.  The Insolvency regulator (Office of Superintendent of Bankruptcy), debt counselling agencies and the Canadian Bankers Association supported its introduction.   In Canada the trustee (or their delegate) must now: (1) make a pre bankruptcy assessment outlining options including that of a consumer proposal (repayment of a portion of debt usually over three years), (2) provide an initial counseling session shortly after bankruptcy is declared entitled consumer and credit education and (3) a second session shortly before discharge which normally takes place nine months after the declaration of bankruptcy. Counselling is financed by a fee which comes out of the bankruptcy estate– $85 for each stage of counselling-usually made from income payments by bankrupt. Ninety percent of the sessions last under one hour. Counselling is  a condition for receiving a  discharge. The current Directive (OSB 1R3) defines it as ‘educating debtors on good financial management practices, including the prudent use of consumer credit and budgeting principles, developing successful strategies for achieving financial goals and overcoming financial setbacks and where appropriate making referrals to deal with non-budgetary causes of insolvency (ie gambling, addiction, marital and family problems)’.

Has the Canadian system of counselling achieved its objectives? It is difficult to measure this rigorously because one ideally  needs a  control group who go through  the process without counseling.  In early reviews  bankrupts generally were favourable in their assessments of counseling.  But does counselling change behavior or result in fewer repeat bankruptcies?  The only rigorous study of the Canadian system using a control group, conducted  by Saul Schwartz and published in the American Bankruptcy Law journal in 2003,  concluded that counseling did not lead to ‘any appreciable improvement in future creditworthiness’ and ‘has little effect on repeat bankruptcies in the first five years after an initial bankruptcy filing’. In Canada the overall repeat filing rate has increased from 10 percent in 2002 to 15 percent in 2011 and 16 percent in 2012.  Notwithstanding these data a recent evaluation  in 2013 by the Canadian Department of Industry argues that counselling has a positive impact because ‘debtors found the sessions useful’. The report  admits that ‘determining the effectiveness of mandatory counseling is challenging because it is difficult to disentangle the results of two counseling sessions from the broader changes that occur in a bankruptcy or insolvency’.  The study  suggests some short-term changes in understanding and behavior by debtors and notes that repeat bankrupts were slightly less likely to cite overuse of credit as a reason for bankruptcy. But the study is hardly a ringing endorsement for mandatory counselling for all bankrupts.

In the US the  2005 Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA)  introduced mandatory counselling  at the pre-bankruptcy stage as an eligibility condition for filing for bankruptcy and also  required bankrupts to undertake a financial education course during bankruptcy as a condition of receiving a discharge.   Pre-bankruptcy counselling is premised on the assumption that debtors turned too quickly to bankruptcy as a solution for their problems.  The Act is vague on the contents of the financial education course but the Federal US trustee has promulgated rules   which indicate that the course must include budget development, money management, wise use of credit (including distinguishing wants from needs), consumer protection, and coping with unexpected financial crisis. The financial education course must last a minimum of two hours  but may be completed in person, over the phone, or through the Internet.

Michael Sousa  in a recent article surveys existing  pre- and post- BAPCPA studies of voluntary counselling in bankruptcy.  He also  presents the results  of a qualitative study of  the effects of the BAPCPA counselling requirements.  Most debtors did not find the courses helpful. Pre-bankruptcy counseling was just ‘jumping through hoops’.  It did not have the consequences hoped for by Congress–where debtors rethought their decision and entered a debt management plan. Rather it either confirmed the correctness of  an individual’s decision  to file for bankruptcy  or helped to allay any fears about declaring bankruptcy.  Most debtors thought that a two-hour financial education course was not enough to provide long-term effects and in any event was  often inappropriate since many  individuals filed for bankruptcy because of  external economic changes unrelated to financial capability. Sousa concluded that the existing BAPCPA counselling requirements  are ‘by and large misguided and are in desperate need of overhaul and reform’.

Scotland  recently introduced counselling in the 2014  Bankruptcy and Debt Advice (Scotland) Act which Act will, according to the relevant Minister, Fergus Ewing,  deliver ‘the most significant change to the bankruptcy process in Scotland for a generation and take us closer to making the financial health service a reality’ (more on this claim in a subsequent blog).  Individuals must consult a money advisor before obtaining access to any  statutory debt relief. The policy objective is that of ensuring that individuals are aware of all debt relief options, although I suspect that it is partly motivated by the objective of ensuring that individuals do not enter too easily into writing down debt rather than the statutory Debt Arrangement Scheme which will generally require full repayment (again more about this on a further blog).   Financial education during bankruptcy is not mandatory for all debtors.  Only repeat bankrupts within the previous 5 years,  or debtors subject to  a bankruptcy restriction order made against them must undertake a course.  In other cases a trustee may refer a debtor to a financial education course where  ‘the trustee considers that the pattern of behavior is such that the debtor would benefit from a financial education course or the debtor agrees to undertake a financial education course.’  The Scottish legislation recognises that counselling is not necessary for all debtors. This suggests that legislators do learn something from comparative experience, since they seemed to be  aware of the criticisms of the US provisions.

England and Wales rejected  counselling in the 2002 reforms primarily because most groups consulted opposed its introduction. Debtors may therefore experience a variety of advice before and during insolvency,  depending on whether they seek advice in the public sector through Citizens Advice Bureaux,  non-profit debt counselling such as Step Change, or a private intermediary.

The UK is sometimes contrasted with continental Europe where it is assumed that a more ‘social’ approach exists to counselling debtors. But this is not the case. Counselling is not an integral part of the French process. Although debt counsellors play a central role in Germany, the large demand for their services means that they function more as processors rather than being able to provide substantial financial counselling. In Sweden, a recent official report was very critical of the standards of debt counselling which are operated by municipalities.

Debt counselling in bankruptcy is a programme which in the abstract can attract a broad support.  It is a policy around which a coalition of creditor, consumer and debt counselling interests can agree, and for regulators it gives a sense of purpose to the bankruptcy system–so the Scots view it as  part of a  ‘financial health system’. It is likely therefore to continue to be attractive but experience suggests an unwillingness by governments to invest significant resources in the project.

The credit counselling requirements are often  based on the assumption that bankruptcy is a consequence of imprudent or unwise use of credit or the need for individuals to adapt their credit behaviour to more desirable norms. But this is clearly not the case for many debtors who are subject to adverse changes of circumstances, unforeseen health costs or small business failures.

 

 

 

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