Home » Uncategorized » Issues in personal insolvency reform I

Issues in personal insolvency reform I

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Iain Ramsay

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

The Insolvency Service promises a review of the personal insolvency framework (see here).

It is almost twenty years since the New Labour reforms to bankruptcy in the Enterprise Act 2002 which reduced the bankruptcy discharge period to one year and over ten years since the introduction of the Debt Relief Order, intended to provide access to debt relief and financial inclusion for individuals with modest assets and income unable to pay for bankruptcy. An initial question as a preliminary to reform is whether these reforms achieved their objectives.

New Labour swept insolvency reform into its flagship Enterprise Bill of 2002, with the argument that a liberalized discharge procedure would assist in promoting entrerpreneurialism. It reflected partly Peter Mandelson’s attraction to the US ideology that ‘if people do not have one or two failures under their belt…they are hardly regarded as serious entrepreneurs’. This New Labour initiative was in some respects a continuation of Conservative ideas of the centrality of markets and entrepreneurialism to ensure prosperity. It does not seem to have been motivated by concerns about consumer protection and the government seemed to overlook the fact that by 2002 sixty per cent of bankruptcy were consumers not small businesses and that liberalisation was more likely to benefit consumers.

Did the Enterprise Act provisions in fact encourage entrepreneurial risk taking? An evaluation by the Insolvency Service in 2007 concluded that it had neither affected the level of business start ups nor the fear of failure (see here). It is not easy to assess the relationship between bankruptcy and entrepreneurialism. One econometric study suggests a correlation between the severity of the bankruptcy discharge and entrepreneurialism, supporting the idea that a more lenient discharge would promote entrepreneurialism . This study used self-employment as a proxy for entrepreneurialism (see here). However the study did not comment on the quality or innovative nature of this self-employment. Another study in the US found no connection between insolvency and innovative entrepreneurship.

The Insolvency Service evaluation found also that the prompt rehabilitation of bankrupts was hindered by credit reference policies of maintaining a bankruptcy on record on six years. Moreover the objective of distinguishing ‘culpable’ bankrupts from ‘innocent’ bankrupts, represented by the Bankruptcy Restriction Order regime was undercut by lenders using credit granting criteria which often did not follow the legislative distinctions. Further, the stigma associated with bankruptcy had not reduced.

These findings indicate a gap between legislative intentions and market practices in credit granting.

The Debt Relief Order, only available through approved intermediaries, was intended to simplify debt relief and reduce costs for debtors through the £90 fee. However, its actual implementation has resulted in a screening process arguably more stringent than bankruptcy, the costs of which are borne by Debt Advice agencies, yet the Insolvency Service makes a profit on DROs (see here).

No contemporary empirical studies exist concerning whether individuals in fact receive a fresh start from the DRO or the longitudinal effects of Debt Relief Orders. While groups such as Citizens Advice provide valuable policy information based on their experiences with clients, it is limited to the individuals who have used their services and does not usually include a significant longitudinal element.

One small scale longitudinal study of individuals who had obtained debt advice in 2007 and 2001 does pose some hard questions about the role of bankruptcy in providing a fresh start (see here). It concluded that at the end of the project in 2015 just over one third of individuals described themselves as ‘debt free’ (i.e. no debts for which they were being pursued by creditors), half described themselves as ‘managing’ their debt and a small number saw little possibility of moving out of debt. Those who were debt free did so either through bankruptcy, inheritance or increased income with a very small proportion doing so through saving and cutting back. The authors concluded that bankruptcy represented ‘a breathing space’ for some but for others was simply a ‘temporary respite in a longer story of indebtedness’. Bankruptcy was a temporary change in long term problems where income does not meet outgoings. The authors conclude that debt advice and financial literacy were of some value, but greater priority should be given to addressing structural problems of low wages, and limited social security and health. They also suggested that insufficient attention was currently given to understanding the trajectory of debt careers rather than writers merely providing a static picture of overindebtedness and its causes

While this was a small scale qualitative study, it underlines the need for systematic empirical analysis of bankruptcy and the differing characteristics of individuals using the process, their route into and out of bankruptcy or a Debt Relief Order. No such contemporary study exists in England and Wales, comparing unfavourably with for example the Consumer Bankruptcy Project in the US. (see e.g. here)

The Insolvency Service do not seem to have reliable data on basic questions such as the breakdown of assets and liabilities in individual bankruptcies. Nor does there seem to be reliable evidence on the breakdown of different types of creditors. Advice agencies claim that since the onset of austerity public creditors, such as Councils, have become more aggressive than commercial creditors. It would be useful to have evidence of the extent of the role of public creditors in bankruptcies. The Insolvency Service during the early 2000s was attentive to the need for empirical studies but currently, little systematic data exists, and one can only retrieve meaningful information through the slow Freedom of Information approach.

Perhaps the reform process will provide the relevant data through the evidence of the various interest groups such as Debt Advice Agencies?

Groups such as Citizens Advice undoubtedly play a valuable role in providing policy information in this area, almost acting like a ‘shadow state’, through collection of data from its experiences with clients. It is however limited to the individuals who have used the service and does not usually include a significant longitudinal element.

Policy making in this area of personal insolvency indeed seems to resemble what political scientists describe as a ‘policy community’ approach. By policy community I mean something akin to a village where most residents, although they do not share the values of their neighbours know that they have to live together and where outsiders and strangers may cause disruption to these relationships. Policy is driven by a search for consensus and civil servant policymakers often claim that the outcome “balances” the interests of debtor and creditor and will therefore be accepted by all relevant parties.

The advantages of this approach to policymaking are that it provides legitimacy through achieving a community consensus and allows generalist civil servants to draw on expert knowledge. The potential disadvantages are that it may permit a hospitable forum for private influence in ‘low visibility’ policy making and may result in a failure to consider innovative solutions.


1 Comment

  1. James says:

    Thanks Iain for your insightful article. It would be great to have more research in this key area.

    Having worked in debt advice for many years, I think there are some practical issues that present significant barriers to the positive suggestions you make.

    With regards to ‘prompt rehabilitation’ of people who have gone insolvent, practically, for most people, they cannot regain their pre-insolvent status and opportunities. Practically they will be asked if they have been made insolvent previously at any point in their lives. That question will not differentiate between the causes, the culpability, the severity or even the decade in which it occurred.

    A positive answer to that question will, most likely, mean a life-long exclusion from: credit at more affordable rates, the amount of credit the individual can take out, certain career opportunities, the cheaper rates for most types of insurance, potentially even exclusion from many private rental properties.

    In practice, insolvency is a life sentence to paying additional premiums and restricted access to products and services.

    Another research void we have is on how many thousands of pounds extra people who have been made insolvent need to pay over their life times, and how many opportunities for loans, mortgages, insurances and rentals they miss because of the black mark on their lives.

    Lastly, as I’m sure you are aware, there is a real lack of research funding in this area. Debt advice organisations are oversubscribed and often struggling to fund advice provision, let alone research projects. The ‘shadow state’ approach is one of necessity, not design. If more funding was available for research, advice agencies would be able to invest time into more thoroughly exploring the poignant questions you raise.

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