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Consumer protection and Responsible Lending in Bankruptcy

      Bankruptcy is a form of consumer protection, providing individuals with the opportunity to write down debt and receive a fresh start. Given the difficulties lower income consumers may face in asserting their rights through individual consumer redress mechanisms, bankruptcy may also be viewed as a substitute for the limitations of these mechanisms. While bankruptcy may be an overinclusive remedy, permitting an individual to write down all unsecured debt, it can provide a type of aggregate rough justice which balances out the interests of creditor and debtor.

       Insufficient attention has been paid to bankruptcy as a site of consumer protection. Since the 2008 financial crash, many jurisdictions have introduced responsible lending provisions and indeed it may be described as a nascent international principle of consumer credit law. Bankruptcy could be one site for raising issues of responsible lending. This is not a novel suggestion since s343 of the Insolvency Act 1986  permits  a trustee to apply to court to have a credit transaction entered into by the debtor set aside if it is extortionate. This provision is similar to the original extortionate bargain provision in the Consumer Credit Act 1974. Earlier Bankruptcy Acts had also contained limits on interest chargeable on creditors claims to prevent rapacious moneylenders taking the bulk of an estate,  an issue highlighted by the Select Committee on Moneylending in 1890. It concluded that claims of other creditors, other than moneylenders were often swamped by the claims of the moneylender (see here at ix). The Cork Committee in 1982 proposed that the court should continue to have the power to set aside an extortionate credit  transaction in bankruptcy but the provision, like the similar provision in the Consumer Credit Act 1974, seems to have had little effect in practice given its vagueness and high burden of proof. Thus the unfair credit relationship provision replaced the extortionate credit bargain provision in the 2006 reforms to the Consumer Credit Act 1974.

         Under current practice the Insolvency Service may investigate the conduct of the debtor and there is always the possibility of a Bankruptcy Restriction Order or Undertaking if an individual has for example run up debts irresponsibly  in the period preceding bankruptcy. A balancing provision could be introduced requiring the Insolvency Service to check for irresponsible lending and any contraventions of consumer protection and debt collection regulation. This would not require the Service to engage in fishing expeditions, but provided some sanctions (such as disallowance of a claim in contravention of consumer protection rules) existed this might be a modest contribution to achieving the goals of responsible lending, one of the objectives of personal insolvency identified by the World Bank (see here at 31). In this context the most recent US proposal for bankruptcy reform include provisions which would disallow the claims of creditors who  violate Federal Financial consumer protection rules and permit the Consumer Financial Protection Bureau to appear in any bankruptcy case to enforce unfair and deceptive practices law as well as acting a  Consumer Ombuds (see here and here) .  

         The Insolvency Service would be unlikely to willingly adopt such a role, but it could clearly be justified in terms of its role as an impartial actor who has an interest in ensuring that irresponsible lending or contraventions of credit rules do not occur. In fact the Service is unlikely to have the resources or competence to undertake such a role. Katharina Möser has shown how the interests of the Policy Unit in London, striving to be a key player in high level policy debates, was content to pursue a strategy which dismantled much of its front line  functions during the austerity following the financial crash in 2008 (see here). The Service  is unlikely to support  any new regulatory functions, which suggests that the implementation of responsible lending in bankruptcy administration should be a significant topic in any review.

Breathing Spaces and Early Intervention: Some Issues

The government has now published draft regulations for a ‘breathing space’ for individuals with problem debt in England and Wales (see here). The breathing space of 60 days, to be accessed through FCA regulated debt advisors, will protect an individual against creditor action and  permit  a debtor to consider possible debt solutions.

A central policy objective is to incentivize individuals to seek professional debt advice at an earlier stage than at present (see explanatory memorandum para 7.2  here) preventing individuals sinking into a morass of debt. A major proponent of the breathing space, the debt charity, Step Change Debt Charity, argues that the breathing space will fill an unmet need for those in temporary difficulties and those who do not need or want an insolvency solution. (see here).

Encouraging earlier recourse to debt advice agencies is an often repeated trope. It is an admirable aspiration, an example of the more general argument that early intervention may prevent more complex and escalating problems and reduce overall social costs. It assumes that individuals wait too long before seeking debt advice and only turn to advisors when a crisis occurs such as an enforcement agent calling.  But a counter argument is that  effective action may only take place when a crisis occurs. Early intervention may simply become an additional step in the process. In short we would probably want a clearer idea of an optimal point for intervention in order to determine what is “early” or “late”.

Early intervention will require that agencies reach out to potential clients. Those with significant debt problems may often be from disadvantaged groups and the reasons individuals may not seek third party advice include the potential shame of seeking debt  advice and its effects on their credit rating (an issue still under discussion with the credit reference agencies)  as well as possibly a belief that the law can do little to protect them. The Wyman review of debt advice cited evidence for the most common reasons that cause individuals to delay seeking advice , ,namely  that individuals  thought they could sort it out themselves, were too embarrassed or ashamed, or thought no-one could help (Wyman, 11 available here). Wyman concluded that it was uncertain how many individuals could be successfully encouraged to seek advice. Since the criteria for entry to a breathing space (reg 24 (4)”unable or unlikely to be able to repay some or all of their debt as it falls due” are not wildly different from those for a bankruptcy application by a debtor (“unable to pay his or her debts”) it may be difficult to ensure the effectiveness of early intervention.

The impact analysis for the regulations predicts an increase in debt advice of 1.3 million people over the next ten years (see Impact Analysis here) but admits to the difficulty of predicting the future take-up of debt advice. It also projects the highest benefits of the policy accruing in higher recoveries for creditors (Impact analysis para 13.1), followed by productivity benefits for employers, and reduced negative mental and physical health outcomes among debtors. The assumption seems to be that more individuals will enter into repayment arrangements with their creditors under the breathing space scheme, rather than spiral into bankruptcy. This fits with the arguments of Step Change above.

The original breathing space proposals were linked to debtors entering  a statutory debt repayment scheme, based on the Scottish model (see discussion here). The government has however delayed the implementation of this aspect perhaps because there is less consensus about the success of the Scottish statutory debt repayment scheme.

The introduction of the breathing space adds to the complexity of the existing English approaches to over-indebtedness (e.g. informal repayment plans, token payments, IVAs, DROs, Bankruptcy, Bankruptcy with an income repayment order). The manner of its implementation will depend significantly on the approaches  of the main debt advice providers.

Contract law, social force majeure and adjusting consumer credit contracts

The Coronavirus pandemic has spawned a raft of responses to address potential debt problems faced by businesses and individuals (see here).  For example, the most recent FCA initiative includes temporary payment freezes on mortgages and credit cards for up to three months with the further proviso that these measures should not adversely affect a consumer’s credit rating (see here).

These provisions have been layered onto existing FCA protections for individuals facing difficulties with repayment.  These include the general principle to treat customers fairly (here), provisions on forbearance in debt collection(here), and rules on addressing persistent credit card debt (here). Critics have suggested that firms have not embedded these policies consistently into their practice (see here). This is one reason for the  proposed statutory “breathing space” (see generally here and here)  for individuals with problem debt, which has been slowly working its way through the policy process.

I do not want in this blog to engage in a detailed analysis of these provisions. I want  rather to note the significance of these specific developments in relation to thinking about and the teaching of contract law, and in particular the approach of the law to changed circumstances affecting contract performance. This is ultimately of much practical importance.

English law students learn from standard textbooks in first year contract law that the courts are very reluctant to adjust the terms of contracts because of a change of circumstances.  “Mere” hardship or inconvenience will not permit adjustment. Students learn that a  contract will only be frustrated i.e. brought to an end, where without the default of either party,  performance has come to be radically different from that which was undertaken (see e.g. Davis Contractors Ltd v. Fareham Urban District Council [1956] AC 696). This proposition is supposedly given more authority by being  expressed in Latin… non haec in foedera veni (roughly translated as it was not this that I promised to do).

This approach reflects classical contract law where the assumption is that parties fix all the risks at the time of entering into the contract. Strict rules on adjustment create incentives on parties to plan at the outset, for example, by inserting a force majeure clause into the contract. A standard force majeure clause is that of the International Chamber of Commerce (ICC) which includes “the occurrence of an event or circumstance (“Force Majeure Event”) that prevents or impedes a party from performing one or more of its contractual obligations under the contract, if and to the extent that the party affected by the impediment (“the Affected Party”) proves: a) that such impediment is beyond its reasonable control; and b) that it could not reasonably have been foreseen at the time of the conclusion of the contract; and c) that the effects of the impediment could not reasonably have been avoided or overcome by the Affected Party.” A party successfully invoking this Clause is relieved from its duty to perform its obligations under the Contract and from any liability in damages or from any other contractual remedy for breach of contract, from the time at which the impediment causes inability to perform, provided that the notice thereof is given without delay (see here). If the impediment is temporary then the party obtains relief only during the temporary period.

Force majeure clauses may be common in many commercial projects and contracts. However lenders do not voluntarily provide such clauses in consumer loan contracts, not surprisingly, given the recognition that consumer credit contracts often represent standard form contracts of unequal bargaining power. The UK Supreme Court recognised this in 2014  in Plevin v. Paragon Personal Finance (see here) where Lord Sumption commented that ‘the great majority of relationships between commercial lenders and private borrowers are probably characterised by large differences of financial knowledge and expertise. It is an inherently unequal relationship’.

It follows from these propositions that events such as loss of employment  are not  treated as a defence to repaying one’s debts.

However,  the statutory development of the law such as the FCA rules above, envisage the potential adjustment of obligations in the event of a change of circumstances.

The introduction of a statutory breathing space confirms this conclusion. It draws inspiration from earlier provisions such as section 107 of the Tribunals, Courts and Enforcement Orders Act 2007 which introduced an Enforcement Restriction Order. This would have restricted enforcement  where an individual was unable to pay one or more of his debts, was suffering from a sudden and unforeseen deterioration in his financial circumstances and   there was a realistic prospect that the debtor’s financial circumstances would improve within the period of six months beginning when the order is made. Unfortunately the government did not bring  this provision into force  but it provided an inspiration for the lobbying by debt charities for the introduction of a statutory  breathing space. The 2007 provisions could themselves be traced back to the report of the  Cork Committee in 1982 (often regarded with great reverence by English insolvency lawyers)  which had recommended the introduction of an enforcement restriction order for such period and on such terms as the court may deem expedient (see para 310).

In addition, section 129 of the Consumer Credit Act 1974 permits a court to make a time order for repayment, if it appears to the court ‘ just to do so’, having regard to the means of the debtor as well as permitting the remedying of any breach by a debtor.  Undoubtedly the courts look at the circumstances of the loan, the  reasons for the default and the payment record of the debtor in making such an order. Such a discretion continues a historical approach of some lower courts which exercised discretion to protect lower income debtors from overreaching creditors.

Moreover, bankruptcy and insolvency law are in substance mandatory ground rules of contracts permitting an individual to discharge their obligations if they are an honest and unfortunate debtor. Tables 1 and 2  below outline the  importance of change of circumstances  such as loss of income, increased expenses and relationship breakdown, as reasons for debtors filing bankruptcy and Debt Relief Orders.

Taken together, all these factors support  a general  legal principle of social force majeure,  as a ground rule of consumer contract law,  with the consequence of a  temporary or more permanent adjustment of the contract.  Thomas Wilhelmsson outlined the idea of social force majeure in the early 90s (see here) as being when an individual is affected by unfortunate change of circumstances outside of her control which cause difficulties in repayment and the consumer is not at fault in causing this situation. To the extent that this may cause any increase in costs, creditors are in a better position to bear and spread these costs. In reality a temporary breathing space may be a method of more effective recovery in the long run rather than an aggressive enforcement policy.

Recognition of such a principle links contract law to one of the pillars of the welfare state,  namely protection against unexpected drops in  living standards caused by for example unemployment or illness. This principle could inject discussion of unemployment and social divisions into the world of contract  law doctrine and texts.  Rather than being viewed as an exception to the dominant idea of pacta sunt servanda (agreements must be observed) , social force majeure represents a counterprinciple in private contract law and not a topic relegated to an exception or to be discussed only in specialised consumer or welfare law courses.

 

Table 1: Debtor application bankruptcy by reason between Quarter 2 2014 and Q1 2018

         Source: Insolvency Service statistics https://www.gov.uk/government/statistics/ad-hoc-statistics-on-the-characteristics-of-people-applying-for-bankruptcy-in-england-and-wales-april-2014-to-march-2018

 

Reason for bankruptcy Number %
Living beyond means 8,280 16.9%
Relationship breakdown 7270 14.9
Reduction of bankrupt’s income 5720 11.7
Other 5040 10.3
Loss of bankrupt’s employment 4970 10.2
Loss/reduction of household income 4650 9.5
Illness/accident 4590 9.4
Loss of market 3120 6.4
Management failure 1310 2.7
Other reason given 2550 5.2

 

 

Table 2: Causes of Debt Relief Order: 2015

Business failure 180 0.74
Illness /Accident 5540 22.9
Increase in expense 2885  11.9
Living Beyond Means 3760 15.5
Loss of employment 2795 11.5
Relationship Breakdown 3430 14.8
Reduction in household income 8080 33.3
Other 1595 6.5
Unknown 225 0.9

N cases =24175, multiple causes cited in some cases. Source: Insolvency Service

 

The EU and Personal Insolvency: Entrepreneurs but not consumers

Much attention has focused on the recent EU Directive on Restructuring, aimed primarily  at facilitating  corporate restructuring. Less attention has been paid to the Directive’s provisions in relation to individual insolvents.  The Directive here only addresses individuals as entrepreneurs, defined as ‘a natural person exercising a trade, business, craft or profession’. The relevant provisions limit the period of discharge for ‘honest entrepreneurs’ to no longer than three years, whether or not the insolvency procedure requires a repayment plan. Discharge will be automatic without the necessity for an application to court. Professional disqualifications based on insolvency may not exceed the discharge period.  When personal and business debts are intertwined, they are to be dealt with in a consolidated procedure.

The provisions on entrepreneurs are driven by the Commission’s belief in the link between a ‘soft-landing’ in bankruptcy and the promotion of entrepreneurialism and innovative risk-taking, a link which also drove the liberalisation of the English bankruptcy discharge to one year in 2002.  I commented on this  in an earlier post on the draft EU proposals (here) when I raised questions about the connection between a liberal fresh start and entrepreneurialism based on studies  using self-employment as a proxy for entrepreneurialism (see here at 173-179).

The Commission’s recent Directive offers little  for consumer debtors. At a recent Finance Watch conference  which I attended, an official of the EU Commission hinted at the possibility of action on debt advice at the European level. Increasing awareness exists at the international level  of the importance of making  insolvency proceedings available for consumers and providing a swift fresh start. However, the EU Commission seems not to be following up on this issue at the European level, or realising the important role of personal insolvency as part of the ground rules of a consumer credit market.

Undoubtedly the issue of consumer insolvency may be more politically contentious with conservative jurisdictions such as Germany and Sweden likely to be opposed to a more generous fresh start for consumers. The exit of the UK, with its relatively swift fresh start,  from the EU, may paradoxically reduce the likelihood of further action on this topic by the EU in the near future.

Safety nets for casualties in the world economy of debt

Branko Milanovich in Global Inequality documents the winners and losers from the globalisation of economies since 1988.  Middle and lower income groups in the rich world  have stagnating incomes while countries  such as China and India have witnessed an increasing middle class. Both groups  have increasingly a shared characteristic: high household debt. The IMF has issued a warning about high world debt (here) and has developed a global debt database.  In countries of the North, the declining middle class use debt to hold on to their way of life in a period of stagnating wages, in emerging economies credit is part of the move to a consumer society.  The growth in inequality within rich countries also  means  that low income individuals make greater use of credit to get by, while low income consumers gain access to credit in emerging economies as part of a drive to financial inclusion.  Inevitably there are casualties who are overindebted.  Farmers in rural India struggle to repay micro-credit; those facing reduced circumstances  in the UK experience a spiral of debt through using credit cards to maintain a lifestyle. This global phenomenon of debt has spawned international proposals  to regulate credit and protect the casualties of the credit system.  The global financial crisis of 2008 spurred the international financial institutions into action as they  discovered consumer finance protection as one tool for fostering financial stability and promoting continued market expansion for credit. The 2017 World Bank’s guide to consumer finance protection now runs to over 200 pages.

A  global proliferation of individual bankruptcy laws has occurred to provide a safety net for the casualties of the credit system.  China, until recently one of the few jurisdictions not to have a consumer bankruptcy law which permits discharge of debts, is now considering reform in the context of rising household debt from 10 percent of GDP in 2006 to 45 percent in 2016 (see here). An increasing global phenomenon is that of the ‘low-income no-asset debtor’ or ‘no-income no-asset debtor’ who may be unable to pay for bankruptcy in those jurisdictions which require individuals to pay for access. In the early 2000s New Zealand floated the idea of a simple “No asset procedure”. English policymakers picked up the idea and the Debt Relief Order was enacted in 2007, a low-cost,  means tested, administrative procedure  accessible only with the assistance of approved debt advice agencies. Variations on this model exist  in Ireland and Scotland.

The IMF persuaded Cyprus to introduce a No-Asset procedure  in 2015 as part of its structural adjustment programme and  Kenya and India now have  No- Asset procedures. The details of these laws differ but  the rapid globalisation of the idea of the need for debt relief for low income individuals is striking.

Women dominate the use of the DRO in England and Wales: they may often be sole parents  who have been hardest hit by austerity.  The DRO is now the most common form of debt discharge in England,  outstripping  bankruptcy. Similar findings exist in relation to New Zealand’s no asset procedure. In the US reforms to bankruptcy law in 2005  substantially increased the costs of achieving a fresh start through bankruptcy and  several writers propose a more simplified procedure for individuals with few assets and little income.

The DRO provides an individual solution for the low income and overindebted, but we know little about its long term effects in providing a fresh start or merely a breathing space in a continuing struggle with debts.  A radical question is whether this individualised form of  relief draws attention away from structural problems of insufficient income and support and the ever present compulsion of credit to meet everyday needs. The introduction of a DRO procedure in India is of particular interest since it contrasts with the across-the-board  use of debt jubilees in that country. The Indian government, and the government of Uttar Pradesh  have both on different occasions  simply wiped out the debts of rural farmers (here). Croatia wrote off the debts of its poorest citizens in 2015 to provide them with a fresh start (here).  The Debt Jubilee campaign in the UK, championed by the actor Michael Sheen,  proposes a targeted debt jubilee for individuals trapped in  persistent debt, and the Financial Conduct Authority  has  raised the possibility  of credit card companies writing off persistent long term debt.

Johnna Montgomerie  in a recent monograph “Should we Abolish Household Debts?”  provides  a lively argument for a modern form of debt jubilee. Montgomerie outlines a  blueprint for debt cancellation, arguing that it would be an effective method of ending wider economic stagnation. The proposals  include a ‘household debt cancellation fund’ equal to half the amount given to the financial sector ten years ago.  This would fund long term refinancing for consumer and mortgage loans  commenced in 2009. It would also pool together old and onerous debt, including the cancellation of non-performing loans and those already written off by lenders. The jubilee would therefore target specific types of debt rather than debtors.

The premise of the proposal is that of a more balanced credit system. At present banks can create credit from nothing, a phenomenon recognised by the Bank of England. The state guarantees this system and steps in to rescue it through methods such as quantitative easing. Debtors meanwhile must continue to repay. Debt cancellation would balance the system.

Economists will undoubtedly worry about moral hazard and the impact on credit availability but we need to start an international conversation about  when it is legitimate not to repay debts (see e.g. here).

 

Debt Relief Orders and the Minimal Asset Procedure: What we know and do not know

As many readers know Scotland and England and Wales  have different insolvency  procedures for debtors with no or little income and few assets. The Debt Relief Order exists for this group in England and Wales,  and I have written about it on my blog here and also here.

The Scottish procedure, known as the Minimal Asset Procedure (MAP),  differs from the DRO  in access criteria (e.g. only once every ten years), has a lower debt ceiling (£17000 rather than £20000) and includes more complex discharge provisions. Thus an individual is discharged from debt after 6 months but is subject to the bankruptcy restrictions for a further 6 months.

The Scottish Accountant in Bankruptcy (similar to the Insolvency Service in England and Wales) recently commissioned an empirical study of MAP clients (here). A central focus of the study was  whether the existing fee of £90 was affordable or acted as a barrier to access. The study involved an online survey link sent  to over 2000 debtors at “various stages of the MAP bankruptcy process” with a follow up conversation with debtors who indicated a willingness to participate. The online survey had a response rate of 14%  and the study concluded 34 follow up interviews.

On the central policy question of the appropriateness of the fee the study found  that only 60 percent of debtors paid the fee in full themselves with 32 percent borrowing from a friend or family member. Almost 50 percent indicated that it was somewhat hard to find the fee.  In addition, the existence of the MAP does not seem to be well-known with 76 percent of debtors hearing about it initially from a debt advisor.

The study also provided  demographic data on debtors. Almost 50 percent of debtors lived in single person households, with 49 percent aged between 40-59. Sixty percent  of debtors have a physical or mental health condition or illness lasting or expected to last 12 months or more. The main reasons identified for debt becoming unmanageable were loss of income (50%), mental health issues (40%)  general overspending (31%), physical health problems (22%) and breakdown of a relationship (21%).

The fact that many individuals find it difficult to raise the funds for a MAP bankruptcy is concerning, but not surprising.  A study in Australia (here) indicates that when a fee of AUS$120 was introduced for individual bankruptcies, it discouraged individuals from applying.  Perhaps accepting that this is bad public policy when the overall social costs of overindebtedness are taken into account,  currently there is no fee payable in Australia if a bankruptcy produces no recovery. England and Wales rejected the idea of waiving bankruptcy fees for low income debtors and is wedded to cost-recovery as a principle for the Insolvency Service.

It is gratifying that the AIB attempted to gather empirical information on the issue of fees but the study raises further questions.

First, the study found that existing data collected on key questions such as the breakdown of debt owing are not reliable. Similarly, in England and Wales the Insolvency Service does not have reliable data on the breakdown of creditors in DROs so that it is not possible to chart the possibly changing nature over time  of creditors. Raw data which I obtained through an FOI indicate that the majority of debt is owed to financial institutions suggesting that although individuals on Debt Relief Orders are generally on low income they are still obtaining credit from financial institutions.

Second, many debtors only became aware of the MAP when they met a debt advisor, suggesting that greater publicity should be given to the process.

Third, approximately 25 percent of debtors in the study found the online application form not easy to complete, underlining the important role of money advisors who were regarded very positively by debtors in providing assistance with the process.

Fourth, most of those interviewed indicated the emotional and physical benefits of the MAP in providing relief, although some expressed uncertainty about the longer term impact on credit ratings. Again this was a finding of the review of the DRO in 2015 (here).  We do not know, however, whether the MAP provides a real fresh start for the debtor or is a band-aid in a continuing battle with debt. The only qualitative longitudinal study in the UK of this issue (here) suggests that even those debtors seeking a fresh start through bankruptcy, continue to face debt problems. Clearly further study of this important question is necessary for intelligent public policy making in this area.

Finally, the Scottish government might come up with a different name than MAP for the procedure. More individuals may be willing to undertake Debt Relief Orders in England and Wales because it is not called bankruptcy. It is also a more appealing name than Minimal Asset Procedure Bankruptcy. Indeed it is not clear why different procedures should exist in England and Wales and Scotland given the similar economic and social context.

 

 

 

 

The Debt Relief Order–Ten Years on

April 2019 marks the tenth anniversary of the implementation of the  English  Debt Relief Order, a low-cost (£90 fee), means-tested, administrative procedure only accessible online through approved intermediaries, which provides a discharge of most unsecured debts after one year.  The Insolvency Service view it as a success (see here) and some debt advice professionals share this view, one referring to the DRO as a ‘magic wand’ for those unable to pay for bankruptcy (Quarterly Account, Winter 2018-19, 39).

I have written elsewhere on the political background to the introduction of the DRO (see here) and its implementation (see here). Its development responded to pressures from groups such as Citizens Advice who argued that the costs of bankruptcy made it out of reach for many of the low-income clients whom they advised. The DRO is intended therefore to provide a fresh start and financial inclusion for individuals unable to afford the costs of bankruptcy and for whom bankruptcy would be a disproportionate remedy. The term Debt Relief Order rather than bankruptcy was adopted to reduce the stigma associated with bankruptcy, encouraging those in irretrievable distress to seek a remedy. The media  dubbed it ‘bankruptcy light’ and it is now used more frequently than bankruptcy. The relevant government departments (Ministry of Justice, Insolvency Service) rejected the alternative policy of waiving the significant bankruptcy fee (currently £550) for those unable to pay. The DRO was ‘sold’ to debt advice groups such as Citizens Advice as a cost-reduction measure: the filing of a DRO by a debt relief agency might permit agencies to close a file, rather than continuing to respond to creditors’ queries about the status of a debtor.

The government in its legislative impact analysis in 2006 predicted an uptake for the remedy of over 40,000 after two years (see here), but the numbers  have never come near to meeting this target, even with the increase in 2015 from a ceiling of  £15,000 to £20,000 of unsecured debt liabilities qualifying for access to a DRO.  Many reasons may account for this pattern but the Insolvency Service has not attempted to explain this discrepancy. In response to a  Freedom of Information request  the Service replied  that the forecast should not have been taken seriously as ‘any predictions of the level of DRO uptake would have suffered from how little relevant data was available’. This was certainly not how the forecast was presented in the original legislative impact analysis.

When the DRO was introduced, the government did promise a thorough evaluation of its impact and a preliminary report was issued in 2010, promising a more in-depth evaluation. In 2014, a review of the legislation was conducted through a call for evidence and consultation.  The government concluded  that ‘the DRO competent authority and intermediary model is working well and…DROs have a very significant impact on the wellbeing of debtors.’ Feedback from clients of the approved intermediaries  indicate that the DRO had the immediate effect of improving their mental and physical health, family relationships and reduced stress.  The Insolvency Service  conducted  a non-random monkey survey where some individuals using DROs  indicated that the DRO had improved their physical and mental health.  However, little evidence was provided  concerning the economic and financial long-term impact of a DRO and the ability of individuals to subsequently obtain credit. These findings suggested the need for more detailed inquiry into the longitudinal effect of a DRO, and a debtor’s journey into and out of the DRO.  No such systematic study currently exists. The only small longitudinal study of individuals receiving debt advice concluded that many individuals continued to face debt problems; even those filing for bankruptcy did not achieve a fresh start (see here )

Is it a lighter touch to bankruptcy–a form of “bankruptcy light”?  Yes, in terms of the price  paid by the debtor but  I have outlined (here) how bankruptcy may in fact be a less complex process than the DRO, that the significant costs of processing the DRO are borne primarily by the approved intermediaries, and an individual may be subject to as much scrutiny under a DRO as in bankruptcy.

A characteristic of the DRO is the “partnership” in its implementation between the Insolvency Service and debt advisors, the approved intermediaries to whom debtors must turn in order to access a DRO. This requirement substantially reduces the costs of the Insolvency Service in processing DROs and means that only a tiny proportion of applications are refused. This compares with New Zealand, (the source of inspiration for the English model)  which does not require the screening by approved intermediaries and  where a substantial number of individuals are initially refused access. The Debt Advice agencies in England and Wales who function as approved intermediaries do the heavy lifting in ensuring that an individual qualifies for a DRO. The £10 allocated to the agencies from the £90 fee certainly does not cover their costs.

A cynic might argue that  the DRO benefits primarily the Insolvency Service who have been able to outsource much of the work on the DRO to the approved debt advice agencies: the Service covers its costs of processing as required by the Treasury and the Ministry of Justice benefits by  some debt cases  being taken out of the courts, reducing their costs.

Analysis of the overall costs and benefits of Debt Relief Orders touches on several policy issues. First, it focuses on the needs of lower-income groups, so that we ought to understand how this procedure fits within existing social safety nets. Second, the availability of the DRO addresses access to justice concerns, namely that poor individuals should have equal access to debt relief compared with middle class individuals. This was a rationale for the introduction of the original ‘poor person’s bankruptcy’ in England and Wales, the administration order in 1883, to provide low-income individuals with access to debt relief as an alternative to imprisonment for debt. Yet  the administration order did not live up to its promise so the question is whether the DRO will suffer a similar fate and fail to meet its objectives of a fresh start and financial inclusion.

It is however difficult to carry out an objective study of the DRO since a key aspect would be interviewing over time a random sample of debtors in order to test whether the DRO provides a fresh start and financial inclusion.  Although all DROs are required to be recorded on the public insolvency register, accessing the register is by name, which creates substantial problems with sampling. Accessing individuals through debt advice agencies skews the sample since it will represent only those individuals using the particular agency. The Insolvency Service probably does not have the resources to conduct a comprehensive study of the DRO so that we have only partial accounts of its operation and success.

The absence of reliable studies of the DRO  becomes more worrying, given the proposals for the introduction of a breathing space, and a statutory debt repayment plan (see e.g. here). Their additions will add a further complexity to  the English system of debt relief. Finally, the DRO has been used  as an international model for several jurisdictions modernising their bankruptcy laws. Thus India has transplanted a ‘no asset’ procedure into its recently reformed Bankruptcy Act based closely on the English model.  South Africa has also proposed a similar scheme. Whether the DRO  will be successful in these  different contexts remains unknown. Systematic evidence based policy is thin in this area.

 

 

Insolvency Service identifies problems with “volume IVA” providers

Volume providers dominate the IVA market in England and Wales. The Insolvency Service published on 26th September, 2018  a review of the monitoring and regulation of insolvency practitioners by the Recognised Professional Bodies. This included the Service shadowing monitoring visits to volume providers. The findings are troubling. Issues identified included “poor quality advice being given to debtors, potentially leading them to enter an IVA when other debt solutions may be more appropriate”, lack of clarity on ‘the justification for some charging of expenses” and “financial products being potentially mis-sold to individuals who do enter an IVA”. Yet in the majority of these cases no regulatory action was taken, even though debtors were potentially in the wrong debt solution. The Service identified some cases where a debtor’s expenses were manipulated to deliver apparent surplus income over £50 so that an IVA could be agreed, and situations of steering of individuals to an IVA when bankruptcy would be the most appropriate option. Disbursements (for items such as “PPI investigation fees” and “File/Storage fees”) have increased substantially with  ‘limited evidence that many of the disbursements charged in volume operations are providing real value to either debtors or their creditors.”   The Service also questioned the value of “early exit loans” provided by some IVA firms. They are apparently sold on the basis that they will improve a debtor’s credit rating but ‘there does not appear to be any evidence that this is actually the case’.

These findings question the effectiveness of existing regulation of volume providers and  highlight concerns about the IVA market. I have raised these in earlier blogs (here and here ) and in my evidence to the Treasury Select Committee inquiry into household savings and debt (here). Other informed observers have also questioned (here) the steering of  individuals towards an  IVA  where a DRO or bankruptcy would be more appropriate.

Clearly it is time for a public review of the role of the IVA.

 

Is the Scottish Debt Arrangement Scheme (DAS) a Success?

The  Scottish government has once again trumpeted the success of its Debt Arrangement Scheme (DAS) in a press release earlier this week. The Minister for Business, Innovation and Energy, Paul Wheelhouse, states that it ‘is the only statutory debt management programme in the UK and we are rightly proud of its success in providing a viable option for those seeking to pay their debts without plunging into insolvency’.  Lord Wilf Stevenson,  chair of  Step Change Debt Charity  also lauds the Scottish scheme as an example of how things work better  in debt management North of the Border (see here) and the Treasury recently completed a consultation on the possible introduction of a similar scheme in England and Wales.

But what evidence exists to support these optimistic views on the Scottish scheme?

The Scottish Debt Arrangement Scheme (DAS) is a statutory debt management plan. Its benefits include a stay on individual enforcement action by creditors, the freezing of interest and penalty fees and the possibility of  a debtor retaining a home.  Plans can be imposed on creditors by the administrator (the AIB) if creditors do not consent, provided the plan is fair and reasonable.  Individuals make a single payment through a payments distributor (one of four private sector organisations awarded the contract by the government) who can charge a fee of 8 percent. An individual must consult an approved money advisor before commencing a DAS.  Both public and private advisers now act as intermediaries with  the  majority of applications  now handled by private advisors (dominated by a few specialists) who can charge a fee.  Debts can only be written off after 12 years, if seventy percent of outstanding debts have been paid. Data from 2012 indicate that they  last on average 6 years 8 months. Fifty-four percent of users are female with an average age of 44 a median level of debt of £12, 913, making an average monthly payment of £238.

The Scottish government highlights the benefits of the plans for creditors, claiming a 90 percent return rate.  However, this is  misleading since it assumes that all plans are completed. Data (see Table below ) which I obtained from the Scottish Accountant in Bankruptcy  suggest that at least 25-30 percent of files are revoked and the dominant reason for revocation is failure to pay when due.  Thus of the 3,939 cases commenced in 2012-13, 1139 had been revoked by 2017.  In addition, given the long time scale of these plans the amount recovered should be discounted and it is possible that some of these debts have already been written off by creditors and bought by debt buyers who will profit from any recovery.

These long term debt plans may be producing modest income for individual creditors but one must question whether it is socially beneficial to have individuals shackled to a repayment plan for so long.  The Scottish government is committed to the principle of ‘can pay should pay’ and Fergus Ewing (then the relevant Minister) celebrated the fact that many individuals were choosing the longer road of the DAS because it demonstrated that ‘most people want to pay off their debts when they can’ (at 25929) and that ‘bankruptcy should not be an easy option’ (same). However these comments neglect the growing international literature (see discussion here  and here ) on the  economic and social benefits of  bankruptcy providing a swift fresh start for debtors. There is a danger of increasing the already significant  social stigma associated with bankruptcy when there should be greater recognition of its value as a safety net in contemporary economies with high levels of household debt.

Individuals generally do want to repay their debts but many individuals who are in debt trouble suffer from continuing problems in terms of unstable employment. Long term debt problems have effects on the health of individuals. Behavioural studies suggest that individuals are often over-optimistic and will underestimate the difficulties of maintaining repayments over a long period.  Their credit rating will continue to be low after they complete the plan and is unlikely to be better than if they declared bankruptcy.

Unfortunately almost no systematic studies exist (see here)  of the experience of individuals who have succeeded or failed on DAS  (and ideally a control group who could have but did not choose to undertake a plan).   The 2012 study did suggest that there was a trend among young individuals to take out a DAS to repay smaller amounts of debt and a DAS could be useful for an individual caught up in high cost credit problems.  So the DAS may be useful for some debtors.  Or it may represent simply a benign state sanctioned collection agency and, given the long length of the repayments–almost a form of ‘debt peonage’.

But once again we encounter  the failure  by governments to develop good evidence based policy in the area of bankruptcy. The danger is that a form of DAS (with its “breathing space”)  is layered on to the unnecessarily complex system of personal insolvency alternatives in England and Wales without a reappraisal of the existing system.

 Scottish DAS Agreements: Closed, Live and Revoked 

           Closed               Live                                           revoked             Total
2005/06 10 0 3 13
2006/07 27 5 4 36
2007/08 124 81 48 253
2008/09 263 236 120 619
2009/10 377 492 228 1,097
2010/11 469 808 394 1,671
2011/12 900 1,242 800 2,942
2012/13 1,108 1,692 1,139 3,939
2013/14 819 2,104 1,546 4,469
2014/15 426 2,345 1,387 4,158
2015/16 64 1,531 447 2,042
2016/17 14 2,071 147 2,232
All cases 4,601 12,607 6,263 23,471

Source: Scottish Accountant in Bankruptcy.

 

 

 

The credit card “sweatbox” and stagnant wages: life in the UK

The ‘sweatbox’ model of credit card lending was set out in a well-known article by Ronald Mann in 2007 (here) . Credit card companies through the use of sophisticated data could make substantial profits from individuals who had difficulties in repaying or were financially distressed. Although certain of these accounts would be written off,  the overall profits  from the various fees and costs levied on individuals who are locked in to an existing lender and struggling to repay were substantial. This sweatbox model benefited from the 2005 reforms to US bankruptcy law which delayed the ability of individuals to file for bankruptcy, extending the time an individual was in the sweatbox of increased financial distress.

Recent studies by the Financial Conduct Authority suggests that the sweatbox model is alive and well in the UK (here and here).  The Authority highlighted two issues. First  a significant group of borrowers carry potentially problematic debt for a number of years with some making repeated minimum payments. Second, they identified a higher risk  group who move swiftly from acquiring a credit card into potentially problematic personal debt.  A  quarter of cards opened in 2013  in this market segment were in serious or severe arrears a year later.  Over 20 percent with serious arrears did not have an active card in 2012 suggesting a ‘rapid descent into arrears’.  The FCA noted in an understatement that these data raise  problems about  the affordability assessments which companies are required to undertake of potential customers. A product which results in a  failure rate of 25 percent would normally not be permitted on the market.

These findings on the use of credit cards must be set in the economic context of the UK with relatively stagnant real wages for many, insecure employment and currently the lowest savings level (3.3 percent) since 1963.  Many writers have underlined how loans may substitute for stagnant wages but that this cannot be a long term fix for the economy.

The FCA propose several behavioural remedies for consumers and earlier intervention by creditors to address persistent arrears. However the ability to write-off debt swiftly would provide a way out for debtors and complement other techniques such as responsible lending. Unfortunately the complexity of current debt write down procedures (IVAs, debt management programmes, bankruptcy, Debt Relief Orders) in England and Wales make this more difficult. A damning report by the FCA on the debt advice industry (here) indicates that advisors often did not give balanced information about insolvency alternatives.

Credit card use raise wider questions about the contemporary role of credit in the UK.  The governor of the Bank of England introduced a recent  financial stability report  with a concern about existing vulnerabilities from high and rising UK household indebtedness. On April 4 the Bank of England Financial Policy Committee noted the continuing rapid growth in consumer credit (here).  At the same time the  respected Institute for Fiscal Studies reports that based on the Autumn  2016 budget statement  real wages will, remarkably, still be below their 2008 levels in 2021. One cannot stress enough how dreadful that is – more than a decade  without real earnings growth. We have certainly not seen a period remotely like it in the last 70 years’

The Institute of Fiscal Studies concluded also that middle income families with children are no longer so different from the poor: almost half middle income families are now renters (home ownership in the UK has reduced from 72 % in 2007 to 64% in 2016 ) and middle income families with children get 30% of their income from benefits and tax credits. This means that credit use is likely to increase as middle to lower income earners use it as a defensive strategy to maintain living standards . Austerity also means individuals having difficulties with current commitments such as utilities and council tax, described by the Institute of Fiscal Studies as a tax ‘deliberately regressive in design’.

These conditions fuel the growth of sweatbox lending and the resulting household misery for some. Solutions may require action at micro- and macro- level. But there is no doubt that action is necessary.