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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.
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.
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
Source: Scottish Accountant in Bankruptcy.
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.
The Insolvency Service published (here) on 27th January further statistics on Individual Voluntary Arrangements.
The latest IVA statistics (here) indicate that 40 percent of IVAs commenced in 2007 were terminated (ie not completed). Although this reduced to 32% in 2009, ten percent of IVAs commenced that year are still ongoing.
A government programme with a failure rate close to 40 percent would result in parliamentary questions, an investigation by the government and possibly radical change. In a previous post I suggested further investigation was necessary of the role of Individual Voluntary Arrangements.
The Insolvency Service data also indicate that the IVA industry is now dominated by a few providers. Two firms have 50% of new IVAs in 2016 and ten firms over 80%.
We know little about whether these repayment plans are effective treatments for overindebtedness. Unfortunately there seems little interest in attempting to fill this gaping hole in empirical knowledge of the insolvency system. Policy making on IVAs is effectively privatised through low visibility committees (here) dominated by creditors and intermediaries. Perhaps the Financial Conduct Authority should take a greater interest.
In my forthcoming book (here) I describe English policymaking on personal insolvency since the 1980s as ‘drift, layering and conversion’. The consumer IVA represents the private conversion by enterprising accountants of a remedy designed for corporate directors and businesses to a mass-produced remedy for consumers. It is time that there was a proper appraisal of whether it serves the public interest. The government seems willing to review corporate insolvency(here) but demonstrates little interest in a comprehensive review of the byzantine personal insolvency law landscape in England and Wales.
This post is a video. Here at: https://www.youtube.com/watch?v=_sCAG3Cn0O0&index=24&list=PL_voamVqJ_ZyVoZdGh4ov5u1PseEJxwEX
One aspect of the memorandum of understanding between the EU and Greece in mid-August 2015 concerns reform of Greek household insolvency law with Greece being required to modify its existing law and administration.
Greece introduced a personal insolvency law in 2010. This included a mandatory pre-judicial settlement procedure and a repayment period of 4 years before a discharge. It also permitted under certain circumstances an individual to remain in her primary residence provided she repaid 80% of the value of the home over 20 years. The law was hardly a debtor’s charter and was based on the defective German personal insolvency law (see e.g. criticisms by Backert et al here) .
It was predictable therefore that the Greek law would face initial problems in implementation. The pre-judicial settlement phase rarely resulted in an agreement. Consumer groups attributed this to the intransigence of the banks but it is also possible that limited specialist advice existed for consumers and no guidelines existed for negotiations. Courts were ill equipped to address bankruptcy issues, free legal advice was not available and the courts became overloaded. Individuals might have to wait years–even in extreme cases until 2024!– for a hearing. These failures on a smaller scale were experienced by France and Germany when they initially introduced individual insolvency laws without thinking through the proper infrastructure for administering large numbers of cases of individuals with few assets.
Greece also introduced in substance a moratorium on foreclosures of primary residences under a certain value.
In face of increasing levels of non-performing loans (not surprising in the light of the austerity measures) the IMF concluded in 2012 that the Greek law was a failure. They claimed that the blanket protection of the moratorium resulted in ‘strategic default’ and moral hazard. Greece duly agreed to change its law, substituting targeted relief for ‘vulnerable debtors’ so as to minimize moral hazard and modernize the Act in line with ‘best practices in the EU’. When the Syriza government was elected it proposed to reintroduce the moratorium while at the same time pursuing strategic defaulters.
The agreement of August 2015 imposes a battery of reform obligations on Greece with a demanding timetable. The obligations include: establishing a stricter screening process to deter ‘strategic defaulters’, tightening the eligibility criteria for protection of the primary residence, introducing measures to address the backlog of cases, short form procedures for debtors with no income or assets, developing specialised court chambers for individual and corporate insolvency and training additional judges, establishing a regulated insolvency profession in line with ‘good cross-country experience’, reactivating the government council of private debt, amending the out of court procedure to encourage debtors to participate while ensuring fairness among creditors. Debt to public agencies will now be dischargeable and the discharge period for entrepreneurs reduced to three years in line with the EU recommendation of 2014. This process of reform will draw on ‘independent expertise’, external consultants and ‘cross country experience’. Greece commits to review the process of reform by mid 2016.
The policies are a mixture of potentially progressive ideas and less well thought out reforms. The introduction of a swift no-income-no-assets procedure and the inclusion of public creditors in the discharge are welcome. Stricter screening criteria are likely to be problematic in implementation and deter those in genuine need. It is not a simple matter to distinguish ‘strategic’ from ‘good faith debtors’. Such measures taken in a crisis may not be dismantled after the crisis, having a long-term detrimental impact on access to insolvency.
This imposition of reforms by the EU raises concerns (for a trenchant critique of the provisions see Yanis Varoufakis here) . Technocratic knowledge substitutes for democratic decision-making. One might feel less unhappy if the technical expertise was based on sound empirical studies and well-tested theories of insolvency administration. However, data were never presented on the level of ‘strategic defaulting’ taking place or the extent of ‘moral hazard’ in Greece. Increases in non-performing loans do not necessarily equate with large increases in strategic default. The abstract economic categories of strategic behaviour and moral hazard may not be helpful for understanding the situation of a country in crisis. I do not doubt that some strategic default existed but the Troika and IMF never provided data on its extent. Given the absence of a ‘scientific’ basis for the EU requirements what is the source of legitimacy for the insolvency norms being imposed? Unlike business insolvency where the UNCITRAL guidelines are used to measure a country’s insolvency law, no international standards exist for individual insolvency. The IMF recognised this fact in 2013. Yet by 2015 the EU is appealing to ‘best practices’ and ‘cross-country experience’ (without identifying countries or why they represent best practice) in justifying its imposition on Greece of particular insolvency norms. In truth, given the absence of international norms, the IMF in their work on personal insolvency reform in Europe have been ‘making it up’ as they go, with changing scripts depending on the ability of the country to resist IMF pressure. It is unlikely that Greece will be able to meet the demanding time line for introducing insolvency reforms, such as the creation of an effective infrastructure of courts. Creating a well-functioning bankruptcy infrastructure is not a short-term task. It is as if Greece has been set up to fail.