International reviews of the efficacy of insolvency regimes are united in their assessment of three constituents elements; its purpose, how foreseeable the outcome will be, and how transparent are the constituent parts.
The provisions of the draft Insolvency Bill (“the Bill”) are confused having
regard to all three foundations.
1. The purpose of the mechanism
Despite recent changes, the Irish attitude to bankruptcy as reflected in our legislation is extraordinary, and is almost certainly the most punitive in the modern world. Up to 12 months ago it was possible to be a bankrupt for life, and as a result not participate in any way in society.
Rather than reflect a vituperative streak in our society, there are built in checks and balances where a creditor has to underwrite the very substantial costs associated with having someone adjudicated and the costs of administering the bankruptcy, together with the very limited benefits that arise. It is a mechanism that is very rarely used indeed. In other words, it does not carry out any useful function.
Internationally there is a “carrot and stick” function of bankruptcy generally; from the creditor’s point of view a stick to encourage debtors to behave in a responsible manner so as to avoid a very undesirable outcome where the debtor loses everything, and from the debtor’s point of view, a carrot to encourage creditors to be pragmatic when assessing the amount of money they are likely to receive over a period of time a debtor can pay them.
Provision for the somewhat liberal bankruptcy process in the UK was made in the appropriately named Enterprise Act 2002 where the term lasts 12 months and sometimes less. There, it is clear that the objective of the process is to enable the debtor draw a line under their financial problems and start again.
In Ireland it appears that the objective is to punish the debtor for getting into financial trouble and to ensure that they are out of the game and so not able to get into financial trouble again for a very long time. Indeed, while the provisions of the draft Personal Insolvency Bill reduce the period of bankruptcy to three years, they provide that once the debtor recovers from that seismic event, they are accountable for their income to their creditors for a further period of five years, thus rendering the process eight years long. Even in frugal Germany the term of bankruptcy is seven years.
If the Oireachtas identified what were its objectives for the Bill then we could see whether it was likely to be successful. Unfortunately they have given us no such insight which in turn leaves us with no indicators as to what is intended to be accomplished with the amendment of the law. Of course without setting out objectives, they cannot be criticized where those objectives are not achieved.
2. Structural difficulties with the provisions of the Bill
For any insolvency process to be credible the outcome must be foreseeable and the process must be transparent. When this is not the case, the resolution of its constituent elements (for example, the treatment of secured debt) and the consequent costs associated with its administration, undermine the process.
a. Foreseeable
While the process of examination is sometimes criticized, having acted for the examiner in almost 100 examinership cases (with an 86% success rate), the likely outcome for the stakeholders of a company in examination usually becomes apparent very quickly, within minutes of hearing about the circumstances of the company and the particulars in a Statement of Affairs.
The success rate is significant because it is so far above the average (of 52%) that it demonstrates two things; firstly only companies for whom the outcome is likely to be successful should seek protection, and secondly, that we can demonstrate that the appropriate treatment will normally yield a successful outcome. The same tests can be applied to individuals and bankruptcy.
The reason for the successful outcomes are that the Companies Acts and case law set out the competing rights, entitlements and interests of stakeholders so that the examiner can evaluate their particular circumstances and put a structure around his scheme of arrangement (“the Scheme”) so that no party can claim that their treatment in the Scheme is unfair as opposed to
other creditors of the company.
While the shape of the draft Personal Insolvency Bill is understandable (albeit in our view unnecessarily complicated) its provisions (most particularly as they relate to secured debt) allow a myriad of ways in which a bank may treat unsecured debt. Of course these options are already available to secured lenders to undertake voluntarily. In the absence of a way to dictate
the framework of lender’s engagement, the much heralded advantages of this process may well come to nought.
While we have ideas regarding mechanisms that would work in terms of an insolvency process, we are not advocating any because the impact on the secured creditors and arrangements they may have regarding their own distressed debt positions. Because of arrangement they have put in place, one arrangement may work with one lender, but be completely unsuitable to another.
There needs to be a process (or a series of clearly differentiated processes) relating to debtor circumstances which are consistent and are clearly identified to the PIT to enable them put proposals to secured creditors that will be positively received. If this protocol was implemented the reality is that no amendment to Personal Insolvency legislation is required because the
Arranging Creditor provisions of the current Bankruptcy Act 1988 could be used to resolve many of the issues regarding problem debt with the attendant savings of the costs that otherwise will be incurred by PITs.
The reality is however, that we are beyond amending what we have. Working from the end of the process to the start, this week’s report A Minimum Income Standard for Ireland, carried out by the Policy Institute at Trinity College in conjunction with the Vincentian Partnership for Social Justice is instructive in setting out the non-housing, childcare and secondary benefits sums required for people having different circumstances to “participate in a meaningful way in society” (the phrase used in the Law Reform Commission’s report of December 2010).
Where an agreed matrix for calculating debtor’s minimum requirements is in place, the amount thus available for distribution from the debtor’s income to creditors is clear and the process becomes both more transparent and the outcome more foreseeable. Setting this as the backstop position for the debtor deals with the one of the “moving parts” of Head 132 of the draft Bill that
require clarification prior to the enactment of the Bill.
b. Transparent
As it is envisaged, because of the lack of clarity regarding appropriate ways to treat all types of debt (particularly secured debt given the proportion and amount of personal debt that it typically constitutes), the approach to Personal Insolvency Arrangements is opaque and thus the process is undermined. With the absence of clarity regarding the banks’ internal treatment of problem
debt, many questions arise, including;
a. What criteria are secured creditors going to use to evaluate proposals put by the Personal
Insolvency Trustee (PIT)?
b. What is informing these criteria?
c. How are secured creditors going to approach their treatment of debt that PIT’s require to be written down as part of the resolution of an individual’s problem debt?
d. Are PITs going to be given criteria that each bank will apply to evaluate any proposal put to them by the PIT?
e. How do PIT’s avoid a lending institution applying arbitrary criteria (for example, resolutions executives applying performance criteria to exclude proposals which otherwise would
qualify)?
If the treatment of one debtor differs from that of another, of course that will give rise not only to an allegation of favouritism, but will also discourage the prejudiced debtor from participating with the process thus undermining it. The question of the transparency of the process where the
debtor’s position is considered is fundamental to the process.
c. Costs
The less straightforward the process of establishing either the foreseeability of the insolvency process and also the less transparent it is, the more complicated the outcome will be and the more time the PIT will need to spend on it. This will have a consequent increase in the costs of the administration of the process.
If those costs are expressed as a percentage of the amount owed, the outcome to the secured creditors (taking them to be the largest creditors), will be dramatically compromised. The more transparent and foreseeable the outcome, the less time will be required and thus the less the PIT can justify charging relative to outcome, but in terms of fixed rates which will certainly result in a better outcome for the creditor.
3. Technical anomalies with the terms of the Bill
a. Thresholds
The thresholds which govern the reliefs available to the debtor are too low. A straw poll carried out of insolvency practitioners illustrates that debt problems are more acute than anticipated when the heads of the Bill were drafted, and that the extent and size of personal debt is in fact dramatically more than provision has been made in the Heads.
The consensus is that under-provision has been made for the threshold at which the value of outstanding debt applies across the three steps that are anticipated; the Debt Relief Certificates, The Debt Settlement Arrangement (DSA) and the Personal Insolvency Arrangement (PIT).
We are not qualified to comment on thresholds applicable to regarding Debt Relief Certificates. However, the level of debt of €3m applicable to DSA and PIA is arbitrary. It excludes from participation guarantors of significant company debt, and investors in syndicated loans (which is an investment structure typical of the past few years) who unwittingly may have given joint
and several guarantees for other’s liabilities.
In the event that creditors are prepared to agree to the treatment of the debt in a particular way there is no reason to apply an arbitrary cap on the size of the individual’s liabilities so as to exclude them from participation in the process. Indeed the larger the debt the less likely the lending institution is going to recover in full, and may be more inclined to resolve problem debt
using the insolvency processes provided for.
b. Debt settlement arrangement as an act of bankruptcy
Whereas provision for a DSA is an act of bankruptcy which exposes the unsuccessful debtor to a third party petition, the same does not apply to the arguably more onerous process of submitting to a PIA.
c. Judgement creditors
A creditor who obtains judgement against a debtor and registers that judgement as a mortgage against an asset benefits from the protections afforded to secured creditors irrespective of any equity in the asset over which the judgment mortgage has been secured.
At the very outset, this process is wide open to abuse by consent judgements being obtained to frustrate the interests of otherwise unsecured creditors. Any abuse of this process will compromise the secured lender’s ability to implement a strategy to recover distressed debt using the provisions of this Bill.
Furthermore it will encourage litigation because of the significance of getting and securing judgement orders. In itself we see this as fundamentally undermining the entire process because of the elevated status of secured creditors and their control of the insolvency Process beyond their entitlement to security based on the value of the asset.
From an avoidance point of view it will encourage structures whereby assets are held in trusts which will be beyond the reach of any creditor. Judgment creditor’s interests must be limited to the value of the equity available to them in the property over which the judgement has been secured. Where a judgement creditor’s interests is limited to the value of the equity remaining
in a property then it is clear that there will be an inconsistency with the treatment of a secured creditor where there loan is otherwise unsecured against equity.
d. Treatment of preferential creditors
The position of the Revenue Commissioners as guardians of the public purse, and citizen’s obligations to pay taxes has long been a feature of the treatment of insolvency and we have no desire to compromise either.
The absolute obligation on a debtor seeking a DSA or a PIT to discharge all preferential debt in full however, is destined to lead to the exclusion of the sole trader with revenue liabilities from the insolvency process as it is currently envisaged. This does not assist either the debtor nor their creditors (nor ironically the Revenue) to maximise their recovery in the process.
In our experience as insolvency practitioners, there are no willing participants in any insolvency process such as this. Taking part in one involves worry, uncertainty, a reduced standard of living, and loss of control of their future to another person (the PIT) whose objectives are not aligned to the debtor’s.
Where the debtor has traded on the account of the revenue (as very commonly occurs, particularly with self-employed PAYE, PRSI, VAT or income tax liabilities), the requirement that this be repaid in full (which in turn limits the availability of funds available to other creditors thus fettering the ability of the debtor to agree other compromises and dramatically reduces the dividend available to any unsecured creditor), this requirement will inevitably result in the failure of the insolvency process.
e. Review of the PIA process
The review of the operation of the PIA after 10 years is simply too long. Given the far reaching nature of this legislation and its likely societal impact, a far more restricted review timeline will need to be implemented.
In our view the reliefs available in the bill will be widely utilised given the pent up demand for its provisions. Thereafter, and as the economy emerges from recession and amendments are made to the accepted way to treat secured creditors, it is likely that secured creditors will need to see the
integrity of their security revisited.
Monitoring and reviewing PIT’s disclosures and returns to the Insolvency Service will enable real time information regarding the performance of the process and will allow for contemporaneous evaluation of the behaviour of all parties, including PIT’s, secured creditors and debtors. Rigorous oversight of this data emerging by representatives of the stakeholders to the process (including the Insolvency Service, debtors representatives, unsecured creditors, secured creditors, Revenue and PITs) will ensure that the system functions in a manner which is appropriate for a 21st century insolvency process.
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