Personal Insolvency – the urgent need for change

The Insolvency Service issued a Call For Evidence (CfE) in July 2022, asking a wide range of questions about personal insolvency in England and Wales:

The purpose of this document is to seek evidence that will help inform the Government on whether the current personal insolvency framework is still fit for purpose and, if not, what reforms are needed.

The CfE started by saying:

What should be the fundamental purpose of the personal insolvency framework? Does the current framework meet that purpose?

I agree with the CfE when it said:

The personal insolvency framework is intended to provide a robust regime which gives a fresh start to debtors and prevents future insolvency. It seeks to strike a balance between the interests of debtors and creditors and to ensure that those who can pay, will pay. 

but too often this is not happening in practice. I think major changes are needed for all three forms of personal insolvency – Debt Relief Orders (DROs), bankruptcy and Individual Voluntary Arrangements (IVAs):

• there are important barriers that prevent DROs and bankruptcy being available to many people;
• IVA mis-selling is widespread and people in an IVA can be treated very poorly;
• there is no insolvency option available in practice for many people;
• IVAs lack the flexibility to cope with changes in people’s circumstances so large numbers fail – over a third. This lack of flexibility also applies to DROs where it is a much smaller problem, less than 1% of DROs fail.

The rest of this article gives my responses to some of the CfE questions. (Some I had no opinion on and some I simply referred to my response to other questions.)

Q2 If ‘fresh start’ and ‘can pay, will pay’ are the right objectives for the personal insolvency regime, does the current framework get the balance right?

No, it is pretty disastrously wrong for too many people for 4 main reasons.

• bankruptcy fees are impossibly high and distort good choices. See Q10 & Q12
• the large scale mis-selling of IVAs for commercial gain, see Q16.
• there is no good insolvency option available for people with little or no disposable income (or income that may well not be sustainable for 5-6years), and either a car worth over 2k or a family house with equity, see Q18.
• there is not enough flexibility in the current framework, with DROs being revoked when the debtor still has no reasonable prospect of repaying debts and very high numbers of IVAs failing. Some IVAs fail because of initial mis-selling but many because of events during the IVA, some of which should have been predicted at the start. Either the individual insolvency options need to be able to cope with change or it has to be possible to move seamlessly from one form of insolvency to a more suitable one, without the need to prolong the time to get a fresh start.

Q3 Please provide any evidence to show how well the objectives of ‘fresh start’ and ‘can pay, will pay’ are being met.

1) The current DRO rules actively discourage someone from taking on additional work within the DRO year as the DRO may be revoked. This benefits no-one – the debtor, the creditors, nor the wider economy. The introduction of a Single Form of Insolvency, adapting to changing circumstances would resolve this problem – if that is not adopted, then there needs to be a way of moving someone from a DRO seamlessly into bankruptcy with no need for additional fees AND with the debts still being written off at the end of the year after the DRO started.

2) The current IPO/IPA rules in bankruptcy, introduced in 2010, have a similar bad effect. There is a major incentive for people to try to avoid having to make monthly payments for 3 years by not taking on any additional work (new job, promotion, overtime) in the first year. And if an IPA is set, this disincentive persists for the 3 years of the IPA.

I understand (FOI21/22-058) the Insolvency Service does not have the details of amounts collected via IPAs and IPOs where an Insolvency Practitioner was appointed as trustee, which is the large majority of IPA/IPO cases. This is a serious omission by the IS.

Again these rules benefit no-one – the debtor, the creditors, nor the wider economy. R3 in 2012 said that less than 1% of their members felt the 2010 changes had increased returns to creditors.

The IPO/IPA regime needs to be rethought, probably returning to what it was pre 2010.

3) the exclusion of social fund loans from DROs and Bankruptcy makes it harder for debtors with these loans to get a fresh start. The monetary advantage to the DWP is tiny compared to the problems this causes for the debtors affected. This should be reconsidered.

4) the length of IVAs The 3 year limit on IPO/IPAs seems to me to be sensible and in keeping with a balanced approach to fresh start and can pay-will pay. But at 5 or 6 years IVAs are already very long at the start – it is impossible for many people to have any idea what their financial situation will be like after that long a period so complete flexibility is needed within this time. Creditors should not have to approve major reductions or for IVAs to be completed on the basis of funds paid to date – this should be automatic. And IVAs should not be extended, so if there has to be a payment break it reduces the amount paid in, not extending the term.

5) keeping insolvency on credit record for 6 years – often 5 years after the debts have been cleared – delays a fresh start, see Q15.

Q4 Please explain whether there should be different objectives for different personal insolvency procedures

No. The overriding aim should be to provide a fresh start for the debtor through insolvency, with essential assets being retained and ensuring that any contributions are reasonable. There may be different practicalities depending on the situation of the debtor, but those are not objectives.

It would help to have a Single Form of Insolvency, see Q23.

If this is not adopted, then it would help to have greater clarity over what groups of debtors each form of insolvency is designed for and to ensure that no one in need of insolvency is excluded.

1) a major improvement would be to clearly identify DROs as the simple form of insolvency for people with no realisable assets (protecting the family home and family car) and low disposable income. There would be no other differences from bankruptcy (scrapping debt total, including all debts whether listed or not including contingent debts (or alternatively allowing debts to be added after a DRO has started), and removing the 1 every 6 year restriction.)

2) bankruptcy should then apply where there is some ability to make monthly payments but it should protect the family home (with a limit on the equity involved) and family car.

3) IVAs can then be retained for the small minority of people with complex assets.

There would seem to be no rational reason why someone should pay more per month in bankruptcy or in an IVA – any repayments should be set at a reasonable, affordable level, that does not discourage hard work, and which is flexible in the light of changing circumstances with the ability to move seamlessly between the different sorts of insolvency.

Q6 How effective are the current safeguards (public records, public registers, restrictions and sanctions on debtors) at protecting the integrity of the personal insolvency framework?

As the CfE says “Misconduct in insolvency is rare”. It isn’t clear to me how far this is the result of the current enforcement regime but there seem to be no grounds for making the BRO/DRRO regime harsher.

I think the practice of publishing debtor details for bankruptcy in the London Gazette should be ended for consumer insolvency. There is no particular reason why this should be confined to just one form of insolvency and it is unreasonably stigmatising.

Where it is determined an IVA has been mis-sold or where a debtor has repaid all their debts in an IVA in full, the IVA should be removed from credit records. This is already done after bankruptcy annulment and there seems to be no reason (apart from the need for a small systems change) why this should not be done for IVAs.

Q8 How, if at all, should the personal insolvency framework distinguish between honest/unfortunate and dishonest/reckless debtors?

I don’t think looking at cases and trying to place them on a spectrum of honest/unfortunate and dishonest/reckless is that useful as it ignores two dimensions: people who simply did not understand what they were doing or what alternatives they had; and people suffering from an addiction.

The one area where I think clarification is needed is preference. Preference where a debtor paid a friend or relative rather than a commercial creditor is something that should be investigated in insolvency. What I would term accidental preference, where a debtor paid some commercial creditors more than others, should not be a reason to deny someone a DRO or consider a BRO/DRRO. This just delays insolvency and benefits no-one.

Q9 Are there any features of other regimes that would be beneficial to consider, for example, debt counselling and rehabilitation programmes

Debt counselling before insolvency is essential.

The so-called “Treasury exemption” allowing IVA firms to provide advice in anticipation of insolvency should be restricted to debtors with significant assets to protect and all adverts from IVA firms should make this clear. Everyone else requires debt advice This needs to come from firms with full FCA authorisation, not ARs which are currently used by a large number of firms that can only be described as IVA lead generators.

The vast majority of people who are insolvent have either had major life problems or an inadequate income or both. They would not benefit from debt counselling after insolvency or rehabilitation programs and it is offensive to suggest that they would. This would also increase the stigma associated with insolvency.

Q10 Who should bear the costs of entering and administering personal insolvency procedures?

It makes no sense to try to charge people who often have no money a fee to enter insolvency.  They are not to blame and making them delay insolvency or choose a form of insolvency which is not right for them just because they can’t afford the fee on another sort does not benefit anyone (apart from IVA firms).

For the many people with negative disposable income, there is no practical way to save up these fees before going insolvent.

A means test could be introduced, but so few people can afford the current fees that the costs of administering it may well be larger than the fees it would generate.

The option of charging people the fees after insolvency sounds superficially attractive, but if people can afford to make payments to bankruptcy they do anyway, and if they can’t then it is fundamentally undesirable to charge people amounts that they cannot afford.

The total amount raised by DRO and bankruptcy fees is small. The Insolvency Service needs to find some other way of covering this. The government could fund it and accept that this is the cost of the fresh start that benefits the economy.  Or it could come from creditors, either through a direct levy or indirectly through lower returns to creditors in insolvency.

The level of IVA fees is a different sort of problem. It is absurdly high because IVAs are made far too complicated for the many relatively straightforward consumer cases. Banning advertising and payments for referrals would enable the high initial costs to be reduced. Flexibility and automation when things change in insolvency will remove the need for variations.  These should then cost no more than a DMP does to administer each year.

Q12 What options are available to debtors and creditors who are unable to afford the cost of bankruptcy, IVA or a DRO?

Debtors who can’t afford the DRO or bankruptcy upfront costs often choose to give up on insolvency or postpone it hoping something will change. This prevents the benefits of a clean start for them and for the economy. Their creditors rarely benefit as often only token payments are made.

Or they may be mis-sold an unsuitable IVA which may go on to fail. That is of little or no benefit to creditors but the IVA firms scrape enough fees overall from these unfortunate debtors for the mis-selling to be profitable.

It can sometimes be possible to raise the money for bankruptcy fees by stopping paying bills such as council tax and energy for a few months and letting the resultant arrears be covered in insolvency. This is a very stressful route for a debtor and is undesirable for many vulnerable people. In any case, it results in a subset of creditors effectively paying the insolvency fees which is hardly desirable.

Debtors who have a car worth over 2k or a house with equity who cannot sustainably afford monthly IVA payments for 5-6 years are currently left with no suitable insolvency option.

Some of these will enter an unsuitable IVA and will struggle with it being likely to fail.

Sometimes the debtor is unaware that their IVA is likely to be unsustainable – IIVA firms do a very poor job of talking to debtors about what will be changing in the next few years with important factors not being discussed or being glossed over.

Q13 What are the main consequential costs of the different insolvency procedures?

These can be divided roughly into three groups:

• where creditors with arrears on debts going into the insolvency take action eg to repossess a car, terminate a broadband contract etc.
• where creditors take what they may see as “precautionary action” eg close a bank account, repossess a car, terminate a contract or tenancy/tenancy even though there are no arrears at the point of insolvency
• where creditors refuse new credit because of insolvency appearing on credit records.

Q14 How can we reduce the stigma of insolvency to both encourage early action by those in financial difficulty and to support a ‘fresh start’ from debt relief?

Taking my rough groups from Q13:

(1) can be seen as a regrettable but not unreasonable consequence of insolvency.

(2) however is not reasonable. For example why should someone paying car finance who has never missed a payment and who has no intention of doing so to lose the car?

Problems for existing tenancies in practice are not common, cars being repossessed do occur but it’s unpredicatable, and many people have bank accounts closed. Together this creates a large amount of uncertainty and stress for people entering DROs and bankruptcy who have the possibilities explained by a debt adviser. This does not encourage early action.

(There is less stress in IVAs beforehand as the IVA firms often don’t mention these possibilities, which can then come as a very nasty surprise if they do occur.)

One change that could go a long way to help resolve this would be for the FCA to recognise these precautionary actions as not being in the interest of the vulnerable group of people who are insolvent. A letter to banks, insurance firms, car finance lenders saying that a creditor needs to be able to justify an action to terminate a contract on the facts of that particular case, not operate a blanket approach to closing accounts which would probably be in breach of the new Consumer Duty. Banks in particular should be informed that they should transfer a debtor’s current account to being a basic account if they do not want to allow the current account to continue.

(3) I think needs to be seen as inevitable while someone is going through an insolvency process. It is a fair warning to other creditors that there are restrictions on the amount a person may borrow. But I see no real reason why this should stay on credit records after the process is complete. The debts in insolvency which have been defaulted will remain on the credit record for the rest of the 6 years, but to keep the insolvency marker for that long seems to me to be prolonging the time to give a genuine fresh start. This is particularly important for private tenancies.

Q16 Do you believe the current insolvency procedures are working as intended?

No. IVA mis-selling and barriers to DROs and bankruptcy have rendered the current insolvency system close to dysfunctional.

Many of these problems are referred to elsewhere in my answers, but let me list some of the main problems with each sort of insolvency.

Barriers to DROs and bankruptcy

DROs: Where someone has no assets and insufficient income to make monthly payments in insolvency they are a “natural DRO candidate” but they face the following barriers to getting a DRO:

• their debts may total over 30k. There does not seem to be any rational reason why there should be an upper limit here. [edit – this limit is being increased to 50k in June 2024]
• they may have had a DRO within the last 6 years.
• there may be concerns that it is impossible to get a complete list of their debts, especially debts which are not shown on credit records such as parking fines and DWP debts
• they may have contingent debts which would be included in bankruptcy but not a DRO
• they may be over 55 and be unsure if a DRO would be rejected because of a pension pot that is not much larger than their debts
• they may have stopped paying some debts before others and have been warned that there may be an issue of preference
• they may have savings they are unable to access such as Credit Union savings
• they may have contacted an IVA lead generator or IVA firm and been told incorrectly that they do not qualify for a DRO.

Often the only route here is bankruptcy but they cannot afford the bankruptcy fee.

Once in a DRO, it may be revoked if they receive a windfall payment which still leaves them unable to repay their debts and having to go bankrupt.

Bankruptcy: The main barrier to bankruptcy is the unaffordably high fee. Additionally the IPO/IPA calculations fail to maximise returns to creditors as they act as a severe deterrence for additional work

IVA mis-selling

There are four main problems with IVAs – the mis-selling at the start, failure to consider the sustainability of the IVA at the start and discuss likely problems with the debtor before the IVA is agreed, appallingly poor treatment during the IVA, and the lack of flexibility when an IVA does become unsustainable,

IVA mis-selling. The main causes of mis-selling are:

• an over-estimation of someone’s disposable income, resulting in cases which should have been DRIOs or bankruptcy being approved. One common factor is where the costs of disability are largely ignored, where in DROs and bankruptcy there would be a “care costs” line to counterbalance disability benefits.
• sometimes disposable income is underestimated, resulting in cases which should have been a DMP are approved. Here the IVA payments are frequently raised significantly at the first IVA review, leaving the debtor feeling conned and the creditors overall getting a much lower return because of the high IVA firm fees.
• there are reports that IVA lead generator firms (or the salesmen that work for these firms using their own private mobile) explain to debtors how their I&E needs to be changed to enable an IVA to go through, by changing the income or expenses. This then results in a SIP 3.1 call where the numbers are not accurate. For example, one person was encouraged to say he had split up from his wife so his expenses were now going to rise a lot.
  It is hard to say how common this is but I have heard similar stories from several people. The debtors in this process are usually aware that they should not have agreed to do this and fear complaining as they may have committed fraud.
• the secured loan clause is not properly explained at the start
• a failure to provide the debtor with information about DROs and bankruptcy in an unbiased way. For example people may be told that DROs are only for the unemployed, not for people in work or retired. There is often no mention of DROs on the lead generator’s website at all. Bankruptcy is described as “the last resort” and the stigma is alluded to
• most people who enter an IVA are not financially sophisticated and the IVA paperwork is unread and may mean little to them if they tried. People commonly think an IVA is like a consolidation loan for a much reduced amount and are then shocked to find that is not how it works.

IVA sustainability

There is a widespread failure to consider the sustainability of an IVA.   Some examples which should have been spotted at the start that can result in IVAs failing include:

• a car on finance that ends in the IVA. IVA firms fail to explain at the start that the debtor will only be able to get new finance at a very high interest rate.
• an old car that may have high repair costs or may need to be replace
• a fixed rate mortgage ending. This one is going to cause major problems over the next couple of years.
• I have recently come across a case where the debtor had the initial 5 year Help To Buy period ending in the IVA and there was no discussion about what would happen to the IVA when the debtor would have to start making the payments on the government’s portion.

The IVA failure rates are not discussed so people do not understand how little room there is to reduce a low starting IVA payment if their expenses go up or income drops over a period of 5 years.

The likely major problems about trying to rent privately with an IVA on your credit record are not discussed. This would be done routinely by a free sector debt adviser advising a client on any form of insolvency.

Poor communications and treatment after an IVA starts

This poor treatment of debtors persists when the IVA starts. Some examples include:

• very poor communications with debtors being unable to get clear answers or explanations for why their payments are increasing. Phone call and email queries are ignored or brushed off. This seems to have got worse over the last few years as increasing numbers of IVA firms outsource their IVA administration overseas.
• failure to conduct proper annual reviews each year resulting in the debtor being told they owe a large amount as their payments should have been increased so their term will be extended
• some IVA firms fail to tell debtors of changes that could help them, eg the Covid-changes to exclude overtime for key workers and the recent additional flexibility introduced because of the Cost of Living crisis.

I have recently come across a case where the IVA firm was claiming that a clause in the IVA allows it to claim 15% of the whole inheritance the debtor gets as its fees, even when the inheritance is many times larger than the amount needed to settled the IVA debts and fees in full. The debtor has had to engage a solicitor challenge this misreading of the IVA terms.

There are what can only be described as attempts to bully people into accepting a very expensive secured loan, without adequate assessment of whether that loan would be affordable for the debtor for its whole term. I have seen cases where the secured loan rate is 19 or 20%.

In a recent case, someone with shared ownership was told they had to take a secured loan and he doesn’t need to inform the co-owners – which would be a breach of his shared ownership contract. He said this and the secured loan broker said they would inform the IVA firm that he was not co-operating and was in breach of his IVA and he may be made bankrupt. He emailed the IVA firm and received no response until I suggested he emailed his IP directly.

Lack of flexibility in an IVA

Where a debtor wants an IVA failed (usually because they have found out a DRO is more appropriate), the IVA firm often takes an unreasonably long time to fail the IVA, leaving the debtor in a very stressful limbo.

IVAs lack sufficient flexibility to be able to cope with what can commonly happen during the IVA. There have always been life events that result in an IVA failing but now we have had macro-economic events as well – Covid, high inflation, escalating mortgage rates, a possible recession.

At the moment the debtor bears all the risk of these events. If an unexpectedly good event occurs (big redundancy pay-out promotion, inheritance) then the creditors get paid more. If an unexpectedly bad event occurs (illness, loss of job, death), the IVA fails and the debtor is left back with often most of their debts plus sometimes IVA fees still owing.

Q17 How well do those in financial distress navigate the current regime and could this be improved?

The term “navigate” implies a degree of control of the process – a choice of where someone wants to go and how to get there.

When someone contacts a free sector debt adviser and it appears insolvency is suitable, there is usually a prolonged discussion about the forms of insolvency and their implications, and also about how the debtor’s circumstances may change. This involves warning about potential problems such as needing a new tenancy agreement. This is help to navigate and make an informed choice.

This discussion with the debtor does not seem to happen with IVA lead generators and IVA firms. DMPs can be dismissed as not legally binding even when they would seem to be entirely suitable. People are left with the impression that an IVA is better for their credit record than bankruptcy. I have come across a case where an IVA lead generator warned about the “upfront fee” require in a DRO but seemed to think the debtor could afford an IVA payment that was larger than that DRO fee.

There is no public information that will let a debtor make an informed choice about which IVA firm to use, even though the failure rates appear to differ significantly. They are not navigating this process, they randomly clicked on an advert and were drawn into an IVA sales process which many people report as being pressured.

And when someone is in an IVA, they may find their case has been sold onto a different firm, sometimes more than once. Any agreement they may have had with their original IVA firm gets lost in this process – for example the debtor may have been told they would have a 6 year IVA so they do not have to release equity – they are happy with this but do not have to knowledge to ask for this to be put in writing. Then after 5 years their “new” IVA firm says it knows nothing about this, there is nothing in the documentation and the debtor now has to pay for an extra year.

When problems arise in an IVA, most debtors do not have enough knowledge to be able to question what they are being told and are very scared of complaining about their IVA firm in case they are made bankrupt. And most are unable to afford to pay for a solicitor to help them. There is a complete imbalance of power in an IVA.

Q18 Are the current personal insolvency procedures the right products to service the needs of both debtors and creditors today or are new procedure(s) needed?

In Q16 I listed ways the current procedures are resulting in poor outcomes for too many debtors. But there is an additional major problem of two large groups of people for whom there is no appropriate debt solution

It is unrealistic to expect people who need a car to sell a reliable one and buy one that costs less than 2k – in many cases this will not be reliable and the running expenses will be considerably more, including ULEZ charges in London which may be extended to other areas. Also in many cases the car is on finance and because of the poor state of their finances the debtor has no realistic option to trade down to a cheaper one. The insolvency options need to be changed so majority of people can keep the family car. [Edit – the allowed value of a car in a DRO  being increase to 4k in June 2024]

It is equally unrealistic to expect people to sell a house with equity and rent. Often the rental costs would be unaffordable or there is very little private rented property available. Social housing is not an option for most people and keeping people in temporary accommodation is costing local authorities over £1.6 billion a year. The insolvency options need to be changed to allow the majority of people to keep the family home. The need for this may become much more urgent next year with the large rises in mortgage costs.

At the moment people are forced to choose between an IVA that is likely to be unsustainable or opt for long term token payment plans that do not help them, their creditors or the wider economy.

So a large number of changes are needed to the DROs, bankruptcy and IVAs, to correct the problem listed in Q16 and prove a suitable insolvency option for the currently excluded.

Introducing a single portal would resolve a lot of the IVA mis-selling problems, see Q23. It could also be used to facilitate flexibility to cope with changing cirumstances during insolvency.

Q22 What are the main factors which influence an individual’s decision to enter a particular procedure?

IVA lead generators and IVA firms are the only debt solution providers that widely advertised on Facebook, Instagram, TikTok, and on Google.

From the moment a debtor contacts one of these firms they are frequently given the hard sell for the advantages of an IVA. The problems in an IVA and its likely sustainability are often not mentioned or glossed over while the problems with DROs and bankrupty are emphasised and in many case exaggerated. See Q17 for details.

Increased funding for free sector debt advice would help, but only banning adverts or rendering them pointless with the introduction of a Single Insolvency portal, see Q23, will really get over the problems.

I have no faith in the ability of minor changes to IVAs to overcome the fundamental problem that these generate large fees for the providers and other debt solutions do not. It is expecting turkeys to vote for Xmas to hope that self regulation can change this. The firms that get most people in to IVAs, however unsuitable, have more money available to pay to lead generators and to advertise with. An ethical firm that takes a small percentage of debtors to IVAs will struggle to compete.

Q23 How could an individual’s decision to enter a particular procedure could be better informed?

Remove the need for the individual to make a choice with the introduction of a single portal.

The Spooner/Ramsey portal discussed in the CfE appears most suitable as it removes the need for a debtor to make a choice so the question about information becomes less important. The entry to the portal could be through an FCA authorised debt adviser so the debtor would have the implications and suitability of insolvency properly explained to them.

This Spooner/Ramsey portal also seems to cope well with the concept of changes during insolvency, reducing failures and the need for subsequent new insolvency applications.

The Walton option leaves the way open for continued advertising by IVA firms with all its associated problems. Advertising is at the root of most of the mis-selling issues. The Walton option doesn’t appear to address the need for flexibility in insolvency solutions.

Q26 Please explain any other barriers to entry to personal insolvency

In Q16 I listed some barriers to DROs at the case level.

In addition to those, the need to list every debt in a DRO makes them very time consuming for a debt adviser to set up. Removing the need to list all debts in a DRO application  by making them all included as for bankruptcy is the best option. An alternative is to make it easy to add new debts that have emerged to the DRO list.

Q27 How could the personal insolvency framework be improved, for example, to make access easier or movement between procedures easier?

See Q 23. If the Spooner/Ramsey portal is not adopted, then major changes are required to try to prevent IVA mis-selling and facilitate movement between insolvency options. I suggest:

• a clearer definition of who a DRO is aimed at, with bankruptcy being restricted to cases where debtors can afford to make monthly payments
• DROs and bankruptcy being changed to allow the majority of debtors to keep the family car and family house
• IVAs being retained for complex asset cases.

If that approach is rejected then there should be a ban on any IVA advertising and no payments allowed for referral fees. And all IVA firms must be fully authorised (not an AR) by the FCA.

Additionally FOS should become the independent complaints adjudicator for what happens in an IVA as well as the debt advice at the start.

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