This article builds on the arguments I put forward in Coronavirus – how the debt advice sector should be planning, looking at one area that needs to be tackled urgently – personal insolvency.
Coronavirus will cause a large increase in the numbers of people who should choose insolvency over the next couple of years. I am not trying to predict how many, but it is likely to be large enough to cause major problems for debt advisers, the Insolvency Service (IS) and Insolvency Practitioners (IPs) to handle well. So we need to identify now how the current processes can be streamlined, improved and simplified and bring in those changes before the numbers are known.
This isn’t just good for the individuals, it’s desirable for the country. Poverty and problem debts are often interlinked. Help resolve someone’s debts and you help their mental health and the life chances of their children. Impossible amounts of unrepayable debts act as millstones around people’s necks and will cause an economic recovery to be anaemic.
In Scotland it is being proposed that the maximum debt level of MAP bankruptcies is increased from £17,000 to £25,000, creditor bankruptcy petition amounts are increased to £10,000, and MAP and bankruptcy fees are reduced.
Equivalent changes in England, Wales and Northern Ireland would be a good start… but these would not be enough because here personal insolvency was already in a mess before Coronavirus.
In making changes to cope with the expected increase in insolvency numbers we need to recognise the current problems and ensure the changes reduce them, not make them worse.
There are major problems with all three types of insolvency.
Bankruptcy fee is way too high
£680 is an absurd amount to charge someone who needs to go bankrupt. Most people who go bankrupt have little money or are already in their overdraft. And many have negative disposable incomes, making it impossible to save up the money without running up more debts or arrears on bills.
Charging this amount makes some people give up on bankruptcy completely or it prolongs the period before someone can go bankrupt:
- they may opt for an IVA even though they would not have to pay an IPA in bankruptcy at all and that IVA may later fail (see below);
- they may just try to ignore their creditors, thinking there is no debt solution open to them.
- it can generate large amounts of work for debt advisers trying to support the debtor while they save up over a long period or make grant applications – which have got considerably harder over the last three years.
For the people who can afford this fee, the money in their accounts would be claimed as an asset by the Official Receiver anyway! So the Insolvency Service is only better off to the extent that it can either put people off going bankrupt (and so save itself some work) or it can pressure some debtors into coming up with money they cannot afford. Neither of these are desirable.
In 2019, the bankruptcy fee generated less than £12million in income for the IS. The IS needs to find some other way to balance its books. The people that ultimately have to bear the costs of all insolvency are the creditors; trying to charge the person in debt misses the point entirely.
- the bankruptcy application fee should be reduced to £200;
- it should be waived entirely for anyone in receipt of any means-tested benefits.
Anyone who thinks this suggestion is too radical needs to explain how people with negative disposable income – less than they need for the necessities – can save money for these fees. Or why they should be excluded from bankruptcy if they can’t.
DROs – too complicated
DROs are a success story. Simple for the IS to operate, very low failure rate, an excellent option for many very distressed clients.
Debt advisers suspect many of the people whose IVAs are failing (see below) should have had a DRO instead. And if Cornavirus results in a lot more people who have lost their jobs or see major income drops, then DROs may be a good option for many of them.
But the current DRO application process is too cumbersome for debt advisers to set up. DRO applications currently often take 10 weeks or more because of the need to list every debt and double-check the debt amount.
Even after this long process, debts can later appear, such as benefits and tax credit overpayments. This is proving an increasing problem at the moment as people move over to Universal Credit and debts the client was unaware of emerge. At the moment these “old debts” are not included in the DRO and the client can’t have another DRO for 6 years.
The application process will cause a log jam if a lot more DROs are required. This could be tackled by recruiting, training and funding many more debt advisers. But an alternative approach of making DROs simpler to set up seems preferable.
CAP suggested last year that the DRO rules on omitted debts should be brought in line with bankruptcy rules. This would be a major improvement.
It also needs to be combined with increasing the DRO limit. Debt advisers see clients who would be “clear DRO cases” apart from the fact they owe more than the current limit. And increasing the limit would also ensure that fewer DROs later fail if a new debt appears that takes the client over the limit.
DROs are intended as very simple forms of bankruptcy, where there are minimal assets and no IPA would be set. What is the point in making someone with say £35,000 in debts go bankrupt? It costs the IS more to process the bankruptcy and creditors still end up with nothing. Why is there a maximum limit on the amount of debt in a DRO at all?
The DRO fee may be only £90 but it is still difficult to save up for clients on benefits often with negative disposable income. I suggest that it should be waived for clients on means-tested benefits or with zero income. Update – in January 2021, the FCA’s Woolard report identified the £90 fee as an obstacle to people starting DROs.
So for DROs I suggest:
- omitted debts should be included, in line with bankruptcy rules;
- the debt limit should be scrapped (or raised to something very large such as £50,000);
- fee waiver for clients on means-tested benefits.
IVAs – far too many are failing
Since 2015 the number of IVAs has soared, while bankruptcies and DROs have remained largely unchanged. This at a time when falling disposable incomes would have been expected to reduce the percentage of people who IVAs are suitable for. IVA failure rates in the first few years are also increasing:
Current one-year IVA failure rates have risen from a recent low of 4.1% for 2013 registrations, to 8.4% for 2018registrations, the highest rate since 2002. The 2-year failure rate: for 2011 to 2014 registrations the rate was around 11% before increasing in subsequent years to a rate of 19.5% for 2017 registrations. This is the highest rate since 2007. The three-year failure rate relating to 2016 registrations, of 25.1%, is the highest since 2009.
StepChange has pointed out that its early failure rates are a lot lower than the market average. Some firms therefore have much higher rates… It is unconscionable that consumers are kept in the dark about this when they set up an IVA.
(I am not going to comment on the Insolvency Statistics for April 2020 published last week which showed that bankruptcy numbers dropped 46% compared to April 2019, DROs dropped 37% and IVAs jumped by 39%. I think some detailed analysis of those numbers is needed.)
The only plausible explanation for the rising IVA numbers and the rising failure rate is that IVAs are being mis-sold to people who should have a DRO or gone bankrupt. RPB regulation of IPs appears to have been ineffective at preventing this. The IS launched a Call for Evidence on IP Regulation last year but nothing has yet emerged.
I think a range of measures needs to be taken to try to counteract IVA mis-selling:
- IVA firms must publish their IVA failure rate prominently on their website and all advertising and must list the high risk of IVA failure as a disadvantage of IVAs.
- IVA firms can only take leads from IVA lead generators who publish failure rates on their websites and all ads, including social media.
- IVA firms cannot take leads from any firms that advertise in a way designed to look like national debt charities.
- IVA firms can only take a lead if it is accompanied by phone recordings of all calls with the debtor and these need to be retained. If these are missing it will be assumed the debt may have been given poor advice and the IVA will be treated as mis-sold.
- Large fines must be imposed for every IVA that is found to have been mis-sold. I would suggest £20,000. A fine has to be many times larger than the profit a firm can make on a case, or it will still be profitable to have a high failure rate.
- If an IVA is found to have been mis-sold, the IVA should be completed on the basis of the funds paid to date, so the debtor does not have to go for a DRO or bankruptcy.
- Any IVA where there is no property and a monthly payment of less than £100 should not be set up unless an FCA authorised firm has recommended that an IVA is suitable.
In addition, I think there needs to be a broader rethink of who bears what risks in an IVA. Creditors benefit when a debtor gets a windfall – inheritance, redundancy etc. They also benefit if the debtor has pay increases and overtime. But if the debtor has financial problems, particularly in the early years, too often the IVA fails. This is not equitable – it leaves a debtor back with debts that they are now in a worse position to pay than when the IVA started. This may well be an increasing problem with the impact of Coronavirus.
I suggest that if IVA payments can no longer be maintained for reasons that are outside the control of the debtor then they should be reduced without the creditors having to approve it. If they would have to fall below some set level (£60 a month?) then the IVA should be completed, not failed.
Other problems with bankruptcy and DROs
The amount allowed for a vehicle needs to be increased in bankruptcy and DROs. In large parts of the country a car is essential for everyday life, not an optional extra. £1,000 is no longer a reasonable amount.
The “insolvency test” should be reviewed. Workers in the 60+ age group are among those most likely to have had problems because of Coronavirus. It makes no sense that people with money in personal pensions should not be able to go bankrupt/have a DRO whilst people with an employer’s pension can go bankrupt.
The IPA rules should be reviewed. The 2011 changes may have sounded as though they would maximise returns to creditors but they effectively removed any incentive for someone to earn any more money at all. Not the way to get the individual or the wider economy back on its feet.
Conclusion – major changes are needed
The current personal insolvency system needs major changes so that tens of thousands more people can get onto the optimum insolvency solution for them, not the most profitable one for an IVA firm.
These changes are made more urgent with the greater numbers expected to need insolvency with Coronavirus, but they were all required anyway. So the changes need to be permanent, not temporary emergency measures.
UPDATE May 2021 – DRO limits are changing
After a consultation, the Insolvency Service is changing many of the DRO criteria limits from the end of June 2021:
- total debt increases to £30,000.
- level of “surplus income” increases to £75 per month.
- an increase in the general assets to £2,000 and the value of a car to £2,000.
These are simple changes to introduce as they can be made through the regulations, not requiring primary legislation.
It is disappointing that the Insolvency Service has not suggested changes in areas that would make DROs simpler to set up, as I have suggested in this article. However, in its summary of the DRO changes consultation responses it said:
The Government recognises there have been significant changes in the personal debt and insolvency landscape over the years, with further changes planned – for example the breathing space scheme, followed later by the new statutory debt repayment plan – and will issue a Call for Evidence on the current personal insolvency framework in due course.