This is a guest post by Dr Joseph Spooner, Assistant Professor of Insolvency Law at the LSE and the author of Bankruptcy – the Case for Relief in an Economy of Debt. He had previously worked at the Law Reform Commission of Ireland, where his papers influenced the enactment of the Irish Personal Insolvency Act 2012.
Systems for addressing difficulties of over-indebted households in England and Wales are laden with paradoxes and contradictions. Bankruptcy – the classic procedure for relieving insolvent individuals from debt – is an expensive luxury, as access is limited only to those able to afford up-front fees of £680. English bankruptcy law “on the books” offers what looks like one of the world’s most generous regimes (cancelling an insolvent person’s debts after a one-year waiting period), but the “law in action” looks nothing like this, as the large majority of people with debt difficulties are forced into long-term debt repayment plans under Individual Voluntary Arrangements (IVAs) or Debt Management Plans (DMPs).
In the USA it took a vicious political fight for creditors to secure legislation forcing debtors out of fast-track debt relief in bankruptcy and into long repayment plans. In contrast, UK creditors achieved a similar outcome without such political conflict, as silent government decisions and market developments have made bankruptcy inaccessible and allowed creditors to shape the terms on which people must repay their debts over time, irrespective of their legislative rights. A personal insolvency system claiming (at least under legislation of a previous government) to be committed to offering those in financial difficulty a “fresh start” through debt relief, nonetheless also aims to maximise repayments to creditors, under an overarching principle of “can pay, should pay”.
One of the greatest puzzles of all, and the subject of this post, is that secrecy surrounds the criteria for determining who can pay, and how much they should pay.
The Standard Financial Statement
The Standard Financial Statement (SFS) is the tool used in debt advice and personal insolvency to calculate spending guidelines for households in debt difficulty. It determines how much of household income can be spared for each of a range of essential household costs, with the remainder then considered available for repayment to creditors. The SFS is used by debt advisors when negotiating repayment plans with creditors on behalf of their clients and by insolvency practitioners (IPs) when negotiating IVAs. The Insolvency Service uses the SFS when calculating debtor eligibility for the “no income, no assets” Debt Relief Order (DRO) procedure, and the amount (if any) payable to creditors under an Income Payment Agreement by an individual entering bankruptcy.
A key feature of the SFS is that “it is not intended for the public to use.” Instead, the figures used under the SFS are available only to organisations such as debt advice agencies, creditor institutions, and government departments. This secrecy includes the “trigger figures” representing what are considered by these stakeholders to be reasonable levels of household expenditure on various categories.
This post argues that this position hides from individuals the “rules of the game” when it comes to personal insolvency and debt management. This situation is unusual when compared with similar practices in other countries where reasonable expenditure standards are enshrined publicly in law, with relevant income and expenditure guidelines in insolvency procedures mirroring those established in social welfare, taxation, or general debt collection legislation. The opacity of the SFS can also be disempowering in the manner in which it deprives individuals in financial difficulty of key information that is vital to assessing the options available for finding a way out of their situations. The secretive nature of the SFS also removes from public scrutiny and political discussion key questions regarding the appropriate level of hardship that society can demand from an over-indebted household in return for the reward of freedom from its debts.
To summarise these criticisms, in the 2013 World Bank Report on the Treatment of Insolvency of Natural Persons, the authors (international experts in consumer bankruptcy) argue that when setting rules for debt relief through personal insolvency, the
“proper levels of sacrifice by distressed debtors, and the appropriate levels of protection of and compromise by their creditors, are sensitive matters of social policy. Policymakers from a wide variety of regions seem to have all but unanimously concluded that these questions in the final analysis are best resolved by political representatives whose task is to balance the competing interests of different constituencies, such as debtors and creditors. Rather than leaving these questions to private negotiations among creditors and debtors, state authorities have consistently been assigned to make the key decisions with respect to the duration and level of sacrifice in insolvency payment plans.”
An Example from Ireland
The recent development of Irish personal insolvency law offers one example of a more transparent approach to setting reasonable expenditure standards. Post-crisis Ireland is a fascinating case, as despite the country being one of the most heavily hit by household debt problems following the Global Financial Crisis, the country did not have a functioning bankruptcy law at the time the economy collapsed (a bankruptcy procedure existed on the statute books, but offered no debt relief and was effectively a life-long procedure). This led Irish lawmakers to pass the Personal Insolvency Act 2012. This legislation has had its problems, but its method of calculating expenditure and debt repayment levels for households in insolvency has been lauded as a model of good practice.
The Irish law provided that the newly created Insolvency Service of Ireland (ISI) would publish regulations setting out a form constituting the “Prescribed Financial Statement”, and develop publish “Reasonable Living Expenses” guidelines. These documents represent an equivalent to the SFS, and are used when calculating the reasonable living expenses of an over-indebted household, in order to determine their eligibility for the various insolvency procedures created by the 2012 Act, and the income that will be available for repayment to creditors. When developing the expenses guidelines, the legislation obliged the ISI to have regard to a number of considerations, including “the need to facilitate the social inclusion of debtors and their dependents and their active participation in economic activity in the State.” The Irish High Court recently described the guidelines as providing “an essential yardstick by reference to which an objective assessment can be made as to what is an appropriate standard of living in any individual case for a debtor and his or her dependents.”
Irish Insolvency practitioners negotiating insolvency arrangements on behalf of debtors, and courts and administrators approving proposed arrangements, must all have regard to these guidelines, (even if a recent court decision sets a worrying precedent in approving arrangements which involve the individual households in question living below the guidelines). The ISI explains that under its view, a reasonable standard of living means neither luxury nor mere subsistence, and that someone entering an insolvency procedure should be able to eat well, dress appropriately, participate in community life, and devote reasonable time to leisure activities.
The ISI developed precise figures regarding various categories of expenditure after a significant consultation process, and relied heavily on a well-regarded regular survey of household financial need published by NGO the Vincentian Partnership for Social Justice. This survey is developed by focus group method, “working with members of the public to establish social consensus on what is needed for a minimum living standard.” The result is a range of figures establishing reasonable expenditures based on household composition, a household’s travel, childcare, and housing costs, and any special circumstances including the health and age of household members.
As well as being published openly, these figures have been integrated into an online calculator through which people can answer a short series of questions in order to approximate their “Reasonable Living Expenses”.
Significantly, the expenditure guidelines were subjected to public scrutiny and political debate. Newspapers and radio shows reported on the figures and debated their reasonableness. The guidelines are discussed in parliament reasonably frequently, with government ministers called upon to defend their adequacy. Court decisions applying the guidelines also make news headlines. The Irish personal insolvency legislation was passed in a context in which household over-indebtedness, and particularly problems of mortgage arrears, were issues of very significant political salience. The law was enacted amidst widespread calls for policy action to assist households in financial difficulty, and much public debate regarding the rights and wrongs of the related reckless lending that had contributed to the Irish banking crisis and “bail-outs”. Questions of the appropriate relief offered to over-indebted households, and the price to be paid for such relief, were considered matters for the public sphere, rather than issues to be resolved secretly on creditors’ terms. Politicians expressed strong concerns when it emerged that Irish banks were requiring customers seeking mortgage restructurings to sign confidentiality agreements concealing the terms of such arrangements. In a political climate in which a household debt crisis could not be denied (in contrast to the seeming denial of the household debt crisis among UK politicians), public opinion demanded that questions of the living standards afforded to households seeking debt relief were matters for democratic scrutiny.
Secrecy and Debtor Disempowerment
This raises the further problem of how secrecy in relation to acceptable expenditure guidelines may disempower debtors in their negotiations with creditors. Recent high profile scandals have reminded us that confidentiality is a tool frequently used by the powerful to avoid accountability and preserve positions of strength.
In the Irish case, debtor advocates were concerned that banks’ practices of concealing any concessions they had made to struggling mortgage customers served to deprive other customers of crucial information that could influence their own restructuring negotiations with their lenders. Noeline Blackwell, then Director of the Free Legal Advice Centre (FLAC), argued that the confidentiality prevented struggling households from becoming aware of the range of options available to them, and of the types of concessions that banks might be willing to make. This meant that every debtor seeking to renegotiate their debts had to start from scratch, with negotiations beginning at a position under which a lender can demand full repayment. This contrasts strongly with a bargaining position under which a debtor can point to precedents of lender concessions, and argue for a similar debt write-down in her case.
In his classic 1973 study Making People Pay, sociologist Paul Rock long ago identified the concealment of such information, and thus creditors’ preservation of threatening ambiguity regarding the consequences of default for debtors, as a key debt collection technique designed to maximise recovery rates to creditors. Often the consequences of default are not as severe as might be feared, and if debtors were aware of this reality their negotiating position would be strengthened.
The secrecy of the SFS conceals key information regarding the acceptable expenditure amounts debtors are entitled to retain, and so regarding the “going rate” of debt write-downs lenders are willing to accept. This practice disarms debtors of one of the very few weapons at their disposal in negotiations with lenders, in which they are usually heavily outgunned. Individuals in financial distress might be more confident entering negotiations with lenders, and even in taking the step of availing of debt relief through insolvency procedures, if they were assured that they would be permitted to keep a reasonable income for themselves and their families. This is especially the case in a system in which government agencies acknowledge that myths regarding bankruptcy are widespread, and where regulators have uncovered evidence of intermediaries spreading misinformation regarding alleged negative consequences of bankruptcy and DROs.
A Market of Hidden Prices?
In my recent book, Bankruptcy – The Case for Relief in an Economy of Debt, I argue that the economic stagnation, inequality, and political instability caused by our economy’s debt-dependence present a powerful case for household debt relief policies. The book argues that bankruptcy law has the potential to deliver such debt relief, but that problems in the current personal insolvency system mean that it fails to fulfil its potential to produce these public policy benefits. One major failing of the law is that it has been increasingly understood by policymakers and courts in terms of an “insolvency market”. The book highlights many ways in which these decisionmakers have tended to view legal procedures (bankruptcy and DROs) as “products” competing for customers alongside market-provided solutions (IVAs and DMPs).
This is deeply problematic. Even under the economic theory which neoliberal policymakers claim to follow when promoting marketized approaches, the area of household debt is particularly unsuited to organisation by market principles. A basic principle of economic theory is that for a market to operate efficiently, all actors in the market must have full information regarding market conditions.
While the absence of information relating to the quality of products and services is a widely recognised problem, an even more fundamental problem occurs when a market suffers from a lack of basic price information. In such a situation, consumers lack crucial knowledge with which to make decisions, meaning they cannot make rational choices as to which options best serve their interests. This all but guarantees market failures and inefficient outcomes. There is little hope that an over-indebtedness or personal insolvency “market” can produce positive outcomes while key price information is concealed through the secrecy of the SFS model. The puzzle of debtors “choosing” long-term repayment plans (IVAs and DMPs) in cases in which bankruptcy or DROs offer them better outcomes is evidence of this theory in action.
Some readers may disagree and argue that it is sufficient for advisors assisting debtors to have access to the information contained in the SFS, so that they can guide debtors towards the most appropriate route out of debt difficulty. The trouble is that evidence of practices in the debt management industry make it difficult to sustain this optimistic view. Numerous regulatory reports have identified sector misconduct, which sometimes involves the specific practice of manipulating debtor income and expenditure figures so as to divert debtors from DROs into more profitable IVAs. Financial Conduct Authority and Insolvency Service regulatory efforts are improving standards in this sector. These actions can do little, however, to remove the structural incentives where revenues for both for-profit and some charitable debt advice/management providers depend on debtors choosing long-term repayment options over the often more beneficial immediate debt relief offered by bankruptcy and DROs. Debtors’ ability to choose optimal outcomes is undoubtedly reduced when control of the key SFS information rests with advisors and creditors who are incentivised structurally towards options least beneficial to debtors. While not the cause of these problems, the secrecy of the SFS certainly contributes.
Even in the charitable advice sector, institutional factors present constraints in an environment of limited resources. Benefits might arise from the most capable debtors receiving the key information they need in order to address their financial problems independently to the greatest extent possible. UK governments of the current colour have sought to promote a “consumer empowerment” agenda, providing consumers with the information necessary “to make better choices”. It appears that this logic of empowerment collapses once a consumer defaults on their loans, with those in financial difficulty supposedly expected to ask meekly for forgiveness.
It is difficult to see how this position can result in anything other than an insolvency “market” doomed to failure, which cannot succeed even on its own terms. This results in negative outcomes not only for financially troubled households, but for an economy suffocating beneath a household debt crisis. Evidence of the sacrifices of financially struggling households can be moving and compelling, and its distribution seems necessary in overcoming political denials regarding the existence of poverty and debt crises.
It is beyond high time for a public conversation about debt. Surely one step must involve dragging hidden realities into view and publishing the figures in the SFS.