Bankruptcy remains the most well-known, and perhaps most feared, of the personal insolvency processes. Since the current threshold was introduced 30 years ago, it has been used by creditors owed as little as £750 as a dire threat to extract payment from reluctant debtors. However, the Government has stepped in and is squeezing the bankruptcy process, seeking to ensure bankruptcy is reserved for the most appropriate cases and encouraging alternative regimes for the management of small debts.

As a result the legal framework underpinning the bankruptcy process is in a state of flux. This article will look at what is changing, what has changed and the opportunities and risks for the insolvency sector.

CREDIT FUELLED GROWTH – HOW LONG CAN IT CONTINUE?

The credit crunch proved a temporary wakeup call about the danger of credit fuelled spending and growth. Over the past five years consumers have sought to pay back their credit, succeeding in reducing their borrowings by a quarter (Precious Plastic study, PwC). However, with economic growth, falling unemployment, real wages rising and historic low interest rates, consumers are fast rediscovering their appetite for credit fuelled purchases.

This good news for consumers translates into the lowest number of formal individual insolvencies since 2005. The same conditions that are encouraging consumer borrowing are helping those with problem debts, especially because creditors are increasingly willing to agree informal repayment plans rather than incur the costs of formal insolvency proceedings. This has led to a significant reduction of bankruptcies (20,318 in 2014, the lowest annual level since 1998) and Debt Relief Orders (’DROs’) (26,688 in 2014, the lowest annual total since 2010). How long this may continue is the million pound question, although the Chancellor and Governor of the Bank of England are presumably hoping it will continue for some time. The Government’s recent bankruptcy and DRO reforms should help maintain this downward trend in individual insolvencies.

BANKRUPTCY THRESHOLD RAISED

The headline grabbing change is the planned increase of the threshold for bankruptcy proceedings from £750 to £5,000: a 675% increase, roughly speaking. The threshold is the minimum level of debt for which a creditor can force a debtor into bankruptcy and this increase is the first revision since 1986. The Government’s stated aim is to reserve bankruptcy, which has the most significant consequences, for those with sizeable debts. This has a massive impact, removing bankruptcy as a threat for thousands of debtors who owe these smaller sums.

The changes have been welcomed by consumers and insolvency professionals alike, who have long campaigned that the £750 threshold was inappropriately low. The current £750 threshold means that creditors can easily threaten a non-paying debtor with, or simply issue, bankruptcy proceedings. When faced with the threat of being declared bankrupt and all that it entails (eg the loss of control over assets, the loss of directorships and the stigma), many debtors suddenly locate the money (either from family or loan sharks) to pay off the debt. However, this is not possible in every case and every insolvency professional who deals with individuals can tell cautionary tales of people’s homes being sold and their lives significantly damaged over comparatively small debts. The reality is that the associated professional costs of bankruptcy often quickly dwarf the original debt.

However, while debtors might be rejoicing, creditors are faced with having to consider other options to pursue low value debts. A bankruptcy petition may have been a disproportionate instrument for recovery of low value debts, but in seeking to redress this balance, the Government has heavily favoured debtors. Suppliers/creditors chasing debtors for less than £5,000 are essentially left with two choices: an informal agreement with the debtor for repayment, or formal court proceedings in the small claims court either resulting in judgment or a negotiated resolution. Given the increase in the threshold is planned to take effect on 1 October 2015, it may be that some creditors rush to recover smaller debts while they can still threaten bankruptcy.

DRO REQUIREMENTS SOFTENED

In addition to the threshold increase, the Government is proposing that debtors with debts of no more than £20,000 and assets of £1,000, plus a vehicle (worth not more than £1,000) will now be able to enter the DRO regime, which is a low cost alternative to bankruptcy. DROs were previously only available to those with less than £300 in assets who owed a maximum of £15,000. The Government estimates that this will enable some 3,600 more people with low level debt to use DROs.

The DRO regime is an administrative rather than court-based procedure and is designed to provide debt relief to individuals who would otherwise be excluded from existing procedures. DROs are designed to support financial rehabilitation by giving debtors an incentive to address their debt issues earlier by offering protection from those debts included in the DRO, preventing enforcement of those debts and discharging them at the end of the DRO (usually after 12 months). The Government clearly sees DROs as something to be encouraged, pointing to a survey of DRO users which showed that 96% of users would have been unable to deal with their debts without DROs. 79% also said that the process had a positive impact on their mental health.

While arguably this change is a further blow to creditors seeking to recover small debts, the Government considers that the people who will benefit from the new DRO regime will be those with very low realisable assets and therefore no realistic ability to repay their debts.

THE BANKRUPT’S ESTATE – KEEP YOUR HANDS OFF MY PENSION

It is common for pension savers to have the right to take some of their pension benefits from age 55 and George Osborne has been busy unlocking pensions in part to encourage consumer spending so that from April 2015, scheme members have significantly greater freedom to cash out their pension savings. However, there is a real risk that unlocking a pension and receiving payments from it may give creditors access to an asset which is otherwise untouchable in any subsequent bankruptcy.

Unless excessive, pension savings are generally safe from a trustee in bankruptcy, except where the bankrupt member has already started to draw his pension. The Insolvency Service’s guidance makes it clear that the official receiver may not influence the bankrupt individual in making the election to draw down. However, inventive trustees have sought to access pension savings and in Raithatha v Williamson [2012] EWHC 909 (Ch), persuaded the court to force a bankrupt member to exercise an option to start receiving a pension that he had not yet touched and therefore bring his pension into the bankruptcy estate for division amongst the creditors.

Arguably, this ruling has now been contradicted by Horton v Henry [2014] EWHC 4209 (Ch). In this case, the trustee applied for an income payments order against three pension policies and a self-invested personal pension held by Henry. None of the pensions were in payment and the amounts that Henry would eventually be entitled to receive from them would not be known until then. Deputy Judge Robert Englehart QC held that there was a difference between pensions that were in payment and those that were not. He further held that a bankrupt’s unexercised rights to draw his pension did not represent income to which the bankrupt was entitled and therefore fell outside of the bankrupt’s estate. Unless the member triggered those payments, they were neither certain nor contractually payable.

While this decision accords with most commentators’ understanding of the law, it has led to confusion as it appears to stand in conflict with the same court’s earlier decision in RaithathaHorton is the subject of an appeal, with a hearing window of 14 May to 14 July 2015 and it is hoped that the Court of Appeal will lay down a clear rule and uphold the reasoning in Horton.

Given the recent pension changes that enable a member to access their entire pension fund as a lump sum, insolvency professionals will be eagerly awaiting the appeal. If the Court of Appeal were to followRaithatha then even a relatively small fund could become an attractive target for an income payments order. Individuals with problem debts should think carefully before unlocking pension assets to pay off debts. They may be best served leaving their pension pot untouched and sitting out a bankruptcy. Insolvency practitioners should beware having their fingers burnt by seeking to crack open a tempting pension pot.

THE BANKRUPT’S ESTATE – KEEP YOUR HANDS OFF MY PROPERTY

While the number of bankruptcies and DROs has significant decreased, since the Enterprise Act 2002 reforms, the length of the processes has stayed broadly the same. The various personal insolvency regimes all usually last for 12 months, save where the bankrupt has been difficult or uncooperative with the trustee in bankruptcy.

By contrast and way of key reminder, the effects of bankruptcy can linger for far longer. For instance, a bankruptcy will often require the sale of the bankrupt’s home to release any equity. However, a bankrupt can seek to prevent or delay a sale if the value of their beneficial interest is less than £1,000 or it is a family home, in which case a bankrupt can delay the sale for up to a year to organise somewhere for the family to live. However, since the Enterprise Act 2002 amended the Insolvency Act 1986 by adding s 283A, a trustee in bankruptcy must take specific steps to realise the bankrupt’s former interest in a dwelling house within three years of the date of the bankruptcy order; after which the bankrupt’s former interest will automatically re-vest in the bankrupt. These are deadlines missed at an insolvency practitioner’s peril.

CONCLUDING THOUGHTS

The proposed changes to the threshold and the DRO regime are subject to parliamentary scrutiny before coming into force in October 2015. Given the positive reception these reforms have received, it is not anticipated that these changes will be watered down.

Debtors are the greatest beneficiary of the proposed changes. The Government is keen to encourage debtors to deal with their small claims at an early stage before they spiral out of control. The planned increase of the threshold removes the threat of bankruptcy from thousands of debtors, forcing creditors to work with the debtors to agree flexible plans for repayment.

Even with the recent changes, £5,000 is still a relatively small threshold given the drastic consequences of bankruptcy. We will wait to see the implementation of these plans and the reaction of the court. However, as the threshold is effectively a pre-assessment of the appropriateness of the bankruptcy process, the courts may be less likely to intervene on a debtor’s behalf. In the meantime, creditors should be considering their debtors’ list for debts worth less than £5,000 and deciding which bankruptcy petitions should be issued prior to October 2015.

The changes to bankruptcy also offer an opportunity for insolvency practitioners to expand their bankruptcy practices. While sometimes viewed as the poor cousin to a commercial insolvency practice, it is clear that with the smallest bankruptcies weeded out, the technical skills of insolvency practitioners will be put to good use dealing with bankruptcies. This is especially the case given the changes to the law which may catch the less wary practitioners out.

This article was published in Recovery journal in May 2015.