On 22 May 2017, the High Court delivered judgment in favour of two homeowners, Paula and Colm Callaghan, allowing a significant write-down of their mortgage debt and rejecting a proposal by their lender, KBC, that the debt should instead be deferred or ‘warehoused’ for future enforcement.
The Callaghans had a mortgage with KBC for over €285,000 for their family home which was valued at just €105,000. The mortgage fell into arrears and the Callaghans sought to enter into a personal insolvency arrangement (PIA).
» The PIA proposed by the personal insolvency practitioner (PIP) involved a reduction of the applicable interest rate, an extension of the mortgage term and a write-off of over €165,000 of the borrowers’ debt.
» KBC proposed an alternative PIA involving a write off of a smaller amount (€15,000) of the debt and splitting the balance into two equal parts (of €135,000 each). One part would remain active and subject to repayments and the other part would be treated as inactive and placed in a ‘warehouse’ account carrying 0% interest. This proposal also gave the borrowers the right to continue to occupy the home for the rest of their lives but subject to the warehoused amount ultimately being enforceable by KBC.
The Circuit Court confirmed the PIA proposed by the PIP and rejected KBC’s proposal. KBC appealed this decision to the High Court.
The criteria to be applied by a Court in reviewing a PIA include that there is a reasonable prospect that the PIA will:
1. Enable a debtor to resolve his / her indebtedness without recourse to bankruptcy,
2.Enable creditors to recover the debts due to the extent the means of the debtor reasonably permit, and
3.Enable the debtor:
a.Not to dispose of an interest in, or
b.Not to cease to occupy all or a part of his or her principal private residence.
Baker J. observed that the test “constrains a court by considerations of reasonableness." Where a PIA is found to be reasonable, Baker J. held thatthe Court should not unduly interfere even if another equally reasonable PIAcould be formulated. The factors relevant to whether a proposal is reasonable are the means of the debtor, the likely return to the creditor, the likely return on bankruptcy as an alternative and the reasonableness of the PIA taken as a whole in light of the objective of the statutory scheme that a debtor should be facilitated to return to solvency.
In this case, applying the criteria, BakerJ. held the PIA proposed by the PIP did not unfairly prejudice KBC and againstthis, KBC’s proposal was not reasonable or fair to the Callaghans.
• Return for the Creditor
Baker J. was not satisfied that KBC had demonstrated that its proposal offered it a better return“albeit superficially the counterproposal provides a greater monetary return than the immediate write-down of more than half ofthe secured debt.” The inactive account would not bear interest for the lifetime ofthe mortgage and, due to inflation, the warehoused amount would have “no real value ” when payment fell due.
• Means of the Debtor
Against this, Baker J. considered that a proposalto warehouse an amount more than 125% of the value ofthe family home was not proportionate to, or reasonably derived from,the current income and capital assets or any future ascertainable means ofthe debtors. She was not satisfied that it was prejudicial to KBC to fail to take into account “hypothetical or future means for which there exists no present expectation.”
• Objective of the legislation
Baker J. held that KBC’s proposal while it may seem“attractive and to some extent benevolent” was capable of creating circumstances amounting to insolvency at the end of the mortgage term (which is contrary to the overall objective of the statutory scheme).
ALL IS NOT LOST FOR LENDERS - KEY TAKEAWAYS
Debtors are likely to rely on this judgment in support of write-off over warehousing solutions to personal debt. However, warehousing solutions proposed in appropriate cases which are properly formulated and evidenced can still be successful.
» The statutory scheme regulating PIAs affords a very broad discretion as to how PIAs are formulated. Importantly for lenders, Baker J. found that KBC’s warehousing proposal was permissible in principle, albeit she found it not to be reasonable in the particular circumstances of this case. Whether warehousing will be allowed in other cases will therefore depend on their individual facts and circumstances.
» A superficial financial comparison of ‘write-off v. warehousing’ options is not enough to convince the Court of the merits of warehousing. Lenders must provide evidence that warehousing offers a better return based on present or known figures “that offer a solution to indebtedness that is likely to be achieved ” (for example, a pension which might provide a lump sum on retirement) and not based on hypothetical future means of the debtors.