There have been a number of smoke signals in the last few months around the increase of consumer debt in the UK and a focus on those firms providing consumer credit across the credit spectrum but particularly in the "sub-prime" or "near-prime" space.

Since the credit crunch, a number of consumer credit businesses have stepped in to fill a gap in the lending market. They give sub-prime or near-prime borrowers, who may find it difficult to obtain credit from traditional sources, with high-cost, short-term credit - instant access to funds.

The availability of this type of credit (often at the click of a button and with very little human interaction), combined with attractive returns, has led to a surge of new participants into the marketplace - both new borrowers and new lenders. While this has created greater choice and availability, it has caused the UK regulators to keep a close eye on the sector to ensure the lending practices remain fair.

This article presents a snapshot of the insolvency regime around consumer credit in the UK and the particular challenges for insolvency practitioners appointed to restructure a consumer credit business.

Financial Conduct Authority

Since 1 April 2014, the FCA has been responsible for regulating consumer finance in the UK. The FCA’s criteria for authorisation are more stringent than those of the previous regime under the Office of Fair Trading, but the FCA did introduce two categories of authorisation to distinguish between higher and lower risk activities:

  • Limited permission applies to less risky activities (such as consumer credit lending where the main business is selling goods and there is no interest or charges)
  • Full permission applies to higher risk activities (such as personal loans, credit card lending, overdrafts, hire purchase and debt collecting)

Since the introduction of the FCA consumer credit regime in 2014, firms have had to adjust to a more complex set of rules and principle-based regulation under The Financial Services and Markets Act 2000 (FSMA), The Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 and the FCA Handbook. In addition, the FCA has taken specific action in sectors where it considers that customers have not been adequately protected. Many of these changes (such as the introduction of an interest cap on providers of high-cost, short-term credit) have had a direct effect on the profitability and/or viability of consumer finance firms.

There is also now precedent for the FCA effectively ordering financial redress for wronged customers, which could have a significant impact on consumer finance firms. In addition, to redress some of the recent press around certain companies in the sector focusing on alleged lending practices, which could result in a significant fines being levied by the FCA if the allegations prove to be true.

Prudential Regulation Authority

The PRA's general responsibilities in this context are first to promote the safety and soundness of the firms it regulates (mainly credit institutions and insurers), and second to facilitate effective competition. The PRA recently expressed a number of concerns in lending practices in consumer credit in the UK as part of its statement on consumer credit on 4 July 2017. It cites particular concerns over a combination of continued growth, lower pricing, falling average risk weights and some increased lending into higher risk segments in credit markets.

Further concern is raised over the adequacy of management information and delayed recognition of credit losses. As a result, the PRA is requiring firms to provide evidence as to how they are addressing these concerns, specifically on credit scoring, stress-testing and prior consideration of a borrower’s total debt.

Automotive finance, which has been the subject of significant press coverage recently, is seen as a particular risk by the PRA and the FCA (particularly PCP products − personal contract plans) which finance over 90 percent of sales in the new car marketplace).

Insolvency Regime and FCA Consent

There is no distinct insolvency regime for consumer finance businesses although (i) there are some additional duties on officeholders appointed over consumer finance businesses and (ii) the FCA does have some limited involvement and powers in relation to FCA authorised businesses under Part XXIV of FSMA. The most significant rights and duties are that the FCA must provide consent before directors can file a notice of intention to appoint administrators or apply for an administration order. The FCA prescribes a form for use for the purposes of the request for consent which includes the nominated insolvency practitioner providing:

  • Confirmation that it has the required professional qualification and experience to accept the appointment
  • Commentary on their experience and expertise, including whether people with the relevant financial services experience will provide the necessary assistance
  • Indication of the purpose of the administration and express satisfaction that this purpose is reasonably likely to be achieved

The powers of the FCA in relation to insolvency processes of authorised firms are set out under Part XXIV FSMA and include allowing the FCA to:

  • Apply for an administration order or present a winding-up petition in relation to an authorised person, who is an appointed representative or is carrying on a regulated activity in contravention of the general prohibition
  • Challenge in court any decision or implementation in relation to a company voluntary arrangement
  • Apply for an order under Section 423 Insolvency Act 1986 (transactions defrauding creditors
  • Participate in insolvency proceedings, attend creditor meetings and receive creditor reports of an authorised person
  • Receive reports from office holders if they think a regulated activity is being carried on in contravention of the prohibition
  • Provide consent before directors can file a notice of intention to appoint administrators or apply for an administration order

Insolvency Practitioners

Every IP has a duty to report to the FCA if the relevant authorised persons act in a way that breaches the conditions of their permissions or carries out a credit-related regulated activity without the necessary permission.

(A) Special permissions

IPs must either seek direct authorisation from the FCA under the FSMA regime if they wish to provide the full spectrum of advice services, or alternatively, operate within the boundaries of a more limited statutory exclusion which is afforded to them. The exclusion for IPs operates such that where IPs are giving advice as an officeholder (i.e. acting as an IP in respect of a formal appointment under the Insolvency Act) or in the context of their pre-appointment obligations, and are doing so in reasonable contemplation of acting in a formal capacity, they and their firms may provide debt counselling, debt adjusting and credit information services outside of the FCA regime1. Their recognised professional body2 will regulate the activities they conduct within this exclusion, and the advice they give is not considered to be activity regulated under the FSMA (provided they act within the parameters of the exclusion afforded to them).

These measures avoid duplication in regulation and assist the many IPs who exclusively engage in insolvency appointments. However, IPs who wish to offer broader advice services or offer non-statutory solutions themselves (including informal negotiations on behalf of consumers) will be conducting regulated consumer credit activities which require direct FCA authorisation. It also raises questions around upon whom an IP can reasonably rely in terms of the advice or other work conducted by others prior to the insolvency appointment.

(B) Potential pitfalls

Regulated credit agreements

It is very easy to enter into a regulated credit agreement. The definition3 simply says that a regulated credit agreement is an agreement under which a lender provides (i) credit of any amount (which includes, but is presumably not limited to, a cash loan or any other form of financial accommodation) to an (ii) individual or a relevant recipient of credit (which includes sole traders and unincorporated partnerships of two or three partners, not all of whom are corporates) and (iii) where the agreement is not exempt.

It is, therefore, arguable that if a debt is immediately due and payable, then giving a debtor further time to pay (and contractually agreeing to defer those payments) could create a regulated credit agreement where the debtor is an individual or "relevant recipient of credit”. However, there may be exemptions which can be relied upon.

Debt collecting by IPs

One of the main functions of any IP is to realize the assets of the insolvent company, including collecting any debts owed to it. After the IP is appointed, he is excluded from the need to obtain authorization for "debt collecting”4. However, complicated issues arise if the insolvent company has entered (perhaps unwittingly) into a number of regulated credit agreements without authorisation.

While the IP may be able to collect the debts due under those agreements, they may be unenforceable under FSMA 2000 without, for example, the court's permission. If the IP threatens to do something which it cannot, or gives a misleading impression to the debtor, it is likely that the IP is in breach of the Consumer Credit Sourcebook (CONC)5 and the IP’s actions may give grounds for the debtor to argue there is an unfair relationship within the meaning of Section 140A of the Consumer Credit Act 1974. IPs will therefore need to ensure they act within the law and do not assume they, or any third party, can collect debts due to the insolvent company.

Pursuing debts under regulated consumer credit agreements

If there is a regulated credit agreement, there are various post-contractual notices which must be served before further action can be taken. The types of notices depend on the type of agreement. For example, if a regulated credit agreement is a fixed-sum credit agreement for a fixed duration, a lender will need to send a default notice under Section 87(1) of the Consumer Credit Act 1974 (in the prescribed form) before taking steps to (for example) end the agreement early, recover possession of goods or land or demand earlier payment of any sum.

The lender must also send a periodic notice under Section 77A of the Consumer Credit Act 1974 at least every year. If a borrower falls into arrears, the lender will normally be required to send a notice of sums in arrears under Section 86B of the Consumer Credit Act 1974 within 14 days of the borrower's arrears, equally two monthly repayments. Further notices will need to be sent at least every six months while the borrower remains in arrears. There are serious consequences for non-compliance with these rules. For example, if a periodic statement is not sent then:

  • The agreement becomes unenforceable during the period of non-compliance
  • The borrower has no liability to pay interest and charges during the period of non-compliance

Conclusion

Owing to the interest UK regulators are showing in the consumer credit marketplace and the record levels of consumer credit in the UK market (against the backdrop of wage stagnation and the prospect of increasing interest rates), it seems highly likely that financially distressed situations will arise in this sub-sector. An understanding of the likely challenges and pitfalls when faced with a distressed consumer credit business and how to manage the interests of the FCA will be imperative when trying to find the right restructuring solutions for the business and all stakeholders involved.