Personal Insolvency - only rich need apply?

After several years in the making, the Insolvency Service of Ireland (ISI) finally opened its doors to process the first applications under the new regime earlier this month. Almost immediately the ISI found itself at the centre of a major controversy following a broadcast intervention by Jim Stafford, one of the most highly respected insolvency practitioners in the country.

The gist of Mr Stafford’s now infamous contribution was to defend the retention of “trophy homes” by insolvent professionals. This, according to Mr Stafford, would be acceptable to banks on the grounds that to deprive them of these homes under an insolvency scheme might undermine their ability to preserve the income-generating capability with which to service their debts.

As Mr Stafford said: “A solicitor should have a bigger house… The same as for hospital consultants, people like that… As a PIP [Personal Insolvency Practitioner], I would be making a very strong case, for example, that a solicitor should have a bigger house that accords with his professional status in society, so that his neighbours and clients can see that, yes, this person is a good solicitor who is living in a good house.”

It is easy to see just how “ordinary” PAYE sector individuals in debt difficulty must be seething at these comments but, viewed from Mr Stafford’s perspective, his thinking is natural and refreshingly frank. That is not to suggest his comments are necessarily valid and the ISI was quick to issue a response in an effort to defuse the issue.

The Personal Insolvency Act 2012, as amended, states that a Personal Insolvency Practitioner is not required to formulate a proposal that requires a borrower to dispose of their interest in a Principal Private Residence (PPR) unless the running costs of staying in the PPR are disproportionately large. The professional standing of a borrower is not expected to be a factor in this assessment. Ultimately it is a matter for the insolvent debtor and creditors to agree a proposal.

Friel Stafford operates at the very high end of the personal insolvency business: individuals, typically with many millions of euros’ worth of debt usually tied in with significant business interests. Jim Stafford gets hired by these people precisely because he puts himself forward as a professional capable of negotiating the very best possible deal for his formerly wealthy clients with a natural aversion to returning to a PAYE lifestyle.

Of greater significance, however, is the damage the comments have wrought on the new regime. Certainly they have led to a deluge of negative reaction in the media if the following is anything to go by.

The system was set up by the Government to ensure that those PAYE workers with low incomes would not be able to engage a PIP. On the other hand, professionals with larger incomes, even if unable to meet all their payments, would be the ones who would be more attractive to PIPs. If you are a pleb, forget it. Unless you have a large income, and some assets, like an investment property, the new state-backed deals are not for you. Those who only have a family home, and little or no income, will not get a PIP to work for them. The Insolvency Service has been set up for former big spending professionals who bought buy-to-let properties and holiday homes and now can't meet the repayments. So now you know.

But this, and other comments of the type, seems unduly harsh. It’s worth reminding ourselves of the very definite benefits of the new regime from a debtor perspective.

First, there is the Debt Relief Notice provision. This allows individuals with low income and assets to write off up to €20,000 in debt once they satisfy the eligibility criteria following consultation with MABS. That is a massive concession to potentially many thousands of individuals.

But it is with the other two schemes on offer where the big issues lie. The Debt Settlement Arrangement scheme allows for partial write-off of an unlimited amount of unsecured debt; the Personal Insolvency Arrangement allows for relief on all debts – secured and unsecured – up to a maximum of €3 million of secured debt.

The principal difficulty with the latter two arrangements – as evidenced by the Stafford controversy – is that without the debtor being able to provide an upfront fee to the PIP, there is apparently little motivation for the PIP to enter into a process of formulating a scheme proposal – something that can be extremely complex and time consuming. Hence, the unfortunate perception that the new regime is largely the preserve of those who retain enough income and assets to avail of it (i.e. to pay to engage the PIP).

Ideally there should be some kind of formal recognition of the upfront work needed to be undertaken by PIPs in order to bring schemes to the proposal stage, particularly in relation to the PIA; this certainly presents a theoretical obstacle to individuals presenting their case to the PIP for consideration.

In practice, however, the merits of a particular individual’s case or otherwise should become more or less instantly apparent and the PIP will likely arrange for some fee front-loading from the first few payments into the arrangement.

Over time, we expect the process of formulating a scheme proposal will eventually become formulaic; we expect the first batch of PIAs to involve a great deal of work and some original thought but, perhaps after a few months, the vast amount of eventualities will have been covered and there will be repeatable and reusable principles and processes that can be followed.

It can be expected that early proposals will encounter opposition from a banking sector keen to disintermediate the new class of PIPs but we expect success rates will increase over time, particularly as a consensus emerges and as PIPs become more proficient and creditor realism increases. In England & Wales, acceptance rates for Individual Voluntary Arrangements (IVAs –UK equivalent for unsecured debt) started out low but are now running at 90 per cent.

In the early days of the England & Wales IVA, we saw PIPs charging upfront fees for the formulation of a scheme proposal but this practice was eclipsed by PIPs deducting fees from debtor payments in to the arrangement with no upfront costs for the debtors.

It has to be said there is the potential for an extra level of complexity in the Irish PIA over the English IVA, mainly because of the inclusion of secured debt, but the this additional work can simply be reflected in the fees taken from the debtor payments in to successful applications; whereas £1,000, to £2,000 maybe a fair reflection of the work involved in setting up an IVA, €4,000 to €8,000 may be a fairer reflection of the work involved in setting up a PIA.

In conclusion, we believe that the depiction of the new personal insolvency arrangements as effectively off-limits to the majority of distressed debtors is substantially wide of the mark – although it must be said that the Stafford intervention and associated fallout has done nothing to encourage individuals to be among the first to apply for relief.

Those who would criticize the new regime as being insufficient should examine what’s on offer in Europe for those who find themselves insolvent. Conditions for those in many European countries who find themselves bankrupt or insolvent have historically been notoriously severe. And while a number of countries have recently introduced U.S. Chapter 11-type commercial bankruptcy provisions to improve this, there is widespread bankruptcy tourism to regimes offering preferential treatment. The preference of England and Wales by bankrupt Germans is the most high profile.

As the IMF notes in a recent Working Paper on personal insolvency in Europe, what it calls “the unprecedented challenge of excessive mortgage debt” has prompted a number of European countries to introduce special legislation.

For example, Greece, Spain and Portugal have introduced special legislation to address unsustainable residential mortgage debt burdens on households. All approaches differ. While the Spanish regime allows financing institutions to opt into the scheme, banks’ participation is mandatory for Greece and Portugal.

Spain and Portugal allow mortgage debtors, subject to certain conditions and as a last resort, to transfer the mortgaged property title to the bank (or a government agency in Portugal) and obtain cancellation of the mortgage debt (up to the assessed value of the residence in Portugal).

Greece allows the court to grant a full discharge of the mortgage debt if the debtor repays up to 85 percent of the commercial value of the principal residence determined by the court over up to 20 years.

The IMF notes it is yet too early to assess the effectiveness of the Spain and Portugal regimes, but the Greek authorities are revisiting their framework due to its low rate of successful restructuring to date.

These variations show there is no consensus approach to what can be an extraordinarily complex issue. The new insolvency regime will take some time to work itself out and, consequently, something of a phony war can be anticipated, perhaps until the new year.