Desperate times call for rational measures

Is bankruptcy a debtor's charter or a fair process for all? Frances Coulson looks at recent trends and considers what they mean for local authorities

The number of individuals becoming insolvent over the past few months has soared to historic highs, in figures released every quarter by the Insolvency Service.

Just over 35,000 people became insolvent between July and September this year, the highest quarterly figure since the Insolvency Service started recording figures in 1960.  This was an increase of just over 28% on the same period a year ago.  

Since 6 April 2009, individuals needing relief from financial impecuniosity now have an alternative to bankruptcy and Individual Voluntary Arrangements, namely the Debt Relief Order. This was a new form of personal insolvency introduced by the Tribunal Courts and Enforcement Act 2007.

In essence a Debt Relief Order (DRO) provides debt relief for persons who do not own their own home, have little surplus income (no more than £50), no major assets (other than possibly a car) exceeding £300 and less than £15,000 worth of debt.

The court does not become involved as the Insolvency Service runs the procedure in conjunction with approved intermediaries who are debt advisors. If a DRO is made, then it runs for 12 months and, just as in bankruptcy, debts are effectively "written off".

The Insolvency Service originally thought that up to 14,000 Debt Relief Orders would be applied for in the first year, but the true figure is going to be somewhat below that.

Significantly, the number of people applying for Voluntary Arrangements and obtaining the approval of their creditors has increased recently. This may have something to do with a New Individual Voluntary Arrangement Protocol, which major creditors are signing up to and there are clear indications that banks and other major creditors are becoming more understanding and supportive of these arrangements than in the past.

Signing the petition

Interestingly, approximately 85% of all bankruptcies are now petitioned for by the debtor himself. This is a major change from the situation in the past when bankruptcy was seen as a remedy for creditors to try and force payment of the debt. What is significant therefore is that many debtors (possibly driven by the recession) are taking their future into their own hands.

With this background, many creditors and those involved in the credit industry, think that the insolvency process has become far too debtor-friendly and it is "an easy way out" of debt problems.  

There is no doubt since the commencement of the personal insolvency provisions of the Enterprise Act 2002 (on the 1st April 2004) the so-called "stigma" of bankruptcy has reduced. Indeed this is one of the government's stated aims. The vast majority of debtors are now discharged from bankruptcy after one year (sometimes earlier) and a Trustee in Bankruptcy now only has three years to realise what is often a major asset in bankruptcy, namely the matrimonial home.  

Given the current recession, matrimonial home values are plummeting and this has caused considerable difficulties for trustees trying to realise a valuable asset for the benefit of creditors. Many bankrupts are finding that their properties are without equity and repossessions by building societies and other lenders are increasing. With this political background, is bankruptcy an effective debt collection tool for creditors?

Bankruptcy still a useful tool for local authorities

Many specialised debt collection solicitors still feel it is. It is a relatively quick process (there is no need to have a court judgment or go through court proceedings). A creditor can start bankruptcy proceedings if he has served a statutory demand and this has not been set aside during a 3 week period, following which he can issue his bankruptcy petition. This will normally be heard approximately 10-12 weeks after issue.  

It is not necessarily a cheap method of enforcement (the Official Receiver's deposit and court fees are much higher than standard County Court claim form fees), but there are still debtors who respond to the threat of bankruptcy with payment and that of course is the ultimate aim of any creditor.

It is now well-established law that a bankruptcy petition should not be issued if the debt is in someway disputed (and the debtor always has an opportunity if he thinks the debt is disputed to apply to set aside the statutory demand or defend the petition). Despite this procedure having been introduced almost 24 years ago, cases are still coming through the courts asking for a decision on whether bankruptcy is the right forum.

The test to set aside a statutory demand successfully is now well established. The debtor has to show that there is a "genuine and serious" issue. The most recent case clarifying this particular threshold was Collier v P&M J Wright (Holdings) Ltd (2007) EWCA Civ1329.

If a court finds that a creditor has wrongly issued a statutory demand or a bankruptcy petition, then it will normally award costs against that creditor (and in some cases even against the solicitors themselves on the basis that this is an abuse of the procedure).

There has been an interesting development in the area of local authorities petitioning for bankruptcy within the last year or so. The amount of money that is owed to local authorities in respect of a myriad of debts is well documented.  

Certain local authorities have therefore taken to using bankruptcy proceedings as a way of recovering, whether because the debt is then paid pre order or the trustee can realise a property in the bankruptcy. In particular it is used for recovery on liability orders that they have obtained against homeowners for unpaid council tax.

According to published statistics, local authorities in England and Wales account for more than 3,000 bankruptcy petitions per year. They also petition to wind up companies.

The Ombudsman gets involved

The Bankruptcy Registrars in London have indicated their disquiet about the use of insolvency procedures by local authorities and in some cases, once the bankruptcy order has been made, the Local Government Ombudsman (LGO) has become involved at the bankrupt's behest.

The first case where this procedure followed was a case of Ford v Wolverhampton City Council when Mr Ford (not his real name) was made bankrupt over non-payment of his council tax debt without the council considering all the alternatives. The sum involved was just over £1,000, but by the time the Ombudsman became involved the amount required to pay off the bankruptcy was around £38,000. The LGO criticised the council in not following "due process" in making him bankrupt.

More recently there have been similar cases when the LGO has become involved in Camden, Exeter and Manchester. It is certain that bankrupts will rely on these decisions by the LGO in negotiations with local authorities if proceedings are threatened.

Some authorities have taken this as an indication they should not use the insolvency route but that is just not so. Why should a persistent non-payer of council tax retain property at the expense of other taxpayers? If national taxes can be collected in this way (and they have been for many years), then why not local taxes which fund local services for all?

What these decisions are not saying is that local authorities cannot use insolvency procedures, but that they have to make sure they have a properly documented policy and that they follow it. In certain of the cases that came before the Ombudsman, orders have been sought against "vulnerable individuals".

Local authorities are, in the main, now taking heed of that and ensuring that they have a proper policy and that they look at the debtor’s individual position when considering whether bankruptcy is an appropriate remedy. They put clear time scales in place as a warning to bankruptcy and they consider whether other methods of enforcement are more appropriate.

It is hard to see why in most circumstances insolvency is not a proper route to use for local authorities. The audit trail of procedures must be in place and adhered to, to avoid being caught out in those cases where it clearly is not. If individuals who cannot pay their debts are encouraged to use debtors’ petitions to relieve themselves of debt, why is it so bad for a creditor to use the same process at the same time recovering funds due to it which actually is for the general local good?

With predictions that the number of insolvencies could reach in excess of 125,000 before the end of this calendar year, and the government and Parliament taking a keen interest in insolvency generally, it is doubtless an issue that is going to continue to hit the headlines.

Frances Coulson is a partner and head of insolvency at Moon Beever