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Between Life and Death, Bankruptcy Style

posted by Elizabeth Warren

The Brits, in their understated way, are on the fast track to revolutionizing the balance between debtors and creditors.  With no public fanfare, the Ministry of Justice announced a plan for debtors to stop making payments on credit cards for up to a year if they had a change in circumstances, such as a job loss or divorce.  (BTW, job loss, medical problems and family break up are involved in 90% of US bankruptcies.) In effect, the debtor can stand somewhere between regular repayment and bankruptcy, getting the automatic stay, but not the discharge. 

There are no reports of mass heart attacks by lenders, no threats to halt all consumer lending, and no reported plague of locusts. 

During the time the debtor has the one-year stay in effect, interest will accrue, but not at penalty rates.  The debtor will have to show that he/she will be likely to resume payments at the end of the year. 

Britain is considering a place in between regular repayment and bankruptcy--a cessation in payments based on changed circumstances. There is some court intervention and some fact finding, but because there is no discharge, the intensity of the inquiry may be considerably less than there might be in a typical bankruptcy.

This move raises an interesting empirical question:  If debtors have a not-quite-bankrupt option, will total payments go up?  If they can suspend payments, but not get hit with ruinous penalty fees and penalty rates of interest, can they eventually pay off their credit cards?  If they can quit paying for a while, will they be able to stay current on home mortgages and car loans? 

To ask these questions is a reminder that the world we often describe as debtor versus creditor is, in fact, often creditor versus creditor.  Suspension of payment to one group of creditors may help another.  In fact, in some cases, it may mean more payments for everyone.   

If the British give consumers this option, the debt paradigm around the world shifts just a little.  No longer will Americans be leading the way on how to think about financial death and rebirth.  Instead, the new paradigm may be to think about how to help a debtor avoid death altogether. 

Comments

Note the concern of the PPI ("payment protection insurance") vendors....

Certainly will put the kebosh on any extension of credit to those who exercise this option. Looks like it will take a few years to determine the efficacy of the remedy. In the meantime what happens the price of risk to the credit card companies? Does this raise the rates for everyone else to cover the loss of income on a potentially bad debt lost in limbo for a year? Hard to believe the card issuers aren't in a hissy fit over this. Sounds like some really worried crooks when they give up breaking legs.

Credit card companies always claim that anything that lowers the yield of consumer loans will increase credit costs for everyone. Yet when these companies get a further expansion of their remedies, with concommitant shrinkage of the borrower's rights (such as the passage of BAPCPA in 2005), or the Federal Reserve lowers the lenders' borrowing costs, credit costs never go down. Sounds more like a rigged game of three-card monte than anything valid.

Sounds innovative. How can we stay on top of how this law will effects credit in UK over the next 36 months.

Greetings to all my American friends from Nottingham, England!

I thought I should try and offer you a British perspective on the reform flagged by Prof Warren's original post. To the few of us in the academic community who profess any interest in consumer bankruptcy this side of the pond the Ministry of Justice reforms are interesting but perhaps a little odd when set in a wider context and juxtaposed with other developments. They will also add further to the complexity (sophistication?) of our system.

The byline in the Times article 'Ministry of Justice announces the biggest shake-up in personal insolvency laws for years...' is hyperbole in the extreme. For starters, the Ministry of Justice doesn't have policy responsibility for bankruptcy law. This pleasure falls to our Insolvency Service which is an agency of the Department of Business, Enterprise and Regulatory Reform (known until recently as the Department of Trade and Industry). The Insolvency Service has promoted a number of reforms in recent years: (i) the Enterprise Act 2002, effective April 2004, which among other things, reduced the period to bankruptcy discharge from 3 years to 1 year; (ii) reform of the individual voluntary arrangement procedure (this is a bankruptcy alternative which involves creditor approval of a plan - in contrast to Ch 13 this is flexible in that assets as well as monthly contributions from income can be brought into the plan); (iii) the introduction of debt relief orders brought on to the statute book by the Tribunal Courts and Enforcement Act - the same legislation that introduced the enforcement restriction procedure referred to in the Times article.

As someone familiar with our bankruptcy system and with the background to all of this reform activity, a couple of things arouse my curiosity. First, our bankruptcy policy is not joined up. The Ministry of Justice - which has responsibility for the running of the courts - is sponsoring reforms designed to provide debt management and debt relief alternatives for consumer debtors. I won't go into the reasons how come this stuff ends up in their intray (let's just say it's path dependent) but there are powerful reasons for thinking that policy development regarding enforcement restriction and county administration orders should have been integrated and headed up by the Insolvency Service (I confess, I'm aligned with the Service - I sit as an external member of its Policy Evaluation Group - I can't say for sure but I suspect that there was something of a turf war between ministries!). Secondly, the general trend of policy is towards more administrative styles of bankruptcy: in other words, taking the courts out of bankruptcy. In its former incarnation as the Department of Constitutional Affairs, the Ministry of Justice favoured the view that the civil court system is about the resolution of disputes and seemed incline to think that uncontested applications for debt relief were a drain on court resource. So, for example, the Insolvency Service is currently consulting on a proposal to take debtor bankruptcy petitions out of the court system altogether. Similarly, the new debt relief order mechanism alluded to above - essentially a bankruptcy discharge for debtors who owe £15,000 (currently around US$29,375) but can't afford to file bankruptcy because of the filing fees (around US$1,000) - will be purely administrative. Seen in that light, it seems odd to persist with court-based mechanisms for debt management and relief.

Another way of telling the story is to see these latest reforms as the final stage in the creation of a sophisticated system which provides a menu of responses tailored to the needs of debtors whatever their financial circumstances. Once everything is in place we will have: (i) court approved payment plans for debtors who owe £15,000 or less (county court administration orders); (ii) a court approved partial stay on creditor enforcement (enforcement restrictions orders) which won't bar foreclosure or home lease forfeiture and won't impact Council tax (local rates) or future utilities payments; (iii) a cheaper form of bankruptcy providing a discharge after one year for debtors whose unsecured debts are £15,000 or less (debt relief orders); (iv) bankruptcy; (v) individual voluntary arrangements; (vi) simple individual voluntary arrangements for consumer debtors whose unsecured debts are £75,000 (US$146,873). Pausing for breath, I should add that we have a flourishing market which provides informal debt management plans to consumer debtors. So we have something for everyone: discharge, payment plans, payment holidays, solutions targeted at low-income debtors etc etc.

For what it's worth my hunch is that the Ministry of Justice reforms will operate at the margins, notably among the poor (as indeed has the existing county court administration order scheme which has been around since the late nineteenth century). Much depends on intermediaries and debt advice. The main conduit towards these schemes (and debt relief orders) will be the voluntary money advice sector used principally by poorer debtors. For the rest, there are now some big beasts in the jungle - volume debt management and individual voluntary arrangement providers with high media profiles - and anyone with debts and surplus income above a certain level who can make contributions that will cover their fees will likely continue down that track. None of these operators will have much to gain by popularising county court admin orders, enforcement restrictions etc.

If there is anyone out there still interested (!), my colleague Donna McKenzie Skene and I co-wrote an article on consumer bankruptcy law reform in GB (covering developments in Scotland as well as England and Wales) which was published at (2006) 80 Am Bankr LJ 477. It gives you most of the background.

Sorry folks - quick correction. The reference to simple individual voluntary arrangements in my previous post should read 'simple individual voluntary arrangements for consumer debtors whose unsecured debts are £75,000...or less.'

With just a temporary stay at best how does your govt. think that your court system will be less burdened if you do not stop the "run to the court mentality" to liquidate the debts owed? ie. mortgages, vehicles etc...? What happens with interest and penalties assoc. with payment plans if the debtors do not get discharges? Here a discharge doesn't mean the debtors do not owe the debt just that the creditor can no longer collect from the debtor or liquidate any of his or her assets. My take on the BK system is a little different because I'm here in Texas where property protection is written into our constitution. Portions seem to be like our debt consolidation companies that work outside of the Bankruptcy system. To me they are no more than handshake agreements with almost no force of law. Is there some provision in England’s law that brings in the competing parties under one set of rules or guidelines? I see that some BK debtors do get discharges but who decides what? Is it strictly income based or debt based? Anyway seems that your BK system as come along way from the Gueen Ann & King George days where death was a definite possibility.

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