Discharge, Yes...But, How Much?

In this post I will explain the extent of the discharge given to insolvent individuals under the new Spanish insolvency law. Different problems arise from the way it has been introduced, ranging from its extent to the differences depending on the nature of the debtor. As in other provisions, looking at the newly introduced discharge one receives the impression of some sloppiness in the amendment or, worse, window dressing. It is hardly believable that the discharge given could be a useful tool for individuals in difficulties, engaged in business activities or not. Some debts that should reasonably be excluded are included while others that should be rationally excluded are included.

If discharge is given, because it is the most effective way to achieve the rehabilitation of the debtor, which is the main purpose of any insolvency system for individuals (or, at least, one of the main purposes, see World Bank Report, par. 359), it should be one of its more carefully thought and drafted parts. I do not dare to decide whether it is the consequence of sloppiness or of window dressing, but the results are clearly inconvenient, in my opinion (and this opinion is shared by others, once again see CUENA, 2013).

Technically speaking, the designed discharged is characterized by two features. First, the discharge is given without a previous payment plan, i.e., after some time where the debtor must be paying some amount of money to the creditors. This earned fresh start is, as most of the readers already know, one of the most relevant differences between the US and the European countries models. The Spanish legislature has opted for what the World Bank Report calls a straight discharge, where no previous payment period is necessary. Second, the discharge is not defined using a list of exclusions, but rather listing the debts that must be paid for discharge to be given. It could be said that it is more or less irrelevant to define it by way of inclusion or exclusion, but the fact is that the approach of the Spanish law seems to have led to maybe undesire results.

Any individual debtor who meets the conditions for discharge (see the previous post) receives, automatically, the discharge of the unpaid debt, in case of liquidation, except (i) the administrative expenses, that should be fully paid; (ii) the specially or generally preferenced debts, that must be equally paid in full and (iii) 25% of the ordinary debt. In the end, the discharge given to ordinary individuals covers, only, 75% of the ordinary debt and any subordinated debt. My guess is that this solution is mainly useless. Anybody who had the ability to pay that amount of debt (after paying the administrative expenses!) would have been possibly able to reach an agreement with the creditors before filing for insolvency. Making the numbers, the impression is that the discharge will only be useful for somebody who probably does not need it (there is no statistics on how much is paid in liquidations, however, so no facts supporting this idea). Considering the figures of personal insolvencies and their evolution in the last years in Spain, this discharge will be given in a very small number of insolvencies, if in any. The question, obviously, is what happens to the debtors who are not discharged. Well, they will continue to be in the same position, remaining personally liable forever and living just with their non-seizable assets.

The position of individuals with business activity seems a little bit better, as the discharge includes all the ordinary debt, because both in article 178.2 and 242.2, 5º LC the remission includes every debt unpaid in case of liquidation, except government debts, administrative expenses and privileged or preferenced debts. The reader may have noticed that, in this case, the ordinary debts are fully discharged, but that there is an exception for government debts that is not present for individuals without business activity. Many of these debts are privileged in some form, so most of its part would have been anyhow excluded, but the provision could be relevant for subordinated government debts (fines and monetary penalties, which may represent a big part of this kind of claims). This difference is, however, not explained.

Leaving aside the role of government debts and their impact (balancing the wider extent of the remission), the impression to the reader (and to the up-to-date commentators) is that the debtor engaged in business activities receives a better solution or, at least, that the intention is to provide him (or her) with a more useful fresh start. Whether it is the consequence of an intention of favoring entrepreneurship or coincidence is just guessing, but being that the amendment was connected to a law of entrepreneurship with that former goal, it is easy to think that the legislative has tried to favor entrepreneurs with this different approach.

A final question that I would like to address is how the extent of the discharge is defined. The Spanish Insolvency Law does not use a specific definition for the debts included or excluded, but for the category of government debts. The article 178 relies on the generic categories used for classifying creditors in any insolvency procedure (with special or general preference, ordinary and subordinated, see articles 90 ff. of the Spanish Insolvency Law –the english translation is once again available here-). The system follows therefore the same approach as the one used for eligibility that I explained in a previous post and causes similar problems. In this context, however, they show more acutely, as the underlying policy principles seem to differ in a more evident way. Under the Spanish Insolvency Law, for example, alimony is not excluded from discharge, because they are not specifically considered under the classification. Or, even worse, they might be considered subordinated. In those cases where the creditor is a person specially related to the debtor such as an ex-spouse, see article 93. This approach, on the other hand, prevents disputes over the extent of the discharge independent from the one on the classification position of the claim. For instance, the provision makes it impossible to discuss whether fines should be excluded even if they should, generally speaking, subordinated to avoid its practical payment by the creditors (as it happens under the Spanish Law, see article 92).

The final impression on the Spanish discharge provision is not very favorable. Whether because it has not been meditated enough and the resulting rules lack of technical quality, or because there has not been an intention to define discharge in a useful way, the result is clearly unsatisfactory. The main question now is if traction to improve the new law can be found. The amendment was very difficult to achieve, and it might be very hard to convince anybody that what has been done is not what should have been done.