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Revisiting 'Debt Relief Orders'

About The Author

Yasmin Daswani (Former Writer)

Yasmin is currently a third year law student at Durham University. Yasmin aspires to be a solicitor and is currently interested in criminal and family law. Outside of her studies, Yasmin is a passionate sportswoman; she is part of her university waterpolo team.

Following warnings that personal insolvencies are on the rise, the Insolvency Service has called issued a call for evidence to question the success of the current insolvency landscape. The consultation seeks to review two things. First, whether Debt Relief Orders have been effective and second, whether a change should be made to the bankruptcy creditor petition limit. The two questions will be analysed in turn.

Debt Relief Orders: a brief overview

Debt Relief Orders (DROs) were introduced in 2009 to offer those with very few assets and relatively small levels of debt a simple process to obtain debt relief. They were conceived to address the gap in provision of debt relief. Debt management plans and individual voluntary arrangements were only possible in cases where an individual had surplus income. Meanwhile bankruptcy required a debtor to pay a £705 upfront fee. DROs were introduced to provide debt relief to those excluded from the existing procedures, and are relatively cheap at just £90. Given that more than 300,000 people with severe debt problems are unable to afford bankruptcy fees, this alternative resolution is of paramount importance.

The Issues

DROs are currently only available to those who owe less than £15,000 and have assets worth less than £300. This has meant that only 3% of the 17,929 bankruptcy cases this year were able to benefit from this substitute insolvency procedure. The insolvency association, R3, has therefore suggested increasing the debt level to £30,000 and the asset limit to £2000.

One type of person who would benefit from a higher DRO threshold is someone like Michael, who was working until he suffered from an unforeseen tragedy. Michael, a chef in Chatham, Kent, had a heart attack and was subsequently made redundant.  As a married man with a four-year-old daughter, he ended up with payday loans and credit card debts as he struggled to support his family. When he finally went to the charity, Christian’s Against Poverty (CAP) he was unable to afford the £705 needed for bankruptcy. Since he owed £19,000 he was ineligible for a DRO. Michael was relatively fortunate, as a CAP member was able to help him out, however others in similar positions have found it harder to get out of debt.

Yet widening the scope of DROs does have its shortcomings; Bev Budsworth, managing director of The Debt Advisor in Manchester, identifies that: 'there are a lot of bankruptcy tourists – particularly from Poland – at the moment. You'd see a lot more bankruptcy tourists coming over if the DRO limit goes up.' Bankruptcy tourism is prevalent in the UK due to the relatively lenient laws here in comparison to other European countries. Foreigners establish a life in the UK just long enough to undergo the bankruptcy process. This is problematic as it creates a burden on our legal system, and uses tax-payers money (as DROs are heavily subsidised). Yet there are ways of reducing bankruptcy tourism in the UK. Currently, anyone residing in the UK can discharge bankruptcy within a year. Increasing this time period to two years would allow people to discharge the debt in a relatively short period of time, whilst also making tourists think twice before deciding to go bankrupt.

Given that the lives of honest people are being put under considerable pressure due to the narrow scope of DROs, adopting the recommendations made by R3 is therefore an effective solution. If the debt level is raised to £30,000 and the asset limit to £2000, it is estimated that 23% of bankruptcy cases will be eligible for DRO. 

Bankruptcy: a brief overview

Every bankruptcy starts with a petition presented either by the creditor or debtor. A person can only be declared bankrupt when they are insolvent. This means that their unsecured debts outweigh their assets (including property and vehicles).

Since 1986, the minimal amount of debt a creditor needs to be owed in order to petition the court for a debtor’s bankruptcy has been £750. A creditor can petition the court in two ways.  First, a ‘statutory demand’ (a written request for payment) may be served on the debtor for the money due, which the debtor has to pay within 21 days. Alternatively, a creditor can rely on an unsatisfied execution of judgment. This is when the court has given a creditor permission to recover the debts, but they have been unable to do so (i.e. if the bailiff was unable to seize enough assets to clear the debt).

The Issues

The petition limit of £750 has not risen in line with inflation, thus creditors have inadvertently been given an enforcement option over low-level debts, which Parliament had not originally intended them to have. This is problematic because although bankruptcy is an effective way for an individual to erase their debt obligations, there are long-lasting consequences. When a bankruptcy order has been made, all assets (including the family home) can be sold, the debtor’s bank account is frozen, and the bankruptcy details are listed on the Insolvency Register (which all members of the public can access online). Significantly, the bankruptcy order can remain on the debtor’s credit report for six years, making future borrowing difficult and expensive. Mortgages, car finances and even phone contracts can be difficult to obtain.

Furthermore, as mentioned previously, bankruptcy is an expensive way of recovering low-level debts. Bankruptcy is a judicial process that requires fees to cover the actions by the Official Receiver, the court and any solicitors; there is a real risk of costs escalating quickly. An exemplary case was provided on BBC Newsnight, where a couple who owed just £7,000 ended up paying £100,000 after the fees charged for bankruptcy were taken into account. For creditors in low value cases, bankruptcy is therefore largely ineffective as the fees may end up costing more than the debt recovered.

Business Minister, Jo Swinson claims that:

[B]ankruptcy has serious consequences and there is a strong argument that bankrupting someone for a debt of £750 is no longer fair or reasonable, especially when there are often alternative cheaper ways for those owed money to seek repayment.

This statement is supported by research done by the Insolvency Service; if the bankruptcy petition limit had risen annually in line with inflation it would now stand at: £1,700. The Insolvency Service further claims that a limit set at nearer £2,000 would have removed 400 cases from the bankruptcy process last year, a figure that equates to 3% of all cases brought in 2013/14. Given the severity of the consequences and the shockingly high number of people in debt, the current £750 limit seems disproportionately low and out of touch with the reality of the debt situation in this country.

In my opinion, however, £1,700 is not a high enough threshold for ruining someone’s credit ratings and potentially even forcing them to re-mortgage their house. In addition, given the severity of the consequences of bankruptcy, a 3% reduction in creditor petitions is unimpressive. Other countries have recently revised the petition levels; the Republic of Ireland, for example, raised its creditor petition limit to £15,900 in 2013. Whilst it is important to protect creditors from individuals dumping high debts, bankruptcy should only be used as a last resort.   An alternative suggestion is fixing the creditor petition levels to the DRO debt level of £15,000, thereby ensuring that there is no gap in the provision of debt relief. Increasing the petition level to £15,000 is estimated to decrease the number of creditor petitions by 42%. 

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Tagged: Banking & Finance, Commercial Law

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