The Insolvency Service- Call for Evidence: Review of the Personal Insolvency Framework

The Insolvency Service is gathering views on the effectiveness of the UK’s personal insolvency framework and is seeking evidence on whether it still serves the needs of debtors and creditors appropriately.

This briefing will summarise the issues being explored in the Government’s Call for Evidence. The purpose of this briefing is to gather views and evidence from members to relay to the Government and help demonstrate the urgent need for reform of the personal insolvency framework.

Please note that the review applies to the insolvency framework in England and Wales only.

Have your say

The Call for Evidence is a key opportunity to demonstrate the need for reform of the personal insolvency market. We are aware that IVAs have caused significant detriment to our member credit unions. As such, we are keen to gather a range of examples on the issues with IVAs, as well as any other issues you have identified with the personal insolvency framework. Once your thoughts have been collected, ABCUL will respond to this call for evidence and encourage the Government to proceed by changing the current personal insolvency framework.

To share your views on the issues discussed in this briefing and provide evidence of the need for change, please complete this survey by 12th October 2022. For any further information or support, please email policy@abcul.org.

Purpose of the Call for Evidence

The Government believes that a review of the personal insolvency framework is needed to ensure it is flexible, proportionate and meets the needs of the modern economy. There has been no substantive review of the entire personal insolvency framework in 40 years. As a result, the Government is undertaking this Call for Evidence to assess if the current set of insolvency solutions remain fit for purpose.

The Government’s review of the personal insolvency framework focuses on three key areas:

• The purpose and objectives of insolvency framework and the balance of needs between debtor and creditor.
• The current model of fees and funding for insolvency solutions, including payment arrangements of insolvency solutions and wider consequential costs.
• The effectiveness of different insolvency solutions, which considers motivations of debtors when choosing an insolvency procedure and the flexibility between the current solutions.

The Current Insolvency Framework

The Call for Evidence explores the three primary debt solutions available to individuals in bad debt: bankruptcy, Debt Relief Orders (DROs), and Individual Voluntary Arrangements (IVAs).

There will be a further debt solution introduced, the Statutory Debt Repayment Plan (SDRP), which will provide a statutory alternative to Debt Management Plans. The Government will be introducing the SDRP independently of this review of the personal insolvency framework.

The table below, replicated from the Government’s consultation paper, compares the requirements, duration, impact and cost of bankruptcy, DROs, IVAs and SDRPs.

Underlying Purpose of Insolvency Procedures

The paper considers the intended purpose of the personal insolvency framework to give debtors a ‘fresh start’ whilst maximising return to creditors. The current insolvency solutions were designed to balance the interests of debtors and creditors, to ensure those who ‘can pay, will pay’, but also giving individuals reprieve from the burden of bad debt. The Government is seeking views on whether the current personal insolvency framework continues to serve these principles in practice, and even whether these principles should continue to form the basis of the framework.

Debt relief: a ‘fresh start’ – It is important that insolvency solutions alleviate the burdens of bad debt for individuals in financial difficulty. It is recognised that the common causes of insolvency are not just poor money-management, but also circumstantial reasons such as  relationship breakdown, ill-health, loss of employment, addiction, or use of credit to supplement needs on low income. In this context, insolvency solutions can aim to fairly provide individuals with an ability to move on from their debts, i.e. a ‘fresh start’. The Government is seeking views if the current insolvency framework continues to deliver on the ‘fresh start’ principle.

‘Can pay, will pay’ debt collection – This principle aims to maximise returns to creditors to ensure that debtors repay what they can afford to. This is to protect creditors from losses, allow wider lending with lower risk, and ensure creditors are treated fairly.

Distinguishing reckless and unfortunate debtors – the paper acknowledges the moral hazard of differentiating between honest and unfortunate insolvents and dishonest and reckless insolvents.  The current framework has some measures to protect again reckless debtors: in cases where bankrupt individuals or those under a DRO are gambling or disposal of assets, they can be subject to civil sanctions of Bankruptcy Restrictions Orders (BROs) or Debt Relief Restrictions Orders (DRROs). These can potentially be escalated to criminal sanctions. BROs and DRROs were designed to deter the debtor from misconduct rather than seek to punish them, and currently they are only used in a small proportion of insolvencies. The Government is seeking views as to whether these measures are sufficient in deterring misconduct.

International Context – In addition, the Government provides some international perspective of the potential principles and aims to guide a personal insolvency policy framework.  In a 2016 discussion paper the European Commission stated that personal insolvency mechanisms should be affordable and encourage timely and definitive resolution. They state it should also offer the genuine possibility of a fresh start, encourage settlements with creditors, offer debtors affordable solutions, avoid disincentive effects for income generations e.g., repayment plans based on pre-defined payments not ‘excess income’, offer full debt discharge after a certain period. The OECD emulated these ideas and added debt counselling as important and believes honest/unfortunate insolvents should not be treated the same as dishonest/ reckless insolvents.

Fees, Funding, and costs

The four main areas of financial cost associated with personal insolvency outlined in the consultation are:

• Debt advice

Debt advice is essential to ensure the correct debt solution is presented to the debtor. Funding for debt advice comes from government, local authorities, charities, an FCA levy and self-funding. The Money and Pensions Service (MaPS) also offers free debt advice services.

The Insolvency Practitioner must provide some advice to those considering entering an IVA, debtors entering a DRO receive some debt advice from the Approved Intermediary, but there is no requirement to seek debt advice when applying for bankruptcy.

• Court proceedings fees

A court fee is paid by creditors wishing to petition for the bankruptcy of a debtor, in addition to the cost of the petition fee. Court petition fees have increased over time, most recently in September 2021 it rose to £302 from £280 during the period of 2014-2021.

• Fees and Costs Charged by the Insolvency Service

The Insolvency Services charges fees to cover the costs associated with their statutory functions and administration of insolvency solutions.

In the case of bankruptcy, the fee charged is designed to prevent cross-subsidy from asset-rich cases to asset-poor cases. Debtor application bankruptcy requires an application fee and a deposit to be paid to cover the initial costs of the Official Receiver.

For DROs, an up-front cost of £90 is charged to the debtor.

• Insolvency Practitioner’s fees and costs

Insolvency Practitioners will charge fees for the processing of both bankruptcy and IVAs, however there is huge variation in the structure and scale of fees charged. For a straightforward IVA, the average fees are around £4000. Fees for IVAs tend to be front-loaded, meaning that arrangements terminated in their first or second year result in most of the debtor’s payments being paid towards IVA fees rather than creditors.

The Current Framework’s Effectiveness

The use of insolvency procedures today – Bankruptcy was the most popular insolvency remedy until 2010 when rates decreased. It is believed the fall in rates is due to the cost to debtors and creditors, the introduction of the DRO procedure, and popularity of IVAs. IVAs are the most common personal insolvency procedure being used today. The graph below shows the number of bankruptcies, DROs and IVAs in England and Wales from 1984 to 2021.

Source: The Insolvency Service, January to March 2022, taken from Call for Evidence on the Personal Insolvency Framework.

The rise of IVAs and Associated Concern – The paper explores some of the incentives of entering IVAs. It is stated that the lower upfront costs of an IVA may incentivise debtors to opt for this solution, although the debtor may pay a large amount over the course of the arrangement compared to a DRO or bankruptcy. It is also noted that the stigma of bankruptcy also causes some debtors to opt for an IVA instead.

Many have raised concerns over the level and quality of information given to debtors, particularly regarding transparency of costs and suitability of other solutions. The FCA has raised concerns regarding debt packager referral fees where income is generated by passing customers onto certain debt solution providers.

The paper states that IVAs generally provide a better result for creditors than bankruptcy. Nevertheless, ABCUL are aware of the usually poor return that IVAs provide to creditors due to the high level of fees charged by insolvency firms. Whilst the paper considers some issues with the IVA market, these are not covered in the detail we would anticipate and we will look to highlight the extensive issues associated with this insolvency procedure in our response to the Call for Evidence.

DROs – Take up of DROs has not been as high as the Government originally envisaged, despite the expansion of eligibility criteria in 2021. Evidence shows that many IVA users would fulfil the current eligibility criteria for a DRO yet choose an IVA instead. The paper highlights research that found that individuals may choose bankruptcy over a DRO because they were close to the debt limit for a DRO, circumstances changing during the 12-month moratorium period and being unaware of DROs.

There is the further challenge that DROs offer no return at all to creditors, though these solutions are intended to provide full debt relief to those with low incomes and little assets.

Barriers to Entry –  The consultation notes that there are a number of barriers to entry that influence debtors choice of debt solution. The two key barriers identified are stigma and up-front costs of entering a procedure.  The Government further notes that the personal insolvency framework is inflexible between the different solutions. If circumstances change, and one debt solution has become more appropriate than another, it is extremely hard to transfer. Although not being consulted upon in this paper, the concept of a single gateway for entry into an insolvency procedure has been raised for discussion.

Debt Advice – The Government is looking for further evidence into the quality and impact of advice given to debtors before they enter a debt solution. It is raised that there are a number of concerns of the level of debt advice given to debtors entering IVAs. It is noted that issues with debt advice provision stem from Insolvency Practioners exemption from FCA debt advice regulation, and that this exemption may allow IPs to recommend IVAs over other more appropriate solutions.