In my comments of July 2023 following, I reviewed the 2022 call for evidence in the UK on reform of the personal insolvency system. The Australian PJC Report of July 2023 has recommended that there be a comprehensive review of both personal and corporate insolvency. While corporate insolvency received some close review by the PJC, personal insolvency was considered only incidentally, although it did have a one-day focus at the Attorney-General’s ‘roundtable’ in March 2023.
I said that without us having to reinvent the wheel too much, Australia would be much assisted by that UK review, submissions on which closed in October 2022. See Call for evidence: Review of the personal insolvency framework – GOV.UK (www.gov.uk).
The outcome of that consultation has now been released Review of the personal insolvency framework: Summary of responses and next steps – GOV.UK (www.gov.uk), on 4 August 2023. It confirms my comments below that Australia would be much assisted by the analysis given in the UK Review, which, for the moment, I will leave to others to read.
Two comments I do make is that, one, while it purports to deal with business insolvency, it does not acknowledge the common intertwining of personal and corporate debts and assets in small business. Having all insolvency laws in the one Insolvency Act 1986 does not seem to overcome the ingrained policy and practice separation between personal and corporate insolvency law.
And two, it reports that the “most significant improvement that respondents from the insolvency profession and debt advice sector want to see is the introduction of a single gateway to access insolvency processes, supported by independent, regulated debt advice”. There are ideas there that Australia might consider.
Without us having to reinvent the wheel too much, Australia would be much assisted by the current review of personal insolvency being conducted in the UK, submissions on which closed a while ago, in October 2022. See Call for evidence: Review of the personal insolvency framework – GOV.UK (www.gov.uk).
While England has different personal insolvency options, and a one-year bankruptcy, the purposes of the regime largely accord with those of Australia, although the consultation asks about the fundamental purposes of the personal insolvency framework and whether the current UK framework meets those purposes. The UK consultation also raises more general issues that are live in Australia, including as to pre-insolvency advice and as to funding the cost of the system.
Australia has bankruptcy, and two non-bankruptcy options – Part IX debt agreements for lower income/asset/debt debtors, and Part X personal insolvency agreements for all debtors, the latter two allowing payments over time or by lump sum.
Bankruptcies comprise about two thirds in number, Part IX debt agreements one third, and Part X personal insolvency agreements only around 1%. All up, under 10,000 personal insolvencies for a population of 25 million, well below the ten year average of 25,000.
In the UK, debt relief orders (DROs) are broadly comparable with Part IX debt agreements, and Part IVAs with Australian Part X personal insolvency agreements.
English bankruptcies last one year, though the bankrupt may be the subject of a bankruptcy restriction order for misconduct. In Australia, bankruptcies last for 3 years, and can be extended by the trustee to 8 years.
Over recent years, UK bankruptcy numbers have also fallen dramatically and IVAs are now the primary insolvency debt relief remedy for both consumer and trader debtors. This much contrasts with Australia’s miniscule numbers of Part Xs. IVAs do offer a better return, in the order of 24c/£ with the repayment plans, in most cases, lasting for 5 years or more. Australian Part Xs last on average 18 months.
Without at all doing justice to the UK consultation paper, here are some extracted comments.
- “The current framework attempts to strike a balance, which has tilted in different directions at various points in history, between two aims which seemingly conflict with each other: the rehabilitation of debtors (the “fresh start” ethos) and the maximisation of returns to creditors (the “can pay, will pay” ethos). This has led to complexity within the framework and, it may be argued, confusion as to its fundamental purpose”.
- “The law does not seek to define a fresh start and there is little longitudinal research, such as empirical studies, on whether insolvency provides it”.
- The “can pay, will pay” ethos is reliant on the debtor holding assets or having surplus income which can be distributed to creditors. In contrast, the purpose of DROs is to provide debt relief, with no prospect of creditors receiving any return; bankruptcy provides limited returns. Only IVAs offer a better return.
- There are a number of measures to police the system and address the issue of moral hazard. The system differentiates between honest/unfortunate insolvents and dishonest/reckless insolvents through a range of criminal and civil sanctions.
- However “misconduct in insolvency is rare”, around 3% of bankruptcies resulting in a BRO.
Cost of entry – cross-subsidisation
It costs a debtor £680 to go bankrupt, and a creditor £990 to file a petition.
The fee generally provides part recompense for the Official Receiver’s costs, the remaining balance coming from realising assets in the estate; but as most insolvents have no or very few assets, a general fee of £6,000 is charged to all bankrupt estates as a cross-subsidy. Where the Official Receiver remains trustee, a 15% fee is charged on net realised income from all assets.
Despite the cross-subsidy, there is currently a deficit incurred in approximately two thirds of debtor petition cases and more than half of creditor petition cases.
Australia once toyed with a $200 filing fee for a debtor to go bankrupt, but the politicians reacted badly, and it did not proceed: see How low can we go – funding the insolvencies of assetless estates – Murrays Legal Cross-subsidies therefore apply, including it seems, within the bankruptcy industry itself, with one sampling showing up to one third of estates handled by private trustees being unremunerated.
There are approximately 5.59 million businesses in the UK private sector and of these 99% (5.54 million) are small businesses with 0-49 employees. Sole proprietorships are the most common legal form and represent 56% of total businesses.
While bankruptcy, IVAs and DROs are all available for sole traders, in order to save the business, the only ‘rescue tool’ available is an IVA, as this allows the individual to continue the same business after entering insolvency. Evidence suggests that most cases are not used for this purpose, as the majority of IVAs are consumer rather than trader based.
Australian small business represents around 97% of all businesses, with a rough composition of half corporate and half sole-trader/partnerships. Small business failures constitute upwards of 40% of all personal insolvencies. Part X agreements purport to allow a business to continue.
Intermingling of personal and corporate debt and assets
One issue not mentioned in the UK paper is the intermingling of personal and corporate debt and assets, such that, as has been said,
“personal insolvency regimes are often more relevant for entrepreneurs and small businesses. Indeed, the corporate vs non-corporate distinction in assets and liabilities is often blurred for small firms, either because lenders require personal guarantees or security – e.g. a second mortgage on the owner’s home – or because prior to incorporating and obtaining limited liability protection, entrepreneurs typically use personal finances …”.
UNCITRAL’s MSE Insolvency guidance also refers to the blending of personal and corporate debt, through personal guarantees and tax liabilities, often compounded by a lack of documentation of ownership of assets and sources of funds. As a matter of best practice, it proposes the concept of insolvency laws that resolve all debts of a business, however that business is defined in insolvency terms.
In relation to the UK’s 2020 CIGA reforms, the Post Implementation Review does talk of opening up the CIGA measures to be “more user friendly to SMEs” and to “strengthen the insolvency regime’s alignment with latest best practice principles”: see UK’s review of its 2020 insolvency law reforms, with Australia compared – Murrays Legal.
Barriers to entry
The consultation identifies at least three barriers to entry that may affect the debtor’s choice of procedure.
- Stigma: Some countries have redesigned their insolvency systems to minimise stigma, such as removing restrictions placed on insolvents, avoiding or repealing judgmental language and punitive measures in existing laws, such as by referring to the “debtor” as opposed to the “bankrupt”, or by reducing the restrictions placed on debtors. Australian laws do stigmatise, its federal constitution linking bankruptcy with treason, and other laws with criminal conduct. Bankruptcy imposes restrictions on employment.
- The cost of entry, mainly being the upfront costs of bankruptcy, which is prohibitive for some. Unlike the UK, and other countries, Australia has rejected the idea of imposing an up-front fee to go bankrupt. It is in the corporate sphere, where there is no government official receiver, that the cost of engaging a private liquidator is an issue.
- A lack of flexibility within the framework. That is the framework does not allow for easy transition between the different procedures as circumstances change. Likewise, although this does not seem to have been raised as an issue in Australia.
Single gateway and pre-insolvency advice
The idea of a single gateway for entry into an insolvency procedure, supported by independent debt advice, has been consistently put forward as an option, one which could “remove any self-interest from the advice that is given” by an IP. Different models are discussed.
In the UK, bankruptcy is the only formal insolvency procedure that a debtor may enter without first obtaining professional debt advice. In contrast, a debtor can only enter an IVA with advice from an Insolvency Practitioner, a DRO or (in the future) SDRP with advice from a regulated debt adviser.
Issues concerning the further regulation of debt advisers are discussed in the consultation, a live issue in Australia and the subject of recommendations in the PJC Report. UK debt advisory firms are required to be authorised by the Financial Conduct Authority before giving any advice to clients. Insolvency practitioners, however, are exempt from FCA regulation where they are giving debt advice and associated activity in reasonable contemplation of a formal appointment. There is “high profile marketing of [IVAs] as a debt solution” and there are concerns over the level and quality of information given to debtors. It has been suggested that this may incentivise IPs to recommend an IVA instead of other, sometimes more suitable, insolvency solutions.
 Design Of Insolvency Regimes Across Countries 2018 OECD Economics Department Working Papers No. 1504 by Müge Adalet McGowan and Dan Andrews, citing Berkowitz, and White, “Bankruptcy and Small Firms’ Access to Credit”, (2004) 35 RAND Journal of Economics; Cumming, “Measuring the Effect of Bankruptcy Laws on Entrepreneurship across Countries”, (2012) 16 Journal of Entrepreneurial Finance).