November 2012

A Debt Lifeline?

A Debt Lifeline?

Recent changes to the Debt Arrangement Scheme have increased its usefulness to debtors, while providing a means for creditors often to obtain more than they would in an insolvency

There is a common misconception that in times of economic hardship the use of formal debt remedies increases. This isn’t necessarily true. It is true to say that in such times there is a greater demand for such remedies, but what determines whether they are used or not is the legislative conditions that exist at the time.

For the Scottish Debt Arrangement Scheme the correct legislative conditions for increased use of this remedy were created with the introduction of the Debt Arrangement Scheme (Scotland) Regulations 2011. The Scheme has existed since 2004, but prior to the 2011 Regulations it had been plagued with problems such as not offering sufficient protection to debtors, and access to the Scheme being a postcode lottery.

The 2011 Regulations dealt with these problems by widening the gateway into the Scheme, and increasing protections for debtors. Since then, numbers have increased by 73%, from 1,910 programmes in 2010-11 to 3,319 in 2011-12.

How does the Scheme work?

The Debt Arrangement Scheme is a statutory repayment plan for debtors, not a type of personal insolvency. It was introduced with the Debt Arrangement and Attachment (Scotland) Act 2002 and provides a number of benefits for debtors who enter into debt payment programmes under the Scheme. These include not only protecting those in programmes from diligence and sequestration, but also freezing interest, fees and charges on the debts that are included.

Those creditors whose debts are included into programmes do have a say, much like they do in protected trust deeds, but where they fail to respond within the statutory notification period of three weeks, they are deemed to consent. Where they object, the proposals are then considered under a “fair and reasonable” test by the Accountant in Bankruptcy, in her role as the Debt Arrangement Scheme administrator. If she finds that a proposal is fair and reasonable she can set aside the objections and approve a programme.

Once in a programme, debtors are provided with a payment distribution service, which administers the payment and distribution of monies towards their debts for them. In addition to this, if during the programme a debtor suffers an income shock and loses over 50% of their income, they can obtain a payment break for up to six months whilst remaining in the programme.

Where a debtor has not applied to the Scheme, but fears they may be in imminent danger of enforcement action or someone raising a petition for their sequestration, they can intimate an intention to apply to the Scheme, in which case they receive up to six weeks’ interim protection.

The benefits of the Scheme do not stop there, however. Where a creditor’s petition for bankruptcy is being heard, it is possible for a sheriff to allow a continuation to allow an application to be considered, with sheriffs not being limited in the amount of time they allow for such continuations.

How is the Scheme being used?

As was intended, the Scheme is now primarily being used to deal with multiple consumer debt problems, and particularly to protect those debtors who have assets they wish to protect from sequestration and diligence, such as cars and family homes.

It is also increasingly being used by debtors trapped in the vicious cycle of payday loans, as a means of freezing interest and stopping the dangerous practice of having to continually roll over such loans.

However, it has also become an extremely useful tool for assisting debtors who have had petitions for their sequestration raised and are in court facing bankruptcy. How successful it has been in such cases is hard to quantify, but it can be said that the number of bankruptcies being awarded on the strength of creditor petitions was down in 2011-12 by 25% on the previous year, despite bankruptcies themselves only being down by 3%.

The Scheme is also increasingly being used to deal with business debts. In one recent case, we helped a large commercial property owner facing sequestration to protect not only his commercial assets, but also his personal assets from business creditors intent on sequestrating him. In another, we were able to put the owner of a small haulage firm into the Scheme, protecting not only his trucks, but his home and business and also the jobs of his six employees. Other programmes have been used to assist landlords and property developers where they have been sole traders.

Another emerging use for the Scheme is to provide protection to company directors who have provided personal guarantees for corporate debts. As was observed by Eric Baijal (“No guarantee of easy recovery”, Journal, April 2012, online exclusive), the use of such securities is on the increase by lenders, and correspondingly we are also seeing an increase in the number of debtors coming to us with liabilities they have acquired as a result of such guarantees.

What we find is crucial to such programmes being approved is ensuring that we work with both debtors and creditors to draw up plans that are credible and sustainable. We do have the benefit of being able to say to creditors that even in the longest running programmes, they will normally receive back within the first three years almost double what on average is received under a protected trust deed, with the prospect of more thereafter.

However, we are also finding that, through qualifying proposals by including discretionary conditions, access to the Scheme is being widened, especially where the repayment of debts would take longer than the maximum 10 years normally allowed.

Such qualifications can take the form of offering to increase payments at later dates where circumstances allow, and offering where other assets are available, to realise those assets within a timeframe that avoids distressed selling.

Future outlook

Going forward, the Scheme is now a key part of the Scottish Government’s strategy for dealing with the problem of personal overindebtedness, and has been heavily promoted with road shows and TV commercials, which is unprecedented in relation to other formal debt remedies.

The Government is also now committed to finding more ways to improve the Scheme and make it more effective, and in all likelihood it will become a remedy that will continue to grow in popularity, providing not only an alternative to personal insolvency for many debtors, but also a more measured and appropriate remedy in these difficult economic conditions.

First Published in The Journal Online, the journal of the Law Society of Scotland.

DAS: The debtor’s panacea to bankruptcy?

DAS: The debtor’s panacea to bankruptcy?

First published in Scottish Legal News

Historically, in Scotland, if you were facing a creditor’s petition for sequestration, there was little to be done. Options under the Bankruptcy (Scotland) Act 1985 were limited. You either had to show it was not competent to award sequestration, or you had to be in a position to repay the debt in full or offer sufficient security for it.

For such reasons, over the years the threat of sequestration has been an invaluable tool in the debt recovery toolbox, especially in relation to debtors with assets that could be put at risk. The threat of an expired charge or the delivery of a statutory demand for payment was often sufficient to motivate the debtor into action.

Since 2004, however, the effectiveness of these debt recovery tools has been eroded with the Debt Arrangement Scheme. Under current regulations, introduced in July 2011, not only is it possible to defeat a creditor’s petition by applying for a Debt Payment Programme, but it’s also possible to prevent one being raised. This could provide an explanation why even in the last year the number of sequestrations awarded on the basis of creditor petitions has fallen by almost 25 per cent, despite the total number of sequestrations in the same period (2011/12) only having dropped by just 3 per cent.

The Debt Arrangement Scheme, however, is much more than a bankruptcy stopper. Launched in 2004, it suffered from a slow start, but last year saw over 3,300 programmes being approved by the Accountant in Bankruptcy in her capacity as DAS Administrator.

It is unique in that it provides individual debtors with a multiple debt remedy that is not a form of personal insolvency and does not require assets to vest in a trustee. It also prevents creditors using diligence or sequestration once a debtor is in a programme and freezes all interest, fees, penalties and charges. Other features are it provides a payment distribution service and an intimation procedure which can be used to obtain six weeks interim protection to allow an application to be made. It also is increasingly being used for not only consumer debts, but also for business debts by sole traders, partners and company directors, where personal guarantees have been provided for corporate loans.

In one recent case we acted in, a client who owned commercial property of significant value was cited to appear in front of a sheriff to show why sequestration should not be awarded. We assisted him in securing a continuation to allow an application to be made to the Debt Arrangement Scheme, which eventually was successful. The petition for his sequestration was dismissed and he was able to enter into a repayment programme with his creditors, allowing his assets to be protected.

In another case, a sole trade who employed six staff and ran a haulage firm was able to protect not only himself, his home, his business assets, but also his business and staff’s employment by applying for a programme.

In all cases, whether its business or consumer, the key is pulling together credible offers for creditors and presenting them as such. As with protected trust deeds, creditors get a right to object, but where none do, they are deemed to consent. Where creditor objections are received, the DAS Administrator applies a fair and reasonable test to see whether she believes it should be protected or not.

Increasingly, we are finding the use of discretionary conditions in applications, such as proposing assets will be realised during the scheme, is widening the availability to more clients, particularly business clients who would not be able to repay their debts within a fair and reasonable time (ten years being the maximum period accepted). Such proposals, however, do tend to take more planning and professional expertise to put realistic valuations on property; where businesses are involved it’s also necessary to ensure proposals are realistic and credible and will assist the business in not only surviving but flourishing.

For creditors, however, although the scheme may make sequestration harder to secure, it does provide more attractive returns. Even in the longest running scheme, it is likely at least 30p in the pound will be received back within the first three years: few bankruptcies will pay so much. The added benefit in this is even after three years, if the scheme has not been completed, the debtor continues paying.

The scheme is also increasingly been seen as a possible tool in the Scottish Parliament’s toolbox that could allow them to use it more effectively and deal with the growing problem of payday loans. Consumer credit law and interest rates are out with their legislative authority, but debt isn’t and Govan Law Centre’s principal solicitor, Mike Dailly has drawn up a discussion paper proposing a new payday loan, fast track, DAS programme.

The future for DAS is bright: the Scottish Government have indicated they are fully behind the Scheme and consider it a growing success and one they wish to encourage as an alternative to bankruptcy and protected trust deeds. From what I can see, they have already achieved that and, for once, I share their optimism.

1,000s could go bankrupt as a result of law reform

1,000s could go bankrupt as a result of law reform

First published in Scottish Legal News

Alan McIntosh explains how the Scottish Government’s response to its Bankruptcy Law Reform Consultation will lead to thousands more debtors unnecessarily becoming bankrupt.

When the Scottish Government announced late in 2011 that it intended to consult on bankruptcy law reform, it came as a surprise to most who worked in the industry. The Bankruptcy and Diligence Etc (Scotland) Act 2007 had only been passed a few years earlier and part two of the Home Owner and Debtor Protection (Scotland) Act 2010 had only commenced in November 2010.

There had also been an announcement in August 2011 that the Scottish Law Commission had been asked by the Scottish Government to consult on consolidating Scottish Bankruptcy law, suggesting the intention at that time was to allow this much reformed area of law to bed in for the foreseeable future.

Then there was the announcement by the Scottish Government that it intended to consult on further reform to create a system suitable for the 21st century.

In its response to that consultation yesterday, however, it became clear although there a number of admirable reforms being proposed, at the heart of the reform agenda are changes that will not benefit debtors or creditors, but instead result in thousands of debtors each year being forced into sequestration in an attempt to address the funding crisis that the Accountant in Bankruptcy’s office is facing due to the Scottish Government’s policy of full cost recovery.

Public funding of the Accountant in Bankruptcy’s office is now at a 20-year low, with 40 per cent of cuts this year following on from 37 per cent of cuts last year. To address its current funding crisis, other than making cuts themselves, the AIB, has to find other sources of revenue. This is only possible in two ways: one is by increasing the fees it charges; and the other is by increasing its market share of the personal insolvency work it undertakes.

In relation to increasing its fees the AIB has already done this in relation to debtor application fees, where it raised the fee in June 2012 by 100 per cent from £100 to £200. This resulted in a 50 per cent decrease in the last quarter in the number of debtor’s applications being made. Fee increases, therefore, carry problems: the more they increase the more that is added to the cost of the remedy and the less people will use that remedy, resulting in falling fees and increasing costs per unit of work you undertake. It’s a vicious circle.

Increasing market share, however, provides more potential, although to do that you must compete with the private sector, except in relation to Low Income, Low Assets bankruptcies, where only the Accountant in Bankruptcy’s office is allowed to be appointed. In relation to other types of sequestrations, the AIBs office is the default trustee, meaning where a debtor chooses or cannot appoint a Licensed Insolvency Practitioner, the AIB acts. Previously the AIB had attempted to increase its market share of bankruptcies when part 2 of the Home Owner and Debtor Protection (Scotland) Bill was announced by proposing only they could act as trustee when the new route of certificate of sequestration was used. However, that proposal was controversial and a breach of competition rules and had to be dropped.

Since then, there has been increasing debtor and money adviser dissatisfaction with how the AIB treats debtors when they are the trustee and this has resulted increasingly in debtors appointing their own licensed insolvency practitioner. The main source of this dissatisfaction has surrounded the level of contribution the AIB agents are seeking from debtors once they are in place, whereas private insolvency practitioners can normally advise on this before being appointed.

In response to this, the Scottish Government have now proposed they will create a common financial tool which will harmonise the amount debtors will pay regardless of the remedy they use. This will allow debtors to know beforehand how much they will pay prior to signing up to any remedy and to that extent is a commendable proposal, although as the AIB will be deciding on the details of any financial tool, much of what is contained in the detail will be crucial.

Of more concern, however, is the proposal that a new statutory minimum dividend of between 35-50p in the pound be introduced for protected trust deeds. Protected Trust Deeds are voluntary, less formal type of personal insolvency in Scotland and over 9,000 people entered into them last year. They generally provide better returns for creditors than sequestrations and, although the majority only last 3 years, significant numbers do run for four to five years to allow debtors to buy out equity in their properties and pay additional amounts to satisfy creditor criteria for the deeds to be protected.

Legally, all Protected Trust Deeds in Scotland, therefore, are agreed to by creditors as they do get an opportunity to object. The effect of protection being legally all creditors are deemed to have acquiesced in the agreement.

Currently, the average dividend payable in a protected trust deed is approximately 16 pence in the pound. If the level of dividend is statutorily fixed at 35-50 pence in the pound, as opposed to it being agreed freely between the parties involved, the simple reality will be thousands of debtors each year will not be able to afford to such remedies and instead will have to enter more severe and damaging sequestrations. The alternative to this will be to enter into a Debt Payment Programme under the Debt Arrangement Scheme, which could see many debtors being trapped in repayments plans lasting up to 12 years.

This is only one feature of the current proposals being made by the Scottish Government and not all should be condemned, but it must be asked, as the AIB cannot act as trustee in Protected Trust Deeds, whether it is being proposed such criteria should apply to Protected Trust Deeds in the knowledge that it will kill off that remedy or restrict its use. The resultant effect being more will have to use sequestration and with the common financial tool, it must be in the AIB’s calculations that this will increase their market share of sequestrations and, therefore, their income from such work.

If this is the case and part of the strategy of the AIB becoming fully self-funding, the proposals must be condemned. A bankruptcy system that we all know will increase damage to the interests of debtors and creditors cannot be a system that is fit for the 21st century, nor can it be in the interest of the country as a whole to force more people into such a drastic remedy. If it’s not, then the question must be asked, why introduce statutory criteria into what is already currently a very popular remedy?