First published in the March 2009 edition of SCOLAG.

Alan McIntosh argues Fergus Ewing’s new Debt Action Forum needs to consider making personal insolvency in Scotland more consumer friendly and increase protection for homeowners.

The traditional view in Scotland of personal debt, has been the debtor who becomes notour bankrupt, becomes embarrassed by their debts and should realise all their worldly assets for the benefit of their creditors and, hopefully, obtain their forgiveness.

Whether this should be the view in 2009 is debateable. Much has changed with regards insolvency and the stigma attached to it. It is no longer seen, necessarily, as something people should be embarrassed about, but rather as one of the unfortunate financial risks we all face in today’s society, the causes of which are as much out of our control as within it. Also, it needs to be questioned the desirability of such a legal remedy having such dire effects and carrying an embarrassing social stigma in today’s society. It was one thing this being the case, when even as recently as 1985, the number of personal insolvencies in Scotland could have been counted in their hundreds[1], but by the end of this financial year, that number could be closer to 20,000[2]. Also, is it fair the individual should bear the full burden of their downfall, when both the Government and the finance industry are, at least, partly if not equally culpable?  From the 1980s onwards, where the origins of this current credit crisis lies, Government done everything possible to deregulate financial services and encourage the growth of the consumer market (underpinned with vast amounts of easily accessible, unsecured credit).

The question now needs to be asked, as we enter the severest recession in 60 years, is whether the thousands of debtors who now find themselves in the position they do, partly as a result of the government and the finance industry’s actions and incentives, should face Dickensian style ruin?

One of the biggest dangers facing many normal working families in the years ahead is their large quantities of unsecured personal debt. It is not uncommon for these debts to equate to 1-2 times the debtor’s net annual income. That is, levels of debt that it should have been obvious to creditors, if not the debtors themselves (many of whom lacked proper financial skills), was ever repayable.

One argument, which has been advocated already by others in Scotland’s wider legal community[3] is personal insolvency is now primarily a remedy for consumers and needs to be modernised, like the sale of goods and contracts for and of services were, to make it more consumer friendly. This would arguably include new protections for debtors and their families.  Such protections could include the protection of the family home and the income of debtors’[4], ensuring they and their families are not forced into poverty.

Unlike many legal systems, however, Scotland’s bankruptcy laws have never treated the home of homeowners as an essential item, but as a realisable asset, to be used to swell insolvent estates for the benefit of creditors.

This may have been acceptable in the past, where the number of bankruptcies were small and social housing was more prevalent, but there is something nonsensical about a legal remedy, which treats the toys of a child as an essential item, but not the home the child lives in; or considers a personal computer or television to be something a debtor cannot do without, but does not afford the same consideration to where the debtor lives.

Although, numerous measures have already been implemented by both the UK and Scottish Government to prevent repossessions by secured lenders, little has yet to be done to protect debtors from losing their homes as a result of unsecured debts.

One possibility is for the Debt Action Forum to urgently consider a Dwellinghouse Exemption Act or provisions, exempting the principal residence of debtors, to some degree, if not completely, in sequestrations and protected trust deeds.

Such a measure may seem radical, but is commonplace in many other legal systems. In the USA, for example, Homestead Exemption provisions exist preventing the homes of debtors from being sold by unsecured creditors. In Texas there is no value to the property protected and in urban areas covers up to 10 acres[5]; In New York the home is protected up to the value of $50,000[6]; whilst in Alaska there is a $54,000 exemption[7]. Similar provisions exist in Canada and vary from province to province.

It would seem pointless for legislators, in response to the credit crunch, to take steps to protect homeowners from repossession, only for them to lose their home as a result of failing to pay a credit card or personal loan.

The vast majority of debtors who have accrued large amounts of unsecured debts were never cautioned, like they would have been with secured lending, that their home were being placed at risk, but for thousands of Scottish debtors, this is the reality they face as they now default on credit cards and personal loans.

The difficulty in measuring the true extent of this problem is although it may be possible to determine how many homeowners were sequestrated or signed trust deeds, it not always possible to determine how many of these resulted in the debtor losing their home. Trustees do not regularly force the sale of debtors’ property, although they have the power to. Most bankrupts “agree” to the sale.

As the credit crunch continues to unfold and the true extent of irresponsible lending becomes clear, there is now emerging a danger, for not only over indebted homeowners, but for the public purse, that it will have to mop up this overspill from toxic, unsecured, financial products.

Yet this is already occurring through the publicly funded Mortgage to Rent Scheme, which was initially set up to protect debtors from losing their homes as a result of repossessions. Under the current rules, the social landlord who buys the debtor’s home, with the assistance of a public subsidy, only pays the secured lenders up to the market value of the property or that which is secured over it, whichever is the lesser. Where there is equity, the debtor is only entitled to £8,000 (if under 60) or £12,000 (if over 60). This means often the full price is not paid, but the debtor gets to remain in the home as a tenant. Where, however, the debtor has been sequestrated or has signed a protected trust deed, the trustee is treated as a secured creditor and is paid the full equity. Effectively, therefore, where this Scheme is used for bankrupts to keep them in their homes, public funds are being used to pay the trustees fees and the debtor’s unsecured creditors.

In addition the availability of affordable, appropriate housing in the public sector is already scarce and Shelter has said the Scottish Government needs to make available up to 30,000 homes for rent over the next three years. These numbers may have to increase if the demand on social housing is increased as a result of bankruptcy.

There, however, is an opportunity, with a Dwellinghouse Exemption Act or provisions, to reduce the social affects of the deepening recession and the pressure on increasingly strained public resources.

If the principal home was exempt in bankruptcy, unsecured lenders would have to evaluate the risks attached to their lending more cautiously, especially if they realised they would only be able to recover unsecured debts from moveable assets. This is likely to promote responsible lending.

Another consequence may be debtors will also find it more difficult, even after the economy recovers, to access similarly large amounts of unsecured credit, with more lenders seeking securities for their loans. This will have a cautionary affect on debtors and will avoid the situation where one partner in a family runs up unsecured debts, unbeknownst to the other and is later sequestrated, placing the whole family at risk of losing their home.

It may even create a situation where our homes become just that and not speculative assets, which give people a false sense of wealth and encourage over indebtedness.