In trying to deal with personal insolvency it is almost inevitable that the debtor will have to consider the two principal solutions available in the U&K, namely entering into an Individual Voluntary Arrangement (IVA) or petitioning for Bankruptcy.
Of course there may in certain circumstances be other more favourable options open to the debtor but they mostly fall into the category of the kindness of strangers or of the generosity of a family member. In reality, since doing nothing is not an option, most people will have to opt for one of the twin pillars of British legislation governing the resolution of personal insolvency. Ultimately, regardless of the quality or quantum of advice sought, it will fall to the insolvent party to decide which route to choose.
Before making that fateful decision, the debtor really ought to weigh up the pros and cons of each solution from their own personal perspective while bearing in mind that other interested parties, particularly creditors, may take a different view of the matter. Let us look at the benefits of an IVA first.
An IVA provides the insolvent debtor with relief from their debts while enabling them to repay as much of their debt as possible to their creditors. It avoids the stigma of bankruptcy with its associated disabilities, restrictions and obligations while at the same time it enables the debtor to keep better control over assets by being able to retain their home and car. He or she can retain their employment or if trading on a self-employed basis, they can often remain in business for the full term of the IVA, leading to higher returns for creditors.
An IVA is binding on all creditors, including dissenting creditors, provided the IVA proposal is supported by 75% or more of voting creditors, as measured by value. From the point of view of creditors, an IVA is likely to yield a higher level of realizations than in bankruptcy, and the administrative costs of an IVA are considerably lower than those in bankruptcy. These two factors lead to higher returns for creditors. The debtor is subject to less publicity in an IVA and avoids the mandatory publication in newspapers and other periodicals which is standard practice in bankruptcy. Should the debtor’s circumstances change significantly over the duration of the IVA its terms may, with the agreement of creditors, be changed.
There is minimal and reducing court involvement in an IVA and government policy has been to simplify IVA processes for the benefit of debtors and creditors alike. The administration of IVAs is nevertheless highly regulated. The insolvency practitioner’s activities are subject to monitoring and auditing by his or her own regulatory body which wields considerable powers of sanction for non-compliance. The insolvency industry as a whole is governed by the DTI with oversight review by the OFT on behalf of the consumer.
Once an IVA is approved, creditor contact with the debtor ceases, interest on all unsecured debts is frozen and penalties are stopped. All debts are dealt with and written off in a known and finite time period, usually five years. In most IVAs the debtor makes affordable monthly payments out of disposable income and may have to contribute a lump sum if he or she owns property which is in positive and realisable equity. A short term IVA may be approved by creditors where the debtor has little or no disposable income but can offer a single one-off lump sum payment, with the funds usually coming from the proceeds of the sale of assets or through the assistance of a third party such as a family member.
There are also some disadvantages with an IVA. The insolvent debtor has to pay the set-up, supervision and disbursement costs of the IVA. There is no time related automatic discharge from an IVA similar to what is available in bankruptcy. The duration of an IVA during which payments must be made is usually five years versus a maximum of three years in bankruptcy. If the IVA is not approved, creditors are free to pursue other legal actions such as petitioning for the debtor’s bankruptcy, obtaining court judgments against the debtor or registering charges on the debtor’s assets. A high level of creditor agreement is needed to approve the IVA. At least 75% by value of the voting creditors must accept the debtor’s proposals for the IVA to be approved.
Creditors also may insist on modifications to a debtor’s IVA proposal which usually have the effect of increasing the debtor’s monthly contributions. Creditors often curtail the debtor’s allowances for living expenses to a greater extent than what is allowed in bankruptcy. The increased financial burden on the debtor may cause the IVA to fail during its term of supervision if the debtor is unable to sustain the enhanced level of contributions demanded. For the last number of years creditors have used the services of voting agencies to act aggressively on their behalf at the meetings of creditors where IVAs are accepted or rejected. These agencies seek to maximize the dividend yield from the IVA on behalf of creditors. They do this by seeking enhanced contributions from the debtor and by reducing the fees of the insolvency practitioner (IP). This two-pronged approach increases the probability that the IVA may fail in supervision, if the debtor is unable to sustain payments, and makes the IVA less commercially viable for the IP. Using such voting agencies adds costs to the IVA process but creditors may feel that efficiencies achieved and increased debtor contributions result in higher net dividend yields.
The debtor is prohibited from engaging in any further borrowing during the life of the IVA, except with the express permission of the supervisor and creditors. The debtor will suffer the consequences of a poor credit rating even after completion of the term of the IVA with his or her name continuing to appear on credit files, as maintained by the credit reference agencies, for six years from the commencement of the IVA or from the date when the default was first registered.
Let us look next at the benefits of bankruptcy. Commencing the process is quite easy since insolvent debtors may petition for their own bankruptcy. Creditors may also petition for a debtor’s bankruptcy. The cost of petitioning is low – approximately £700 at present. No other legal costs are incurred. Citizen Advice Bureau officers and Court officers can assist the debtor in completing relatively simple forms and submitting them. The debtor is automatically discharged from bankruptcy after one year, provided it is a first time bankruptcy. Most, if not all, debts will not survive the bankruptcy. All further contact between the bankrupt debtor and creditors ceases with the debtor enjoying the consequent reduced stress and worry.
The duration in which the debtor has to make contributions is limited. Income Payments Orders (IPOs) and Income Payments Agreements (IPAs) are limited to three years and in many cases no IPO or IPA is applied where the debtor’s disposable income is deemed to be too low. The debtor enjoys more generous I&E allowances than are allowed in an IVA and thus is left with more income on which to live, although this advantage has diminished somewhat in recent years.
There are also considerable disadvantages to bankruptcy. Historically the major disadvantage for most people is the stigma of bankruptcy with its associated disabilities, obligations and restrictions which make it difficult and sometimes impossible for the debtor to trade (commence or continue) or to obtain or retain employment. Bankruptcy can be a career breaker with many professions and trades imposing sanctions on bankrupt members of their organizations, including the ultimate sanction of expulsion. The bankrupt debtor also faces potential liability for any bankrupt offences he or she may have committed. The trustee has powers to challenge the validity of any prior transactions if they appear to be preferential or at an under-value. Some bankruptcy restrictions may be applied for between two and fifteen years.
In bankruptcy, the debtor loses control of his or her assets, and is likely to lose their home or their share of it. The debtor’s poor credit rating continues even after discharge from bankruptcy and their name will continue to appear on credit files which are maintained by the credit reference agencies for six years from the commencement of bankruptcy. The debtor cannot engage in any further borrowing before discharge without the express permission of the trustee. The biggest downside for creditors is that the higher costs of bankruptcy result in lower returns and in many bankruptcies, creditors receive nothing.
In reaching a decision, the insolvent debtor can tick the boxes that apply to him or her for both processes. If making the decision is still too difficult, it makes sense to consult with an insolvency professional who can clarify any remaining doubts, taking into account the individual circumstances of the debtor and particularly what the debtor wants to achieve in terms of paying back as much as possible of the debts, avoiding stigma and rebuilding credit worthiness.