Fourth Year Valuation & Beneficial Interest Explained Simply
It has long been standard practice for creditors to require of a debtor who owns property and who enters into an Individual Voluntary Arrangements (IVA) with them that he or she should take steps to release some part or even all of the equity in that property and to contribute all or some of the proceeds into the IVA.
The debtor may already have anticipated that creditors would insist on this being done and may have already addressed any equity in their property in their IVA proposal. One of the benefits of an IVA from the debtor’s perspective is that the debtor does not usually lose their home provided that they can address the equity appropriately and to the satisfaction of their unsecured creditors. In Bankruptcy loss of the debtor’s home is almost inevitable if there is any realisable equity therein.
When a debtor who owns a property fails to address any equity therein in their IVA proposal, the usual approach taken by creditors is to modify the IVA proposal requiring them to do so. The modification generally spells out how this is to be done and how much of the equity is to be contributed. Such a modification usually requires the supervisor to obtain at least one but usually two independent valuations of the relevant property in the fourth or fifth year of the IVA. The debtor is usually further required to obtain at least one offer of re-mortgage on the property and to contribute at least 75% and sometimes up to 100% of their share of the equity in the property into the IVA. Where the property is jointly owned, as is usually the case when the property is the marital home, then the question of the debtor’s equitable interest in the property arises and this is dealt with at the end of this article.
Every IVA is different from every other one and there can be significant variation in how different creditors require equity to be addressed. A number of issues may arise when the time comes for the ‘fourth year modification’, as it is frequently described, to be implemented. The property, at that point in time, might be in negative equity or zero equity. The equity might be so small that that the costs of realization would wipe it out. Even if there is some equity in the property, the debtor may find it impossible to obtain a re-mortgage for various reasons such as the credit crunch, a poor credit rating or lenders putting a cap on the loan to value (LTV) ratio for example. In addition, even when there is equity available in theory, it may be impossible to realize it in practice. It may also be that ‘high street’ lenders, who normally quote the best mortgage interest rates, will not offer a re-mortgage at all and that only ‘sub-prime’ lenders are willing to do so and then at adverse interest rates, with the consequent long term effects on the borrower’s finances.
What can the debtor do, given that failure to contribute an equity lump sum would depress the dividend payable to creditors significantly?
The usual solution is for the debtor to offer a variation proposal to creditors. Such a variation can simply request the removal of the ‘equity’ modification, allowing the debtor to successfully complete the IVA without making any equity contribution. If creditors were to accept such a variation, they would receive a dividend similar to that originally proposed but less than that required by the creditor modification. Alternatively, the debtor may offer a variation proposal offering to extend the term of the proposal for up to one additional year and to make additional monthly income based contributions in lieu of any equity in the property. While extending the arrangement by up to one year may not be attractive for the debtor or indeed for the creditors, it is probably preferable to re-mortgaging at adverse rates, which is likely to have long term negative financial consequences for the debtor. Creditors of course retain the right to reject or modify any variation proposals put forward by the debtor but extending the term, with additional monthly contributions being paid in lieu of equity, is frequently acceptable to them.
The insolvency practitioner (IP) supervising the IVA will advise the debtor on the available options regarding addressing equity and creditors are generally sympathetic to debtors who are genuinely attempting to address their financial affairs.
The term ‘Beneficial Interest’ is used to describe the equity in a property which belongs to the owner or part owner of that property. The marital home is usually but not always owned by the husband and wife or indeed by cohabiting persons on a 50-50 basis i.e. each party owns 50% of the equity in the property and if there is no mortgage or other interested party, each spouse or partner will own 50% of the value of the property. When this is the case, each of them can be said to have a beneficial interest of 50% of the value of the marital home or perhaps more accurately, of the net equity in the property. The split of beneficial interest however, need not be 50-50. Depending on circumstances it could be any mix of ownership e.g. 70-30 or even 100-0.
The term ‘Beneficial Interest’ is frequently used in the context of bankruptcy where the bankrupt person partly owns a property, often the marital home. In cases where there is little or no equity in the property the bankrupt may be able to buy back his (or her) beneficial interest in the property for a nominal sum, perhaps £1, plus any legal costs of the transaction. Such a buyback of beneficial interest prevents the Official Receiver or Trustee from doing nothing in regard to dealing with the property for several years and then revaluing the property just before the three years that are allowed for action have passed and taking any equity which may have grown in the property in the meantime.