It has long been standard practice for creditors to require some part of equity in property to be released and contributed by debtors who own such property and who enter into Individual Voluntary Arrangements (IVAs).
The debtor may already have anticipated this requirement and addressed any equity in their property in the IVA proposal. One of the benefits of an Individual Voluntary Arrangement is that the debtor does not usually lose their home which they will almost certainly do in Bankruptcy.
When a property owning debtor has not addressed such equity 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 independent valuation (and often two valuations) of the debtor’s property in the fourth or fifth year of the IVA. The debtor is further required to obtain at least one offer of re-mortgage and to contribute at least 75% (and sometimes up to 100%) of their equity to the IVA.
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 may be in negative or zero equity. The equity may be so small that that the cost of realization wipes 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 – 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 will not offer a re-mortgage at all and only ‘sub-prime’ lenders are willing to do so – but only at adverse interest rates, with the consequent long term effect 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 certainly 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 to address equity is frequently acceptable to them.
The insolvency practitioner (IP) supervising the IVA will advise the debtor on the options regarding addressing equity and creditors are generally sympathetic to debtors who are genuinely attempting to address their financial affairs.