As UK PLC braces itself for a financially turbulent time, it is an opportune moment to consider what the past two years have meant for Joe Public and to contemplate what the future holds for those carrying unmanageable levels of personal debt.
The UK is perceived to have one of the more debtor-friendly insolvency regimes.
During the early to mid-2010s, we experienced a significant increase in bankruptcy tourism, with the UK becoming the destination of choice for many Europeans looking to declare themselves bankrupt.
This was because the personal insolvency regimes in certain European countries were considered harsh compared to our own, which provided a much quicker discharge.
Over time, however, those countries have adopted simpler models to our own, with Germany, for example, reducing the duration of bankruptcy to three years from up to six years and Ireland to one year from three years (having previously been as long as 12 years).
The current personal insolvency numbers are, however, at their lowest levels since 2017, with both the numbers of bankruptcies and debt relief orders (DROs) declining since then, particularly since the onset of the pandemic. Bankruptcy numbers are at 50 per cent of pre-pandemic levels.
This is not, however, because there has been a decline in personal debt but is rather a reflection of the government measures introduced in response to the Covid-19 pandemic and the general forbearance extended by lenders in relation to enforcement, particularly HM Revenue & Customs, which traditionally is the biggest petitioner for bankruptcy.
A pent-up problem
What we have, therefore, is a pent-up problem, an accumulation of those who were already insolvent during the pandemic combined with those that are now insolvent because of it.
The National Audit Office estimated in September 2021 that over the course of the pandemic, 2.4mn more UK taxpayers had fallen into debt with the HMRC.
Following the chancellor’s recent spring statement, the Office for Budget Responsibility predicted that UK inflation could reach 8.7 per cent in Q4 2022, with real household disposable incomes per person reducing by 2.2 per cent in the next financial year – the biggest such reduction in more than 65 years, generated largely by supply bottlenecks, the impacts of soaring energy prices and the escalating seriousness of the situation in Ukraine.
Added to this, a gradual uptick in interest rates is loading additional cost onto consumers’ mortgage and credit payments.
While the Bank of England’s forecast is that the increase in inflation can be expected to be only a temporary spike, the reality is that it comes at a time when many consumers are already struggling to cope, and it may, therefore, prove to be the final straw for a great many people.
To exacerbate this, the restrictions on debt enforcement during the pandemic are now removed, leaving creditors able to petition for corporate winding-ups and potentially the bankruptcies of individual directors, with the Covid-19 protections having given many such individuals a false sense of security since March 2020.
> Creditors are generally sympathetic towards debtors who want to pay but cannot and seek a short respite or want to renegotiate terms
In addition, the widespread incidence of fraud identified in the claiming of the coronavirus support measures across many businesses may lead to numerous directors being held liable for fraud or misfeasance claims, thus increasing the potential personal insolvency numbers.
Individual voluntary arrangements (IVAs) have remained reasonably consistent at 7,000 a month, reinforcing the procedure as the debtor’s insolvency process of choice. But the official statistics fail to tell the full story.
Although debt management plans (DMPs) can be useful procedures to ring-fence debt to accommodate a short financial shock such as redundancy, it is not a long-term solution if individuals are carrying unmanageable levels of debt, when at best it will simply maintain the status quo and at worst result in individuals falling deeper into debt.
In such situations, debt management simply masks the problem and renders lenders and borrowers in financial limbo with no timely resolution in sight.
As a DMP is an informal arrangement, the numbers are unknown but are suspected to dwarf all other statistics.
Moreover, the UK personal insolvency regime has seen changes over the past 12 months.
June 2021 saw the maximum liability threshold for DROs increase to £30,000, and May 2021 saw the introduction of the Debt Respite Scheme (more commonly known as Breathing Space), an online process that allows individuals to apply for a period of grace of up to 60 days whereby no enforcement action can be taken (subject to a creditor’s right to appeal to the debtor’s advisor or potentially the court).
In 2019, the government’s impact assessment on the consideration of their Breathing Space proposals estimated that there were 9mn over-indebted people in the UK, and debt charity Step Change has since estimated that the number of struggling individuals has doubled over the duration of the pandemic, with a worrying number of people using one form of credit to pay for another.
> The key is preparing a sensible proposal that is attractive to creditors and offers a real incentive to the debtor to adhere to
The impact of social stigma and other anxieties is that all too often people delay seeking help for their financial difficulties, which often only exacerbates the situation in the form of increased debt levels or increased severity of collection activities.
Both changes signal a recognition that accessibility for what many consider is 'low-level debt' needed to be widened, and help for those experiencing creditor pressure should be formalised.
In reality, creditors are generally sympathetic towards debtors who want to pay but cannot and seek a short respite or want to renegotiate terms.
The issue is with those debtors who can pay but simply do not want to as it may involve tough choices such as downsizing or removing children from private education.
Those debtors will eventually find themselves staring down the barrel of a bankruptcy petition. Yet, sometimes, bankruptcy should be embraced rather than avoided.
Every case is obviously different but, in general terms, if a debtor has no assets and no prospect of repaying liabilities, then bankruptcy can provide an effective insolvency solution, with discharge after 12 months bringing release from the liabilities and an opportunity to regroup and rebuild.
For those with assets and surplus income, an IVA can be the most appropriate process for all stakeholders because the process is generally cheaper than bankruptcy and maximises the return for creditors, with contributions being made for a longer period. The key is preparing a sensible proposal that is attractive to creditors and offers a real incentive to the debtor to adhere to.
Insolvency numbers likely to rise
So, what does the future hold?
The maelstrom of factors – rising costs, rising interest rates, pressure on companies to cut costs and creditors having a renewed appetite for collection – will all impact the personal insolvency numbers. It therefore appears unavoidable that we will see an increase across all processes.
Moreover, the financial squeeze will impact household incomes, which may then result in the failure of large numbers of income-contribution-based IVAs currently in operation. This may again lead to an increase in bankruptcies and DROs.
If you are carrying unsustainable levels of debt or are being pursued for personal guarantees, what should you do?
The first step is getting good advice sooner rather than later.
Good advice will mean that you will fully understand the range of insolvency procedures available and the right one for your circumstances.
Face into the problem and do not bury your head. Fully document the extent of the problem and consider what assets can be realised to deal with them. Always talk to your creditors, explain you are having difficulties and the steps you are proposing to take to resolve them.
The outcome for debtors is almost always vastly improved if early action is taken by them to present viable and fair solutions to their creditors, as opposed to taking no action or insufficient action, which only places the onus on the debtor’s creditors to provide their own solutions to the problem.
Joanne Wright is a managing director in the restructuring advisory practice of Kroll
