Doing bankrupts a favour

It cannot have escaped anybody’s notice that bankruptcy numbers in the UK have soared. According to figures from the OPEI, 36,000 people were declared bankrupt in 2004, an increase of 28% on the previous year.

Figures published earlier this month highlighted 10,091 bankruptcies in the first quarter of 2005, a 2.8% increase on the previous quarter and up almost 25% on the corresponding quarter of last year.

That upward trend is set to continue, raising questions about the effectiveness of the existing insolvency regime, and the Enterprise Act in particular.

It’s just over a year since the introduction of personal insolvency provisions of the Enterprise Act, and a number of interesting trends have emerged.

The rise in bankruptcies can be attributed to a number of factors, and although detailed analysis is needed to determine the relative effects of these, one significant reason for this is that the Enterprise Act introduced an updated approach to bankruptcy, which effectively made the procedure more appealing to debtors.

This may be more perception than reality – after all, the powers and duties of trustees in bankruptcy changed little under the new provisions. But a survey conducted by KPMG clearly shows that the stigma of bankruptcy, while still there, is fading fast.

In particular, the early discharge from bankruptcy – now potentially after only a few months as against three years under the old rules – is helping to make bankruptcy more attractive as a means of resolving personal debt problems.

The survey also highlighted a clear trend towards more people making themselves bankrupt, as opposed to being forced into bankruptcy by a creditor.

More than two thirds of all bankruptcies now result from people bankrupting themselves – the highest proportion ever. A key driver of this must be the trend towards bankruptcy being seen as a more acceptable way of dealing with debt difficulties.

A ‘once in a lifetime’ event occurred on 1 April 2005. According to our calculations, more than 42,000 bankrupts were automatically discharged on that day because of transitional provisions in the Enterprise Act.

Most people made bankrupt under the old rules, who would typically have stayed bankrupt for three years, were discharged from bankruptcy after just one year of the Act coming into force.

The aim of the earlier discharge for bankruptcy (in months rather than years) was to meet the government’s ideal of rehabilitating ‘innocent’ debtors and encouraging them to contribute once more to the economy as soon as possible. Our survey found that 56% of the general public still believe there is a social stigma associated with bankruptcy.

That figure is high, but it is well below an equivalent result in a survey conducted by KPMG two years ago.

One unfortunate but inevitable consequence of the new legislation is that some ‘culpable’ bankrupts have escaped punishment this year due to human rights legislation.

The Enterprise Act introduced Bankruptcy Restrictions Orders and Undertakings to help deal with ‘culpable’ bankrupts – those who in the eyes of the law have contributed to their own bankruptcy or who have been involved in one or more wrongdoings. These orders and undertakings can impose weighty restrictions, including a 15-year ban on running a business for the worst offenders, where the debtor’s conduct has been dishonest or they were in some way to blame for their bankruptcy.

But human rights legislation means that wrongdoings that took place before 1 April 2004 cannot be taken into account in determining whether or not an order should be made or an undertaking sought.

This potentially means that thousands of bankrupts have avoided the imposition of an order or have not been required to enter into an undertaking.

So far only 12 orders and undertakings have been sought, although more are in the pipeline. I fully expect that, in due course, the numbers of these orders and undertakings will be measured in the thousands each year.

Another provision of the Enterprise Act was the introduction of the fast-track voluntary arrangement (FTVA), designed to offer a simpler and less costly alternative to the traditional individual voluntary arrangement (IVA).

Under an FTVA, the official receiver is empowered to put debtors’ proposals to creditors for what is effectively a scheme or compromise. The benefit for debtors is that, although initially they would be subject to the bankruptcy process, their bankruptcies would automatically be annulled if an FTVA was approved.

Only a very small handful of FTVAs have been implemented since April 2004, however. Meanwhile, the number of traditional IVAs has increased by 50%. So far, FTVAs have spectacularly failed to have any impact or to achieve the economies of scale envisaged when the idea was first floated several years ago.

As is often the case, the UK seems to be following US trends in bankruptcy matters. Thankfully we have some considerable way to go before the UK matches the 1.6 million personal insolvencies that occur each year on the other side of the pond.

The various measures contained in the Enterprise Act, most of which are designed to rehabilitate bankrupts sooner rather than later, were certainly drawn from the US example.

Interestingly, since the Enterprise Act came into force in the UK, steps have been taken in the US to tighten some aspects of personal insolvency law. Those in the US who have, for some time, held the view that their personal insolvency laws have moved too far towards the debtor are at last having their voices heard.

Steve Treharne is head of personal insolvency at KPMG