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What happens when a bankrupt’s house has negative equity? This year’s changes to the Insolvency Act provide the answer. Adrian Hyde reports
This year saw the first major revision of the personal insolvency provisions of the Insolvency Act 1986 come into effect. On 1 April the amendments to the Insolvency Act came into effect through the Enterprise Act 2002. The key changes were small in number, but potentially significant in their effect. This article looks at two of them, and their impact.
The first significant change was in the provisions relating to dealing with the bankrupt’s residential property. Historically, a bankrupt’s assets have automatically vested in the trustee in bankruptcy upon their appointment, and remained so until they are disposed of. So, notwithstanding that a bankrupt was formally discharged from bankruptcy after three years, unless the trustee applied for this to be suspended, their assets remained vested in the trustee.
That, in itself, sounds like a laudable concept – the assets should be retained until the value has been realised for the benefit of the creditors. However, in the early 1990s, when property prices plummeted, many bankrupts found themselves with negative equity in their residential property. It was the first time that this had happened since the Insolvency Act had come into force and trustees dealt with it in different ways. Some agreed deals with bankrupts for their spouses or families to buy the trustee’s interest for a nominal amount. Others, however, retained their interest in the property, protected it by a caution or notice, and waited. These cases were then passed to the Official Receivers Offices’ Protracted Realisations Unit. The theory was that when the market picked up, these properties would be realised for the benefit of the creditors.
Now imagine the young husband and wife of the 1990s that now have two young children and need to move to a larger property, or the couple in their late 50s with £120,000 equity in their property and their eye on an apartment in Spain at £90,000 and no mortgage. As each tries to sell their property, they find the caution or notice, and shortly afterwards the cost of buying out the trustee’s interest.
Many former bankrupts have found themselves in this situation. One solution would appear to be to make a payment to the trustee to pay off the debts – in theory, bankruptcy debts from 10 to 15 years ago should be small, relatively speaking. But there are a number of other significant factors that must be taken into account. First, the Insolvency Act provides for statutory interest to be paid to creditors if the bankrupts’ assets are sufficient to pay the debts off in full. So, a £30,000 debt from 1994 equates to more than £50,000 today. There is also the ad valoremfee to pay – a levy on realisations that is used to fund the Insolvency Service. On a realisation of £50,000, the fee would be approximately £8,500. Finally, there are the trustees’ costs. All of this means that settling a £30,000 debt could easily require £65,000 to £70,000.
A practical alternative is for the former bankrupt to contact their creditors and make an offer directly to them. Most creditors look upon this favourably given the time that has elapsed – most institutional creditors have long since written off the debt and are grateful for even a small portion of it. The effect of this is to eliminate the debts, reducing the interest and ad valorem fees to a minimum, leaving only the costs to be settled. This can still be a relatively large sum to someone who was made bankrupt and then discharged many years ago.
From 1 April 2004, a trustee in a bankruptcy has three years from the date of the bankruptcy order in which to deal with the sole or principal residence of the bankrupt, their spouse, or their former spouse. The trustee must either seek an order for possession or sale, a charge over the property, or reach a deal to facilitate the protection of their interest in the property. In the event that this does not happen, the property revests in the bankrupt.
So what of those made bankrupt prior to 1 April 2004? Transitional arrangements mean that all bankrupts and former bankrupts will benefit from this change, so any relevant property will cease to form part of the bankruptcy estate on 1 April 2007 if it has not been appropriately dealt with. So, the cabinets of the Protracted Realisation Unit are open and the files of several thousand bankrupts are being distributed to insolvency practitioners around the country on a rota basis. Thankfully, however, once the task has been completed, this unexpected hardship will not arise again.
The second key change is to the period for which someone is ‘a bankrupt’. There was a great deal of publicity surrounding this change. Under the Insolvency Act, an individual was normally discharged from bankruptcy after three years. Under the Enterprise Act this has been reduced to one year. After one year the restrictions applying to trading and to obtaining credit no longer apply. While that is a significant change, records of the bankruptcy will no doubt remain with credit reference agencies and banks. In addition, the trustee can, prior to the bankrupt’s discharge, seek an order from him for a contribution to the bankruptcy estate from their income. These orders can last for up to three years from the date they are made.
The concern when the new provisions took effect in April was that it would make bankruptcy more acceptable and that there would be many more people making themselves bankrupt to avoid their liabilities, taking the easy way out. So, five months on, what do the figures show? The second quarter statistics, produced on 6 August, showed a 29 per cent increase in bankruptcies compared with the same period last year. However, independent voluntary arrangements, the alternative to bankruptcy, have also risen by almost 9 per cent. This seems to indicate that there is, in any event, an increase in personal insolvency problems, over and above any increase in bankruptcy that may be attributable to the changes in the legislation.
Is this the sign of things to come? With five interest rate rises since November last year, and a recent online survey of homeowners quoting 17 per cent of them experiencing some difficulty in making their mortgage repayments, it might well be. Despite concerns regarding the ease with which one can become bankrupt and be discharged, it seems that the real cause of increases in the numbers of bankruptcies is more likely to be a result of economic pressure and not a desire to shed one’s creditors.
Adrian Hyde is a partner and head of insolvency at Matthew Arnold & Baldwin