To Whom Do You Owe A Debt?

October 11th, 2008

Every time you pick up a paper it seems to be full of stories about the economy and a rising cost of living.  The buoyant economy over recent years led people to borrow to pay for the lifestyle they wanted, but now the bubble has burst potentially leaving loan repayments that cannot be met.  There are different ways of dealing with this situation, from an informal re-jigging of finances to more formal procedures such as bankruptcy and Individual Voluntary Arrangements (IVAs).  The following is a brief outline of the more formal approaches:

Bankruptcy

Bankruptcy is a legal status that can be a way of clearing debts you cannot pay.  When you are bankrupt your non-essential assets and excess income are used to pay off your creditors and at the end of the bankruptcy period most debts are discharged.  Bankruptcy usually lasts for a year although it is possible for it to be shorter or longer depending on how co-operative you are.  A court can declare you bankrupt by issuing a ‘bankruptcy order’ after it has been presented with a ‘bankruptcy petition’.  If you have no assets an Official Receiver will act as trustee of your bankruptcy affairs.  If you have assets an Insolvency Practitioner will be appointed to act as trustee and sell your assets to pay your creditors.

There are legal restrictions imposed under bankruptcy.  It is a criminal offence for an undischarged bankrupt to:

  • obtain credit of £500 or more either alone or jointly with another person without disclosing the bankruptcy;
  • carry on business (directly or indirectly) in a different name without telling all those with whom you do business the name in which you were made bankrupt;
  • be concerned (directly or indirectly) in promoting, forming or managing a limited company, or acting as a company director, without the court’s permission, whether formally appointed as a director or not.

The purpose of bankruptcy is to free you from overwhelming debts so that you can make a fresh start, subject to some restrictions and make sure your assets are shared out fairly among your creditors.

Whilst bankruptcy offers some advantages including the chance to make a fresh start and not having to deal with your creditors personally, there are disadvantages including:

  • If you own a business this could be immediately closed and any employees dismissed.
  • You will lose any assets of real value such as your home, life insurance and possibly your pensions.
  • You will lose any assets you may acquire during your bankruptcy such as any inheritances, insurance settlements and any growth in the value of your house.
  • All bank accounts and credit cards etc. will be closed.  Anything you might be leasing, or buying on hire purchase such as your car will be returned to the owner.
  • You could have some employment opportunities prejudiced and face rejection from many associations and societies.
  • A bankruptcy will appear on your credit record for 6 years.

Individual Voluntary Arrangement (IVA)

An Individual Voluntary Arrangement or IVA is a formal and legally binding agreement between you and your creditors to make reduced payments towards the total amount of your debt in order to pay off a certain percentage of what you owe.  Due to its formal nature, an IVA has to be set up by a licensed professional called an Insolvency Practitioner (IP) and the IVA itself must be presented to and granted by the county court.

Under an IVA, any interest and debt charges are frozen, creditors are prohibited from demanding additional payments and debts are normally deemed to have been settled after a fixed period of 5 years.

There are fewer restrictions with an IVA than with bankruptcy however there are also a number of disadvantages including:

  • You cannot leave out some creditors.
  • The Insolvency Practitioner will monitor wage slips regularly, if you earn more you may be required to pay more into the IVA.
  • The Insolvency Practitioner may request some of the equity in your property is released as part of the IVA deal with creditors.
  • Individuals may find it very difficult to obtain further credit either during or following an IVA.
  • An IVA will show up on a credit report for up to 6 years.
  • Failure to adhere to the agreed terms of an IVA can lead to bankruptcy.
  • IVAs are expensive as fees can run into thousands and will be taken from the initial payments before any money is paid to creditors.

How are pensions treated in a bankruptcy?

The main piece of legislation concerning pensions and bankruptcy is the Welfare Reform and Pensions Act 1999.  Prior to this Act coming into force there was great uncertainty as to which pension benefits would be safe from the Trustee in Bankruptcy. It depended on the type of pension scheme; whether there were protective provisions included in the pension documentation; how the protective provisions were drafted; and whether the bankruptcy occurred after the Insolvency Act 1986 came into force on 29th December 1986.

The position is somewhat clearer for those made bankrupt on or after 29th May 2000 following the introduction of the provisions in this Act.  In summary, all approved pension schemes, plus any state pensions, that have not yet come into payment will be protected from the Trustee in Bankruptcy under s.11 of the above Act.

Where however pensions have already come into payment it may be possible for the Trustee in Bankruptcy to apply to the court for an ‘income payments order’ claiming any income the bankrupt does not need to meet the reasonable domestic needs of the bankrupt and his family. The maximum length of an income payment order is 3 years and can only continue after discharge if the court so directs.

All pensions in payment, whether via drawdown or annuity and irrespective of whether the original benefits were built up under a personal pension or occupational scheme can be subject to an income payments order payable to the trustee in bankruptcy, apart from the following notable exceptions:

  • State Pensions in payment
  • Any benefits in payment that have been built up by contracting out of the State Earnings Related Pension Scheme (SERPS) or the State Second Pension (S2P)
  • A spouse’s pension in payment

So, what can be deduced from the above?  Perhaps it is that there is no easy way out of debt and it is important to review your finances on a regular basis to ensure that any potential problems are nipped in the bud before it gets to the point of going down a formal route.  Bankruptcy and IVAs are only two examples of the options which may be available to individuals in debt and you should seek advice from an appropriate source before making a decision.