Urgent reform is needed to drag our Victorian personal debt system into the 21st century, writes Caroline Madden

‘A MAN who pays his bills on time is soon forgotten,” Oscar Wilde once said, no doubt to glamorise his own rather relaxed attitude towards settling debts. However, it is those who can’t pay their bills who have been forgotten by modern Irish society. Despite the explosion in consumer credit in recent years, our systems for dealing with personal overindebtedness have not been modernised to reflect this change; they remain more suited to Wilde’s pre-credit society than to 21st-century Ireland.

The result is that Ireland is out of sync with Europe, as we don’t have a modern consumer insolvency system. The only insolvency option is the little-used Bankruptcy Act. Although overhauled in 1988, the fundamental principles behind our bankruptcy system have not been updated since puritanical Victorian times. As a result, personal bankruptcy in Ireland remains punitive in nature, taking at least 12 years to discharge compared to 12 months in the UK and between three and five years in other European countries, where the focus is on rehabilitation.

“The penalties for being adjudicated a bankrupt are not of this time,” says Barry Lyons of Lyons Kenny Solicitors. “The 12-year term for bankruptcy is longer than many jail terms handed down for manslaughter.”

It is also a blunt instrument, in that it fails to distinguish between debtors who can’t pay and those who won’t pay.

Not surprisingly, given the shortcomings of the system, there were just four bankruptcies in Ireland in 2007, rising to eight last year. This compares to more than 100,000 personal insolvencies – between formal bankruptcies and individual voluntary arrangements (IVAs) – in the UK in 2008.

Some voluntary debt settlement initiatives have been set up outside the legal system, such as the operational protocol agreed earlier this year between the Irish Banking Federation (IBF) and the Money Advice and Budgeting Service (Mabs), to which 12 credit institutions signed up.

However, these voluntary initiatives only offer partial solutions. Speaking at a personal insolvency briefing last week, Grant Thornton partner Michael McAteer pointed out that the IBF voluntary code on mortgage arrears did not cover non-mortgage lending. Furthermore, credit institutions that are not members of the IBF, for example subprime lenders which are responsible for the majority of home repossessions, are not included.

Speaking at a Law Reform Commission (LRC) conference on personal debt on Wednesday, LRC commissioner Patricia Rickard-Clarke said: “While the commission endorses all of this work, we believe that a voluntary arrangement is no substitute for legislation and a proper legal system.”

Many informal plans fail due to unrealistic conditions, she said, and the rights of consumers need to be put on a statutory footing.

Aside from the antiquated bankruptcy system, the imprisonment of debtors – a practice long since abandoned in most countries – is another bone of contention. According to Paul Joyce of the Free Legal Advice Centre (Flac), some 276 people were imprisoned – some of them twice – in relation to the nonpayment of civil debt court orders last year.

In response to a High Court decision earlier this year, imprisonment of debtors due to an inability to pay a debt has been abolished. However, imprisonment has been retained as an option for dealing with debtors who “won’t pay”, although only as a method of last resort.

The LRC is currently considering whether imprisonment can be justified at all, not just because of the “huge human cost” of this course of action, Rickard-Clarke said, but also because of the cost to society, given that the cost of imprisoning an individual amounts to roughly €2,000 a week.

She also criticised the overall debt enforcement system, describing it as “hopelessly out of touch with society”. One of the problems of the current judicial system is the lack of information available to the court concerning the debtor’s financial circumstances, making it impossible to distinguish between those debtors who are willing to pay their debts but can’t afford to do so, and those who simply refuse to pay.

Furthermore, complicated procedural rules and archaic terminology such as fieri facias, bailiwick and garnishee orders, mean that debtors are often in the dark as to how the debt enforcement system operates.

So what is to be done to improve the system? The LRC has drawn up a detailed consultation paper outlining its provisional recommendations on reforming the law on personal insolvency and debt enforcement.

Fundamentally, it advises a complete overhaul of the outdated bankruptcy system, alongside the introduction of a statutory non-judiciary debt settlement system (ie operating outside the court system). The LRC feels that the latter would be more suited to consumer debt than bankruptcy, as it would reduce the costs and stigma associated with the court system.

Although there are voluntary debt settlement systems in place, making such systems legally binding would ensure the legal rights of overindebted individuals, as creditors could be compelled to participate.

Another key tenet of the system as envisaged by the LRC would be the establishment of a centralised debt enforcement office. One major advantage of a centralised system would be the ability to monitor all enforcement proceedings brought against a single debtor by their creditors. At the moment, the court is not necessarily aware of the total indebtedness of a debtor, as there is no means of assessing all enforcement proceedings against them.

The establishment of a debt enforcement office would also address the problem of assessing a debtor’s means. This assessment would be carried out in private, rather than heard publicly in open court, which, according to Flac, deters debtors from turning up in court. “The public nature of the debt enforcement system is a major barrier to participation,” says Flac in its publication To No One’s Credit, which examines the experience of debtors in the Irish legal system.

The provisional recommendations of the LRC have been well received, both by Government and by debtor support agencies, but the question of how long it will take for the necessary reforms to be implemented has been raised in several quarters.

Joyce of Flac says a plan to deal with the financial crisis has been introduced in the form of the National Asset Management Agency (Nama), but there seems to be “no plan or even a recognition that a consumer debt crisis exists”.

“Increasingly, ordinary people are asking where the rescue plan for them is,” he says.

Grant Thornton’s McAteer warned that, although the LRC’s proposals were “excellent”, if the process of implementing legislative change followed its normal course, it could take three to five years before the system was reformed. If the political will that enabled the Nama legislation to be rushed through existed, this would be “great”, but if the normal cycle was followed it could be too late to resolve the current problems, he said.

Because of this likely timelag, he suggested that a short-term solution such as a credit management plan similar to the IVA system in the UK (whereby the debtor signs up to a formal agreement with creditors to pay off a portion of what they owe over a five-year period) to which Irish banks would voluntarily sign up might be necessary to bridge the gap.

Grant Thornton has also warned that bankruptcy legislation is “crippling” the entrepreneurial classes. McAteer explained that, as business failures increased, the number of personal insolvencies was rising. In his experience, more than 90 per cent of directors of failed companies have debts associated with the company as a result of personal guarantees. It is critical to ensure that entrepreneurial classes are not punished to the extent that they never return to business, he said. That adds to the urgency of reforming the current system.

Whether the political will exists to fast-track the necessary reforms is another matter. The new programme for Government contained commitments to reform debt enforcement. In his opening speech at the LRC conference, Minister for Justice, Equality and Law Reform Dermot Ahern provided some glimmer of hope when he stressed the need to have the personal debt system in place “fast”.

“I understand that legislation takes time. I understand also that we cannot afford unintended consequences,” he said.

He requested that the LRC consultation process be concluded “in as timely a fashion as is possible”, and encouraged the LRC to consider the early release of its finalised proposals. “We want short-, medium- and long-term proposals as soon as possible.”

He also said he would push for the implementation of the commitments in the Programme for Government.

Rickard-Clarke pointed out that there were many examples of bodies, such as the Legal Aid Board, being set up on a non-statutory basis. “There is nothing to stop the Government from putting the wheels in motion,” she said. “A lot can be done in terms of advice and non-judicial debt settlement.”

However, Joyce highlights the fact that Mabs already engages in these types of activities on a day-to-day basis. Difficulties arise if one or two creditors are unwilling to engage in this process, which “can put the whole thing into chaos”.

Until now, the need to provide solutions to the mounting problem of consumer overindebtedness has been overshadowed by the need to rescue the banks.

If Nama legislation can be drafted in six months, one imagines that the Government could fast-track the long-overdue reforms needed to drag the country’s Victorian personal debt system into the 21st century.

Consumer debt: the facts and figures

Household debt as a percentage of disposable income increased from 48 per cent in 1995 to approximately 176 per cent in 2009, placing Ireland fourth among developed countries in terms of debt ratio.

The number of new clients contacting the Money Advice and Budgeting Service (Mabs) rose from 14,551 in 2006 to 19,041 in 2008. The rise in total initial arrears owed by new clients rose from €92 million in 2006 to €210 million in 2008.

Mabs has received 23,000 calls to its helpline so far this year.

The total value of residential mortgages provided to Irish residents rose from approximately €34 billion in December 2001 to more than €120 billion in June 2008.

The most prevalent group affected by debt is young families from their mid-20s to mid-40s, with women appearing to be more vulnerable to debt problems than men.

The level of debt enforcement proceedings in Irish courts has risen in line with unemployment. For example, in 2007 some 1,208 debt-related High Court execution orders took place. This rose to 1,601 in 2008.

Between 2001 and 2007, about 200 people were imprisoned in connection with debt. In 2008, 276 people were imprisoned.

In 2008, just eight people became bankrupt in Ireland. This compares to 106,544 insolvencies in the UK in the same year (broken down into 67,418 informal insolvencies and 39,116 individual voluntary arrangements).

(Sources: Law Reform Commission's consultation paper on personal debt management and debt enforcement and Flac).

Reforming the law: recommendations

Provisional recommendations of the Law Reform Commission on reforming the law on personal debt:

A system for regulating debt-collection agencies should be considered. Similarly, a system for regulating commercial debt advice agencies should be examined.

A new system of personal insolvency law should be created in Ireland. In particular, a statutory non-court-based debt- settlement system should be introduced.

Overall, the new personal insolvency laws should facilitate the European rehabilitative approach to debtors and move away from the Victorian punitive approach.

The Irish debt-enforcement system needs fundamental reform. The system proposed by the Law Reform Commission would be based on the introduction of a central debt enforcement office and the removal of much (but not all) of the debt enforcement proceedings from the courts.

The key principles underpinning the new system should be: proportionate, balanced enforcement in each individual case; improved access to information on the means of debtors; clear and simplified enforcement procedures; a holistic approach to enforcement; the encouragement of increased participation of debtors in enforcement proceedings.

On the issue of debt management, the commission advises that the current system of credit reporting in Ireland may need to be expanded or otherwise improved.

The issue of whether imprisonment of debtors can be justified, even if the debtor won't pay their debts (as opposed to can't pay), will have to be considered.