Planned insolvency legislation needs beefing up to deal with intransigent banks

MINISTERS WHO open conferences connected with their portfolio tend to come in, pass a few remarks about how wonderful everyone in the room is before heading straight back to their Mercs and on to to the next launch, lunch, cabinet meeting or late constituent’s funeral.

When the Minister for Social Protection, Joan Burton, arrived to address a recent conference on personal insolvency organised by the Free Legal Advice Centre (Flac) few people in the room expected her to linger.

She talked briefly but eloquently about the twin curses of personal debt and unemployment that have sent many Irish people into a tailspin, but rather than leave she took a seat in the audience and listened to a presentation delivered by a slight, mild-mannered law professor from Chicago.

What Prof Jason Kilborn had to say can’t have made comfortable listening for her. The draft Personal Insolvency legislation unveiled last January as one of the key planks of the Government’s efforts to tackle the financial crisis was, he said, pretty much doomed. At the draft’s launch, the Minister for Justice, Alan Shatter, described it as the “most radical reform of insolvency law since the foundation of the State” but, according to Kilborn, it would not work because it was voluntary, offered creditors an absolute veto on any deal and had nothing by way of a stick with which to beat financial institutions who refused to play ball in a meaningful way.

“You cannot leave public policy in the hands of banks, and the Government needs to step in and impose solutions,” he said. Prof Kilborn said much of the debate about how to tackle the debt crisis had become bogged down with moral hazard and he suggested that default was seldom “solely the debtor’s fault”. He pointed out that many thousands of Irish people had been left with “crushing” debts through no fault of their own. Offering them relief should not raise the question of moral hazard.

He drew parallels with the car insurance market and pointed out that just as payouts in that sphere were not widely considered as an “unfair penalty on ‘safe’ drivers” a properly functioning insolvency system should not be viewed as “an unfair penalty on ‘responsible debtors’ who would never default. Accidents happen, with or without driver fault, and default occurs with or without debtor fault,” he told delegates.

He said the personal insolvency arrangements as proposed were “the status quo masquerading as a solution”, and added that, when a creditor has “an absolute veto review with no review for reasonableness or good faith”, the problems would not be resolved. He was right when he said there are no impediments to the banks agreeing to voluntary modifications to debt, but that is not happening.

Unless independent and trusted intermediaries who could command the respect of financial institutions could be drafted in to negotiate between debtors and creditors with the backing of the courts, who could impose solutions, any system in place in Ireland would be unlikely to succeed.

He cited a French model that seems to work. When developing negotiated settlements between debtors and creditors there is a success rate of more than 50 per cent there, largely because the French central bank has taken a very proactive role in negotiations

In France, the alternative to the negotiation process has been very unpleasant for creditors. Since 2010, 25 per cent of French debtors entering the insolvency system get an immediate discharge.

“The key to the success of the French system has been the 800lb gorilla of the French central bank,” Kilborn said. “The bank encouraged creditors to engage properly, and the fact that it was there as a trusted intermediary – not representing debtors or creditors – made an enormous difference. The courts were also there to impose reasonable restructuring plans on creditors who had simply acted unreasonably.

“There has to be a stick behind the door waiting for creditors to slap them if them don’t do the right thing. The alternative in the Irish bill is not a very compelling stick. I am afraid the cure may well be worse than the disease. There are a lot of incentives to encourage debtors to agree to everything. If we encourage debtors to agree to things draconian enough to attract a majority of support from creditors, these plans will fail. We cannot be forcing debtors to agree to plans that are destined to failure. Promising to do something you can’t do is not useful and then we have the Sisyphean task of pushing the rock up the hill over and over again,” he told the audience.

Paul Joyce of Flac was also at the top table. Speaking last week, he said it wasn’t too late to fix the proposed legislation, “but expecting creditors to voluntarily agree to debt write-offs is like getting turkeys to vote for Christmas. If there is no compunction then it will not happen.”

Under the draft proposals for any personal insolvency arrangement to be effective, at least 55 per cent of the unsecured creditors and 75 per cent of secured creditors must agree to the arrangement. Joyce says that while the Department of Justice may lower the loan threshold, giving banks a veto any such move will not be enough.

“When the legislation was published, the Irish Banking Federation were not long saying the inclusion of secured mortgage debt in the personal insolvency process was unprecedented in the developed world. We pointed out that it was not unprecedented and that it was done in Norway and across Scandinavia and most recently in Iceland. Even Greece has built such mechanisms into their legislation. Where was the IBF’s research?” asks Joyce.

Details of the Norwegian model were outlined at the Flac conference. In the 1990s Norway was gripped by a mortgage crisis not unlike ours, said Egil Rokhaug, an adviser to Norway’s ministry of equality and social inclusion and an author of Norway’s debt settlement act. “By 1993, house prices were down between 50 and 70 per cent. It was more or less the same type of problem you are facing here now,” he said.

A debt settlement act was introduced. The country has a high rate of home ownership, and the law included mortgage debt. “We did that because it gives debtors the opportunity to keep the family home, which is very important in Norway. We introduced a system where the debtors could get an official valuation of the home and they could adjust their mortgage down to the real value of the home and write down the part of the mortgage that was no longer effective.”

When Pricewatch asked the IBF to explain how it could have said that including secured debt in personal insolvency legislation was unprecedented when it had happened in Europe 15 years ago, a spokesman said that when it had made those comments it had been unaware of the situation in Norway.

“Up to a point this year, no one was aware of the situation in Norway. Clearly our research was not enough, but once we learned of what happened in Norway in the 1990s we changed our language and we were not satisfied that the model had been tested satisfactorily,” says the IBF’s Felix O’Regan.

Joyce is not entirely pessimistic. “I don’t think it is too late to resolve it. There is still a whole process to go through. It they get it wrong they are going to explain that. If in the first six months 5,000 people apply for a personal insolvency arrangement and 4,900 applications are rejected by the creditors, then this is going to become very clear very quickly. I don’t think it makes sense for the Government to sit back and say to creditors, ‘Here’s your veto, use it wisely’.”

The Bill was to appear by yesterday at the latest but will not be ready for two months. According to the Department of Justice, it is “a very lengthy and complex Bill from a legal standpoint, with proposed provisions which do not currently exist in Irish law”. A spokesman said that the most important thing is that “we get the Bill right”. He’s not wrong.