There are several areas where the existing procedure needs to be reformed to address the issues discussed above. These include defining bankruptcy, improving incentives for early intervention, and addressing the need to make the existing regime more appropriate for all cases.

7.1 Defining Bankruptcy

Defining who is bankrupt and at which point they became bankrupt will affect the returns to creditors and the level of certainty in the market. The aim is to improve the current system, which is not used as it is too complex and involves defining when insolvency has occurred. One option is a "simple" rule that states, for example, that bankruptcy begins at a certain defined point like adjudication or any point where an objective test can be applied. This would remove the relation back doctrine. Another option is a "complex" rule that attempts to deal with the issues on a case-by-case basis. This provides substantial flexibility. Improving bankruptcy, in terms of simplicity, will involve trade-offs in terms of certainty and flexibility.

In the context of bankruptcy administration, providing a simpler rule will mean people can apply the rule before bankruptcy and know for certain whether they fall within the procedure. The use of simplified rules has the benefit of easily applied, simple tests. This will provide certainty, but will also decrease flexibility, as simple rules generally do not catch all the parties they are intended to catch and normally catch parties for whom the rule was never intended. The trade-off for a simple rule to determine when bankruptcy begins is a lack of flexibility.

Complex rules provide flexibility by allowing case by case application. Flexibility is an important fixture of a bankruptcy system because it means the rules can be applied to the parties they are intended for, minimising the chance of unintended consequences. However, the costs of the system could increase as parties may be forced to litigate to determine the position at law.

A simpler rule for determining when bankruptcy begins will mean individual cases will not be so easily dealt with on their merits. However, maintaining the courts role in this area will introduce flexibility in cases where the parties disagree as to whether the debtor should be adjudicated bankrupt. The majority of bankruptcies begin with debtor filed petitions, and a simpler rule as to when bankruptcy begins would give them certainty. In creditor-filed petitions, the court will be able to determine the matter should flexibility be required.

A simpler rule for determining when bankruptcy begins should provide certainty when combined with the flexibility of court procedures to resolve complex cases where disagreements about insolvency arise. The simple rule could be that bankruptcy begins at adjudication, when the debtors legal status.

Recommendation:

That the doctrine of relation back be removed, and the rules of voidable transactions be relied on to achieve the same purpose. To remove this doctrine, the bankruptcy should begin at the point of adjudication, not the time the act of bankruptcy was committed.

7.2 Early Intervention

Issues involved in solving the problem of lack of incentives for early intervention revolve around the trade-offs between the debtor and creditors. Possible solutions could be an increase in the amount of information available to the debtors and the creditors, or proactive intervention by the parties or the Assignee. In considering these alternatives, weighing the impacts on all the parties is important and should be considered in light of the need for certainty and simplicity without increasing the costs on either party.

Currently, an audit occurs when the debtor has been adjudicated bankrupt. By changing the timing of the audit so that it occurs before bankruptcy, it could be used as a tool to sort debtors into the most efficient procedure for distributing their assets to creditors. This would not necessarily affect the incentives for creditors, but would improve the debtor's access to alternatives

To take this further, and actually provide a tangible incentive, the audit could provide "breathing space" for debtors by instituting a moratorium on creditors, claims while the Assignee determines the debtor's financial position and provides information on the options available. For example, once the audit begins, all claims by creditors could be placed on hold for 14 days. This would affect creditor rights by decreasing certainty of outcome. However, it would be worthwhile to trade off less certainty for increased returns to creditors, as debtors start to seek help at a stage when they have assets to pay creditors.

Debtors could complete a form that signals their intention to file a debtor's petition (Request for Solvency Assessment, or RSA) which would allow the Assignee to provide a financial audit before a debtor's petition is filed. Debtors would have to provide information on their financial position, including a list of creditors and amounts owing and their total pool of assets. Information could also be provided on alternatives to bankruptcy at this stage.

7.2.1 Financial Counselling

Extending this option further could involve a commitment to provide complete financial counselling for the debtor at this point, regardless of the options they have available them in terms of bankruptcy or alternatives. This service could be provided by the Insolvency Service or by private counselling services, and counselling could be compulsory or voluntary. The focus would be on rehabilitation and providing debtors with appropriate financial skills.

The key to providing effective information to debtors is to provide it at all stages of the credit process. Education of consumers and lenders about their rights and responsibilities in relation to credit may help consumers in their financial decision-making. The aim would be to help consumers avoid over-committing themselves. Providing information during the credit process could involve using community agencies that educate debtors on good money management and assist them in financial distress. The next stage is information provided towards the end of the credit process, where the debtor will already be in severe financial difficulty. This information would be centred on bankruptcy and the formal alternatives available to the debtor under insolvency legislation. Finally, information should be provided on exit from the credit process. Education at this stage should aim to decrease the possibility of the debtor repeating similar mistakes.

The Ministry of Consumer Affairs is involved in a review of the consumer credit law, with a discussion document for public consultation released in August 2000. One of the topics of Part 4 of this review is overindebtedness. In terms of information and education, that review focuses on the early and middle stages of the credit process. This raises the need for information and education in the final stages.

The factors that need to be considered here are what benefits will be gained and at what cost. The benefits of counselling centre on rehabilitation. Providing basic information to debtors about budgeting, credit management and responsible risk taking will result in increased knowledge. The effectiveness of this cannot be quantified if it is provided at the end of a credit process, but that does not mean the information is ineffective. Debtor awareness of the risks and responsibilities associated with credit is important information.

The costs of providing financial counselling could be high, and the returns to capital invested would be difficult to measure. The Insolvency Service could not provide as high a level of service as community agencies which specialise in providing support.

7.2.2 Preferred Options for Providing Incentives for Early Intervention

The Ministry favours the introduction of a financial audit, instigated by a Request for Solvency Assessment form ("RSA form"). This form could signal the debtor's intention to file a bankruptcy petition. The RSA's purpose would be to determine the debtor's financial position and list the options available given that information. Information could then be provided on the next step, whether it is using a formal alternative, or filing for bankruptcy. If a formal alternative was available contacts could be provided for private sector administrators. If bankruptcy was the only option available to the debtor, the Insolvency Service could advise on how to file a debtor's petition and the consequences of doing so. At that point, the debtor could be given time to consider options, or could instigate a solution then. The time taken to consider would be influenced by the moratorium placed on creditors. The content of the form could provide for a list of all assets and all liabilities.

The RSA form could be made available via the Insolvency Service website and distributed to firms and organisations e.g. the Budget Advisory Service. Debtors would be able to fill one in either before an appointment with their local Insolvency Service office, or fill one in at an appointment with a branch of the service. The RSA form could be similar to the Statement of Affairs form currently used once a debtor has been adjudicated bankrupt, listing the debtor's assets and liabilities.

The RSA form could include sections on demographic information for statistical purposes. This information will aid the Ministry in reviewing policy. The RSA form would affect creditor rights and would be legally binding on a debtor. Once the form had been processed, the debtor would be provided with "breathing space" for 14 days, during which all creditors claims would be temporarily postponed. This will allow the debtor to seek early advice or intervention. Existing penalties for failing to disclose all information in the current proceedings will also apply to the proposed proceedings. A debtor should only be able to use one RSA form within any 12-month period.

The balance between incentives for debtors to seek early intervention and certainty for creditors in terms of protection of their rights, is important. The debtor's incentive to approach the Assignee regarding their options would be the "breathing space" that a stay on proceedings would provide. For creditors, the stay could have two impacts on their position. If creditor-initiated proceedings had already commenced and the debtor filed an RSA form with the Assignee, the RSA form could mean the stay of proceedings took precedence over the creditor-initiated proceeding until the stay expired, for example after 14 days. During this time, alternatives could be pursued with creditors. If no proceedings had been initiated, and the debtor filed an RSA form with the Assignee, the effect would be to stay any proceedings that individual creditors may wish to make for the following 14 days, for example.

Providing a debtor with incentive to seek early intervention will increase the number of debtors using alternatives or debtor petitions, thereby limiting the cases where individual creditors expend the resources to pursue the debtor via the court. This would provide certainty for creditors that no one creditor was asserting their rights over and above any other creditor. The Ministry does not have a preferred option in terms of financial counselling. Comments are sought on this issue.

While the information set out in this section on a possible solution is specific, it is by no means a predetermined solution. The Ministry seeks comment and welcomes suggestions on alternative options.

Recommendations

The Ministry recommends:

The introduction of a financial audit, instigated by a Request for Solvency Assessment form ("RSA form"); and
A 14-day stay of proceedings that begins when the RSA is filed with the Assignee.

The Ministry has no recommendations to make in terms of financial counselling. Comments on this issue are sought.

7.3 Tailoring the Regime to Suit the Debtor's Financial Position

An aim of this review is to reduce the number of estates with assets that proceed to bankruptcy by encouraging early intervention so that the alternatives to bankruptcy are valid options for debtors and creditors. These alternatives will be strengthened and debtor access to them will be improved. For those estates with assets that do end up in bankruptcy, the aim is to find the best method for dealing with those estates. This aim is countered by the knowledge that the bankruptcy regime must also cater for debtors that are not honest.

7.3.1 Formal Alternatives to Bankruptcy

Improving the formal alternatives to bankruptcy should increase debtors and creditors' access to and use of them. This should decrease the number of debtors in bankruptcy that could have explored other options. The formal alternatives would be improved by either improving the existing alternatives or creating new alternative procedures.

7.3.1.1 Improving the Current Alternatives

Removing the prohibitive time and cost of court involvement from the alternatives will increase the viability of summary instalment orders and proposals under Part XV of the Act as alternatives to bankruptcy. Providing for the Assignee or private administrators to manage the alternatives would significantly reduce the time and cost of the alternatives while increasing debtor awareness of them at an earlier stage.

7.3.1.2 Summary Instalment Orders

Already some private administrators are administering summary instalment orders and Part XV proposals. With summary instalment orders, the private administrators are responsible to the court.

The option could be made available to more debtors by increasing the threshold of debt for a summary instalment order from $12,000 to $40,000 and improving debtor access to information at an earlier stage.

Increasing the commission available could make the administration economically viable for private administrators. The commission for private administrators could be increased to 10percent, with changes to commission fees made by Order in Council. This would provide increased incentives to administrators to work in this area. The private administrator would have the right to waive the fee. Trust accounts and the ensuing obligations would apply to private administrators.

7.3.1.3 Part XV Proposals

Providing for private administrators to administer Part XV proposals, rather than the court, would allow administration decreased costs due to less court involvement. Debtor awareness of the alternatives, at a stage where they are viable options, will be provided through early intervention at the audit and options stage.

As proposed with regard to summary instalment orders, the commission for private administrators could be increased to 10 percent.

7.3.1.4 The Role of the Court and the Assignee

The court's role could be partially carried out by the Assignee in the particular situation of alternatives. The Assignee could monitor or supervise debt repayment schemes for suitability, make cosmetic changes, or recommend significant changes that will require creditor approval before the Assignee will approve the scheme. High Court procedures would be available in complex situations, and the right of appeal would remain.

Where there are breaches of agreements, creditor access to the punitive provisions of bankruptcy would be improved, as the Assignee would be directly involved in administering the failed scheme and the consequential bankruptcy procedure. If an alternative became onerous on the debtor, they could apply to the Assignee to alter its terms. Creditors would have to be informed of reasons behind changes and would be able to apply to court to have the debtor comply with the original proposal or order, or to have them adjudged bankrupt.

This issue is being considered in Tier Two of the insolvency review, under the role of the state. Comment on this issue should take into account the further work that is taking place and the context in which that work will occur. Issues to consider concern how much involvement the state should have in bankruptcy, whether the involvement is currently acceptable, and what role is appropriate for private administrators.

Using alternatives to bankruptcy will maximise returns to creditors. Part payment will, probably continue, but the sooner the debtor becomes involved in the active repayment of the debt, the higher the level of assets available for distribution to creditors. Compliance costs are expected to decrease, as alternatives to bankruptcy impose less onerous structures on creditors than bankruptcy. Where the returns to creditors will be maximised, the costs of credit will decrease as certainty of return increases.

The Ministry would like comment on options for creating new alternative procedures and for improving the existing alternatives.

Recommendations

The Ministry recommends:

Increasing the threshold of debt for a summary instalment order from $12,000 to $40,000;
Providing for private administrators to administrator the Part XV proposals and the summary instalment orders, rather than the court; and
Increasing the commission for private administrators to 10 percent.

7.3.2 Asset Distribution Where There Are Few, or No, Assets

The options to improve bankruptcy administration when the debtor has few, or no, assets centre on decreasing time costs and administration costs, while maintaining quality administration of estates.

7.3.2.1 Proceedings Consequent on Adjudication

Where it is determined that the bankrupt has no assets, a bankruptcy administration procedure that focuses on distribution of assets will not provide the best outcome at the lowest cost. Without assets to distribute to creditors, the meeting of creditors and the process undertaken by the Assignee's is costly and time consuming and unlikely to increase returns to creditors. In particular, the procedural could be lessened, while the working relationship between the Assignee and creditors could be more suitably catered for.

Currently, the Assignee uses its back office to administer all non-complex estates (making up 70percent of all estates). Section 34A of the Act allows the meeting of creditors to be dispensed with, and such meetings are very rarely held. In its first notice to creditors, issuing within 25 working days of adjudication, the Assignee notifies creditors whether a meeting will be held.

Recommendations:

The Ministry does not have a preferred solution on proceedings consequent on adjudication for estates with no assets for distribution. The Ministry would like comment on issues and options for reform of this area. The Ministry is interested in whether the current practice is the most appropriate one for dealing with estates without assets.

There would be lower compliance costs for stakeholders if the bankruptcy administration procedure were able to decrease the costs of administration where the returns to creditors will be minimal.

7.3.2.2 Discharge

Currently, in approximately 90 percent of cases where an estate has no assets, the administration is completed within six months. Discharge could be automatic at any stage after the Assignee has processed the estate, for example after six months, one year or 18 months. The factors to consider in determining the length include deterrence and rehabilitation. Where the estates have little or no assets to realise, the underlying reasoning behind long periods for bankruptcy relate to deterring future debtors from less than sensible risk-taking and keeping bankrupts out of the community where they can cause financial harm to themselves or others.

The underlying reason behind allowing for discharge at all is summed up in the third overarching objective of the bankruptcy administration review:

Enabling individuals in bankruptcy again to participate fully in the economic life of the community by discharging them from their remaining debts in appropriate circumstances.

Automatic discharge allows bankrupts who have not been involved in commercial misconduct to receive a discharge without the expense of a court application. The dishonest bankrupt can be prevented from obtaining an automatic discharge.

The automatic discharge that applies after three years could be altered to apply after one year. The early discharge would provide the debtor with incentives to disclose all information to the Assignee and to consider ways in which of paying a greater portion of their claims.

It would be possible for the Assignee, or creditors, to apply to the Court to suspend the operation of the discharge.

There is a strong argument for ensuring that society is given some protection from any future repetition of commercial misconduct. As bankruptcy statistics show, the number of repeat bankrupts is very low. However, some individuals are simply dishonest or have shown little or no regard for the interests of their creditors.

Repeat bankrupts, or fraudulent bankrupts, should not qualify for automatic discharge at the same time as other debtors. Instead, the discharge would become automatic after three years. The Ministry notes that the court has an existing discretion to provide restrictions on such individuals once they have been discharged.

Recommendations

The Ministry recommends that:

Repeat bankrupts, or fraudulent bankrupts, should not qualify for automatic discharge until after three years; and
Bankrupts, who have not been involved in commercial misconduct should receive an automatic discharge :

After one year; or
After two years.

The Ministry seeks comment on which discharge period is preferred.

7.3.2.3 After Discharge

It is possible to increase the total pool of assets available for redistribution so that money owed by the bankrupt is paid. This would increase the certainty of payment function of bankruptcy, which would aid the objective of goods and services being produced at least cost. This would be achieved through Income Payment Orders ("IPOs"). It could be used for debtors who experience a significant increase in assets or income after discharge from bankruptcy.

The Assignee would be able to grant an automatic IPO, and a creditor would be able to request an IPO from the Assignee, but where the Assignee declined a creditor's request for one, the Assignee would have to state the reason for doing so. If the creditor was unsatisfied with that reason, they could apply to the court to consider the matter.

For one year after the bankruptcy, the debtor would have to provide the Assignee with information on their financial position and either a signed declaration once every 3 months stating that the debtor's position has not altered or a signed declaration stating the alteration to the debtor's position within 14 working days of the alteration. During that one year, an IPO could be made, which could run for up to one year. The debtor would have to disclose all information regarding their financial position during that one year after bankruptcy. If they did not disclose all information, the IPO could be made, at the Assignee's discretion after the six-month period, when the failure to disclose was brought to the Assignee's attention.

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Printed: 30/08/2008