On 25 January 2012 the Government approved and published the heads of the proposed Personal Insolvency Bill (the "Draft Bill"). The Draft Bill proposes the introduction of three non-judicial debt settlement arrangements and a reform of the existing bankruptcy regime. The new arrangements will allow for the write down or restructuring of both secured and unsecured debt owed by certain eligible individuals. This briefing introduces the arrangements, with a focus on the proposals relating to secured debt.

There has been general agreement that change to the existing regimes for the resolution of personal insolvency has been necessary for some time and various public groups have reported on the relevant issues.1 The Draft Bill represents the Government's proposals to implement reform in this area and is likely to be subject to considerable comment and change during the legislative process.

The proposals

Insolvency Service and personal insolvency trustees

The Draft Bill proposes the establishment of an independent body to be known as the Insolvency Service that will oversee the non-judicial personal insolvency system (the "Service"). The Service will have a role in the debt settlement process and will maintain a register of the settlement arrangements. It is also proposed that personal insolvency trustees ("Trustees") and approved intermediaries will be licensed or authorised and will play a key role in advising and formulating certain of the arrangements.

Settlement arrangements

The Draft Bill provides for three separate non-judicial debt settlement arrangements (the "Arrangements") designed to offer an alternative to bankruptcy. These are:

  • Debt Relief Certificates ("DRC");
  • Debt Settlement Agreements ("DSA"); and
  • Personal Insolvency Arrangements ("PIA").

There are a number of common themes in each of the Arrangements, such as:

  • they are available in respect of certain debt incurred by a natural person (not a corporate) through personal consumption or in the course of his or her business, trade or profession;
  • a debtor will only be eligible where they are insolvent (i.e. unable to pay their debts as they fall due) and meet other eligibility criteria (such as in relation to residency);
  • the application or proposal is always made through an approved intermediary or Trustee, who will also offer advice to the debtor;
  • a DSA and PIA will generally not affect the full repayment of "preferential debts", as defined under the current bankruptcy regime (e.g. rates, income tax, etc.); and
  • in all cases there is a restriction on the number of times and frequency of use of the Arrangements and there may be restrictions on the availability of the Arrangements where certain other processes (such as bankruptcy) are in train or have previously been availed of.

Only the PIAs affect secured debt.

Summary

Of particular note in the Draft Bill is the inclusion of PIAs (see Personal Insolvency Arrangement below). Secured debt (including residential mortgages and Buy to Let loans) can be included in these arrangements. Whilst the current drafting makes it unlikely that mortgage lenders will, in many circumstances, be compelled to accept a write down of their debt, the Draft Bill provides a formal process by which debtors can at least apply for this. The process should be robust enough to differentiate between the "can't pays" and the "won't pays", so in our view it is unlikely that there will be a flood of mortgage write downs. Having said that, in many cases this will be the only option and in those cases there are still protections for secured creditors (including a claw back).

Many parties will be interested in the Draft Bill as it proceeds through the legislative process. These include:

  • investors in Irish RMBS and covered bonds who will be concerned that collateral could be written down;
  • unsecured investors and shareholders in Irish banks who may fear that large writedowns would result in bank losses in excess of current capital buffers; and
  • potential purchasers of Irish residential mortgage books who also may fear wholesale write downs but will welcome the first step towards a formal process for working out the debts.

Possibly the most contentious point in the Draft Bill is the extent to which secured creditors can or cannot block PIAs, or can be squeezed out if in a minority.

Debt Relief Certificate

A DRC allows full write-off of qualifying unsecured debt up to €20,000 following a one-year moratorium.

It has no effect on secured debt.

Scope

The DRC procedure is designed to provide debt forgiveness to those debtors with little or no ability to pay off their debts. In addition to being insolvent, the specific eligibility criteria for a DRC include the debtor having a net disposable income of less than €60 per month after certain expenses are deducted and assets or savings worth €400 or less. A DRC can only be made in respect of qualifying unsecured debt which include debts related to credit cards, overdrafts, unsecured loans, utilities and guarantees.

In contrast to DSAs and PIAs, a DRC is proposed by the debtor to the Service (through an approved intermediary), rather than to creditors. The Service may then grant or refuse the application on certain grounds.

Effect

Once the DRC is entered into the register a moratorium of one year takes effect unless it is terminated or extended. During this period restrictions are placed on the relevant creditor's ability to petition in respect of the relevant debt or otherwise commencing any action or other legal proceedings against the debtor for the debt. Pending actions may be stayed. The creditor may object to the DRC or to the debt being included therein on prescribed grounds during the moratorium period.

Assuming the moratorium period does not terminate early and the debtor is still unable to repay, at its conclusion the debtor is discharged from all the qualifying debts specified in the DRC.

Debt Settlement Arrangement

A DSA allows for settlement of unsecured debt where a debtor's liabilities are €20,001 and over.

It has no effect on secured debt.

Scope

A DSA may be proposed to two or more creditors by a debtor with liabilities of at least €20,001, in respect of the payment or satisfaction of his or her unsecured debts. A DSA may only be proposed by a debtor who is insolvent and meets certain eligibility criteria.

Protective certificate and Process

A debtor may apply to the Service for a protective certificate, that will generally last for thirty or forty working days, to prevent the enforcement of any personal debt while proposals are made to reach a DSA. The application must provide for the appointment of a Trustee.

The Trustee must gather financial information from the debtor and prepare a proposal to be considered and voted upon at a creditor's meeting.

Where a proposed DSA is approved at a creditors' meeting by a majority of 65% in value of actual votes2 cast at the meeting it becomes a DSA and will then be binding on every creditor who was entitled to vote at the creditors' meeting. The DSA will be deemed to have effect thirty days after the communication of the result of the creditors' meeting to the Service unless a creditor enters an objection in the Circuit Court. A challenge can be made on specified grounds, for example a failure to follow procedural requirements or that the DSA unfairly prejudices the creditor concerned. Failure to agree to a DSA would terminate the process and leave the debtor open to bankruptcy proceedings.

There are provisions for the variation or termination of a DSA where the relevant creditors again approve by a 65% majority as outlined above. A DSA will be deemed to have failed after a three month arrears default once the Service has been notified.

Effect

The DSA may involve certain specified repayment options which will result in creditors being paid or satisfied in part or in full over the period of the DSA. It is proposed that the maximum duration of a DSA is to be five years, but may be six years with the express agreement of the creditors. On completion of the obligations specified in a DSA the debtor shall be discharged from the remainder of the debts covered by the DSA.

In addition, under the proposals the effect of registration of a DSA (which takes place once it is deemed to take effect) will be to restrict a creditor's ability to petition for the debtor's bankruptcy for a debt, or enforce or recover a debt, covered by the DSA.

Personal Insolvency Arrangement

A PIA allows for the settlement of secured and unsecured debt where a debtor's liabilities are between €20,001 and €3,000,000. The aim is to provide for a realistic alternative to bankruptcy.

Application

An insolvent debtor who meets certain eligibility criteria may propose a PIA with one or more of his or her secured and unsecured creditors in respect of the payment and/or satisfaction of his or her debts over a period of time. The proposal is formulated and made by a Trustee.

The Draft Bill proposes a detailed list of eligibility criteria. Amongst these is a requirement that the debtor owes a debt to at least one secured creditor holding security over an asset or property situated in Ireland. In addition it must be unforeseeable that over the course of a five year period the debtor will become solvent and a DSA would not be a viable alternative to make the debtor solvent within a period of five years.

Protective certificate

As with a DSA, a first step in the process is for the debtor to apply for a protective certificate in respect of certain proceedings which will be in force for forty to sixty working days. A further extension of ten working days is possible. The Trustee must give notice to creditors of the issue of a protective certificate and invite submissions from creditors as to how their debts should be dealt with. The Trustee will consider the financial circumstances of the debtor and any submissions made in preparing the proposal for a PIA and will summon a creditors' meeting.

Terms

It is proposed that the maximum period of a PIA will generally be six years, during which the obligations are to be performed.

A PIA is not generally permitted to require a debtor to cease to occupy or dispose of an interest in his principal private residence. The Trustee is under a duty, insofar as reasonably practicable, to formulate a proposal that will not require the debtor to vacate their principal private residence. The duty does not apply with debtor consent or where the costs to the debtor of remaining in possession are disproportionately large. Legal advice must be received in those cases.

The Draft Bill provides a range of repayment options that may be in a proposal for a PIA. There are also specific provisions in respect of secured debts and also how secured property can be dealt with. For example the principal sum due may be reduced and payments deferred.

The specific provisions include that where the PIA requires the sale of the property and there is a shortfall, the balance due reduces in equal proportion to the unsecured debts covered by the PIA and shall be discharged with them on completion of the obligations specified in the PIA.

The proposals also include certain protections for secured creditors so that a minimum amount is payable to secured creditor. This aims to ensure that any write-down does not reduce the principal below (a) the value of the security, or (b) the amount of the debt secured thereby. It also provides for a clawback in the event of a subsequent sale of the property unless agreed otherwise.

Valuation of security

The value of security is to be determined by agreement between the debtor (acting through the Trustee) and the relevant secured creditor. Under the proposals the secured creditors will submit to the Trustee an estimate of the value of their security. Where the debtor or the Trustee does not accept a secured creditor's submission the debtor, the personal insolvency trustee and the secured creditor shall in good faith endeavour to agree a fair value for the security having regard to any matter relevant to the valuation of security, including a list of specified factors. In the absence of agreement the valuation will be performed by an independent person.

It is interesting that all secured debt (principal private residence mortgages, buy-to-lets loans and second charges) are all treated the same. Judgement mortgages are also treated as secured debt. This could produce unforeseen results in any meeting of creditors and be potentially unfair on holders of PDH mortgages.

Creditors' meeting

The creditors must be given certain documents by the Trustee when he or she summons a creditors' meeting, including certain statements and opinions of the Trustee including as to eligibility.

Under the proposals, where a proposed PIA is approved at a creditors' meeting by a majority of 65% in value of actual votes cast at the meeting of the creditors as a whole (whether secured or unsecured) the PIA will be binding on every creditor who was entitled to vote at the creditors' meeting. The current proposals provide that the approval will be subject to:

  • the agreement of all secured creditors; or
  • (i) a majority of 75% in actual votes3 cast at the meeting of the secured creditors; and (ii) a majority of 55% in actual votes cast at the meeting of unsecured creditors.4

Under the proposals the Service will receive copies of the PIA and send one copy to the Circuit Court. Unless a creditor enters an objection in the Circuit Court within 30 days from the communication of the result of the creditors' meeting to the Service it is provided that the Circuit Court will make an order approving the PIA. An objection can be made on similar grounds to those set out above in respect of DSAs.

Failure to agree to a PIA would terminate the process and leave the debtor open to bankruptcy and other enforcement proceedings.

The PIA will be deemed to have effect from the making of the order and will be placed in the register maintained by the Service.

Effect

It is proposed that where the PIA has expired and the debtor complied with his obligations the debtor will be discharged from the remainder of the unsecured debts covered by the PIA. The debtor will also be discharged from the remainder of the secured debts to the extent provided for under the terms of the PIA.

Once deemed to have effect, the PIA will restrict a creditor's ability to petition for the debtor's bankruptcy for a debt, or enforce or recover a debt, covered by the PIA.

Currency of PIA and termination

During the currency of the PIA the Trustee has certain functions, such as to ensure that the PIA proceeds are paid in accordance with its terms.

A PIA may be varied with the consent of a debtor and with the approval of creditors at a creditors' meeting. The same qualified majority and a similar process applies. In certain circumstances an application can also be made to have a PIA terminated and there is a deemed failure of a PIA after six months arrears default.

Where a PIA terminates prematurely the debtor will be generally liable in full for all debts covered by the PIA except in certain circumstances. An application for an adjudication in bankruptcy against the debtor may also be made by a creditor or debtor on the ending, termination or failure of a PIA.

Bankruptcy

In summary, the main effects of the Draft Bill are that:

  • bankruptcy will only be available where a debtor's liabilities are over €20,000 in a creditor's petition;
  • the automatic discharge period under the Bankruptcy Act 1988 will be reduced from twelve years to three years; and
  • a court will have discretion to order a discharged bankrupt to make payments for the benefit of creditors for a period of five years from the date of discharge.

Next steps

The Draft Bill represents a first draft of proposals reflecting the Government's policy. Comments on the Draft Bill can be made to the Department of Justice and Equality by 1 March 2012. The formal drafting of the Bill itself is to be arranged on a priority basis with the aim of it being published by the end of April 2012, as required under the EU/IMF Programme of Financial Support for Ireland.

Comment

The introduction of non-judicial settlement options is a welcome step aimed at bringing a consensual end to the difficulties of those debtors who are eligible. Indeed in respect of DSAs and PIAs (with PIAs applying to secured debt), the proposals offer debtors options to resolve their position while ensuring that lenders can play a part in a process so that they can recover as much as possible. The current uncertainty and absence of non-judicial options is helping neither borrowers nor lenders, and is a significant source of concern for potential purchasers of bank assets (and in particular consumer and mortgage loans).

While creditors may vote against a DSA or PIA, the effect of such a course of action would be to leave debtors with the option of seeking bankruptcy, which would generally free them of all debts in three years. In such circumstances, a lender will be left with no guarantee of recouping its losses and, in respect of secured property, may be left with property that might be difficult to sell. Therefore, in practice, the non-judicial arrangements may not be so voluntary after all.

Further information and discussion is needed around certain key issues, such as:

  • Do secured creditors have a veto or can a dissenting minority be bound?
  • Will secured creditors in different classes be treated differently?

Links

The Personal Insolvency Bill is available here.

The accompanying press release is available here.

The Arthur Cox briefing on the Inter-Departmental Mortgage Arrears Working Group is available here.

Footnotes

1 The proposals contained within the Draft Bill build upon those contained in report of the Law Reform Commission on Personal Debt Management and Debt Enforcement published in 2010. The Draft Bill was also preceded by the publication of a report by the Mortgage Arrears and Personal Debt Expert Group in 2010 and a report by the Government's Inter-Departmental Mortgage Arrears Working Group in September 2011.

2 This is not defined.

3 Again, it will be important how "vote" is defined. For example, does a subordinated creditor have the same votes as a senior creditor?

4 These provisions are in square brackets in the Draft Bill and therefore there is obviously some ongoing debate how this provision will ultimately read. It will be a key issue whether the secured creditors have a "veto" or can be compelled to accept a personal insolvency arrangement ("squeezed out").

This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.