Changes to Personal Bankruptcy Law

Originally published Summer 2004

On 1 April 2004 the provisions of Part 10 of the Enterprise Act 2002 (the "Act") relating to personal bankruptcy came into force. The new regime is designed to reduce the stigma of bankruptcy for "innocent" (as opposed to "culpable") bankrupts and thus to encourage entrepreneurs to start new businesses and take risks, thereby promoting the growth of the economy.

It aims to strike a balance between, on the one hand, encouraging new businesses and providing a fresh start to those who have failed through no fault of their own and, on the other hand, protecting the public and the commercial community from those whose conduct of their financial affairs has been irresponsible or reckless.

Under the new regime, most bankrupts will be automatically discharged after a maximum of one year from the start of the bankruptcy - as compared with the 2 or 3- year period under the old regime. The Official Receiver will make an initial enquiry into the circumstances of each bankruptcy, including interviewing the bankrupt, and if the Official Receiver considers that no further investigation is necessary, the bankrupt may be discharged earlier than the expiry of the one-year period. However, if the bankrupt fails to comply with his obligations, a court may suspend the automatic discharge on an application by the Official Receiver or the trustee in bankruptcy, thereby extending the duration of the bankruptcy.

If, after his initial enquiry, the Official Receiver concludes that further investigation into the conduct of the bankrupt is necessary, the new regime enables him to carry out that investigation and make a report to the court, which may lead to the Secretary of State or the Official Receiver applying for a bankruptcy restriction order ("BRO"). The BRO will last for a minimum of 2 years and a maximum of 15 years, regardless of the intervening discharge of the bankrupt, and will restrict the activities of the bankrupt - for example, preventing him from acting as a director of a limited company or obtaining credit over a certain limit.

Examples of behaviour that could lead to a BRO include, but are not limited to:

• failing to co-operate with the Official Receiver or trustee in bankruptcy;
• failing to account for prior transactions causing loss;
• entering into a transaction at an undervalue;
• failing to supply goods or services which have already been paid for;
• trading at a time when the bankrupt knew he could not pay his debts; and
• incurring a debt with no reasonable expectation of being able to repay it.

Previous bankruptcies will also be taken into account by the court.

Alternatively, the bankrupt can agree to give a bankruptcy restriction undertaking ("BRU") by which he agrees to be bound by specific restrictions. These restrictions can be imposed for between 2 and 15 years and will legally bind the bankrupt in the same way as a BRO, but without involving the court.

The court can make an income payment order ("IPO") requiring the bankrupt to make payments from income towards discharging his debts. Even though the bankrupt can now obtain a discharge within 12 months, an IPO may still last up to 3 years.

As an alternative to an IPO, the Act enables the bankrupt to enter into an income payment agreement ("IPA"). This does not involve the court but is still a legally binding agreement between the bankrupt and his trustee, lasting up to 3 years, and will require the bankrupt to make affordable payments towards discharging his debts.

An individual voluntary arrangement ("IVA") is a legally binding compromise between the bankrupt and his creditors regarding the repayment of debts, as an alternative to bankruptcy.

The Act allows the Official Receiver to propose a "fast-track" IVA after the bankruptcy order has been made, if he feels that the creditors would benefit and the bankruptcy should not continue. Under the new "fast-track" procedure, creditors will be offered a proposal, but there will be no creditors' meeting and creditors will not be able to modify the proposal. Instead, they will either accept or reject it by correspondence. The new process should be fast and cheaper than a normal IVA, but a debtor will still be able to enter into a normal IVA as an alternative to becoming bankrupt in the first place.

Under the previous regime, the bankrupt's interest in the family home formed part of the bankrupt's estate and vested in the trustee, who could sell it even many years after the bankrupt had been discharged. The new regime provides that the trustee must deal with the family home within 3 years after the bankruptcy order or it will cease to form part of the bankrupt's estate and will revest in the bankrupt. Within the 3-year period the trustee must therefore either realise the interest, apply for a charging order or an order for sale or possession, or agree with the bankrupt that a specified liability on the bankrupt's estate will be charged on the property.

The new regime is more "debtor-friendly" and is clearly intended to reduce the stigma of bankruptcy and encourage entrepreneurship. Against this, some commentators believe that the new procedure increases the risk for the public and the commercial community by making it easier for individuals to go through bankruptcy and avoid paying most of their debts. Others have expressed concern at whether the Official Receiver will have sufficient resources to perform his new role and still others are sceptical as to whether the changes will actually encourage business startups.

Clearly, it remains to be seen what effect the new regime will have in practice.

© RadcliffesLeBrasseur

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.