Insolvency: giving a second chance to businesses and consumers

On the 12th of July, the Slovak Presidency and the European Commission held a conference entitled “Convergence of insolvency frameworks within the European Union – the way forward”. The conference kicked off by a speech from Commissioner Věra Jourová, stressing the importance of providing both businesses and consumers access to insolvency, giving them a “second chance”. COFACE Families Europe, represented by Martin Schmalzried, spoke on one of the panels about the importance of a minimum harmonization of insolvency law across the EU.

Is there a need?

Looking strictly at the “cross border” dimension, there is clearly a need for a harmonization of insolvency law. EFIN (European Financial Inclusion Network), of which COFACE is a member, has collected a number of case studies on cross-border insolvency. The results point to a well-known phenomenon, namely “forum shopping” or “insolvency tourism” which enables some consumers to take advantage of a more favorable national insolvency law by moving their COMI (Centre of Main Interest, for instance their primary residence) to that country. German consumers for instance, have been known for taking advantage of UK insolvency law by calling upon the services of specialized lawyers to help them access the UK insolvency scheme which is much more favorable than the German one. Besides these cases, there are many other cross-border insolvency situations: families working in one country and residing in another, families moving from one country to another with left over debts etc.

But even beyond the “formal” justification for action, there are many social and economic arguments for the EU to intervene. Poorly designed insolvency laws result in dramatic social consequences. People who are over-indebted and have no way to repay their debts experience health issues, stress, suffer from poverty, are more likely to undergo a divorce and in some cases even attempt or commit suicide. Furthermore, poorly designed insolvency laws come at high economic costs. The administrative procedure for attempting to recover debts from insolvable consumers is extremely costly and in most cases, the procedure barely covers its cost, with a recovery rate for the principal and interest of 0%! The state suffers losses of tax revenues, often because of the lack of motivation for an over-indebted person to maximize his/her revenue or even to work altogether, while its social welfare costs increase as some insolvable consumers rely on social benefits to survive. There is also a risk of increased reliance by over-indebted consumers on the informal economy for revenue.

Finally, the current Capital Markets Union initiative and the Single Market for Financial Services will require some form of harmonization of insolvency in order to provide legal certainty and a level playing field for businesses, financial service providers and consumers.

Insolvency: only for business?

The European Commission is to decide whether any initiative in harmonizing insolvency should only concern businesses or also extend to consumers. COFACE strongly supports the latter. As it was stated during the conference by a number of speakers, it is often impossible to distinguish debts/assets of micro-entrepreneurs or independent business owners and consumers. Many micro-entrepreneurs work from home (their primary personal residence) and their financial situation is often “mixed”, meaning that it is hard to distinguish between clear “consumer debt” from “professional debt” or personal assets vs. business assets.

One suggestion, which deserves closer examination, was voiced by Joseph Spooner from LSE: distinguishing between “high net worth” debtors and “low net worth” debtors when designing an insolvency procedure, including issues of restructuring. Clearly, multi-million euro debts from a medium sized SME are different from several thousand euro debts from an independent business owner. But setting the correct thresholds will be essential to ensure a fair treatment and solution of over-indebted consumers/small business owners/large businesses.

An insolvency framework, based on what principles?

The starting point of any insolvency framework should be to preserve human dignity of debtors and guarantee decent living conditions based on transparent and independently drafted reference budgets. Family associations in France and Belgium provide reference budgets which estimate the expense structure of a variety of family models in a transparent way.

The following recommendations are based directly on the FSUG position paper of 2012:

  • Good faith should always be presumed and bad faith must be demonstrated.
  • Insolvency procedures must abide by a number of criteria among which: accessibility, efficiency, enforceability, promptness, intelligibility, independence, access to justice, trust, fairness and especially, affordability. Although this might come as a surprise to many, even a “flat” entry fee of as little as 50€ can prevent a consumer from accessing an insolvency mechanism.
  • The procedure must be timely: a discharge after 1 year with a 3 year repayment plan.
  • The procedure should move from courts to administrative processes. Access to justice should be guaranteed for appeal only.
  • Insolvency procedures should always be precluded with strong pre-emptive measures and early intervention, namely via the availability and provision of independent debt counselling.
  • Independent debt counsellors should be given a number of core responsibilities including:
    • Determining an acceptable solution
    • Have the power to attach earnings based on transparent rules (exempt income based on social benefits, reference budgets…)
    • Only have the right to liquidate assets worth over a substantial threshold
    • Have the power to impose a “zero plan” where there is no chance for the consumer being able to make payments with immediate discharge if a consumer cannot over 3 years repay either 10% of their total debt or 10000€ whichever is lower.
    • Have the right to impose a “cram down” on creditors.

An insolvency framework should allow for a combination of existing solutions such as debt cancellation, debt relief and datio in solutum. While a model based on mortgage forbearance is best for all parties, datio in solutum has its uses. For instance, at the point where the consumer is informed that the lender wishes to move to enforcement, being able to evidence its efforts to agree and deliver a viable restructuring and the borrower’s failure to comply with this, all consumers, irrespective of income should be able to apply for datio in solutum immediately.

For more information, contact Martin Schmalzried, Senior Policy and Advocacy Officer

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