There were more than 30,000 personal insolvencies in Australia in the 2016/17 financial year – an increase of around 2 per cent over the previous year. Importantly, there was strong growth in the number of debt agreements (up 12 per cent to 13,597) while the number of bankruptcies fell.
Debt agreements were introduced into the insolvency world 20 years ago, with the intention of giving debtors a less onerous alternative to bankruptcy.
However, a review of debt agreements highlights concerns that they are causing harm and argues that many debtors would be better off going into bankruptcy or using hardship provisions to negotiate directly with creditors.
Ian Ramsay, professor at the Melbourne Law School, University of Melbourne, Vivien Chen, lecturer at Monash Business School, and Lucinda O’Brien, research fellow at University of Melbourne were the authors of the report, An Evaluation of Debt Agreements in Australia. They have called for reforms to the personal insolvency system.
The report should spark debate about what can be done to make personal insolvency arrangements work better. In the meantime, it is important for debtors (that’s most of us) to be aware of problems in this area and understand the other options available for dealing with insolvency.
Debt agreements are binding agreements made between debtors and their creditors in accordance with Part IX of the Bankruptcy Act. Debtors who are insolvent may propose legally binding repayment arrangements to their creditors. The proposal becomes a binding debt agreement if enough creditors vote to accept.
These agreements are subject to oversight by the Australian Financial Security Authority. There are some restrictions on who can propose a debt agreement: there is a limit on the value of unsecured debts; and debtors cannot have been bankrupt.
Debt agreement proposals must include an authorisation for a specific person to administer the debtor’s property in accordance with the terms of the agreement. This provision has given rise to a small industry profit-making debt administrators. Many debtors appoint registered debt agreement administrators who provide the service for a fee.
An accepted debt agreement is recorded on the National Personal Insolvency Index. Creditors may not take legal action against debtors to recover debts that are subject to a debt agreement. An NPII listing is for five years, while a bankruptcy listing is permanent,
Unlike bankrupts, debt agreement debtors are not subject to restrictions on overseas travel, nor are they disqualified from managing corporations. There are fewer employment restrictions and they can keep their homes.
In a survey that forms part of the report, debt agreement debtors report improvements in their lives after personal insolvency. Some of the positive that respondents report are flexible repayment arrangements, escaping harassment from creditors and saving their homes.
According to the report, the debt agreement system has, to some extent, achieved its objectives. A substantial number are completed and the completion rate has increased over time.
However, it also found that debt agreements pose significant risks to some debtors and called for reforms.
Debt agreement administrators fail to inform debtors of the full implications of signing a debt agreement. Which is an act of bankruptcy with long-term legal and financial consequences.
Some administrators establish agreements that require debtors to repay more than 100 per cent of the debts owed. One financial institution revealed that it was party to a number of debt agreement proposals in which the debtors offered to pay as much as 196 per cent of the value of their original debts. In some of these proposals administrators fees were equal to or greater than the debts.
Among the reform called for in the report, administrators should be required to submit a statement with each debt agreement proposal, certifying that the proposed agreement is a suitable option for the debtor in light of their circumstances. The statement would include an explanation of why other options, such as bankruptcy or a hardship variation are not suitable. Debtors should be given a key facts sheet explaining risk and cost in plain language.
Administrators’ fees should be more transparent and more strictly regulated. The Bankruptcy Act should be amended to provide that administrators’ fees cannot exceed a certain proportion of the original debt. Fees should only be payable after a debt agreement proposal is accepted by creditors.
Administrators should be required to join an external dispute resolution scheme.
The financial hardship rules in the consumer credit law should be strengthened. Many creditors are willing to allow payment by instalments or short-term extensions of time for payment, but are unwilling to reduce debts. Consequently, financial hardship arrangements are best suited to debtors facing short-term financial difficulties.
Debtors facing longer-term hardship are often unable to afford the payment plans offered. In order for financial hardship schemes to be a viable alternative for a broader group of debtors, creditors need to offer more affordable payment plans and make them more accessible.