On 13 May 2015, the Government announced that it intends to give the courts the power to overrule the rejection by secured creditors of arrangements under the Personal Insolvency Act 2012 (the "Act").
There is scant detail in the announcement save that it is intended to "support mortgage holders who are in arrears" and that legislation is to be brought forward before the Summer recess. How is such legislation likely to work and what potential frailties could it have?
To approve a proposed Personal Insolvency Arrangement ("PIA"):
- 65 % in value of the creditors participating in the meeting and voting;
- 50 % in value of the secured creditors who are entitled to vote and have voted; and
- 50 % in value of the unsecured creditors who are entitled to vote and have voted
must vote in favour of it. There are currently no constraints on how a creditor votes.
The concern identified by lobby groups for those in mortgage arrears is that PIAs are being voted down by banks even though the PIA provides for a repayment, over time, of an amount greater than the current value of the property.
For example, a borrower may owe €350,000 on a family home currently worth €200,000 with 15 years left on the mortgage. The borrower may propose in a PIA that the debt be written down to €275,000 and repaid over the 15 years.
A bank may vote against this proposal and 'veto' the PIA, assuming that it is owed most of the borrower's secured debt. To the borrower this seems illogical – why is the bank refusing €275,000 over time when it will only get €200,000 less costs now? But the bank may have other reasons for refusing the deal, such as the borrower's likely ability to repay the entire debt - perhaps over a longer period, the borrower's credit history, the bank's cost of funds and the systemic effects of agreeing such write downs on the existing mortgage book and on future borrowers.1
However, the Government appears convinced by the borrowers rather than the banks and the Minister for Justice has stated:
"The new provision for independent review by the courts is an important reform to protect distressed mortgage-holders from any unfair lack of cooperation from their banks when it comes to seeking to agree a personal insolvency solution." [Emphasis added]
The Government has characterised this as an 'Examinership' approach to enable Courts to overturn vetoed PIAs subject to certain tests.
The Analogy with Examinership?
Examinership operates only in relation to companies that are insolvent. In an examinership, and subject only to very modest voting thresholds, the court can force dissenting creditors to take deals provided that the creditors do not suffer "unfair prejudice". For secured creditors, this has been interpreted by the courts as meaning that the secured creditor must receive at least its current security value in any imposed deal.
In almost all examinerships, an investor makes a proposal and puts money into the company. In many cases, there are multiple potential investors, enabling the market to determine an appropriate value. In contrast, in PIAs there is no 'investor' seeking a commercial return. Occasionally, a family member or friend contributes to the available funds but this is on an altruistic rather than a commercial basis.
Because altering the terms of secured debt, whether in examinership or a PIA, involves an interference with constitutionally protected property rights, it is difficult to draft legislation that does this in a proportionate, and therefore constitutionally acceptable, way.
In examinerships, a dissenting secured creditor usually gets their current security value in short order – often within months and rarely in longer than a year. The liquidity to make this payment is provided by an investor. In a PIA, prompt payment of the full security value is inherently unlikely. Rather, banks will probably be asked to accept current security value payable over a decade or longer. It will be difficult to reconcile this curtailment of property rights with the constitutional protection if there are no balancing provisions which take account of a debtor's change of circumstances over such a long period.
Separately, the justification underlying examinership, as identified by the courts, is to assist the economy by preserving the company's undertaking and enterprise and the jobs provided by the enterprise. The courts have expressly held that examinership is not designed to assist those who have simply made a bad investment. In general, the shareholders are expected to lose their original investment and it is the investor who takes the future upside.
The same justification does not necessarily apply to PIAs. There are arguments that swift debt resolution and forgiveness aid an economy but equally there are arguments that an economy only prospers where contractual rights are strongly upheld by rule of law. Moreover, in an examinership the economic stakeholder, the shareholder, is expected to lose everything with third parties, the employees and the investor, benefitting. In a PIA, it is the economic stakeholder, the debtor himself, who benefits. Accordingly, it seems likely that the legislation will need to articulate an objective of social justice, the exigencies of the common good and/or the desirability of home ownership, perhaps related to the constitutional status of the family, in order to help legitimise the erosion of property rights. Such an approach could limit the scope of any legislation – for example by excluding investment properties or requiring a balanced review of changed circumstances of both debtor and creditor.
The Government faces a political challenge: appeal to those in arrears without losing support from the compliant majority or undermining the return to profitability of the banks. There is a connection between loan losses, ease of security enforcement and the rates that new borrowers are offered.
It also faces a legislative challenge to design legislation which will be constitutionally robust and functionally efficient.2 Any failure to execute this challenge is likely to have a political cost but, more importantly, may significantly change the rights of key interest groups with unpredictable social and economic effects.
1 The disparity between the arrears rates in Northern Ireland, where a less debtor friendly regime has continued, and arrears rates in the South, when correlated with unemployment rates in both jurisdictions, has often been referred to by banks as an indicator of a culture of strategic default in the South.
2 In Irish Life and Permanent plc -v- Dunne and Irish Life and Permanent plc -v- Dunphy (Supreme Court, unreported, 15 May 2015), the court held: "...courts do not at present have the necessary resources to engage in detailed analysis of the merits or otherwise of debt resolution procedures and proposals in every, or virtually every, repossession case.".
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