People with severe financial problems or who are insolvent have several options to consider when deciding how best to satisfy their debts and resolve their financial difficulties. Caroline Clark of RMCSC spells out the options available.

What is personal insolvency?

Personal insolvency is defined by the Insolvency Act 1986 (IA1986) as when someone is unable to pay their debts when they fall due. Being unable to pay debts when they fall due is defined by if a statutory demand (in respect of an unpaid debt) has been served by a creditor to the insolvent person (the debtor) and the debt remains unsatisfied within the 21 days it allows, or if the debtor fails to apply to set it aside within 18 days.

Satisfaction of personal insolvency is not defined by IA1986, but for the purposes of this article personal insolvency is considered to be legally satisfied when the debtor has made what payment is possible in respect of their outstanding debts, creditors have received whatever dividend is possible in respect of amounts owed to them, the process has been administered independently and creditors can no longer take legal action to recover amounts still owed to them.

So how can personal insolvency be legally satisfied? In general, there are three options available under IA1986:

• bankruptcy
• individual voluntary arrangements (IVAs)

What is bankruptcy?

Until IA1986, people who could not pay their debts as they fell due had two options: bankruptcy or deeds of arrangement. Bankruptcy meant that the debtor's assets were sold by the trustee in bankruptcy to enable a dividend to be paid to creditors in satisfaction of their debts.

Few deeds of arrangement were successful as a creditor who did not agree with the deed of arrangement could petition for the debtor's bankruptcy. The execution of a deed of arrangement was itself an act of bankruptcy and this Catch 22 situation meant that before IA1986 bankruptcy was the main way of satisfying personal insolvency.

Until 1861, only people who bought and sold goods for a living could be made bankrupt, preventing legal action by their creditors to recover amount due to them. Other people who could not pay their debts as they fell due were liable to be thrown into a debtors' prison until their debts were paid in full. The last debtors' prison in London was not closed until 1880 and Andy Wood has written an excellent article about the tyranny of debtors' prisons.

Although bankruptcy does give legal satisfaction of personal insolvency, by 1986 it was seen as a 'one fits all' solution that did not deal humanely or successfully with sole traders or people with steady incomes as well as, or rather than, high value assets.

What is an individual voluntary arrangement (IVA)?

Bankruptcies administered by a trustee in bankruptcy, who since IA1986 must be an insolvency practitioner, are still a valid option. But IA1986 introduced individual voluntary arrangements (IVAs) as an alternative.

IVAs enable a debtor to make a proposal to their creditors for either realisation of assets or the payment of contributions from their salary over a defined period (usually five years) or a combination of both. The receipts from this are distributed to creditors who receive a dividend in settlement of the amount owed to them. An IVA is administered by an insolvency practitioner, the supervisor.

Creditors bound by a successful individual voluntary arrangement can no longer take legal action against the debtor in respect of amounts owed to them, and therefore IVAs have proved to be a popular way of satisfying personal insolvency.

What is a debt relief order?

The incidence of personal insolvency has steadily increased since 1986, and perhaps because of this in 2009 the government introduced debt relief orders as a third option under IA1986 for satisfying personal insolvency.

Only debtors who owe less than £20,000, do not have more than £1,000 in assets, have less than £50 a month spare income, and who do not own their own homes may apply to the official receiver for a debt relief order. Debt relief orders usually last for 12 months and creditors can no longer take legal action against the debtor in respect of amounts owed to them. The official receiver is responsible for the administration of debt relief orders.

How can debt management plans and administration orders help financial difficulty?

Two further options are open to people in financial difficulty: debt management plans and administration orders. Neither of these options are included in IA1986 and both debt management plans and administration orders provide for the payment in full of amounts owed to the debtor's creditors.

Strictly speaking, debt management plans and administration orders do not apply to the definitions given at the start of this article, which refer to insolvency situations where only a dividend or proportion of the amount outstanding is paid to creditors.

However, debtors with increasing financial problems who take prompt professional advice and who can prevent their debts increasing and avoid insolvency may find a debt management plan or administration order a good way of resolving their financial problems.

What options are available during personal insolvency?

It can be seen from this that there are three ways of legally satisfying personal insolvency under IA1986; bankruptcy, individual voluntary arrangement and debt relief orders. Debt management plans and administration orders may also assist in preventing the need for an IA1986 insolvency procedure and anyone with financial difficulties would be best advised to seek professional advice without delay.

About the author

Caroline Clark is director of RMCSC, a fellow of the Insolvency Practitioners Association and R3, and has an MBA. She established RMCSC in 2013, providing compliance consultancy advice for insolvency practitioners.

See also

Can personal bankruptcy affect your business?

What happens once I've been discharged from bankruptcy?

Find out more

Insolvency Act 1986 (Legislation)

Contact an official receiver (Gov)

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