Individual Voluntary Arrangements (IVAs)

BRIEFING PAPER Number CPB5165, 6 April 2016 Individual Voluntary Arrangements (IVAs) By Lorraine Conway Inside: 1. Introduction 2. Alternatives to bankruptcy 3. Characteristics of an IVA 4. Who is eligible to start an IVA? 5. The cost of an IVA 6. A brief explanation of the IVA process 7. The IVA protocol 8. Advantages and disadvantages of an IVA? www.parliament.uk/commons-library intranet.parliament.uk/commons-library papers@parliament.uk @commonslibrary

Number, 5 April 2016 2 Contents Summary 3 1. Introduction 4 2. Alternatives to bankruptcy 5 3. Characteristics of an IVA 6 4. Who is eligible to start an IVA? 7 5. The cost of an IVA 9 6. A brief explanation of the IVA process 10 7. The IVA protocol 12 8. Advantages and disadvantages of an IVA? 13 Cover page image copyright: Money UK British pound coins by hitthatswitch. Licensed under CC BY 2.0 / image cropped.

3 Individual Voluntary Arrangements (IVAs) Summary An Individual Voluntary Arrangement (known as an IVA) is a legally binding agreement between a debtor and his/her creditors. The agreement sets out how creditors will be repaid and normally involves setting up monthly repayments over a specified period of time. Alternatively, if an asset (such as a property) can be sold, the agreement may specify that the proceeds from the sale will be used as payment. An Insolvency Practitioner will normally assist in working out what the debtor can afford to repay and how long the IVA should last. The IVA will start if creditors holding 75% of the total debt agree to it. For an IVA to be approved, the IVA proposal must usually offer a higher return to creditors than could otherwise be expected were the debtor to be made bankrupt. Once approved, the IVA will apply to all creditors, including any who voted against it. For the purposes of an IVA, a debtor is taken to mean an individual, sole trader or partner (in a business partnership). It is important to note that an IVA can be cancelled by the Insolvency Practitioner if the debtor fails to keep up with repayments. An IVA is an alternative to bankruptcy for a debtor who is in financial difficulty (for other options see Box 1 below). The main benefit of an IVA is its flexibility and the fact that (unlike bankruptcy) it allows the debtor to retain control of his/her assets. However, an IVA can be expensive and there are risks to consider (see Box 2 below). This Commons briefing paper provides an overview of IVAs, including information on: who is eligible to start an IVA; the IVA process; and the advantages and disadvantages of an IVA. This Paper applies only to England, Wales and Northern Ireland. Scotland has its own law on personal insolvency, including the option of a Protected Trust Deed (instead of an IVA).

Number, 5 April 2016 4 1. Introduction An IVA is an agreement entered into by a debtor with his/her creditors to pay off their debts over a set period of time. It is one option a debtor can use to pay off their debts. It is a formal, legal debt solution. This means it is approved by the court and both the debtor and his/her creditors must adhere to the terms of the IVA. An IVA must be set up by a qualified Insolvency Practitioner, who will then deal with the creditors throughout the life of the IVA. Of course, the Insolvency Practitioner will charge a fee for setting up and supervising the IVA. In practice, if a debtor decides to enter into an IVA, their first step will be to work out a repayment plan with their Insolvency Practitioner. This repayment plan is then put to the creditors. Acceptance of an IVA proposal requires 75% in value of those creditors who vote either in person or by proxy at the meeting. 1 Assuming the creditors agree the plan, the IVA will start and the debtor will pay back a set amount each month, usually for five years. This monthly repayment will be paid directly to the Insolvency Practitioner who will then distribute the money to the creditors. Some of the monthly payment may be kept by the Insolvency Practitioner to pay their fees. At the end of the IVA, if the debtor s payments into the IVA are not enough to pay all his/her debts in full, the rest will usually be written off. An IVA can be flexible to suit the needs of the debtor, but it can be expensive and there are risks to consider (see Box 2 below). It is not the only option for someone in financial difficulty (see Box 1 below). 1 By value means voting creditors who hold more than 75% of the total debt, not the number of creditors there are.

5 Individual Voluntary Arrangements (IVAs) 2. Alternatives to bankruptcy Box 1: Alternatives to bankruptcy For the individual in financial difficulty, there are four main alternative options to bankruptcy. They are: Informal Arrangement this is where the debtor writes to all his/her creditors to see if a compromise can be reached. To have any hope of success, the debtor should include a timetable of when he/she will repay each creditor. However, an informal arrangement is not legally binding. Individual Voluntary Arrangement (IVA) an IVA is a formal legally binding agreement between the debtor and his/her creditors. Personal Administration Order such orders are only suitable for those individuals who have personal unsecured borrowings (i.e. debt) of 5,000 or less. It is a way for an individual to deal with debt if they have several County Court judgments (CCJs) against them, in aggregate only owing a relatively small amount. Under this court order, the debtor makes a monthly payment to the court, and the court will divide this money between the creditors. While the debtor is making payments in accordance with the Administration Order, creditors listed on the administration order can't take any further action against the debtor to get their money without the permission of the court. Debt Relief Orders (DROs) - DROs are suitable for people who do not own their own home, have little surplus income and assets and less than 20,000 of debt if you live in England or Wales or less than 15,000 in Northern Ireland. An order lasts for 12 months. In that time creditors named on the order cannot take any action to recover their money without permission from the court. At the end of the period, if the debtor s circumstances have not changed they will be freed from the debts that were included in the original DRO. Of course, if the debtor s circumstances have significantly improved, creditors may receive payment. The benefit of a DRO is that it does not involve the courts; a DRO is administered by the Insolvency Service in partnership with approved intermediaries (debt advisers). This note only looks in detail at Individual Voluntary arrangements (IVAs).

Number, 5 April 2016 6 3. Characteristics of an IVA An IVA is basically a formal legal agreement between the debtor and his/her creditors. An IVA proposal sets out the amount the debtor intends to repay his/her creditors over a specified period of time (usually five years). Any unpaid parts of the debts that were included in the IVA are written off when the arrangement is completed. An IVA can be set up in a number of different ways, for instance, it can be: A monthly income payment arrangement, whereby a set amount is paid by the debtor each month for a set period of time (usually over a 3 to 5 year period). An IVA is a formal legal agreement between the debtor and his/her creditors A lump sum fixed-term or a short-term arrangement may be agreed if a lump sum is expected by the debtor (perhaps from the re-mortgage of a property, sale of an asset, or a family members contribution). This lump sum is then used to make a payment to the creditors. Some IVAs are a mixture of both instalments and lump sum payments. In a nutshell, the purpose of an IVA is to enable a debtor to reach a compromise with his/her creditors and avoid the consequences of bankruptcy. To achieve this aim, it is usual for the compromise to offer a larger repayment towards the creditor s debt than could otherwise be expected were the debtor to be made bankrupt. This is often facilitated by the debtor making contributions to the IVA from his income over a designated period, from the re-mortgage or sale of an asset, or from a third party contribution. An IVA has to be set-up by a licensed Insolvency Practitioner. Unlike an informal arrangement to repay debts, an IVA is legally binding and prevents all creditors notified and therefore included in the IVA from taking any enforcement action against the debtor post-agreement (assuming the debtor complies with his obligations in the IVA). An IVA has to be set up by a licenced Insolvency practitioner An IVA can therefore be an effective way for someone in financial difficulty to deal with their debts under the guidance of a licensed Insolvency Practitioner. The debtor should be aware however that an IVA will only deal with his/her unsecured creditors and not secured creditors (such as a mortgage company). An IVA is legally binding provided the debtor does not default on repayments

7 Individual Voluntary Arrangements (IVAs) 4. Who is eligible to start an IVA? An IVA is available to all individuals, sole traders or partners (in a business partnership) who are experiencing financial difficulty. For example, depending on his circumstances, a sole trader may elect to enter in to an IVA in order to ride-out the storm and maintain his/her business as they believe it will be profitable in the future. IVAs may also be particularly useful to those who own their own property and wish to avoid the possibility of losing it in the event they are made bankrupt. For their part, creditors are often willing to accept an IVA proposal because it offers them a higher return than could otherwise be expected were the debtor to be made bankrupt. However, an IVA is not right for everyone. The debtor must meet certain criteria. For an IVA to be a realistic option, the debtor would normally need to show: they are resident of England, Wales or Northern Ireland (debtors who live in Scotland should consider a Protected Trust Deed instead of an IVA); An IVA is available to individuals, sole traders, partners (in a business partnership An IVA is not right for everyone certain criteria must be met they are insolvent - this is generally taken to mean that they cannot pay their debts as they fall due; they have some spare income each month to pay creditors; any amount of debt can be included in an IVA, there are no minimum or maximum limits set by law, but according to Citizens Advice, creditors are unlikely to agree an IVA unless the debtor s total debt is more than 10,000; any number of debts can be included but normally an IVA will be suitable if the debtor has more than three debts and two or more different creditors An IVA will normally only be right for a debtor if they have a regular and predictable income. This is because an IVA depends on the debtor making monthly payments to his/her creditors over a period of a few years. If the debtor s income changes from month to month, an IVA may not be right for them. A debtor doesn t have to own any assets to get an IVA. However, any assets they do own might help him/her to repay their debts in the IVA. For instance, the debtor might own property, land or a car which could be sold or re-mortgaged. The debtor is expected to be honest with his/her Insolvency Practitioner and should seek their advice on what assets should be included in the IVA. Debtor must honestly disclose all assets to their insolvency Practitioner

Number, 5 April 2016 8 Most debts can be included in an IVA. However, an IVA is normally used for the following types of debts: bank and building society loans and overdrafts credit cards personal loans store cards charge cards catalogue loans Debts that can be included in an IVA These are called non-priority debts. However, an IVA can also include priority debts, such as: council tax arrears tax debts fuel debts (e.g. gas and electricity debts) and so on However, the following debts cannot be included in an IVA: maintenance arrears that have been ordered by a court; child support arrears; magistrates' court fines; student loans; and mortgage, secured loan or rent arrears unless the lender or landlord agrees (which is extremely unlikely) Debts that cannot be included in an IVA Such debts will need to be dealt with separately. The debtor must make sure that they have enough money to pay these debts before paying money into an IVA. Secured loans are debts which are secured against a property (often the family home). An example of a secured loan is a mortgage with a bank or building society. If the debtor defaults on repayments, the lender can take the property (known as repossession ). In theory, secured loans, mortgage or rent arrears can be included in an IVA, however, the lender will have to give their permission for it to be included. In most cases, they are unlikely to do this. If the debtor owns his/her own home, the IVA proposal may (but not always) include an equity clause. This means that during the life of the IVA (often in year 4 of a 5 years fixed term IVA) the debtor may be expected to apply for a secured loan or re-mortgage to pay back some of the debt. Whether an equity clause is appropriate in an IVA will depend on the circumstances of a particular case. This is something that the Insolvency Practitioner (acting as nominee) should be able to advise on. Finally, it is important to note that if a debtor owes money to family members or friends, they can be included in an IVA. However, the debtor s insolvency practitioner (nominee) is under a duty to scrutinise such debts thoroughly. Mortgages, secured loans and rent arrears What happens to the debtor s home? Debts owed to family members

9 Individual Voluntary Arrangements (IVAs) 5. The cost of an IVA The debtor has to pay for an IVA to be set up by an Insolvency Practitioner. Insolvency Practitioner fees will vary depending on the work involved. According to Citizens Advice, fees are in the region of 5,000 on average. How and when the debtor pays the Insolvency Practitioner varies. Some practitioners will ask to be paid in full before setting up an IVA. Others will deal with the fees as part of the IVA; in effect, the fees will be taken from the monthly debt repayments. In terms of what the fee covers, the Insolvency Practitioner has three roles throughout the period of the IVA, and will charge the debtor for the performance of each. These roles are: Adviser: the Insolvency Practitioner will advise the debtor on whether an IVA is suitable. A debtor who wants to set up an IVA, should ask a number of Insolvency Practitioners for quotes or estimates on what fees they will charge in order to compare costs Nominee: the Insolvency Practitioner will help the debtor put together a proposal for an IVA, make an application to the court and hold a meeting with creditors to get agreement on the proposal. Legally, this work has to be done by an Insolvency Practitioner. Supervisor: assuming the court approves the IVA and the creditors agree, the Insolvency Practitioner will supervise the IVA as it progresses, making sure the creditors get the monthly payments and acting as a go-between for the debtor and the creditors if anything changes. Legal aid is not available for setting up an IVA.

Number, 5 April 2016 10 6. A brief explanation of the IVA process An IVA has to be set up by an Insolvency Practitioner, who acts as the debtor s nominee. It is the nominee who draws up the IVA proposal using information provided by the debtor. The proposal should show why an IVA is in the interests of the creditors and should include full details of funds and assets available for the creditors. The nominee then submits this proposal to the court with his comments on the merits of the proposal. IVA has to be set up by an Insolvency Practitioner If there is impending legal action (such as a possible bankruptcy petition), the nominee can also apply to the court for an interim order. An interim order is an order made by court precluding creditors from taking any action against the debtor whilst a meeting of creditors is called and held to decide whether the IVA proposals are acceptable to them or not. Interim order Assuming an interim order is made by the court, the nominee is required to circulate to creditors the following information: The IVA proposal in full The nominee s comments on the debtor s proposals Notice of the date and location of the meeting of creditors to vote on the proposals A statement of affairs, this effectively being a list of the assets and liabilities of the debtor A schedule advising creditors of the requisite majority required to approve the IVA A complete list of creditors A guide to the fees to be charged by the insolvency supervisor following approval of the IVA A form of proxy for voting purposes. The creditors meeting is held not earlier than following 14 clear days notice after the above has been circulated to creditors. The purpose of the meeting of creditors is to agree or reject the debtor s proposals (with or without modifications which can be requested by creditors at the meeting). Creditors meeting to consider the IVA Acceptance of the IVA proposals requires 75% in value of those creditors who vote either in person or by proxy at the meeting. 2 However, it should be noted that the 75% relates only to those who actually vote and assuming the creditors receive notice of the proposals, Approval of an IVA 2 By value means voting creditors who hold more than 75% of the total debt, not the number of creditors there are.

11 Individual Voluntary Arrangements (IVAs) all will be bound by the terms of the arrangement whether they voted or not. In effect, if the proposal is agreed, it will be binding on all creditors who had notice of the meeting. However, there is one important exception no IVA proposal may, without their consent, reduce the rights of preferential creditors or secured creditors. 3 In practice, creditors may open negotiations about the terms of the IVA. For instance, they might ask the debtor to pay more every month, or make payments over a longer period, or include the sale of assets that the debtor does not want to lose. It is the role of the Insolvency Practitioner acting as nominee to advise the debtor on the exact terms of the IVA. Negotiating terms of an IVA If the IVA proposal is approved, a supervisor is appointed (usually the nominee) to ensure the proposals are adhered to and to distribute dividends to creditors. It is important to note that if the debtor is unable to maintain the monthly payments under his/her your IVA there is a risk that they may be made bankrupt. If the debtor s circumstances change, he/she must tell the Insolvency Practitioner. If the debtor is unable to keep up with payments, the Insolvency Practitioner can ask the creditors to accept lower payments and agree a modified IVA. If the debtor cannot make any payments or his/her creditors refuse to accept lower payments, their IVA may fail. If this happens, the debtor will have to reconsider his/her options. Again, the obvious risk is that one or more creditors may petition for the debtor s bankruptcy. If the debtor is unable to maintain the payments under his/her IVA there is a risk that they may be made bankrupt What happens if the debtor s circumstances change? An IVA will last for a set time, usually three or five years. Assuming the debtor complies with the terms of the arrangement, upon completion of the IVA he/she will be fully discharged from all liabilities included within it. This means the debtor no longer owes those creditors any money. Any leftover debt that has not been repaid is written off. The record of your IVA will also be taken off the Insolvency Register. What happens at the end of an IVA? 3 For the purposes of an IVA, preferential debts are unsecured debts which, by statute, are to be paid in priority to all other unsecured debts (wages due to employees is an example of a preferential debt). A secured debt means that the creditor has the legal right to repossess the goods or property that the loan is secured against (a mortgage is an example of a secured debt).

Number, 5 April 2016 12 7. The IVA protocol A number of Insolvency Practitioners follow the IVA Protocol (currently, the 2014 version). The Protocol is a voluntary agreement, which provides an agreed standard framework for dealing with straightforward consumer IVAs and applies to both IVA providers and creditors. In effect, the Protocol sets out a number of voluntary guidelines. 4 The IVA Protocol covers a number of areas, including: what the Insolvency Practitioner should do to check the debtor s income and outgoings; how any equity in the debtor s home should be dealt with; what to do when the debtor s income and outgoings go up or down; and what should happen if the debtor misses any payments Under the Protocol, the Insolvency Practitioner is also required to make sure that the debtor has had full information on different ways to deal with his/her debts. It is important to note that not all Insolvency Practitioners use the IVA Protocol and, because each IVA can be very different in complexity, not all IVAs can follow the Protocol. The Protocol has been set up to make the IVA process quicker and simpler for Insolvency Practitioners 4 The Straightforward Consumer IVA Protocol (2013 version) is effective from January 2013

13 Individual Voluntary Arrangements (IVAs) 8. Advantages and disadvantages of an IVA? What are the possible advantages of an IVA? For the debtor an IVA can be an effective alternative to bankruptcy proceedings. The potential advantages include: An IVA gives the debtor a level of protection against impatient creditors. (An IVA, when in place, is binding on all creditors). An IVA enables a sole trader or business partnership to continue to trade and generate income towards repayment of creditors. IVA proposals are drawn up by the debtor and are entirely flexible to accommodate his/her personal circumstances. The debtor does not suffer the restrictions imposed by bankruptcy, such as not being able to act as a director of a limited company or applying for personal credit. (However, in practice, credit may prove more difficult to obtain once an IVA is in place). An IVA can be flexible to suit the debtor s needs but it can be expensive and there are risks to consider The debtor is able to avoid the stigma of bankruptcy For the creditors, there are also benefits: The costs of administering an IVA are considerably lower than in bankruptcy, enabling a higher return to creditors. Creditors often receive more than they would via bankruptcy proceedings. IVA's operate as an insolvency procedure and creditors can, as a consequence of this, still reclaim tax and VAT relief as a bad debt. What are the possible disadvantages of an IVA? Most of the disadvantages associated with an IVA affect the debtor (see Box 2 below). The main disadvantages of an IVA include: The IVA is entered on a public insolvency register. Where contributions from income are being made, an IVA is generally expected to last for a much longer period than bankruptcy (in practice, most IVAs are negotiated to last fiveyears). If the debtor s circumstances change and the Insolvency Practitioner cannot get creditors to accept amended terms, the IVA is likely to fail. The debtor will then still owe the creditors the full amount of what he/she owed at the start of the IVA (less whatever has been paid to them under the IVA).

Number, 5 April 2016 14 If the debtor fails to comply with the terms of the IVA, his/her home and personal assets may still be at risk. If the IVA fails, there is a risk that the debtor may be made bankrupt. Box 2: Risks associated with an IVA An IVA can be flexible to suit the debtor s needs but it can be expensive and there are risks to consider. For example: The debtor s savings and personal pension payments will usually be used to pay his/her creditors. If the debtor owns a home, he/she may have to re-mortgage it. If the debtor s circumstances change, he/she could struggle to keep up with the IVA payments. If the creditors won't accept less, the IVA will fail and the debtor could be made bankrupt.

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