Credit Unions: are they a special case in personal insolvency?
One of the most controversial issues in the Scottish Government’s consultation on bankruptcy law reform is the issue of extending the type of debts that should be excluded from bankruptcies and protected trust deeds.
Two specific examples are suggested: debts owed to credit unions and child maintenance arrears.
The problem with excluding debts, however, is it dilutes the protections that personal insolvency offers and can be a slippery slope.
However, is there a case for extending the list?
Child Maintenance Arrears
There are clearly strongly moral reasons why child maintenance arrears should be excluded: others may suffer as a result and there are possibly few more deserving cases than innocent children who are the dependents of their parents.
However, life is rarely simple and often child maintenance isn’t paid because estranged parents are raising other families or relationships have broken down to the extent that access to children is being denied and maintenance is not paid.
Also it doesn’t take long for arrears to accrue to the extent where they cannot be repaid.
There is also no evidence from England, where they are excluded, to suggest giving them special status improves recovery rates.
It is also has to be borne in mind that other children in new families can also suffer where there are no effective methods of relief.
In relation to Credit Unions, however, there may be a stronger case for special treatment. Other than a few large industrial and city wide credit unions, the vast majority of these organisations are small and particularly vulnerable to debts owed to them being included in insolvencies.
Few debtors will actually become personally insolvent because of a credit union debt and the amounts loaned are normally small. In actual fact, many debtors may prefer not to include credit union debts, feeling a strong responsibility to the other members, who may be neighbours or work colleagues.
Another reason for credit unions to be given special treatment is that, unlike other creditors, they are restricted in how much interest they can charge (which is effectively limited to 2% per month, although in reality most charge 1%). They are, therefore, restricted in what they can do, unlike other consumer creditors, who can just increase interest rates when they suffer significant losses due to insolvencies.
For example, if a Credit union suffers a bad debt of £7,000 they would have to lend £350,000 at 2% within a year to recover the loss. For many small community and workplace based credit unions this is just not feasible.
However, other involuntary creditors, such as HMRC or local authorities can make similar arguments, especially when they use the summary warrant procedure to constitute debts and can only charge a 10% surcharge on the debt, instead of charging the judicial rate of interest at 8% per annum.
That is the slippery slope of excluding debts.
There are other arguments in favour of excluding credit unions, however. They could continue to offer small amounts of credit to debtors during their insolvencies for small emergencies, such as broken washing machines etc. This would remove the risk of debtors failing to make contributions to their bankruptcies and protected trust deeds.
They could also provide a vehicle for debtors to continue having modest savings, although this would possibly require legislative change, but most trustees do permit allowances in debtor’s financial statements for costs that have to be set aside; so logically should we not encourage debtors to set these aside for the purposes intended?
The Accountant in Bankruptcy office is also keen to incorporate some form of education for debtors in Scotland’s debt relief and management remedies and generally support for this principle is supported across the board.
Credit unions could play a pivotal role in this education, by not just making any education a classroom exercise at the end of an insolvency, but by encouraging good practice, such as saving with and borrowing from socially responsible lenders during the operation of the bankruptcy or protected trust deed.
Arguably there is a case for allowing credit unions to have priority during a debt payment plan under the debt arrangement scheme if this approach is taken as most debtors in an 8 year DAS will require some form of credit during that programme.
Even if we don’t accept credit unions deserve to be excluded from bankruptcies and protected trust deeds, this does not mean we cannot give them some form of special treatment.
Changes could be made to the way claims are settled in personal insolvencies. Currently many involuntary and socially responsible lenders are disadvantaged with the current scheme of division, where dividends are paid to ordinary creditors on the basis of what is owed at the time of the insolvency, including interest.
This means the pay day lenders that might charge say 3000% APR and front load interest onto loans, proportionately can claim more in relation to what they loaned than a credit union or a local authority can.
This could be avoided by introducing a system where dividends are initially paid on the original debt, with interest having a deferred ranking. This would mean our bankruptcy system would still treat all creditors equally but also more fairly. It would also mean we don’t reward predatory lending and would remove the requirement for trustees to challenge extortionate credit agreements, which rarely occurs anyway.
There is no clear answer to the question of what debts should be excluded and what should be included. Many creditors have strong cases, but the argument for excluding credit unions is particularly strong, especially in a society where we see the growing scourge of payday lenders.
They also have a strong case as institutions we would wish to encourage Debtors to use.
They are also arguably part of the solution for dealing with the recurring issue of over indebtedness amongst some of the poorest in Society and could help prevent Debtors repeatedly becoming insolvent.
Maybe it’s time to make one last exception.