ANNEX D: Draft Regulatory Impact Assessment

THE ENTERPRISE BILL
INSOLVENCY PROVISIONS

1. The Issue and Objective:

Issues

1.1      The Insolvency Act 1986 as amended by the Insolvency Act 2000 sets out the regime for dealing with the affairs of both insolvent companies and individuals.

1.2      At present, insolvency legislation subjects all bankrupts to substantially the same process and restrictions irrespective of the facts of their individual case or whether they are in any way culpable. Furthermore, the restrictions, prohibitions and disqualifications that currently automatically attach to all bankrupts on the making of the bankruptcy order act as a real barrier to enterprise by discouraging business start-ups and restarts.

1.3      Individual voluntary arrangements (IVA), which are intended as an alternative to bankruptcy, are subject to some criticism by both creditors and debtors due to the level of fees charged by insolvency practitioners and the poor returns to unsecured creditors. The numbers of IVAs commenced over the last 5 years are as follows:

1996      3,983


1997      4,211


1998      4,620


1999      7,086


2000      7,909

1.4      The promotion of collective insolvency procedures where all creditors are owed a duty of care and have an opportunity to influence the outcome.

Objectives

The Insolvency Aspects of the Enterprise Bill will:­

(a)      Provide for non-culpable bankrupts to be discharged from most of their debts and released from the restrictions that currently apply to bankrupts after a maximum of 12 months.

(b)      Reduce the stigma attached to bankruptcy by reducing the number of restrictions that are automatically imposed on undischarged bankrupts.

(c)      Provide for a new regime (Bankruptcy Restriction Orders) to protect both the public and business from those bankrupts whose conduct before and during bankruptcy has been found to be culpable.

(d)      Provide a power for the Official Receiver to act as nominee and supervisor of IVAs commenced after the making of a bankruptcy order.

(e)      Give the Official Receiver discretion to investigate the cause of failure of all bankrupts where he sees fit.

(f)      Streamline the procedure of administration, a collective court-based procedure to make it more efficient and accessible to ensure that companies do not fail unnecessarily. At the same time we will place a substantial restriction on the ability of secured lenders to appoint an administrative receiver.

(g)      To remove the Crown's preferential rights in insolvencies.

Note:

Under current legislation, the Crown is able to claim preferential status in relation to part of its debt. This is mainly in respect of debts owed in relation to VAT, Income Tax and National Insurance contributions. Full details of preferential debts are found in Schedule 6 to the Insolvency Act 1986. In insolvencies the order of payment out of the estate is set down in legislation.

In broad terms, the order of payment is:

• The costs and expenses of the insolvency.
• Preferential creditors.
• Secured creditors.
• Unsecured creditors.

2. Risk Assessment:

Bankruptcy

2.1      The Government is committed to making the United Kingdom the best place to do business. In order to achieve this people from all walks of life need the opportunity to realise their creativity, innovative ability and entrepreneurial potential. If the proposals were not adopted then the existing provisions would continue to act as a barrier to achieving this goal.

2.2      The Official Receiver has a statutory duty to investigate the cause of failure in most bankruptcy cases (approximately 21,000 a year). The majority of cases lead to no further action against the bankrupt and little administrative activity beyond the first few months. Most bankrupts are discharged three years after the bankruptcy order. Thus, in addition to the continuing cost of The Insolvency Service administering these cases, most bankrupts are denied the opportunity of prompt rehabilitation in relation to their financial affairs.

2.3      The only sanctions currently available to address misconduct or dishonesty by bankrupts are criminal ones. The high evidential requirements of the current criminal sanctions mean that very few bankrupts have action taken against them (about 3% of cases in the last year). The civil BRO regime, with its lower standard of proof (i.e. the balance of probabilities rather than beyond reasonable doubt, will allow for greater protection of the public and business. That protection will not be present if the proposals are not brought into force. The BRO regime will require additional resource from the courts by way of court time, but this should be balanced against a reduction in case numbers taken through the criminal system.

Company

2.4      There may be concerns that companies, particularly SMEs, will find that the cost of borrowing from secured lenders will increase as a result of the restrictions on administrative receivership. However, it is intended that the enhanced administration procedure will be seen by such lenders as a procedure which is as flexible and cost effective as administrative receivership. The reforms should help to ensure the proper alignment of, and the maximisation of value in insolvent companies. This should lead to increased returns to creditors and the preservation of value in the economy.

2.5      There might be increased pressure on the court system if the numbers of administration orders under the existing procedure were to increase substantially. However it is intended that this impact should be minimised by the streamlining of the administration procedure;

2.6      In abolishing Crown preference, the benefits might, without additional protection, accrue to floating charge holders rather than unsecured creditors. However it is intended to provide for a percentage of funds to be ring fenced to avoid this outcome. The level of that percentage is yet to be established.

3. (i) Identify options:

Bankruptcy

3.1      Option 1 ­ Continue to rely on the provisions of the Insolvency Act 1986.

3.2      Option 2 ­ Accept the need to reduce the stigma of bankruptcy in the long term but seek to do this by way of education rather than legislative change.

3.3      Option 3 ­ Legislate to reduce the stigma of bankruptcy by removing unnecessary restrictions, allowing for an earlier discharge for the majority of bankrupts whilst at the same time providing a more punitive regime for culpable bankrupts.

Company

3.4      Option 1: Rely on the existing legislation. The current insolvency regime in the UK is prescribed principally by the Insolvency Act 1986 and Insolvency Rules 1986. This option would leave the current system unchanged and would be the cheapest, short-term, option. However the paper "Productivity in the UK" published on 18 June indicated the Government's intention to bring forward proposals to ensure that collective procedures have clear primacy in corporate insolvency. This would give all interested parties the opportunity to influence the outcome. The objectives outlined above are all based on this intention and keeping the status quo would not be working towards them. It should also be borne in mind that there are likely to be long-term costs in failing to provide more effective mechanisms for rescuing viable businesses. There would be no particular benefit to businesses in adopting this approach.

3.5      Option 2: Introduce a voluntary code of practice for charge holders. A code of practice would aim to encourage creditors with the ability to appoint an administrative receiver, to allow a company to put together a rescue proposal, before enforcing their security. The advantage of this non-statutory approach would be its relatively low costs and ease of introduction. The difficulty is that such a code would only succeed if all secured creditors adopted it. In practice, this is very unlikely, particularly with the growth in number and importance of secured creditors such as factors and discounters and asset financiers. Self regulation is unlikely to operate effectively in a fragmented market.

3.6      Option 3: Introduce new legislation to realise the objectives of this part of the Bill. This option is likely to be the most effective means of achieving the objectives and in addition, the abolition of Crown preference could only be achieved by statutory means.

3. (ii) Issues of Equity or Fairness

Bankruptcy

3.7      Option 1: This would mean that the majority of bankrupts remain undischarged for three years and subject to the large number of outdated restrictions. Creditors (especially unsecured creditors) would not receive the likely increased returns that the changes will bring.

3.8      Option 2: This raises similar issues of fairness to option 1. Is it fair and practical to aim to reduce the stigma of bankruptcy through educating society in general, when there is a need to act in the short term?

3.9      Option 3: Section 307 of the Insolvency Act 1986 gives the trustee in bankruptcy power to claim property that vests in the bankrupt after the bankruptcy order ("after acquired property"). By reducing the period of bankruptcy the after-acquired property provisions will apply for a substantially shorter period thus potentially reducing the assets available to creditors. In practice, trustees do not often use the current powers.

3.10      Reducing the restrictions placed on bankrupts could result in those whose conduct is on the margins of acceptability not having their conduct addressed.

3.11      Whether culpable and non-culpable bankrupts are treated the same or differently is unlikely to have much effect on returns to creditors.

Company

3.12      Option 1: Is it fair to keep the status quo, as this is likely to result in some companies which might otherwise be viable not being saved with a negative effect on the economy.

3.13      Option 2: Is it fair and practical to introduce a code of practice and could any lapses from the code be addressed.

3.14      Option 3: There will be less money available to the Crown from their preferential claims but a compensatory amount made available through taxation applied to firms continuing to trade, which might otherwise have failed.

3.15      The current regime contains aspects, which are perceived to be unfair and inequitable, particularly the treatment of unsecured creditors. Options 1 and 2 will not, or only partially, address this as they are in favour of retaining the status quo or relying on a voluntary code which is without a statutory means of addressing departures from its terms. Option 3 will put a more equitable system in place to ensure that those who stand most to lose when a company fails are given an opportunity to influence the outcome. In addition the increased prospects of a business surviving should ensure that the Crown recoups any loss through the abolition of preferential status by increased tax received from continued trading.

4. (i) Identify the Benefits

Bankruptcy

4.1      Option 1 ­ There will no additional costs placed on businesses.

4.2      Option 2 ­ The benefits of an economy strengthened by increased entrepreneurial activity might be achieved in the long term. Entrepreneurs may have increased awareness of the pitfalls of business and the stigma of bankruptcy may gradually be reduced through a programme of education. This option would not require legislative change.

4.3      Option 3 ­ The early discharge provisions will mean the prompt rehabilitation of non-culpable bankrupts. The removal of the automatic application of the various restrictions, disqualifications and prohibitions that currently attach to bankrupts will reduce the stigma attached to bankruptcy and increase both business start-ups and restarts by encouraging responsible risk takers back into business and thereby contributing to the economy. Rogues will have greater restrictions placed on them so protecting the public and business community. Where such restrictions are agreed through undertakings there will be a reduction in both administrative and court costs.

4.4      The provisions for Official Receivers to act as nominees and supervisors of IVAs, linked to increased contributions by bankrupts through Income Payment Orders, will generate greater dividends for creditors and allow greater number of bankrupts to have their bankruptcy annulled.

Company:

4.5      Option 1 ­ There will be no additional costs placed on businesses.

4.6      Option 2 ­ There will be some benefit in that a Code of Practice might aid business recovery but the code is unlikely to be mandatory therefore, there may be no reduction in the number of administrative receiverships and no increase in administrations.

4.7      Option 3 ­ Amendments will improve the administration procedure and will help to maximise economic value by aligning incentives properly. This should make it less likely that viable businesses will go to the wall. The abolition of Crown preference is likely to increase dividends to creditors.

4. (ii) Quantifying and Valuing the Benefits

Bankruptcy

4.8      Option 1 ­ No additional monetary benefit to the public or business.

4.9      Option 2 ­ It is difficult to quantify the cost of educating the wider community. This might, for example, involve the production and distribution of leaflets. It would also be difficult to assess the most effective method of distribution. Financial budgeting and education could be introduced into school syllabus but at the expense of other subjects.

4.10      Option 3 ­ Creditors will benefit from the removal of the Crown's preferential rights in both bankruptcies and IVAs.

4.11      Administration costs will be reduced in all bankruptcies through the early discharge provisions. The Insolvency Service currently deals with about 21,000 bankruptcies a year. The vast majority of these require little input after the Official Receiver has completed his enquiries.

4.12      The public and businesses will be protected from those culpable bankrupts who are the subject of BROs.

4.13      Most IVA proposals are prepared by insolvency practitioners and presented to creditors in return for a "nominee's fee". If the IVA is accepted it will be administered by a supervisor who will charge fees over the term of the IVA. The Insolvency Service has researched IVAs either completed or abandoned in the period 1 August 2000 to 31 October 2000. The number of cases in the sample was about 900. The nominees' fees ranged from about £150 to £9,000 with an average of about £1,500 a case. Supervisors' fees varied according to the length and complexity of the case.

4.14      Creditors will get a higher return from the anticipated increased number of post-bankruptcy IVAs as debtors will have to pay a drastically reduced up-front fee (currently about £1,500) to have proposals drawn up. The Official Receiver will already have access to most of the required information and will be able to draw up proposals at minimum cost. The level of the up-front fee currently acts as a real deterrent to entering a post-bankruptcy IVA. About 2,300 bankrupts a year pay surplus income to their estate via an "income-payments order". If half of those were to go down the IVA route instead approaching £1,725,000 (£1,500 x 1,150), less Official Receiver's costs, could be applied to meeting creditors' claims rather than the up-front fee for an IVA.

Company

4.15      Assuming that the abolition of administrative receiverships resulted in an increased number of administrations, it is unlikely that any material change in fee levels for insolvency practitioners would result. However from a wider perspective the benefits will be seen in the form of increased survival rates and recovery rates for creditors through the streamlined administration procedure. The combination of the introduction of a more efficient administration procedure and abolition of Crown preference which will free up to £100m per annum for other creditors and would also be expected to provide greater numbers of rescues.

4.16      As far as direct benefits are concerned, Option 1 one will be neutral, as it does not advocate change. Options 2 and 3 will potentially result in the benefits referred to above in terms of survival rates and improved returns to creditors, with some uncertainties as to the practical effect of a voluntary code outline under option 2.

5. (i) Compliance Costs for Business, Charities and Voluntary Organisations

Bankruptcy

5.1      Options 1 and 2 are unlikely to place any further burden on businesses, charities or voluntary organisations. However, there are about 1,850 licensed insolvency practitioners (with about 1,000 active covering about 450 firms). There are also some solicitors who are involved in company director disqualification. It is likely that solicitors will be involved in some BRO proceedings.

5.2      Option 3 imposes no additional costs for business in general. However, there will be a need for insolvency practitioners to familiarise themselves and their staff with the revised bankruptcy regime and to set up systems to cope with it. It is anticipated that the training cost will largely be absorbed into existing regular staff training programs and continuing professional education but that the cost of setting up new systems might be between £500 and £5,000 depending on the size of the firm.

5.3      Option 3 has potential to reduce the burden on organisations, including charities, as rather than hearing appeals by bankrupts against automatic disqualification, they could rely on the making of a BRO to determine an individual's suitability to act. This would lead to considerable savings in administrative time and costs.

5.4      Option 3 may have an impact on voluntary organisations in the debt advice sector (e.g. Citizens' Advice Bureau, Paylink, National Debtline and Consumer Credit Counselling Service) as they will need to be familiar with the new provisions but those costs might be able to be assimilated into existing staff training programs. The proposals might also lead to an increase in the number of applications for advice.

5.5      Option 3 will place a burden on the court system, as they will have to deal with the new regime for making Bankruptcy Restriction Orders (BRO). However the Bill will provide an option for a bankrupt to agree to a BRO without involving the court. It is presently envisaged that approximately 10% of bankruptcy cases will result in a BRO and that at least half will not involve a court hearing i.e. approximately 2,100 per year of which about a thousand will need a court hearing.

Company

5.6      There would be neither costs nor benefits under option 1, as no change would take place.

5.7      There would be familiarisation and training costs for both options 2 and 3, these being higher for a substantial change in the law. These costs would fall mainly on insolvency practitioners, those providing financial/legal advice to companies and financial institutions.

5.8      Option 2 would require financial institutions to agree a code of practice and put this in writing and publicise the final version.

5.9      Overall it is anticipated that these costs will be largely absorbed into existing regular staff training programs and continuing professional education. For businesses in general it is not likely that even the changes contained in option 3 would be substantial in cost terms as they do not involve additional regulation and will only be of relevance for those subject to insolvency proceedings. Furthermore, for secured lenders and IPs there are likely to be reduced compliance costs through the relaxation of the requirement on section 2.2 reports.

5. (ii) Compliance costs for a typical business

Bankruptcy

5.10      Options 1, 2, and 3 impose no burdens on a typical business, the compliance costs for insolvency practitioners has been dealt with above.

Company

5.11      Option 1 places no burden on any business sector.

5.12      Option 2 places a burden on banks/chargeholders to draw up (and adhere) to a code of conduct.

5.13      Option 3 imposes no additional costs for business in general but there will be a need for insolvency practitioners to familiarise themselves with the revised corporate (and the previously mentioned bankruptcy) regime. It is anticipated that this cost will largely be absorbed into existing regular staff training programs and continuing professional education.

5. (iii) Policy costs

Bankruptcy

5.14      There should be no need for further staff resources (InsS), as the new procedures will very likely utilise redeployed staff.

5. (iv) Total compliance costs

5.15      Having regard to the number of active insolvency practitioner firms (about 450), and if we take the mid-point of the estimated non-recurring cost of between £500 and £5,000 to put in place the systems, the total compliance cost is likely to be about £1,237,500 (450 x £2,750)

6. Consultation with small business: "The Litmus Test"

Bankruptcy

6.1      Small firms of insolvency practitioners and solicitors and individual bankrupts are being consulted in order to identify any costs and benefits of implementing the proposals. In total 15 firms or individuals have been contacted and asked to return a questionnaire.

Company

6.2      Small firms of insolvency practitioners and solicitors, financial institutions and directors of limited companies that have entered either administration or administrative receivership are being consulted in order to identify any costs and benefits of implementing the proposals. In total 25 firms or individuals have been contacted and asked to return a questionnaire.

7. Identify any other costs

7.1      None presently identified other than the cost to Government of preparing the legislation.

8. Results of consultation

8.1      There have been extensive previous consultations.

Bankruptcy

8.2      The Insolvency Service published the consultation document "Bankruptcy ­ A Fresh Start" in April 2000. A copy of this document can be found on The Insolvency Service website at http://www.insolvency.gov.uk/introduction/freshstart/foreword.htm.

Company

8.3      The Insolvency Service published the consultation document "A Review of Company Rescue and Business Reconstruction Mechanisms" in November 1999 and a report on that consultation was published in February 2001. Copies of those documents can be found on The Insolvency Service website at http://www.insolvency.gov.uk/introduction/condoc/reviewof.htm
and http://www.insolvency.gov.uk/introduction/condoc/condocreport.htm respectively.

9. Summary and recommendation

9.1      Option 3 in both bankruptcy and companies are recommended as the most effective means of ensuring the survival of viable businesses and of improving the returns made to creditors. The overall costs of these options are unlikely, for the reasons set out above, to be material as the regulatory burden on businesses generally will be minimal and on the professional, financial and voluntary sectors, restricted to training, system and familiarisation costs.

10. Enforcement, Sanctions, Monitoring and Review

10.1      The bankruptcy proposals will repeal two offences in the Insolvency Act 1986 (section 361 ­ failure to keep proper accounts of business and section 362 ­ gambling). Conduct that would currently be dealt with under these provisions will be dealt with under the BRO regime. The effectiveness of the new legislation will be monitored after the new legislation has been in operation for a period of three years.

10.2      It will be a criminal offence to breach a BRO and will be subject to penalties of a fine and/or imprisonment.

10.3      There are no new offences created by the company proposals and the effectiveness of the new procedures will be monitored after the legislation has been in operation for three years.

Declaration

I have read the Regulatory Impact Assessment and I am satisfied that the balance between cost and benefit is the right one in the circumstances.

Signed ___________________________________________________________________      

Parliamentary Under Secretary of State
for Competition, Consumers and Markets

Contact Point

John Madill
The Insolvency Service
Policy Unit
Room 5.6
P.O. Box 203
21 Bloomsbury Street
London WC1B 3QW

Telephone number 020 7215 6757