8.    An incentive for "responsible risk takers" in business

8.1    When someone decides to go into business on their own account or to become self-employed the question of failure and its consequences is unlikely to be uppermost in their minds. But where that person is the principal bread-winner in a family with responsibility for maintaining the roof over the family’s head, what might happen to the family home if things go wrong is a factor to be taken into account. The very high level of owner-occupation in England and Wales means that for most families the equity in the family home is likely to be its largest asset. As such it will be looked to by creditors for payment of their debts if things go wrong. It is in this area that encouragement could be given specifically to those in business (or to those thinking of going into business) by making an addition to the provisions of Section 283(2) of the Insolvency Act 1986, which detail property that is exempt from the claims of a trustee in bankruptcy.

8.2    In the United States bankruptcy is almost exclusively a debtor’s remedy (rather than a creditor’s) because it offers the debtor some real advantages. Principal amongst these is the so-called ‘homestead allowance’ which varies from state to state and which exempts some or all of the equity in the debtor’s home from the claims of the creditors. Such an exemption is available to all debtors in the US where more than 96% are consumer, rather than business, bankrupts.

8.3    Where the potential loss of the family home is a disincentive to people starting a business, then an exemption of some or all of their interest in that home should be a clear incentive. The exemption could be made more ‘business friendly’ by being made conditional. It would be possible to amend the present law to provide for the possibility of an individual who has been in business on his own account or in partnership and who goes into bankruptcy, to claim an exemption in relation to his interest in his home on a pound for pound basis to the extent that he can demonstrate that he has introduced capital into his business. A maximum limit would be placed on such claims (say £10,000 or £20,000), which would in any event only be of any value if there were equity in the property. It would be up to the bankrupt to claim the exemption and to prove that the capital introduced came (directly or indirectly) from his own resources. This exemption would not be available to bankrupts who were made the subject of ‘restriction’ orders.

8.4    There would need to be provision to disallow, for example, excessive drawings or the introduction of "unnecessary or inappropriate" capital, e.g. the purchase of an expensive motorcar in a one-man plumbing business. There would also need to be safeguards to prevent bankrupts, in the period immediately prior to the bankruptcy, effectively using assets that would otherwise be available for their creditors to create equity in a home that they could claim as exempt. The current provisions regarding preferences could well be enough to ensure that any such transactions could not succeed.

8.5    There are some obvious advantages to such a scheme. First, it addresses a real concern on the part of those who are "responsible risk takers" in business whose concern to provide a home for their families is a powerful motivator. Secondly, it could encourage the better capitalisation of businesses (and new businesses in particular), many of which fail in their first three years, with lack of capital being a principal cause. Thirdly, the need to substantiate a claim should provide an incentive to better financial record keeping (the absence of adequate financial information is another prevalent cause of failure especially amongst very small businesses). Finally, in the event of insolvency, the exempted amount could provide a deposit on a new home or, if the debtor and his family decided to move into rented accommodation, the capital for a new business venture.

8.6    Clearly it is the unsecured creditors who are potential losers from such a change. They would be denied access to an asset they can (where it exists) currently look to for payment of their claims. In practice, the position might not be as stark as it may seem. Currently the law provides that an individual made bankrupt (and his dependants) has a right to possession for a period of twelve months before the trustee in bankruptcy can force a sale to realise the bankrupt’s interest for the benefit of the creditors. There are often difficulties in realising such an asset and there can be substantial costs involved, thus reducing the amount actually available to creditors.

8.7    The availability of such an exemption should act to encourage the better capitalisation of businesses in their early stages so that creditors (particularly trade creditors) might enjoy a wider and more profitable range of supplier/customer relationships than at present.

8.8    Finally someone whose business was in irreversible decline might be encouraged to take earlier steps to cease trading (at the risk of his creditors) and either to seek to come to an arrangement with those creditors or to file for bankruptcy while he still had some equity in his home to preserve. Alternatively it might encourage those who wished to continue trading to introduce fresh capital into an ailing business – capital that could well be used to save the business and pay pressing creditors.

• To what extent do you think these objectives would be achieved by what is proposed?