The value of the banker-customer relationship: INSOLVENCY LAW AND PRACTICE

Comments 0

Since passage of the 1986 Insolvency Act, insolvent UK personal debtors have had access to a statutory Individual Voluntary Arrangement (IVA) procedure which is designed to avoid the finality and penalties of bankruptcy. The IVA between debtors and creditors was designed to allow viable sole traders to continue in business or to achieve a better and more orderly realisation of assets for the creditors. The legislative provisions followed the recommendations of a review committee and extensive consultation that noted the need to ‘rescue’ debtors and to distinguish between the dishonest and the unlucky. Although the review committee also recommended a curtailed procedure for consumer debtors this was not carried through to the statute books and so the IVA ‘rescue’ vehicle remains available to small unincorporated businesses and individual debtors alike.

The IVA is a private contract for the satisfaction of personal debts. As such it can be influenced by the quality of the relationships between lenders and debtors. In this court-supervised procedure the debtor proposes the way in which the debts are to be satisfied, under the guidance of a licensed insolvency practitioner (IP) and under the protection of a ‘moratorium’ on creditor action. The creditors are given the opportunity of amending and accepting or rejecting the proposal.

While bankruptcy ends the banker— customer contract the IVA does not. Consequently, creditor predisposition, influence and action have had an important place in the IVA procedure and the years since 1986 have seen a steady rise in the incidence and acceptance of IVAs. There is also growing evidence of their successful application. At the time of writing around 25 per cent of formal personal insolvencies are dealt with by IVAs.

The choice faced by an increasing number of insolvent debtors is between IVA, and the avoidance of penalties, restrictions and opprobrium connected with bankruptcy, and bankruptcy itself (liquidation of available assets). The choice faced by the creditor is limited by the predisposition of the debtor towards bankruptcy in the first instance and by the existence of ‘moral hazard’, which makes the IVA riskier for the creditor. However, a successful IVA can improve creditor recoveries and increase customer retention, since income from continued employment or trade is often included as a benefit.

Moral hazard exists in the IVA situation because the creditor is forced by the Insolvency Act 1986 to make a choice between IVA acceptance and bankruptcy. If the creditors choose IVA, debtors can take actions, unobservable by creditors, that transfer greater risk to creditors. This is compounded by the lack of a formal investigation of the debtor’s affairs in an IVA and the debtor’s retention and possession of assets. Creditors must be aware that overambitious repayment proposals made by debtors may look attractive initially but may fail to materialise as debtors fail to cooperate with the IP once the IVA has been accepted. Creditors who doubt the integrity of the debtor or the IP can choose bankruptcy and the possibility of a public examination of the bankrupt in open court.

Creditor experience of bankruptcy is rarely good as official costs and the preferential treatment of some Crown debts deplete available assets, and average returns from bankrupt estates are low. This contrasts with the overall experience of IVAs. For banks and larger lenders, with wider portfolios of debtors, successful IVAs are balanced against those that fail during their agreed term and return nothing. In this way larger creditors are more likely to favour IVA acceptance since their overall experience is positive. Smaller creditors, with their less extensive experience, may have more dichotomised views.

The asymmetric bargaining power of larger creditors is a result of their corporate experience, centralisation and specialisation, security position, size of debt and their increasing use of the professional ‘meeting services’ offered by insolvency practitioners. All of this also helps banks, in particular, to influence the acceptance of IVAs more readily. Generally, larger creditors are able to use their experience and select only IVAs that have a realistic chance of returning better dividends than bankruptcy. In these cases, their recoveries will be greater and, arguably, their retention of customers more marked.

Representative APR 391%

Let's say you want to borrow $100 for two week. Lender can charge you $15 for borrowing $100 for two weeks. You will need to return $115 to the lender at the end of 2 weeks. The cost of the $100 loan is a $15 finance charge and an annual percentage rate of 391 percent. If you decide to roll over the loan for another two weeks, lender can charge you another $15. If you roll-over the loan three times, the finance charge would climb to $60 to borrow the $100.

Implications of Non-payment: Some lenders in our network may automatically roll over your existing loan for another two weeks if you don't pay back the loan on time. Fees for renewing the loan range from lender to lender. Most of the time these fees equal the fees you paid to get the initial payday loan. We ask lenders in our network to follow legal and ethical collection practices set by industry associations and government agencies. Non-payment of a payday loan might negatively effect your credit history.

Calculate APR

Happily Served Customers

Get pre-approved for a large personal loan today!