The Lingering Traces of Moral Hazard in 'Fresh Start' Personal Insolvency: Ireland's Radical Reform
Alex Casey is an LLM, International Commercial Law Student at the School of Law, University of Limerick. In this blog, Alex critically analyses Ireland's radical reform of personal insolvency law, in particular, the effect of the Personal Insolvency Act 2012. This blog discusses the 'moral hazard' versus 'fresh start' rationale of personal insolvency, placing particular emphasis on Ireland's 'radical' approach to reforming personal insolvency law over the last 10 years. Alex discusses the current Irish personal insolvency framework, explicating four viable options that insolvent individuals can avail of, whilst comparatively critiquing them with other common law jurisdictions and their counterpart mechanisms.
Introduction
Personal insolvency arises where debtors are unable to meet their debts because their total liabilities exceed their available assets at the relevant time.[1] The question of how the law should approach such situations has historically attracted varied responses [2] due to the competing objectives and interests involved. [3] The 21st Century has seen ‘a remarkable cycle of reform’ amongst international approaches towards insolvency.[4] However, one jurisdiction where a particularly ‘radical and innovatory approach’ has occurred is Ireland.[5] The Personal Insolvency Act 2012, having largely been in force since February 2013, warrants analysis of its impact over the past decade.[6] This discussion will first sketch the global landscape of the insolvency reform paradigm[7] before analysing the extent to which Ireland’s legislative developments preserve concerns regarding moral hazard. In discussing these global trends and Irish developments, reference will also be made to international counterparts as appropriate, including, inter alia, the UK, US, Australia and New Zealand.
Moral Hazard versus ‘Fresh Start’
The moral hazard concern recognises that insolvency procedures which forgive debts provide a transfer of wealth from creditors to debtors.[8] An overly generous discharge of debts is akin to a form of insurance for creditors which incentivises careless or opportunistic borrowing.[9] Such concerns coincide with the traditional view that insolvency is economically undesirable and warrants deterrence rather than encouragement.[10] Accordingly, there has historically been a punitive objective behind insolvency laws.[11] The moral hazard issue influences insolvency legislators in ensuring debts cannot be discharged too easily.[12]
However, it appears that the same emphasis on moral hazard no longer exists across many jurisdictions.[13] Rather, the primary aim behind modern insolvency provisions is allowing individuals to achieve a ‘fresh start’ by relieving them of their debts as expeditiously as possible.[14] This view acknowledges the various economic benefits to getting individuals swiftly re-immersed in ‘the cycles of consumption and investment’, such as promoting entrepreneurialism and social inclusion.[15] This theory typically favours ‘a straight discharge from debt’, thus granting the indebted a ‘clean slate’.[16] In light of this compelling economic reasoning, the current paradigm of insolvency reform worldwide adopts the ‘fresh start’ objective to a considerable extent.[17]
Regrettably, insolvency laws which fully address the dangers of moral hazard while also fulfilling the ‘fresh start’ objective are not always achievable. For instance, establishing a lenient system which encourages the honest majority to recover cannot be achieved without also risking abuse of the system by an underserving minority.[18] A certain degree of compromise is inevitably required. Accordingly, while the World Bank Report acknowledges the moral hazard concern, the Report ultimately felt this was outweighed by the overwhelming economic benefits of debt relief.[19] Nevertheless, moral hazard retains an important role in balancing the interests of creditors, debtors and society as a whole.[20]
In attempting to reconcile these competing considerations, the majority of jurisdictions now enforce repayment plans for insolvency and will only allow immediate discharge for the deserving poor.[21] This seemingly achieves ‘the fresh start while addressing concerns about moral hazard’.[22] Ramsay regards this as ‘the most solid aspect of the paradigm’ in modern international insolvency.[23] Outside of this narrow point of agreement, there remains significant jurisdictional differences regarding insolvency law.[24]
Ireland – Taking International Trends to the Extreme
Having considered the modern departure from moral hazard across jurisdictions generally,[25] the focus of this discussion now turns to Irish personal insolvency reform. Like many other jurisdictions, the 2008 financial crisis provided the political impetus for urgent insolvency reform in Ireland.[26] The evolution of Irish insolvency law provides one of the most extreme examples globally of such a radical shift in insolvency policy.
Prior to 2012, Ireland possessed an unimaginably antiquated and limited insolvency framework.[27] The law viewed insolvency as a means of coercive debt collection focused upon the interests of creditors rather than debtors.[28] Furthermore, imprisonment for non-payment of debts was only removed this century.[29] The Irish system did not offer any choice within personal insolvency, with bankruptcy proving the only option for those unable to meet their debts.[30] The Irish Law Reform Commission described the system as ‘outdated and ineffective’, as well as being ‘unsuitable to providing solutions to the realities of a modern credit society’.[31]
However, the landscape of Irish insolvency law was fundamentally reimagined by the Insolvency Act 2012, to the extent that the new system is ‘unrecognisable.[32] This legislation came as a condition for the EU/IMF bailout, with the Irish government committing ‘to lower the cost and increase the speed and efficiency of proceedings, while at the same time mitigating moral hazard and maintaining credit discipline’.[33] This reform, along with subsequent amendments, now guarantees ‘a vital pathway for people to get back to solvency, and to re-engage with our economy’.[34] The increased effectiveness of the new system is beyond doubt. Illustratively, while Ireland had only 8 bankruptcy orders in 2008,[35] the ISI has facilitated over 12,000 insolvency solutions within its first decade.[36]
Post-Reform Ireland – International Counterparts and Moral Hazard
Under the new legislative framework, there are now four viable options for insolvent individuals under Irish law.[37] These consist of a revitalised bankruptcy process along with three new non-judicial alternatives. Each mechanism is permitted only once per individual, thus acknowledging abuse concerns. Each of these four options are discussed below, paying particular attention to their international counterparts, effectiveness and the influence of moral hazard.
1.Bankruptcy
First and foremost, the classic insolvency option of bankruptcy merits consideration. Following significant revisions, the measure has been retained in Irish law.[38] As alluded to above, the Irish bankruptcy procedure was historically plagued by considerations of moral hazard to an extent incomparable with other modern insolvency regimes.[39] The two primary safeguards which eliminated the possibility of bankruptcy being abused by dishonest or opportunistic debtors were the lack of swift discharge and strict accessibility requirements.
Quite strikingly, Ireland did not offer any automatic discharge of bankruptcy debts until 2011, at which point an excessive twelve-year discharge period was added.[40] Fortunately, this was soon reduced to three years by the 2012 Act and has since been diminished to merely one year by the 2015 (Amendment) Act.[41] This brings Ireland’s discharge period in line with international standards.[42] However, there have been growing concerns that perhaps a one-year discharge might prove too lenient, with the UK considering returning to a three-year period.[43] Seemingly such an increase would align with the growing emphasis upon implementing repayment plans where possible, rather than straight debt forgiveness.
Regarding inaccessibility, the Law Reform Commission (‘LRC’) had equally observed that potential bankruptcy petitioners were excluded by the requisite asset value of €1900, along with the €650 deposit and cost of proceedings.[44] The irony that those unable to meet their debts were financially prohibited from seeking bankruptcy is not unique to Ireland.[45] While limited measures have been taken, such as the increased availability of legal aid, the larger problem remains.[46] Nonetheless, 287 debtors self-petitioned their own bankruptcy in 2020-2021, highlighting the increased availability of the measure.[47] Ultimately, bankruptcy remains the insolvency option of last resort. The legislation expressly acknowledges this by mandating a sworn affidavit by the petitioner that the alternative non-judicial mechanisms (discussed below) have been attempted.[48]
2.Debt Relief Notices
The first of the newly introduced insolvency options under Irish law is the Debt Relief Notice (‘DRN’).[49] Initially, this mechanism was available to debtors with low incomes and few assets who were unable to pay their debts only up to €20,000.[50] This financial limit was since increased by the 2015 Amendment Act to €35,000.[51] The DRN lasts for up to three years, after which the debts are written-off.[52] Interestingly, the LRC had recommended a shorter one-year duration for DRNs, a timeframe which some commentators deem preferrable.[53] Debtors are not obliged to make any payments unless their financial situation improves during the period, thus potentially open to abuse.[54] Crucially, the DRN is only available to individuals with total assets valued below €1500 and a ‘net disposable income’ of up to €60 after deducting reasonable living expenses.[55] Such means-tested measures ‘suggest a continuing fear… about moral hazard and opportunism in insolvency’.[56]
Specific insolvency arrangements applicable to Low Income, Low Asset (‘LILA’) debtors have been endorsed by the World Bank and has seen growing international acceptance.[57] These measures avoid the traditional stigma regarding insolvency and have been described as ‘Bankruptcy Light’.[58] Ireland’s DRN model was largely inspired by the UK’s similar Debt Relief Order (‘DRO’) measure,[59] itself an adaptation of the ‘No Asset Procedure’ originating in New Zealand.[60] While the DRN was seemingly underutilised initially, there were 184 DRNs recorded in 2021.[61] This represented a 50% increase from 2020 and was the only insolvency measure trending upwards in 2021.[62]
3.Debt Settlement Arrangements:
Another newly introduced option is the Debt Settlement Arrangement (‘DSA’).[63] This is available to debtors capable of paying at least part of their unsecured debt(s). The individual agrees to repay an affordable percentage of the overall debt for a period of up to five years, at which time the remainder is written-off.[64] There is no financial limit on the total debt for the DSA and so this acts as a ‘counterpart’ to the DRN for debts exceeding €35,000.[65] Interestingly, the means-testing applicable for DRNs is not extended to DSAs, thus seemingly relegating the moral hazard concern in this context. However, the requirement of good faith and full disclosure by debtors and the threat of prosecution for breach of same serves as a necessary safeguard against immoral application.[66]
Repayment alternatives to straight bankruptcy have been a feature of international insolvency law for some time.[67] The DSA embodies the common-sense ‘master narrative’ that those who can pay should pay, which permeates modern insolvency[68] The tradition was initially less prevalent in Common Law systems, however, the Irish DSA is now comparable to the identically named Australian mechanism, as well as the UK’s Individual Voluntary Agreement (‘IVA’) and Canada’s Consumer Proposal.[69]
Such attitudes found favour in Europe and were largely inspired by the partial repayment system under Chapter 13 of the US Bankruptcy Code.[70] As aforementioned, certain jurisdictions currently make no provision for LILA debtors and have been criticised for instead relying on unrealistic and inappropriately long repayment plans.[71] The DSA’s duration seemingly reflects contemporary trends, with the US Chapter 13 and UK’s IVA respectively also facilitating five-year agreements.[72]
Although the DSA mechanism has to date been the least commonly adopted of the new Irish insolvency options, there has still been a healthy uptake with 148 new cases of DSAs and 84 court-approved DSAs in 2021 alone.[73] Notably, 2021 saw fewer approved DSAs than each of the three preceding years, although it is presently unclear why this may have been the case.[74]
4.Personal Insolvency Arrangements
Despite the raft of foundational reforms outlined above, perhaps ‘the single biggest change to the personal-insolvency framework’ is the introduction of Personal Insolvency Arrangements (‘PIA’).[75] The PIA allows for the settlement or restructuring of secured debt of up to €3 million over a maximum of six years.[76] The primary objective of the measure is to facilitate repayment while allowing debtors to maintain ownership of their family homes. This ‘inventive solution’ is almost unprecedented internationally, with personal insolvency typically applying only to unsecured debt.[77]
Albeit still in its infancy, the PIA is already the most popular Irish insolvency options, with 925 PIAs granted in 2021 alone.[78] Crucial to this was the introduction of the s115A court-based review system for unreasonably refused PIA proposals in 2015.[79] This means the refusal of proposals which are held to be fair and reasonable to all concerned can be overturned.[80] The ensuing case-law has dealt primarily with issues of the appropriateness or sustainability of PIA proposals,[81] along with assessments of the relevant debts or incomes.[82] Overall, there have been 826 successful s115A challenges to date, boasting a greater than 50% success rate, demonstrating the effective implementation of the novel measure.[83]
Conclusion
Many jurisdictions have made drastic shifts in terms of insolvency priorities, with the moral hazard issue often being the primary casualty. This could be due to a dwindling of the moral hazard issue or, perhaps more likely, simply that any such concerns are outweighed by the benefits of the ‘fresh start’ objective.[84]
While it appears too early to judge the merits of these reforms just yet, the early signs are promising.[85] Ireland’s radical changes coincide with a significant increase in the uptake and effectiveness of Irish insolvency. Ten years on from the commencement of this revolutionary legislation, it appears Ireland’s newfound congruence with the international paradigm has justified its inception, albeit preserving niggling remnants of moral hazard.
[1] Fiona Tolmie, Corporate and Personal Insolvency Law (2nd edn, Portland: Cavendish Publishing 2003) 3. [2] Eugenio Vaccari and Emilie Ghio, English Corporate Insolvency Law: A Primer (Cheltenham: Edward Elgar 2022) 18-41. [3] Hamish Anderson, The Framework of Corporate Insolvency Law (New York: Oxford Academic 2017) 6-7. [4] Karen O’Brien, ‘Overview of the Irish Personal Insolvency Regime in 2018’ (2018) 25(4) Commercial Law Practitioner 94. [5] Cormac Keating, ‘A Second Bite at the Cherry’ (2019) 113(8) Gazette of the Law Society Ireland 44. [6] Personal Insolvency Act 2012. S.I. No. 63/2013 – Personal Insolvency Act 2012 (Commencement) (No.2) Order 2013. [7] See Iain Ramsay, ‘Towards an International Paradigm of Personal Insolvency Law? A Critical View’ (2017) 17(1) QUT Law Review 15. [8] Joseph Spooner, Bankruptcy: The Case for Relief in an Economy of Debt (Cambridge: Cambridge University Press 2019) 216. [9] Teresa Sullivan, Elizabeth Warren and Jay Lawrence Westbrook, As We Forgive Our Debtors: Bankruptcy and Consumer Credit in America (Washington DC: Beard Books 1999) 333. [10] Elena Cirmizi, Leora Klapper and Mahesh Uttamchandani ‘The Challenges of Bankruptcy Reform’ (2012) 27(2) The World Bank Research Observer 185, 187-189. [11] Michael Forde and Daniel Simms, Bankruptcy Law (Dublin: Round Hall 2009) 7. [12] Wilfred Dolfsma and Robert McMaster, ‘Revisiting Institutionalist Law and Economics: The Inadequacy of the Chicago School: The Case of Personal Bankruptcy Law’ (2007) 41(2) Journal of Economic Issues 557, 558. [13] Rutger Claassen, ‘Financial Crisis and the Ethics of Moral Hazard’ (2015) 41(3) Social Theory and Practice 527. [14] Thomas Jackson, ‘The Fresh-Start Policy in Bankruptcy Law’ (1985) 98(7) Harvard Law Review 1393, 1395-1399. [15] European Commission, Proposal for a Directive of the European Parliament and of the Council on Preventative Restructuring Frameworks, Second Chance and Measures to Increase the Efficiency of Restructuring, Insolvency and Discharge Procedures, Directive 2012/30/EU, COM (2016) 723 Final, 2016/0359 (COD) 4. Jose Garrido, ‘The Role of Personal Insolvency Law in Economic Development: An Introduction to the World Bank Report on the Treatment of the Insolvency of Natural Persons’ (2014) 5 The World Bank Legal Review 111. [16] Nicola Howell, ‘The Fresh Start Goal of the Bankruptcy Act: Giving a Temporary Reprieve or Facilitating Debtor Rehabilitation’ (2014) 14(3) QUT Law Review 29, 32. [17] Ramsay 2017 (n 7). [18] Michelle White, ‘Why It Pays to File for Bankruptcy: A Critical Look at the Incentives under US Personal Bankruptcy Law and a Proposal for Change’ (1998) 65(3) The University of Chicago Law Review 685, 689-690. [19] World Bank, Report on the Treatment of the Insolvency of Natural Persons (Washington DC, 2013) [113]-[119]. [20] Insolvency Service of Ireland, ‘Debtor’s Guide to Bankruptcy’ (assets.gov.ie, June 2016) <https://assets.gov.ie/239402/73513a11-c89b-4318-a8b2-23e19caf4b53.pdf> accessed 30 April 2023. [21] Jodi Gardner, ‘Rethinking Bankruptcy Alternatives in Singapore’ (2020) Singapore Journal of Legal Studies 502, 520-521. Ramsay 2017 (n 7) 20. [22] Ramsay 2017 (n 7) 20. [23] Ramsay 2017 (n 7) 20. [24] Emilie Ghio, Gert-Jan Boo, David Ehmke, Jennifer Gant, Line Langkjaer and Eugenio Vaccari, ‘Harmonising Insolvency Law in the EU: New Thoughts on Old Ideas in the wake of the COVID-19 Pandemic’ (2021) 30(3) International Insolvency Review 427, 430-436. [25] Vanessa Finch, ‘The Recasting of Insolvency Law’ (2005) 68(5) The Modern Law Review 713, 714. [26] William Poole, ‘Moral Hazard: The Long-Lasting Legacy of Bailouts’ (2009) 65(6) Financial Analysts Journal 17, 18-19. 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[34] Department of Justice, ‘Press Release – Minister Humphreys and Browne announce commencement of the main provisions of the Personal Insolvency (Amendment) Act 2021’ (gov.ie, 24 June 2021) <https://www.gov.ie/en/press-release/e762e-ministers-humphreys-and-browne-announce-commencement-of-the-main-provisions-of-the-personal-insolvency-amendment-act-2021/> accessed 30 April 2023. [35] Courts Service, ‘Annual Report 2009’ (2010) 43 <https://www.courts.ie/acc/alfresco/5575b9c8-2cf8-463d-93dd-d4b880618fc2/Courts%20Service%20Annual%20Report%202009.pdf/pdf#view=fitH> accessed 30 April 2023. [36] Insolvency Service of Ireland, ‘Annual Report 2021’ (2022) 6. [37] Personal Insolvency Act 2012. [38] Personal Insolvency Act 2012, Part 4. [39] Spooner (n 27). [40] Civil Law (Miscellaneous Provisions Act 2011, Part 7. [41] O’Brien (n 4) 94. [42] Cirmizi, Klapper and Uttamchandani (n 10). [43] R3 Association of Business Recovery Professionals (UK), ‘The Personal Insolvency Landscape: A way forward for formal debt relief (re.org.uk, January 2014). [44] LRC (n 29) [3.161]–[3.262]. [45] Karen Gross, ‘Debtor as Modern Day Peon: A Problem of Unconstitutional Conditions’ (1989) 65 Notre Dame Law Review 165. [46] Cormac Keating, ‘A Second Bite at the Cherry’ (2019) 113(8) Gazette of the Law Society Ireland 44, 46-47. [47] ISI (n 36) 8. [48] Insolvency Service of Ireland, ‘Bankruptcy in Ireland’ (gov.ie, 10 February 2023) <https://www.gov.ie/en/service/f6dd3-bankruptcy-in-ireland/>accessed 30 April 2023. [49] Personal Insolvency Act 2012, section 25. [50] Regarding ‘low income and few assets’, the Personal Insolvency Act 2012 prescribes a net disposable income limit of €60 per month and a net assets threshold of €400. [51] Personal Insolvency (Amendment) Act 2015, section 3. [52] Personal Insolvency Act 2012, section 34. [53] Stuart Stamp and Paul Joyce, ‘For The Few But Not The Many? An analysis of debt relief notices from a debtor perspective (MABS, March 2022) <https://mabs.ie/wp-content/uploads/2022/06/For-the-Few-but-Not-the-Many-Report-Stuart-Stamp-and-Paul-Joyce-May-2022.pdf> [accessed 30 April 2023]. [54] Ramsay 2017 (n 7). [55] Personal Insolvency Act 2012, sections 23 and 26. [56] Ramsay 2017 (n 7) 33. [57] World Bank (n 19). [58] Iain Ramsay, ‘Bankruptcy Light – The English Debt Relief Order, Bankruptcy, Simplification and Legal Change’ (2018) 27(5) Norton Journal of Bankruptcy Law and Practice 610. [59] Law Reform Commission, Report on Personal Debt Management (LRC 100 – 2010) 114-125. [60] Ramsay 2018 (n 57) 614-615. [61] ISI (n 36) 7. [62] ISI (n 36) 6. [63] Personal Insolvency Act 2012, section 55. [64] Personal Insolvency Act 2012, sections 57, 79 and 80. [65] Stamp and Joyce (n 52). [66] LRC (n 58) 96-97. [67] Charlene Sullivan and Debra Worden, ‘Rehabilitation or Liquidation: Consumers’ Choices in Bankruptcy’ (1990) 24(1) The Journal of Consumer Affairs 69, 71-72. [68] Ramsay 2017 (n 7) 26. [69] LRC (n 58) 11-16. [70] Nick Huls, ‘Towards a European Approach to Overindebtedness for Consumers in the EC Member States: Facts and Search for a Solution’ (1993) 16 The Journal of Consumer Policy 216. [71] World Bank (n 19) 134. [72] Ramsay 2017 (n 7). [73] ISI (n 36). [74] ISI (n 36). [75] John Phelan, ‘Going for Broke’ (2023) 117(2) Gazette of the Law Society of Ireland 18, 20. Personal Insolvency Act 2012, section 89. [76] Insolvency Act 2012, section 91. [77] O’Brien (n 4) 95. Alan McGee, ‘Personal Insolvency is the Best Way Forward’ (2018) Irish Examiner (1 March 2018). <https://www.irishexaminer.com/opinion/commentanalysis/arid-30830340.html> [accessed 30 April 2023]. [78] ISI (n 36) 7. [79] Personal Insolvency (Amendment) Act 2015, section 21. [80] O’Brien (n 4) 95. [81] Part 3, Chapter 4 of the Personal Insolvency Acts 2012-2015, Re Cremin [2021] IEHC 80; Re Quirke [2021] IEHC 186. David Boyle, ‘Affordability and Sustainability of the Personal Insolvency Arrangement Considered’ (2022) 40(20) Irish Law Times 289. [82] Part 3, Chapter 4 of the Personal Insolvency Acts 2012-2015, Re Gallagher [2021] IEHC 686; Re Horan [2021] IEHC 171. [83] ISI (n 36) 10. [84] World Bank (n 19). [85] O’Brien (n 4) 94.
