« Previous | Contents | Next »
Listen
PART TWO - TRUST DEEDS AND PROTECTED CREDITORS
1. Protected Creditors
1.1 Some creditors are treated more favourably than others in an insolvency, and are in that sense 'protected'. There are two types of protection:
- The sum due to a creditor is not cancelled by the insolvency, and
- The sum due to a creditor is treated as a preferred debt.
2. Debts not Cancelled
2.1 In bankruptcy, all available assets and income is gathered in by the trustee and paid to the creditors. The general rule is that the obligation of the debtor to pay any part of a debt that has not been paid by the trustee is cancelled.
2.2 This general rule is subject to some limited exceptions. Section 55 of the Bankruptcy (Scotland) Act 1985 (the 1985 Act) provides that a sequestrated debtor is not discharged from certain types of debt, such as Court fines.
2.3 The 2007 Act will introduce a provision so that a sequestrated debtor will not be discharged from the obligation to repay a student loan. It is the Executive's intention that the same rule will apply to Protected Trust Deeds and the Debt Arrangement Scheme.
2.4 The Executive considers that there are good policy reasons for exempting student loans. For example, students have an automatic right to a loan, it is repayable only in certain circumstances, and the benefit of the education 'bought' with the loan extends over the whole working life of the former student.
2.5 A further factor that needs to be kept in mind is that the main purpose of bankruptcy is to give the debtor relief from their debts. The effect of not cancelling debt is that the debtor is not given full relief, and the potentially harsh effect of this on the debtor should be balanced by there being a good reason for protecting a particular creditor.
2.6 The exempting of debts from the obligation to pay them is a matter that is devolved to Scottish Ministers. This option could be included for in the Protected Trust Deed Regulations.
3. Preferred Debts
3.1 A preferred debt is paid before any other claims are dealt with. There are three types of preferred debt under the 1985 Act in a bankruptcy, namely money owed by the debtor:
- as a contribution to an occupational pension scheme,
- to a person who is or has been an employee of the debtor
- as a levy on the production of coal and steel
3.2 The class of preferred creditors used to include Crown Preference for the Inland Revenue for tax debts, HM Customs and Excise for VAT and customs debts, and the Contributions Agency for Social Security contributions. However, their protected status was abolished by the UK Enterprise Act 2002 on 15 September 2003.
3.3 The ordinary creditors are not paid until (or if) the preferred debts are settled. The great majority of creditors are ordinary creditors, and include tradespeople and other small businesses. Fairness therefore requires that there should be a good reason for protecting any one creditor by making their debts preferred.
3.4 For example, it is right that anyone who works for the debtor should have a first right to claim their wages. It is not so clearly right that tax debts should have such a claim before (say) a local joiner. This is the reason Crown Preference was abolished in 2003, even although taxes pay for public services that we all use.
3.5 The 1985 Act rules do not apply to trust deeds. However, in practice trustees pay debts that would be preferred in a bankruptcy before the other creditors. This is in part because those creditors might object to a trust deed if that were not done. The practice in trust deeds is consistent with Scottish Executive policy, although the law on preferred debts is in fact reserved to the UK government.
3.6 The Executive cannot make any changes to a reserved matter without the agreement of the UK Government. We have received advice from our solicitors that indicates that the UK Government agreement would be unlikely because the trend of previous UK legislation has been to remove existing preferences rather than to introduce new ones.
4. Protection for Credit Unions
4.1 It has been said that the effect of debts cancelled in Protected Trust Deeds is causing serious losses to Credit Unions and threatening their viability, and therefore that Credit Unions should be protected by making Credit Union debts preferred, or by providing that Credit Union debt is not cancelled by a trust deed, or both.
4.2 This argument raises a number of issues. In particular, whether Credit Unions are a special class of creditor, how far trust deeds impact on Credit Unions, and what kind of protection is appropriate.
4.3 There are about 130 Credit Unions in Scotland. These fall broadly into two types: "live and work" Credit Unions, with substantial numbers of members, including many in employment, and community-based, or 'residential' Credit Unions, which generally have fewer members and cover areas with high numbers of low income households,
4.4 The core business of Credit Unions is making affordable loans to their members, who traditionally were required to save with the credit union before they could borrow. Loans are at fixed rates and do not normally consider the member's ability to repay. Community based credit unions know their members well, which should reduce some of the lending risks.
4.5 The role which Credit Unions can play in tackling financial inclusion, which the Executive defines as
'access for individuals to appropriate financial products and services, including people having the skills and understanding to make best use of those products and services'
was recognised by the Scottish Executive in its Financial Inclusion Action Plan, launched in January 2005.
4.6 The Executive has provided financial support to help Credit Unions build their capacity and to work towards self sufficiency, through the Capacity Fund which was launched on 3 September 2003 and ran until 31 March 2006, and subsequently through the Assistance Fund. The Service of General Economic Interest approval and funding scheme, introduced in April 2006, encourages Credit Unions to widen both their lending policies, by offering flexible credit (a more risk-based approach to lending) and the range of financial services they provide. The UK Government is also encouraging Credit Unions to increase the availability of affordable personal loans through its Growth Fund.
4.7 Local authorities also provide support to Credit Unions, for example, by offering rates relief or subsidised start-up rent. The 11 local authorities receiving the Executive's £10.6 million Financial Inclusion Fund provide further funding to local Credit Unions, for example, to extend their coverage or to offer additional products.
4.8 Credit Unions therefore have an important role in the delivery of the Executive's financial inclusion policies, which would on the face of it justify treating Credit Unions as a special class of creditor if the cancellation of debt though trust deeds was having a particularly adverse impact on Credit Unions.
4.9 Information from Credit Unions has indicated that the majority of trust deeds, where a Credit Union are a creditor, do not pay a dividend. This means the debt has to be written off by the Credit Unions and can, therefore, impact on their on-going ability to offer affordable personal loans to their members. This is particularly hard on the smaller 'residential' Credit Unions.
5. Options for Protection
5.1 Three options have been considered by the Executive:
- Do nothing
- Providing that Credit Union debt is not cancelled by a trust deed
- Making sums due to Credit Unions a preferred debt
Option 1 - Do Nothing
5.2 Or to be exact, do nothing further. The Executive already recognises that Protected Trust Deeds do not always work in the best interests of creditors, and is taking action to remedy that problem through proposed reforms to Trust Deeds during 2008. The intended reform of Protected Trust Deeds will make sure that creditors receive fair payment. Many existing Protected Trust Deeds are unfair to creditors, so numbers are expected to fall. Credit Unions, like other lenders, will benefit by being paid more when a debtor signs a Protected Trust Deed.
Option 2 - Debt not Cancelled
5.3 If Credit Union debt is not cancelled in a Protected Trust Deed then the Credit Union could recover any outstanding debt after the discharge of the debtor from their other debts. This would improve the amount recovered by Credit Unions but limits the debt relief offered by a Protected Trust Deed.
Option 3 - Preferred Debt
5.4 Making Credit Union debt preferred would be a significant advantage for Credit Unions. Indeed, in some cases where a Protected Trust Deed covered a Credit Union loan the Credit Union might be the only creditor paid. Of course, the Credit Union would only be paid where the debtor actually had funds.
5.5 The Executive could only add a new type of preferred debt with the agreement of UK Government. It is likely that the key barrier to this further reform would be the impact on other creditors. For example, the Crown Preference has only recently been abolished, and there is an argument that it is inappropriate for public sector creditors to be disadvantaged by postponing their claims to that of a Credit Union.
5.6 We have received advice from our solicitors that indicates that the UK Government agreement would be unlikely because the trend of previous UK legislation has been to remove existing preferences rather than to introduce new ones.
5.7 For these reasons, we have concluded that this third option is unrealistic.
« Previous | Contents | Next »