The Over-Indebtedness Regulatory System in the Light of the Changing Economic Landscape

Author:Signe Viimsalu
Position:Lawyer with the Estonian Development Fund

1. Different national approaches to individuals' insolvency - 2. Various aspects to address in a European cross-border insolvency system - 3. Conclusions


The number of individuals' insolvency proceedings, including cross-border insolvency proceedings, has increased globally. The last quarter century has witnessed a rapid expansion of consumer credit, manifested most notably through the proliferation of credit-card lending. This expansion has led to what social scientists term the democratisation of consumer credit, a process in which credit is extended to social groups to whom it was not traditionally available2. For instance, 20 years ago an academic book about consumer bankruptcy systems around the world would not have been possible, because most countries did not have a consumer bankruptcy system3. In 2001, the Council of the European Union noticed that only 10 European Union member states had specific legislation concerning the collective settlement of debts governing the social, legal, and economic treatment of over-indebted consumers, whereas ordinary debt collection procedures continued to apply in the other Member States4. The democratisation of credit has led to a re-examination of the importance of having consumer insolvency laws, and the grant of a discharge for over-indebted individuals. On the basis of social and economic considerations, countries have decided that it is necessary to develop solutions to address the increase in the number of consumer over-indebtedness cases, by somehow regulating this type of insolvency. The question remains-how? The current financial crisis has influenced states to find and take under consideration more rapid measures to deal with consumer over-indebtedness problems. The question arises then of how to find solutions to the problem of over-indebtedness and regulate individuals' insolvency, also in cross border insolvency cases. The author of this paper is of the opinion that insolvency law should always be simple, transparent, and efficient and should prevent or support mechanisms and developments that appear in the economy. Unfortunately, governmental actions on national and EU level reveal no transparent systematic approach to the problem of individuals' over-indebtedness. Furthermore, different policies are applied also in cross-border insolvency proceedings, which influence the simple and proper functioning of the procedures, especially in the context of secondary insolvency proceedings based on Council Regulation (EC) 1346/2000, of 29 May 2000, on insolvency proceedings (hereinafter 'European Insolvency Regulation', or EIR)5. Therefore, the purpose of this paper is to consider possible regulatory measures in finding a balance between the needs to provide an appropriate mechanism for enabling over-indebted individuals to start over with their lives and social concerns that debts should always be paid (pacta sunt servanda).

1. Different national approaches to individuals' insolvency

Credit is as old as mankind. Representing a pattern of social behaviour, credit also is subject to human weaknesses and environmental conditions. There is no causal necessity ensuring that a loan will be repaid. On the contrary, default is an ever-present possibility, although the relative risks of default can be identified and managed to an extent. Where there is credit, non-payment can equally occur. Although debts are generally repaid, the possibility of default can be seen as an inevitable feature of the credit phenomenon. Laws from the earliest times (the Code of Hammurabi, the Twelve Tables of early Rome, laws of ancient Greece, etc.) reflect this and provided various remedies for a creditor against the insolvent, from enslavement to death. Under early Roman law, when a debtor had too many creditors, the law gave them the option of cutting the debtor in pieces to be divided among themselves6.

Nowadays, there are two primary paradigms for individuals' insolvency: the American liberal paradigm and the European welfare state paradigm7. Consumer bankruptcy law in the United States (US) is described as a market function in which bankruptcy serves as an exit from and a complement to the open-access credit market system8. Conversely, a goal of the welfare state is to protect citizens against risks caused by natural disaster, accident, illness, and economic misfortune. In such systems, the state actively promotes equality of citizens and legal regulation as one means by which politically set goals are achieved9.

In everyday usage, the term 'bankruptcy' carries the meaning of personal disaster and a fate to be avoided at all costs. Yet, in the majority of modern societies, the process of bankruptcy aims to relieve the debtor from the cumulative burden of debts that, as a result of his current economic circumstances, he cannot realistically repay in full. Historical and cultural differences underlying civil and common law jurisdictions also lead to different approaches to bankruptcy. Notably, in the US, the term 'bankruptcy' refers generically both to liquidation and to reorganisation, with or without a trustee. A trustee is always appointed in liquidation (Chapter 7 in the US Bankruptcy Code) and in repayment plans for wage-earners (Chapter 13), and one may be appointed in exceptional circumstances in reorganisation (Chapter 11). Natural persons, corporations, and most other entities are eligible to seek protection under Chapter 7 or Chapter 11 of the US Bankruptcy Code, which can be applied to both natural persons and corporations10. Chapter 13 is available only to physical persons with a regular income.

Even terms such as 'consumer bankruptcy', 'indebtedness', 'over-indebtedness', 'debt counselling', 'debt restructuring', and 'fraudulent debts' may have a different meaning and usage from one country to another. For example, in Portugal, indebtedness means the amount owed by a family unit, whether resulting from a single credit obligation or from multiple obligations, from multiple sources. Frequently, where there is more than one debt, the concept of multi-indebtedness is applied11. As used in the INSOL International Consumer Debt Report (hereinafter 'INSOL Report') 12 , the term 'consumer debtor' refers to a debtor whose liabilities are incurred primarily for private, family, or household purposes, as distinct from business debts incurred either on the debtor's own account or in partnership with others, or arising from guarantees given on behalf of limited-liability entities. The INSOL Report describes the following types of consumer debts: survival debts 13 , over-consumption debts 14 , compensation debts 15 , relational debts 16 , accommodation debts 17 , and fraudulent debts18. In short, as defined in the INSOL Report, a consumer debtor's liabilities are related primarily to bank overdrafts, loans from banks and other financial institutions, personal credit cards, mortgages, and hire-purchase or credit-sales agreements associated with purchases of capital items such as automobiles19. No generally recognised definition of a consumer debtorexists. These words may have different meanings in different jurisdictions. Whether liquidation or rehabilitation procedures by nature, these are usually collectively referred to as insolvency procedures20.

The credit card is a symbol of consumer-led societies. As consumer-led economies having high levels of personal financial credit and allowing a discharge, the US and Canadian systems depend on important monitoring and control mechanisms to manage the risks of default. Instead of punishing the debtor, the US Bankruptcy Code facilitates a 'fresh start' for a debtor at the conclusion of a bankruptcy proceeding by allowing a discharge of all dischargeable debts. Under US bankruptcy law, most general unsecured consumer debts are dischargeable, including credit-card debt and medical debt. Some debts are considered non-dischargeable, among them student loans 21 , domestic support obligations, and many tax obligations, or debts that were incurred through fraud or wrongdoing. When a debt is discharged, it may no longer be collected from the debtor, but it is not cancelled22. The bankruptcy system permits a debtor to keep certain of his assets that are considered to be 'exempt' from the bankruptcy estate and therefore not subject to the claims of creditors. A debtor has an option to elect the exemptions granted either by federal law (i.e., the Bankruptcy Code) or by state law. Some states in the US have much more generous exemptions than others. For example, New York state law permits a debtor to retain $50,000 in a homestead exemption, $2,400 in a motor vehicle exemption, food and fuel to last 60 days, clothing, and household furniture. Under Texas state law, a debtor may keep up to 200 acres of rural homestead property, along with other exemptions. Even if creditors are not repaid in full, the debtor is allowed to keep exempt assets in order to provide a 'fresh start' in his economic life following the discharge23.

Canadian bankrupts are now required to pay their creditors a portion of the surplus income they earn during the period between their filing for bankruptcy and the discharge of their debts. An administrative edict defines surplus income as a function of Canadian poverty lines. After discharge, however, no payments are required from the former bankrupt's income24.

Under most European bankruptcy laws, the discharge of a debtor from (all) debts is almost unheard of without the creditors' approval. This could be the result of widespread historical perceptions about causes of insolvency being attributable to economic distress, unemployment, serious disease, or financial mismanagement. As a result, consumer insolvency in Europe is generally treated as a social problem caused by a force majeure, rather than as a market exit or adjustment mechanism.

A development in the opposite direction has taken place in continental...

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