27 Mar 2014 09:25am

“Simplification” of insolvency regulation

Later this week, a consultation will close on the Insolvency Service’s proposals to update elements of insolvency regulation and alter the fees-setting mechanisms used by the UK’s insolvency practitioners

While the proposals on the profession’s regulation and creditor engagement are broadly on the right lines, the same, unfortunately, cannot be said for the plans to prohibit insolvency practitioners from charging fees on an hourly basis in cases with no engaged creditors or creditor committees.

Instead of using ‘time-costs’ – which is currently the industry standard – insolvency practitioners would only be permitted to charge fixed-fees, agreed up-front, or a percentage of the assets realised.

This latter proposal is experimental, far from evidence-based, and would have a detrimental effect on the UK’s insolvency profession – currently ranked as the world’s 7th best by the World Bank – and UK creditors.

Moreover, the fees proposal will not meet the government’s own aims of increasing unsecured creditor engagement, nor necessarily reduce the ‘noise’ around insolvency fees.

Worryingly, the Insolvency Service appears to be under the impression that moving from three fees option to two represents ‘simplification’. Simple it may be, but it shows a failure to grasp exactly how insolvency procedures actually work in practice.

The fees ‘issue’

The Insolvency Service’s proposals follow two government-backed reviews into insolvency fees – by the Office for Fair Trading in 2010 and by Professor Elaine Kempson in 2013.

Both reviews reached similar broad conclusions: the process of setting insolvency fees works well when creditors are engaged; and that disengaged or unsecured creditors are less effective at exerting downward pressure on fees.

R3 agrees with these conclusions. But, whereas we believe they point to a need to help and encourage creditors to engage with insolvency processes, the Insolvency Service has focused elsewhere. Indeed, the Insolvency Service’s proposals are nowhere to be found in the recommendations of either of the earlier two reviews.

The result is a set of proposals that represent an untested over-reaction to the actual ‘issue’ at hand.

We understand that insolvency fees will always be a controversial topic. Insolvencies are stressful, and creditors often lose money while at the same time an insolvency practitioner is paid for their work out of the funds that the creditors would otherwise get. However, as Professor Kempson and the OFT found, the profession delivers plenty of value in return for its fees.

The fees about which the OFT and Kempson had concerns are relatively small, forming part of an estimated £15m of “excess” in insolvency-related costs. To put that into context, that’s under 0.4% of the £4bn of assets returned to creditors by insolvency practitioners every year. Indeed, the £15m figure itself could be challenged: it’s based on an extrapolation from a limited sample and mixes scale rates and actual recovery rates. It also assumes a volume discount given to one party automatically means another party is being overcharged.

Reducing the ‘noise’?

Amending the fee-setting mechanisms rather than focusing on creditor engagement would be defensible if doing so actually tackled any ‘over-charging’ or reduce some of the ‘noise’ on fees, as the Insolvency Service aspires to. The Insolvency Service’s ideas will not achieve this at all.

Fixed-fees are already used in some cases, where appropriate, and insolvency practitioners often provide an up-front cost-estimate for a case. However, there is usually no telling exactly how much work will eventually be needed to complete a job; agreeing a fair, up-front, inflexible fee would be next to impossible.

Creditors will still need to be engaged in the process of negotiating a fee in the first place, and either the creditors would lose out if the insolvency practitioner was able to wrap a case up quicker than expected, or the insolvency practitioner would suffer if a case turned out to be more complex than first thought.

The problem with charging fees as a percentage of realisations is that there is no link between the amount of work done and what could eventually be charged by the insolvency practitioner.

Some cases might be as simple as distributing a large amount of money held in a bank account; another case might involve many months of work for an insolvency practitioner – possibly including investigations into the behaviour of a firm’s directors – but might produce few returns.

In fact, calculating fees as a percentage of realisations was abandoned as a standard practice in the UK by the 1980s as being unfair and inequitable to creditors.

Who is impacted?

According to our members, one stark consequence of these proposals is that the Insolvency Service would have to take on more work: 70% of our members say enforcing fixed-fees would increase the number of cases taken on by the official receiver; 65% say fees as a percentage of realisations would increase the number of cases taken on by the official receiver.

Conversely, 40% believe fixed fees would hurt returns to creditors (only 11% say returns would be improved), and 64% say they would redice the number of business rescues – although licensed to carry out insolvency work, the official receivers do not have the same training and qualifications as insolvency practitioners, nor are they subject to the same scrutiny, or liable for negligence.

The simple fact is that the proposals will either generate disproportionate payments to insolvency practitioners at creditors’ expense, or will make it uneconomical for insolvency practitioners to take on some cases.

If insolvency practitioners cannot afford to take on more work, then creditors will not benefit from their expertise and experience, whilst taxpayers will be left with a swathe of extra cases to pay for. With much of the government striving to find ways to cut budgets and scope, it is surprising to see the Insolvency Service, intentionally or not, taking work from the private sector.

What is needed from the Insolvency Service is a re-think. Its proposals on fees are not based on any evidence that show they would be workable. What little evidence there is suggests the opposite.

No other country that operates a system like the one that the Insolvency Service proposes. The government is proposing to abolish a method of fees-setting that works and which allows the UK insolvency profession to bring better and faster returns to creditors than their counterparts in Germany, France, the US, and other large economies.

Government needs to look again at what its own reviews recommended – including combining time-costs with fixed-fees for statutory work – and should listen to calls from the profession and others to require the provision of up-front estimates of case costs and better information from insolvency practitioners for creditors. Government itself should lead the way on unsecured creditor engagement: HMRC debt accounts for almost a quarter of unsecured debt.

In 2012, the UK’s insolvency profession saved over 6,000 businesses and rescued 750,000 jobs. In 2010, the profession contributed almost £750m to the UK economy. That is too important to put at risk – and that’s exactly what the Insolvency Service is doing. 

Graham Rumney, chief executive, R3


Related articles

Insolvency profession welcomes landmark pension decision 

Insolvency Service increases fees 

Insolvency Service almost insolvent