Counting the cost of going bankrupt

The severity of the bankruptcy regime in Ireland suggests it will remain the last resort for both debtors and creditors, writes CAROLINE MADDEN

IN THE United States, it’s almost considered a badge of honour and, in Britain, it’s an everyday occurrence, but in Ireland personal bankruptcy occurs so rarely that the legal term has all but disappeared from our lexicon. Until last week, that is, when the issue hit the headlines after fallen property titan Paddy Kelly told the Commercial Court that he is exploring the possibility of bankruptcy.

Now that Kelly has raised the frightening spectre of personal insolvency, will we see a flood of over-indebted developers – and for that matter overextended consumers – throwing themselves on the mercy of the courts and seeking refuge from their creditors through the bankruptcy process?

The severity of the bankruptcy regime in Ireland would suggest that it will remain the avenue of last resort for both debtors and creditors, but nonetheless industry practitioners expect it to become more common.

“I would expect a sharp increase in the amount of activity for different reasons, mainly because the number of people with ostensible wealth has increased and those people, in a personal capacity, owe a lot of money,” comments Barry O’Neill, head of corporate recovery at Eugene F Collins Solicitors.

This issue of “personal capacity” is at the heart of what is a growing problem. Many property developers formed partnerships to conduct their business and, therefore, are potentially personally liable for the debts of that business. Other developers formed limited companies in order to protect themselves from personal liability, but then personally guaranteed the debts of their businesses – businesses which have since gone under. This exposure now leaves them open to the threat of personal bankruptcy.

The process of bankruptcy is normally driven by a creditor, and this is what makes Paddy Kelly’s case so unusual – he is voluntarily exploring it as an option himself.

“It’s interesting that the first public mention of bankruptcy is where someone is actually considering resorting to it themselves despite all the emphasis in the last six months of creditors pressing their debtors,” says O’Neill.

“If he’s leading the pack, it might set a precedent,” James Treacy of credit bureau BusinessPro surmises.

The attraction of going down the bankruptcy route is that it frees the debtor from the constant pressure and stress of being pursued by irate or vindictive creditors and it eventually (after a period of at least 12 years) allows them to draw a line in the sand, shed their historic debt and make a fresh start.

Of course, there are a great many downsides (see panel) which in most cases outweigh the potential benefits. “Every step you take and every move you make for the next 12 years is being watched,” says Kevin Smyth, a partner at the law firm Dillon Eustace. “It just puts you into a no-man’s land . . . Certainly it would be avoided by any normal person if they could.”

There are also a number of factors that would deter creditors from instituting bankruptcy action against debtors, even “big fish” like Kelly. Firstly the process can prove prohibitively expensive, as it must go through the High Court no matter what the level of debt.

“Our system is very expensive in comparison to other jurisdictions,” Smyth says.

BusinessPro’s Treacy highlights another problem that might cause creditors to think twice before petitioning for a debtor’s bankruptcy: “What we notice is that quite a large percentage of the people who are declared bankrupt have already died, because [the process] takes so long. It might take 20 years by the time it’s recorded.”

After spending considerable amounts of time and money, at the end of the process the creditor may not recover anything.

Smyth points out the petitioner (ie the creditor who institutes the bankruptcy process) does not get priority over other creditors in relation to the payment of their debt, as the purpose of bankruptcy is to create a level playing field between all of the individual’s creditors. “What’s the point in going through the court system for six months, a year, two years ratcheting up legal costs and then having no redress at the end?” he says.

Despite all the deterrents, O’Neill predicts that we will see an increase in bankruptcies. “I think there’s going to be two trends – one will be the mega-bankruptcies and the other will be the minnow bankruptcies,” he says.

Although the threat of bankruptcy is expected to be used more and more by creditors as a means of pressurising individuals into making good on their debts, it is unlikely that banks and other creditors will institute bankruptcy proceedings against small individual consumers. “Because it’s a High Court process, it’s expensive and lower levels of the debt won’t attract creditors to make people bankrupt,” says O’Neill. “It’s not cost efficient.” But will overburdened consumers start to consider bankruptcy themselves, as a means of escaping their debt spiral? In the US, a culture of “consumer bankruptcy” has developed. This is largely because people can be discharged from bankruptcy within a year, enabling them to wipe the slate clean and start afresh very quickly. Given that the bankruptcy period stretches for 12 years in Ireland, it’s certainly not a quick-fix panacea.

“Personally I think they probably could sort their problems out without resorting to bankruptcy. It’s a massive step to take for someone to sort out low-level debt,” says O’Neill. “My sense is that the floodgates won’t open on that, because of that 12-year [time horizon], because of the stigma and simply because people with low-level debt should really be able to sort the problem out in some other way.”

There are alternatives that debtors, such as developers in trouble because of personal guarantees, should consider before taking the extreme decision to become a bankrupt.

For example, O’Neill suggests that they could pursue a personal version of examinership in order to avoid bankruptcy. Under this scheme of arrangement, the individual gets the protection of the court and makes a proposal to their creditors.

“If you can get 60 per cent of your creditors to agree , that’s enough to succeed,” he advises. However, he says that, if it fails, the individual becomes a bankrupt, so it’s still a high risk strategy.