How best to deal with bankruptcy
Bankruptcy was once a public and deliberately humiliating experience. Until 2004, the system of insolvency seemed better suited to the 19th century: bankrupts' names were published in the local newspaper, and the whole process was tinged with a suggestion of dishonesty or even criminality on the part of the debtor.
How times have changed. Dramatic changes to bankruptcy legislation in 2004 were designed to remove much of the shame of insolvency. Now, most bankrupts are discharged after 12 months, instead of three years, and the process is far more anonymous.
Such attempts to remove the stigma of insolvency appear to have made bankruptcy more acceptable to many people. Official figures from the Insolvency Service show that personal insolvencies have increased massively in the last decade. In the year to April 2010 there were almost 140,000 individual insolvencies.
Between July and September 2010 alone, one in 311 people in the UK - almost 34,000 individuals in total - became insolvent. Over the last 25 years as a whole the annual average was one in 575.
The path to self destruction
The reasons for people filing for bankruptcy remain complex. The combination of easy credit over the last decade followed by the recent economic downturn has seen many individuals lurch from boom to bust. But despite the preconception, not all of those who opt for insolvency have been reckless in their spending.
When Emma Smith realised that she was going to have to declare herself bankrupt last summer, she admits she felt a failure and was too embarrassed to tell anyone other than her closest family.
The 32-year-old had not borrowed money to go on expensive holidays or buy designer clothes. Instead, Emma had taken out a personal loan from Sainsbury's to fund the deposit on her house in Milton Keynes, and got a car loan through her bank Barclays - all within the budget her job in advertising sales allowed her each month.
However, when the recession began to bite and advertising revenue dropped sharply, she found that her pay, much of it commission-based, also plummeted. Suddenly, she was relying on her credit card to meet monthly costs and struggling to make the repayments on her outstanding loans.
Before she knew it, her debts had soared to £22,000 - and she saw no way out of the borrowing black hole.
IVA or bankruptcy?
Her first stop was a debt management company, which suggested that she take out an individual voluntary arrangement (IVA) that would pay back her creditors 40p in the pound. However, when the plan was put to her largest creditor, Barclays, it was rejected. This left Emma with only one option, bankruptcy - a route she had been keen to avoid.
Today, Emma feels differently about it all. "In retrospect, bankruptcy was a better option than an IVA, as I would have struggled to make the repayments necessary for that arrangement," she says. "As it is, I've wiped the slate clean."
Emma will be discharged as a bankrupt in June this year, but she emphasises that she did not take the decision lightly.
"I'll admit that there was an immediate feeling of relief," says Emma. "But I was never someone who had planned to run up debts and then just declare myself bankrupt and walk away from my responsibilities. I borrowed money to put a deposit on a house and buy very basic furniture for it."
However, the experience of going bankrupt has altered Emma's view of debt. "As long as I've got a roof over my head where I know I can stay, then nothing else matters," she says. "Even though the bankruptcy means that I can't get credit over £500, that's not a problem, because I simply won't buy things I can't afford."
Steven Law, president of R3, the organisation representing insolvency practitioners, thinks that the liberalisation of bankruptcy legislation has caused the increase in people becoming insolvent.
"There's less stigma now," he says. "For example, the Insolvency Service passed changes so that the fact of an individual's bankruptcy no longer has to be published in the local newspaper. Ostensibly, this was done on cost grounds, but it has had a positive side effect for those going through this often traumatic process."
Two years ago, 54-year-old Terry Donaldson could not sleep for worry about how he was going to keep his travel agency going and maintain payments on his mortgage. He and his business partner had taken out loans to set up the tour operator business in 2006 and Terry had remortgaged his house in Huddersfield to raise more capital.
When the recession took hold and the business started to flounder, Terry's partner, who ran the financial side of the operation, said that they could no longer afford to take any salary from the company and each would have to put in more money or accept that the business had to fold.
"I had to look at the facts," says Terry. "The business wasn't making any money, we owed £20,000 to the HM Revenue & Customs, and I had got to the stage where I had six or seven credit cards that I'd been relying on just to pay the mortgage.
"I totalled up all of my personal debts and realised I owed more than £23,000 in loans and credit card debts on top of the business's liabilities. Sadly, bankruptcy was the only sensible choice."
For more information on tackling debt and bankruptcy, read: 20 ways to escape debt for good
The bankruptcy process
In January 2009 Terry visited the local courts to start the bankruptcy process and immediately felt as if a weight had been lifted from his shoulders.
"I had one telephone conversation with the receiver after I filled out the forms detailing what I owed to whom and what assets I had," Terry adds. "In fact, I'd already had to hand back my house to the mortgage lender, Birmingham Midshires, so I was really left with nothing. But I felt as though I could start again."
Terry and his wife Katherine moved to Blackpool, where she has since taken out a mortgage on a small house in her name. Terry has abandoned his career as a travel agent and is working part-time in a marketing job, with a view to a career change.
"I do feel guilty that I wasn't able to pay back the money I owed," he says. "I'm an honest person and I don't like the idea of having walked away from debts. And I will admit that my confidence has taken a knock.
"But timing was a key factor. I've been very open with everyone about it all and most understand that what happened to me is also happening to a lot of other people. I'm just one of thousands who have been caught up in this economic mess, and I happened to be one of the first to fall foul of the recession."
Law adds: "Let's not pretend that bankruptcy is easy. A person's credit rating will be damaged for up to six years, though there are ways around the problems this poses, such as getting other members of the household to take out credit subsequently. But a lot of people say that almost as soon as they apply for bankruptcy, the pressure is released and they are able to sleep again."
A year ago, Michelle Cheston could see no way out of her money troubles. Michelle, 27, from Newcastle, gave up work as a communications officer in the Royal Air Force three years ago when she became a mother for the first time. But while she was pregnant with her second son, her husband Billy lost his construction job due to a severe back injury.
They were unable to pay the mortgage, barely had enough money for food, and decided to separate once the rows about their financial situation had become too much to bear.
"It was the darkest time of my life," Michelle says. "Billy had gone from bringing home about £800 a week to being on statutory sick pay, to then losing his job altogether. It was the money worries that drove us apart."
In January last year she approached the local Citizens Advice Bureau for help, thinking that bankruptcy might be the only answer. She had an additional £20,000 of personal debt on the mortgage, plus about £4,000 on two credit cards.
"The adviser told me the fees I'd need to pay and I felt desperate. I really thought I couldn't even afford to declare myself bankrupt," Michelle says.
A person applying for bankruptcy must pay a court fee of £150, although the court may waive the cost in some cases, such as when someone is claiming income support. A further £450 is payable towards the costs of administering the bankruptcy. However, some charitable trusts will help individuals with this deposit.
Michelle says: "The adviser asked me about my past employment and I said that I'd been in the RAF. I was told that there was a British Legion representative who could probably help me with the cost of the court process."
The British Legion agreed to pay Michelle's fees and she was declared bankrupt in April last year. Her house was sold, and through the Legion's benevolent fund, she received shopping vouchers for food and children's clothes.
Because the bankruptcy has damaged her credit rating, Michelle has found it hard to rent a property, but she and Billy have been reconciled and the family has moved back in together.
Gill Hankey, founder of the Bankruptcy Advisory Service, insists that people can rebuild their lives after being declared bankrupt, but she believes it's still easier for some than others.
"It's still a bit of a lottery how a bankrupt will be treated, based on which insolvency practitioner is appointed as trustee. Some are very good and others less so," she says. "But the simple fact is that in this economic climate going bankrupt is hard for everyone. Credit is hard enough to access even for those with an unblemished record."
However, Michelle concludes: "Going bankrupt at 27 was a huge undertaking and there have been negative side effects, but it means that we can have a fresh start and a life in the future."
Generally speaking, insolvency is to businesses what bankruptcy is to individuals. A company is insolvent if the value of its assets is less than the amount of its liabilities, or it is unable to pay its liabilities (loan payments) as they fall due. It’s an offence for an insolvent company to keep trading, so the main options available to an insolvent company are: voluntary liquidation, compulsory liquidation, administration or a company voluntary arrangement.
An alternative to bankruptcy, an Individual Voluntary Agreement is a legal agreement drawn up between the debtor, all creditors to whom money is owed (banks, credit cards etc) and a licensed insolvency practitioner who then administers the arrangement. Unlike a debt management plan (DMP), which is a more casual arrangement, an IVA is a legal process by which your unsecured creditors cannot then pursue you for payment of your debts outside the agreement. To qualify for an IVA, you must be a private individual (not a company), your debts must exceed £15,000 and you must have a regular income. If you are a homeowner with equity in the property, you may have to remortgage and use the equity to clear some of the debt before you enter into an IVA.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
A person (or business) unable to pay the debts it owes creditors can either volunteer or be forced into bankruptcy – a legal proceeding where an insolvent person can be relieved of their financial obligations – but loses control over their bank accounts. Bankruptcy is not a soft option. Although it may wipe the financial slate clean, it is extremely harmful to a person’s credit rating (it will stay on your credit record for six years) and will adversely affect your future dealings with financial institutions. Bankruptcy costs £600 paid upfront.