A tale of two debtors

Written by Pamela Muir, insolvency partner, Thorntons 

Why are individuals reaching for help when businesses are suffering in silence?

Introduction

A difficult economic landscape, exacerbated by recent budgetary constraints, has left businesses – particularly micro-, small- and medium-sized enterprises (MSMEs) grappling with mounting financial pressures as businesses adapt to depressed consumer spending, inflationary pressures, rising national minimum wage levels and the increase in employers’ National Insurance. At the same time, the cost-of-living crisis is severely impacting individuals, straining household finances to breaking point.

It is well-known that debtors fall into two categories: can’t pay or won’t pay. Debt recovery is a matter of practicality; a pragmatic response to non-payment by debtors. For debtors who cannot pay once the formal debt recovery escalation begins, soon follow the mechanisms of default, bankruptcy and insolvency.

For individual and corporate debtors, debt-recovery usually commences with the engagement of creditors’ credit control processes and may be escalated to formal debt recovery procedures and enforcement against the debtor’s assets. Where a debtor is unable to meet the demands of creditors, they may consider the options open to them to manage their debts to avoid formal creditor action.

Reviewing the insolvency statistics available for 2024 indicates a different uptake of rescue mechanisms for personal debtors than corporate debtors. We consider why that might be.

Individuals turning to DAS

Trends in personal bankruptcy in Scotland show an increase in the uptake of formal debt management tools. Despite the ongoing cost-of-living crisis, the number of sequestrations has been falling steadily and remains at or around its lowest levels in the past 20 years. This is thanks to the availability of moratoriums preventing creditor escalation against individuals and the rising adoption of the Debt Arrangement Scheme (DAS).

DAS is a debtor-in-possession (DIP) framework that empowers individuals to repay their creditors without the finality of bankruptcy. By allowing debtors to repay their debt while freezing interest, charges and enforcement, it offers a crucial alternative for those overwhelmed by debt. DAS is free to the debtor at point of uptake, provides free financial advice and ensures no restriction on employment (which comes hand-in-hand with trust deeds and bankruptcy). It can also allow debtors to retain their home alongside providing a stay on enforcement action through the use of the statutory moratorium or once in an approved dept payment programme (DPP). The scheme has shielded more people than ever before from the long-term consequences of bankruptcy, providing both relief and a potential path to financial recovery.

DAS also provides preferential outcomes for creditors to a formal insolvency. Legislative intervention in the form of the Debt Arrangement Scheme (Scotland) Amendment Regulations 2018 boosted statutory fees to 20% and amended creditor entitlement from 90% to 78% of aggregated debts. Critically, creditor return in a DAS is likely to be more than could be expected from any other personal insolvency scheme, and so the attractions to creditors and debtors alike are clear. Last year DAS filings represented 39.5% (5,278) of all personal bankruptcy filings, and were up 6.7% year on year. With strong Government involvement, regular review (notably, since its inception, two Accountant in Bankruptcy (AiB) consultations and a 2019 Scottish Government consultation) and legislative reform – no fewer than seven updated sets of regulation up to the Bankruptcy and Debt Arrangement Scheme (Miscellaneous Amendment) (Scotland) Regulations 2023 – the uptake of DAS continues to climb.   

Writing in 2004 in the Law Society of Scotland’s Journal, Jonathan Lewis pointed out that the success of DAS was heavily dependent on the commitment of the executive to its promotion. He went on to note how crucial it was that sufficient resources be devoted to the scheme – allowing a change in perception of those debtors who refuse to recognise their problems or have no inclination to address them.

Statutory debt solutions by type, 2006/07-2023/24 (Source: AiB, August 2024)

From the chart above, it may be seen that there was a clear commitment to DAS for the first 10 years and this had the desired effect, with steady rises in the uptake of DAS. Alan McIntosh, writing in the Journal in 2020, points to a temporary 45% reduction in funding for frontline, free money advice services as explaining the blip in uptake around 2015. This highlights the correlation between Government commitment to DAS and its uptake.

In another example of strong Government investment in the outcome of the new DIP measures, the statutory moratorium – introduced by the Bankruptcy (Scotland) Act 2016 – offers another tool to individuals struggling with debt: six months’ breathing space for debtors to address debt issues and seek free advice.

Further reform has come through the Bankruptcy and Diligence (Scotland) Act 2024, with the current provisions being recognised as inaccessible to debtors with mental health issues. When it comes into force, the Act will introduce a mental health moratorium to provide a framework of protections tailored to individuals with serious mental health issues, modify the Bankruptcy (Scotland) Act 2016 and modernise debt recovery mechanisms. The mental health moratorium is intended to provide regulations to pause debt enforcement against individuals with serious mental health issues, providing breathing space for the debtor until their mental health improves. These changes bring Scotland in line with the provisions that have been in place in England and Wales since 2021 through the mental health crisis moratorium. The policies around individual debt continue to be considered and promoted by the legislature.

Yet, the uptake in rescue mechanisms for individuals does not extend to the corporate world. The success of DAS underscores the need for pragmatic routes to recovery in the corporate sector, where rescue mechanisms require enhanced accessibility and appeal to encourage broader adoption.

The corporate conundrum

For companies, like individuals, there is a prevailing desire to remain in charge of one’s own affairs. While individuals increasingly turn to DAS, the corporate world presents a starkly different picture. Businesses, particularly MSMEs, remain hesitant to engage with available rescue mechanisms.

The Scottish economy is 99% MSME. We routinely hear that a company in financial distress considers liquidation to be the only insolvency route available to them due, in no small part, to the cost of funding any recovery mechanisms – and this anecdotal evidence would seem to be borne out by the figures. Liquidation accounted for 95.3% of Scottish insolvency filings for 2024 (to November). Administration is expressly designed to rescue a company as a going concern or to achieve a better result for creditors than would be likely if the company were immediately wound up. Yet with these aims, similar to the recovery aims of DAS, only 4.4% of formal insolvencies in Scotland were administrations. Administration, while ostensibly providing rescue for an ailing entity, may be distinguished from DAS as it is a practitioner-in-possession mechanism, wherein an insolvency practitioner takes over administering the affairs of the company until one of the stated aims is achieved.

Comparable corporate insolvency mechanisms to DAS are Company Voluntary Arrangements (CVAs), schemes of arrangement and the Corporate Insolvency and Governance Act 2020’s Part 26A restructuring plan. These DIP procedures, where management remains in control of the business, seek to bind creditors in agreeing a reconstitution of debts (noting that CVAs do not bind secured creditors). They come with a significant amount of professional oversight in a complex process, which comes with a cost. The uptake of these mechanisms in Scotland is very low with only two Part 26A restructurings since its inception in 2020, one CVA and no schemes of arrangement filed for in 2024. The chart below sets out the minimal use of those alternative mechanisms (alongside the other available ‘rescue’ mechanisms of administration and the Part A1 moratorium) within ‘other’.

Monthly company insolvencies by type, Scotland, November 2019 to November 2024, not seasonally adjusted (Source: The Insolvency Service, December 2024)

While 2024 marked a pivotal moment with the first use of the Part 26A restructuring plan’s cross-class cram-down mechanism in Scotland (for Dobbies Garden Centres), this case remains an outlier. For most struggling businesses, especially MSMEs, the restructuring solutions available in the Insolvency Act 1986 are commercially unviable, as evidenced by the prevalence of Creditors’ Voluntary Liquidations (CVLs). UK-wide, CVLs are up 86% compared to pre-pandemic levels and now represent 80% of all insolvencies.

Why does this lack of engagement matter?

The rise in CVLs may be taken as a proxy indicator of small firm failure, with costs associated with administration and other rescue procedures (outlined above) generally beyond the financial capabilities of small firms in distress. The cost of these entities leaving the marketplace is clear: it has long been understood that in jurisdictions where corporate rescue is employed effectively, creditors tend to recover 83% of their claims on average compared to 57% through the route of terminal windings up (COM(2016) 723 final, p3, referring to World Bank, ‘Doing Business 2016’).

Recent legislative reforms have been tailored to larger enterprises, leaving MSMEs underserved. The Part 26A restructuring plan – of which, in Scotland, since its introduction, there have been only two – and an amended moratorium procedure introduced to Part A1 of the Insolvency Act 1986 (not as yet used at all in Scotland) have failed to curb the increasing tide of terminal insolvency proceedings.

Learning from DAS

The success of DAS provides a valuable blueprint for improving corporate rescue mechanisms. While it could be assumed that the DIP feature itself is what makes DAS attractive, the stark contrast between individual and corporate insolvency suggests that this alone may not be sufficient. Instead, the scheme’s accessibility, governmental support and clear communication have been instrumental in encouraging individuals to seek help. Moreover, DAS is provided free of charge to debtors, cutting through the expense barrier to implementation found in corporate restructuring schemes. By ensuring that DAS remained appealing to creditors, the Government demonstrated how targeted legislative efforts can drive successful outcomes.

With the economic landscape appearing to be on a troubling trajectory, it is unfortunate that there is not a stronger uptake of corporate restructuring options, as accessible restructuring schemes have statistically outperformed terminal insolvencies in returns to creditors. When comparing the uptake of insolvency mechanisms for personal debt against corporate debt, it is clear that access to advice is paramount. For individual debtors in distress, the Scottish Government has provided frontline services and access to free advice alongside regular legislative reform. For directors of ailing enterprises, such services must be sought rather than being provided.

The issue of debtors and creditors in the context of corporate vehicles is complicated by the potential for personal liability of directors upon insolvency. In the absence of further reform, directors should seek advice at the earliest possible time (Cork Review Committee Report on Insolvency Law and Practice 1982 (Cmnd 8558), pp53-54) and be alive to the financial health of their organisation, with a view to early intervention and steps towards recovery.

Written by Pamela Muir, insolvency partner, Thorntons