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Reforming Insolvency and Second Chances for Business


25th March 2008

During a European Standing Committee debate on Insolvency and Second Chances, Jonathan Djanogly outlines proposals to provide real solutions to the real problems faced by entrepreneurs and SMEs in the UK.

5.18 pm

Mr. Djanogly: I had not intended to speak first on the motion, but given the number of participants, I think I am there.

I welcome this European Committee sitting as an important opportunity to review solutions to some of the major problems that face businesses in our country, especially small and medium-sized enterprises and those entrepreneurs who have honestly failed once, or perhaps more than once, but still have the potential to succeed. The Minister explained the rationale for helping such people. Given our faltering economy, relatively high interest rates and mortgages, the credit crunch limiting companies' access to funds, high factory-gate inflation and fuel costs rising way above inflation-not helped by punitive Government taxes-it is timely to debate the threat of insolvency and its implications.

Successful economies are built on successful businesses. To start successful businesses, one needs a catalyst, which is most often an entrepreneur-an individual with a good idea, who has the confidence in himself and the macro-economic environment in which he wishes to operate to turn that idea into a real business. I have no doubt that the UK possesses in abundance the creative, intelligent and business-savvy minds needed to generate many potential entrepreneurs. We need to question, however, whether the UK has at present the regulatory regime that is fit to encourage potential entrepreneurs to set up and successfully grow their own businesses, a necessary part of which is having the confidence in the system to be able to start again when they have already failed once.

We agree with the European Commission's assertion that member states need to encourage entrepreneurs who have failed through no fault of their own to try again. Some member states have already started to do that. For example, the French association, Re-crÃ(c)er, created with the backing of the French chamber of commerce and industry and the French association of bankers, has specific programmes for boosting the confidence of restarters who underwent business failures. Do such industry backed schemes exist in the UK, where it seems that the incentives to start a new business are increasingly outweighed by the risks?

Miles Templeman, director general of the Institute of Directors, has complained that since the Government came to power,

"the burden of regulation on business has increased substantially".

He further points out that

"whereas in 1998 the UK was judged to be the fourth most competitive nation, by 2004 we had tumbled to fifteenth place according to the World Economic Forum."

The total cost of regulations on business since this Government came to office stands at £65.99 billion. There is now the equivalent of 14 new regulations for every working day that the Government have been in power. Small businesses spend an average of seven hours a week complying with Government paperwork. The national chair of the Federation of Small Businesses, John Wright, sums up the situation:

"the Government has beaten small businesses over the head for the last six or seven years".

Furthermore, the UK has the longest and most complex tax code in the world. A report on stimulating entrepreneurship and business growth, "Enterprising Britain: building the enterprise capital of the world", singles out small and medium-sized enterprises in particular as suffering at the hands of this Government's steadily increasing tax burden. One example of that burden is that the compulsory VAT registration threshold of £60,000 has not been increased since 1993. The number of VAT-registered enterprises has increased every year in which the Labour Government have been in power. Many regard the failure to increase the VAT registration threshold as another example of a stealth tax. The Trade Minister, Lord Jones of Birmingham, once said that business men and women listening to the Prime Minister-in his days as Chancellor, of course-would wonder why he missed the golden opportunity to boost UK competitiveness and cut the corporate tax burden.

As we might expect, such unfavourable economic conditions have had an adverse effect on businesses, particularly SMEs. I raised that point with the Government during the debates on the Enterprise Bill in 2002, when we were analysing the impact of that Bill. I warned then that

"Over-regulation will cause companies to leave the marketplace, which will mean less choice for consumers and higher prices."-[Official Report, 10 April 2002; Vol. 383, c. 104.]

My warning appears to have rung true. Although the number of SMEs has increased, the start-up rate has fallen significantly. In addition, businesses are struggling to grow: the number of businesses that had achieved an annual turnover of more than £1 million five years after creation fell from 48 per cent. in 1997 to just 16 per cent. in 2006. It now takes an average of 14 years for a company to reach an annual turnover of £5 million.

Research carried out on behalf of the European Commission has also shown that, between 2001 and 2003, the UK recorded sizeable net job losses in small and medium-sized businesses. Not only were the job losses in UK non-financial SMEs the largest of any EU member state, such losses were also in marked contrast to the trend in other EU countries: in almost all other member states, job numbers in SMEs increased. That serves as a reminder of how other countries have encouraged and helped their SMEs and have done a much better job of recognising the importance of this sector of the business community than our present Government. In that regard, the Government have failed to help the SMEs, which employ 50 per cent. of the working population in the UK and are hugely important to the country's economy.

According to the most recent figures available, debtor bankruptcy petitions filed have increased from 9,636 when the Labour Government came to power in 1997 up to some 52,700 in 2006. The growing financial pressure on individuals is also highlighted by the rising number of individual voluntary arrangements being sought. In Wales, for example, this is the seventh consecutive year that both the number of bankruptcies and the number of IVAs have increased.

What is being done to improve the situation for the UK's business community and to encourage entrepreneurship? The Government have proposed changing insolvency laws, yet again, to leave the advertising of bankruptcy to the discretion of insolvency officers. I am not convinced that that is the answer to the problems faced by business, and neither, by the way, is Nick O'Reilly, the vice-president of R3, the Association of Business Recovery Professionals, who is an authority on getting failed businesses back on track. He says:

"The government needs to revisit this proposal if it is to ensure that it really helps to boost enterprise".

He argues that abolishing compulsory advertising of a bankruptcy would do no more than

"open a floodgate of people declaring themselves bankrupt in order to cope with personal debt."

He sums up the feelings of many businesses in the UK today by concluding:

"The government is out of step with how bankruptcy is used in this country."

I made the point in 2002 that bankruptcy regulation needs to be implemented with a view to encouraging and protecting business, not to enhancing careless risk-taking and excess consumer credit, which, given the huge levels of consumer credit and rising interest rates, could present an easy way out of debt for thousands-so much for being a Government of prudence.

The Insolvency Service seems to agree that the current requirement that one must advertise a bankruptcy is not a major deterrent to potential entrepreneurs. An article published in September last year entitled "Changing attitudes to bankruptcy" outlined the main factors contributing to the stigma of bankruptcy. The three most important were: first, problems in obtaining a bank account; secondly, not being able to repay creditors; and, thirdly, a resulting poor credit rating. There was no mention of the mandatory advertising requirement.

In the 2002 debate, my view was that we had a major problem in this country with getting support for business, especially in the form of banks lending to business start-ups and smaller companies. According to the Financial Services Authority, today just two of 17 high street lenders are prepared to offer basic bank accounts to undischarged bankrupts. The Government's attempts to tackle the problem have been ineffective. They have encouraged the growth of roughly 3,000 business support schemes in the UK, which cost the taxpayer some £2.5 billion a year, but those support schemes are constantly changing and wasteful, and so complex that they deter the very people who they are meant to help. Just 0.5 per cent. of SMEs both use state support and are satisfied with the service.

The credit crunch could exacerbate the problem, of course, yet the Government's response to date, not least in their handling of Northern Rock, has been little short of pitiful. The European High Yield Association, a well informed group of institutional investors, bankers and lawyers, has warned that the Government's measures for dealing with the restructuring of insolvent companies are insufficient.

The Conservative party is advancing several measures that we believe will provide real solutions to the real problems faced by entrepreneurs and SMEs in the UK. First, measures are being designed to drive out the "regulate first" culture in Whitehall. My hon. Friend the Member for Rutland and Melton (Alan Duncan) has just launched an independent taskforce led by Sir David Arculus, which is looking into an overhaul of the regulation machine. All aspects, including the use of targets, management and training, will be examined in order to make regulation the last resort rather than the first option.

We are also looking at effective ways to tackle the financial exclusion faced by potential entrepreneurs and those who have become bankrupt. As already mentioned, the Insolvency Service has declared such financial exclusion to be one of the three main factors in contributing to the stigma of bankruptcy and in deterring individuals from starting a business. Those who have been excluded from mainstream credit because of a poor credit history, or, for example, because they have been declared bankrupt, often turn to illegal lenders who typically charge extortionate rates of interest and are often connected with illicit activities and antisocial behaviour. We shall commit to ensuring greater co-operation with the police and other public bodies to crack down on illegal lenders. Coupled with that, we also want to increase competition in the home credit market, which would allow individuals access to fairer and cheaper credit deals, which would then give them the financial freedom necessary to pursue a business venture.

Upon filing for bankruptcy, all bank accounts are closed, and bankrupts need to make alternative arrangements for receiving wages, cashing cheques and paying bills. Insolvency practitioners report that gaining access to a bank account can be a significant hurdle for undischarged bankrupts and can actually compound their problems by forcing them to use expensive alternatives such as cheque-cashing services that charge a high fee. We support R3's proposal that the Government should work much more closely with high street banks than they presently do to widen the provision of basic bank accounts to undischarged bankrupts.

The EHYA supports the idea of introducing funding measures to support distressed companies. In the US, the bankruptcy code provides a super-priority status for post-bankruptcy petitions-it is called debtor in possession lending. A specialised market has evolved for rescue funding for businesses in trouble and, as a result, struggling businesses have found it easier to secure the funding that they need to survive. In the UK, no such market exists, because there are no legislative provisions to prioritise rescue finance. If the UK is to provide the same amount of support and encouragement to small and growing businesses as that given in the US, we need to assess the merits of implementing a US-style funding scheme. It is the ability of struggling businesses to access additional investment, rather than another headline-grabbing, but ineffective business support scheme, that will give businesses the help and second chance that they want.

R3 advises that

"the availability of funding is crucial to ensuring that insolvent companies can reorganise successfully and be rescued from financial difficulty".

Currently, companies in administration cannot release equity and assets held by them if there is a fixed security, such as a mortgage, on those assets. For example, if a company has a property worth £1 million, with a mortgage of £650,000 secured against it, the company is not allowed to use the £350,000 difference as a source of funding to help if it enters administration. Giving companies the power to use such equity would require very little legislative change, but would make administration a much more powerful tool in rescuing companies.

The Conservative party has set up a taskforce led by Doug Richard, a serial entrepreneur and former "Dragons' Den" panellist. The taskforce's review will be published in May, but the underlying conclusions are that the present information system does not work and that business schemes should be business led rather than politically driven. That will cut the red tape associated with running a business, release entrepreneurs from the regulatory shackles placed upon them by the current Administration and, ultimately, help them not to fail

The Committee acknowledges and aims to protect the interests of both creditors of failed businesses and potential creditors. In 2002, with such creditors in mind, I raised concerns about the number of companies entering administration. The insolvency process is lengthy and costly. For almost 5,000 companies that entered administration or liquidation more than 10 years ago, the process is still ongoing. The wasted costs associated with that are exorbitant, while goodwill in the business is steadily reduced. The end result is that creditors are returned a much lower proportion of their investment in an ill-performing business. The Government have not done enough to address that problem since the Enterprise Act 2002 and show little sign of looking out for the interests of potential investors, without whom much of the business in the UK cannot function and entrepreneurs cannot be given a second chance.

We support the use of IVAs as a frequent alternative to companies entering administration. They are one of the great successes of the 1986 Act and, time and again, have saved people from bankruptcy and creditors from losing their money, and enabled entrepreneurs to be given a second chance without the albatross of a previous bankruptcy hanging around their neck. We believe that IVAs should be encouraged, rather than the ability to go bust for a few months through the Government's weak proposals for non-advertised bankruptcy. However, in the past few years, so-called IVA factories have aggressively marketed their products, while failing to state their fees clearly and openly, which has resulted in consumers losing faith in the IVA regime. The Conservative party is calling on the Advertising Standards Authority to enforce the rules governing the marketing of IVAs more rigorously. We are also calling on the relevant public bodies, such as the Law Society, to examine the quality of advice given by IVA advisers to individuals more vigilantly.

No formal scheme is currently in place in the UK to educate people who have previously been bankrupt to help them to understand the causes of their financial problems and how the situation could be avoided in the future. In Canada, for the past 15 years, a scheme has been in place whereby those who declare bankruptcy must attend two financial counselling sessions before they are eligible for automatic discharge from bankruptcy. The objective is to include a rehabilitative element in the process to prevent future bankruptcies. A study conducted just after the scheme's introduction found that 67 per cent. of bankrupts who had undergone that mandatory education believed that it would have a considerable impact on their ability to keep their financial affairs in order. We believe that the Government should explore the idea of having a mandatory financial education programme for bankrupts. EU member states such as Luxembourg have implemented similar schemes.

Finally, we are advancing a reform of the UK's tax system to make it simpler, fairer and, when affordable, lower for UK businesses. For example, we have committed to remove all estates of less than £1 million from inheritance tax requirements. That would simplify the tax affairs of millions of people and would lower tax bills for families, which is an especially important consideration for SMEs. We are also committed to voting against any small company corporation tax rises. Tax is rarely the cause of insolvency, but it can be a relevant factor.

We are grateful for this important and timely debate on saving businesses, and I hope that I have shown not only the deficiencies in the Government's proposals, but the Conservative party's practical, viable and entrepreneurial alternative to what is currently on offer.

5.36 pm



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