Managing creditors’ risks and rehabilitating over-extended debtors: contradictory or complementary objectives?
by Micheline Gleixner and Michael J. Bray, Q.C.Footnote 1March 2013
Note: While abstracts are available in both English and French, some research papers are only available in their original language. This document is only available in French.
Abstract
Consumer credit is a new term that refers to a global phenomenon with a long history. For centuries, individuals have been borrowing money to meet their basic needs or realize personal goals, only to sometimes find themselves unable to repay the advances that have been extended to them.
We hope that our study of the history of the pathology of consumer credit and the treatment of insolvent debtors will lead to further study of both the economic and ideological forces at play in contemporary society and the reciprocal relationship between creditors and debtors. Our analysis compares the historical, legal, social, cultural and economic perspectives of consumer credit and insolvency in the two legal traditions, with a focus on the countries that have had the most influence, that is, France, England and the United States, as compared with Canada.
Credit has been a survival mechanism since the earliest human civilizations, and the over-indebtedness of individuals has come to symbolize financial problems in numerous cyclical economic crises. The extremely harsh treatment reserved for insolvent people—personal slavery of the debtor and the debtor’s family or the death penalty—stems as much from the duty to respect contractual obligations as from creditors’ social, economic and political domination.
Credit, therefore, is closely tied to power, both literally as a means of financing those in power and as the foundation for the definition and organization of social divisions. To alleviate the suffering of insolvent individuals, authorities have often been obliged to temporarily recognize the rights of debtors by lightening their debt load, which inevitably opened the door to economic recovery.
However, while the use of credit and the correlated debt have often represented signs of economic growth for a society, failure to resolve the problems that lead to debt crises quite often proved to be the catalyst for the fall of these civilizations. The distress of indebted peasants thus gave rise to an ideological countercurrent prohibiting usury, that is, loans at interest, a prohibition that intensified with its adoption by Christianity and extended to the moral and legal tenets of all Europe through the Catholic Church and the monarchs who conformed to its religious tenets.
The aversion to usury professed by the Catholic Church was somewhat tempered in England and the British colonies by the Protestant Reformation. Unlike continental Europe, these regions saw credit become popular during the Industrial Revolution, evolving from the pledge loan to instalment sales and eventually to consumer credit. This new access to credit was defined as a democratization of consumer credit. While promoting the growth of consumers individually and national economies collectively, this democratization nevertheless contributed to personal over-indebtedness and insolvency.
In our recent common law tradition, opinion has radically and consistently moved away from insolvency being considered a civil tort, comparable to fraud and punishable by a term of imprisonment, to bankruptcy being brought before the courts for rulings on measures designed to offer creditors limited recovery, while discharging debtors from bankruptcy and giving them an opportunity to rectify their financial situation.
Over the last three decades, the world has seen a cultural shift toward promoting increased consumption using consumer credit, which has led to the over-indebtedness of consumers. Two factors brought about this change: first, the culture of consumerism that feeds the demand for easy, accessible and flexible credit and, second, the resulting exponential increase in consumer lending by financial institutions. The increased popularity of consumer credit and the disconcerting ease with which it is obtained have directly led to a corresponding hike in the rate of consumer insolvency, particularly since the late 1980s.
Consumers overwhelmed by their crushing debt often find themselves excluded from both the credit market and economic and social life in general. The consequences of failing to honour contractual financial obligations, for individuals in particular, but also for other stakeholders in the economic community, have become pressing issues, in addition to having significant impacts on bankruptcy and insolvency law.
At its root, personal insolvency is an individual economic problem, but dealing with it quickly becomes political when a debt crisis develops. As our study shows, consumer debt has played a key role historically not only in nations’ financial recovery but also in numerous social and political upheavals. The new European insolvency regimes illustrate very clearly the considerable impact of these financial difficulties.
The response of civil law to this global phenomenon proves particularly interesting in a comparative perspective because even though the level of insolvency among European consumers is increasing, it represents only a fraction of the insolvency rates in common law countries. Originally arising out of historically divergent social and political opinion, the timid use of consumer credit, the sacred nature of the contract and the resulting protection of contract laws, as well as the economic conditions leading to relaxation of these commercial values, are all currently shaping the legislative framework and the administration of personal insolvencies, as well as the lending practices of financial institutions.
The law pertaining to personal over-indebtedness thus constitutes a new legal development in the civil tradition; it essentially reflects a reaction to the growing rates of debt and insolvency, themselves symptoms of the current culture of credit and consumption. The new insolvency regimes in civil law countries prioritize the interests of creditors and respect for contractual obligations. Rehabilitation of the bankrupt consumer, therefore, is not triggered by the bankrupt’s discharge, but rather by repayment to creditors of the consumer debt.
While the period that followed saw growing concern in European regimes for the protection of the rights of consumers and their financial discharge from insolvency in practice, a clear market downturn also made way for a debt repayment model through recent legislative amendments to bankruptcy and insolvency law in several common law countries.
Influenced and inspired by our analysis of the history of personal over-indebtedness and, as a result, our identification of the current ideological convergence of insolvency regimes, we were able to formulate recommendations that will be useful for those responsible for amending legislative texts and drafting legal decisions, as well as for financial and consumer lending education.
To avoid a financial collapse similar to those that sealed the fate of a number of older civilizations, we can no longer ignore the international consensus that over-indebtedness must be prevented to stem the rise in consumer insolvency. The increased use of consumer credit urgently demands of consumers to improve their financial literacy and behaviour, including enhancing the skills and knowledge needed to avoid over-indebtedness and insolvency. A more vigorous financial education program is necessary, both in the school system and in adult education, and it should focus on leveraging learning opportunities when individuals are making important decisions by participating in the consumer credit system.
Moreover, the consumer credit industry appears somewhat disengaged with regard to the current bankruptcy system in Canada, despite the rising number of bankruptcies and resulting increased losses for creditors caused by the bankruptcy of their debtors. The positive financial results being reported by banks and financial institutions show that they must be making up for their losses elsewhere. While affirming the usefulness and necessity of consumer credit in the modern era, current federal regulation of financial institutions should be maintained and extended to the parallel market of consumer credit.
In addition, responsibility for preventing consumer over-indebtedness and rehabilitating insolvent debtors should be shared with the credit industry. To this end, we recommend that Canada follow the initiative of certain European countries that make creditors accountable for the problems of over-indebtedness. Responsible lending and the enhanced role of creditors in preventing and correcting current insolvency rates should become a social and government priority.
In conclusion, modern bankruptcy laws effectively legalize what the law originally attempted to sanction in the past, that is, the non-payment of debt. Now that rehabilitation of insolvent individuals has become a legal reality, it is time to protect consumers before they become burdened with the problem of over-indebtedness. Unlike former civilizations that were unable to resolve the causes of personal over-indebtedness, contemporary society should now confront one of the fundamental problems at the source of economic crises, credit—not its existence, but rather its irresponsible use by both debtors and creditors. The solutions we put forth, therefore, are aimed at addressing this problem and achieving the two complementary objectives of an insolvency regime, that is, managing creditors’ risks and rehabilitating over-extended debtors.
Footnotes
Footnote 1 Micheline Gleixner is assistant professor in the Faculty of Law at the Université de Moncton and Michael Bray is a registrar with New Brunswick’s Court of Appeal and Court of Queen’s Bench. They would like to acknowledge and thank research assistants Ian Girard and Julie Villeneuve, 2012 J.D. candidates at the Université de Moncton, for their excellent contributions. The authors would also like to thank the Office of the Superintendent of Bankruptcy for providing access to its database, as well as for providing financial support to conduct the research for this report. The opinions expressed in this report are not necessarily those of the Office of the Superintendent of Bankruptcy, Industry Canada or the Government of Canada. (Return to footnote 1 referrer)
