The Finnish Act on the Adjustment of the Debts of a Private Individual

1 Johanna Niemi, 2010 The Finnish Act on the Adjustment of the Debts of a Private Individual The Act on t he Adjustment of the Debts of a Private Individualwas (shortened as Debt Adjustment Act) enacted by the Finnish Parliament in December 1992 and became effective 8th of February 1993 (1993/57) (lag om skuldsanering för privatpersoner). At the same occasion, two other related laws were enacted, namely Restructuring of Enterprises Act 1993/47 (RP 182/1992) (lag om företagssanering) and Law on Priorities in Bankruptcy and Debt Enforcement 1992/1578 (RP 181/1992) (lag om den ordning i vilken borgenärer skall få betalning). The latter means that basically all general priorities (those of taxes, wages etc.) in bankruptcy were abolished. Finland had experienced a rapid expansion in credit supply in the late 1980s. Credit was in practice rationed until mid 1980s and the expansion thereafter was facilitated by the unsatisfied demand and high income expectations of the households. The economic conditions changed rapidly in the beginning of the 1990s with a steep rise in unemployment, interest rates, bankruptcies and debt problems as a consequence. Preparation of the consumer debt adjustment legislation was pursued by the Ministry of Justice under high pressure. The proposal (RP 183/1992) was introduced in the Parliament in September 1992 and accepted by the Parliament with minor modifications. Even if the need for the new law was apparent, the number of applications was hard to foresee. No immediate rush was observed, however. The debt counselling services have been in hard use and the availability of the counselling rationed the influx of applications to the courts in the beginning. During 1993-2002 73.800 applications were filed in the courts. From these 73.800 applications have 55.000 been accepted. The rate of filings levelled at c. 3 000 per year during the 2000s. The recession of late 200s that has increased payment claims in the courts can not yet be observed in the number of consumer debt adjustments. In 2008 only 2816 cases were filed and in

2 2009 the number was 2922. During the first five years, the applications were most often grounded on unemployment (40 %), guarantees of loans of another person (20 %). Illness and failed business was also frequently mentioned as a reason for debt adjustment (15 % each). These figures overlap since several reasons can be given. The reasons for filing seem to have changed over the years. In late 1990s and early 2000s most of the application were grounded on the unlucky situation as a guarantor of loans of another person or failed business (40 %). The next frequent reason was unemployment (20 %) followed by illness and divorce (only 8 % each). The loss of home and too high mortgage debt, quite usual in the early 1990s, were named just in some cases (4 %). Law reforms The Law on Judicial Debt Adjustment for Consumers has been reformed a few times. The reforms have not been big but some deserve to be mentioned. One problem with debt adjustment was that the debtor had no incentive to increase her income. The reason was simple: everything he got had to be paid to the creditors. At same time the duration of payment plan was 5 years, the living costs were growing every year but the plans were not modified accordingly. That is why the law was reformed in 1997. After the reform the debtor was allowed to keep 25% of her increased income and 75% was paid to the creditors. In the reform 2003 was the debtor s part was raised to 1/3 of the increased incomes above 800 (RP 132/1997). In 1997 reform the debtors who have no payment capacity at all were excluded from the debt adjustment unless their status was permanent. At least two years of no payment capacity is required before the status is deemed permanent. In 2007 the law was changed again to allow debt adjustment for persons who have become indebted a long time ago, for example, due to the financial crisis in the beginning of the 1990s (RP 178/2007). Debt counselling

3 Debt counselling is considered as an important complement of the judicial debt adjustment by all interest groups. In the first draft for the legislation on debt adjustment, published by a working group of the Ministry of Justice in April 1992, a proposal for a law on municipal debt counselling was included. It was proposed that each municipality should establish or ensure that free debt advisory counselling would be available, offered either by the municipality or some noncommercial body. Debt counselling should have provided general advice on budgeting and economical planning to the households as well as counselling to overindebted households. In the latter cases the advisor should have helped to find out solutions, to give support for negotiations with the creditors and to prepare documents needed in judicial debt adjustment. 1 This part of the proposal was more or less overturned in June 1992 as it became clear that no extra resources for debt counselling could be expected in the 1993 state budget. The municipalities, on the other hand, made it clear that no debt counselling tasks will be taken without extra resources from the state budget. As a consequence no provisions on debt counselling were included to the governmental proposal introduced in the Parliament. The Debt Adjustment Act, however, requires that the applicant, overindebted consumer, must have taken steps to negotiate for an informal adjustment with his creditors before going to the court. Even without a legal obligation, the Government and municipalities took steps to ensure that counselling was available. The municipalities arranged debt counselling programs and legal aid agencies were active in supporting debt counselling. Thus, when the debt counselling law was finally enacted in 2000, a network of debt counselling was already in existence. Act on finance and debt counselling (2000/713) was enacted in August 2000 (RP 37/2000). The municipalities have to arrange debt counselling and to help debtors with debt adjustments and applications. The debt counselling is free of charge for the debtors. Recently a commissioner (Rissanen, Kirsti) has proposed that debt counselling would be transferred from the 1 The proposal of the working group of the Ministry did not prescribe the debt counselling as a formal precondition before the consumer would have access to the court. This was the proposal of some researchers in 1991, see Johanna Niemi-Kiesiläinen, Jyrki Tala and Thomas Wilhelmsson, Consumer Debt Advising, Restructuring of Debts and Discharge in Finland - an Analysis of Consumer Debt Situation and a Proposal for a Model of Legislation (Finnish title: Kuluttajien velkasaneeraus. Tarve ja mahdollisuudet), National Research Institute of Legal Policy, Helsinki Finland 106/1991.

4 municipalities to the state budget and under the legal aid offices. The scope of the Act on Debt Adjustment Together with the Debt Adjustment Act for private individuals, a parallel Restructuring of Enterprises Act to avoid bankruptcy was enacted. While the latter is meant only for business compositions, the former is not applicable if the debtor is engaged in business and has debts deriving from his ongoing business. Ex-businessmen having debt from their former business, however, have access to the debt adjustment procedure. A new business with no debt does not exclude the debtor from the procedure if he has debt from his previous business (DAA 45-47 ). This means in practice that new business must be at a low scale. Also a minor business carried out by the debtor does not exclude him if the source of debt problems is connected with his private economy. The preconditions of the debt adjustment Debt adjustment is confirmed by the local court. The first decision of the court, to open the proceedings, concerns the admissibility of the application. The admissibility is decided on formal and material grounds. Formal grounds refer to the debtor's non-business character, homestead etc. and to the required formalities concerning provided information on debts, creditors, estate and income. If the information is incomplete, the court may order a specific investigation to be carried out by the enforcement officer or a preliminary hearing of the creditors. If, on the basis of the presented evidence, the preconditions for the adjustment exist (material grounds for admissibility), the court shall declare the application admissible and open the proceedings. The material conditions for adjustment can be divided into three groups; (1) debtor's insolvency, (2) quality and source of the debtor's insolvency and (3) the debtor's loyalty towards his creditors (DAA 9 ). The material conditions are evaluated by the court both in the admissibility test and before the final confirmation of the plan. (1) The debtor is insolvent if he can not pay his debts as they become due and this situation is not incidental.

5 (2) An adjustment can be confirmed if either of the following conditions is fulfilled: (2a) The insolvency is mainly due to unemployment, illness or other like change in circumstances which cannot be attributed to the debtor and there is no reasonable way in which he could improve his solvency. (2b) The alternate condition is that the reason of insolvency is different but there are other weighty reasons for the adjustment when the amount of debt is taken into account. Typical example of the latter condition is the case of a former business bankrupt. Also in the latter case it is required that the debtor can not reasonably improve his solvency in any other way. (3) The debtor's good faith and loyalty towards his creditors is measured in light of specific exclusion clauses (DAA 10 ). The debtor will not qualify for the adjustment and discharge if any of the following circumstances exists: 1. The debtor has been convicted of a crime and liable to payments because of this crime and the nature of the crime and other circumstances considered debt adjustment is not reasonable. 2. The debtor is suspected of such a crime. 3. The debts derive from a business in which the debtor has acted against the interests of his creditors. 4. The debtor has worsened his economic position and made transactions and other arrangements that are against the interests of his creditors. 5. The debtor has not disclosed his affairs or has given false information in a preceding execution procedure. 6. The debtor has given a false statement to get the credit and this information has been essential to get the credit. 7. There are reasonable grounds to believe that the debtor has run into debt in an irresponsible way or with a debt adjustment procedure in mind. This judgement should be based on his way of handling his economy, the source of the debt and the circumstances when running into debt etc. 8. The debtor has not tried to negotiate with his creditors for a composition through agreement, has not disclosed his affairs or has given false information in the debt adjustment procedure, or has not obeyed the orders of the court or provisions of the law in the procedure. 9. There are reasonable grounds to believe that the debtor will not follow the payment plan. 10. The debtor has had a payment plan confirmed before.

6 All these exclusion clauses, including the bar, are subject to consideration by the court. According the 11, the court should especially consider the age of the debts and the debtors efforts to repay them when granting the adjustment notwithstanding an exclusion clause. In practice, DAA 11 point 7, running into debt in an irresponsible manner has been most frequently invoked in practice. Generally, indebtedness through guarantees for another person s debt had not been regarded as irresponsible, nor business debt or big loans for purchase of an apartment. Consumer debt has been looked at most negatively, as speculative investment debt. The stay of enforcement The filing for debt adjustment is done at the district court. The court may hear the creditors or some of them. Most debtors get help from municipal debt advisors but private advocates can assist them as well. The opening of the debt adjustment gives effect to the stay of enforcement and debt collection. The stay stops payments by the debtor, the recovery efforts by the creditors and official enforcement procedure (DAA 12-13). Relief from the stay can be given to a secured creditor if his right would otherwise be impaired. Garnishment of wages is not automatically discontinued. The enforcement agent keeps the garnished part of the wages, which is later distributed to the creditors according to the payment plan. The court usually assigns a private advocate as a trustee but that is not necessary. The debtor has to pay a part of the fee of the trustee. The debtor s payment of the fee is as much as he can pay to the creditors during the first four months of the plan. These four months prolong the duration of the payment plan. The rest of the trustee s fee is paid from public funds (64-71 ). The plan The trustee or, if no trustee is appointed, the debtor makes a proposal for the payment plan.

7 The court invites the creditors either to an oral hearing or to present their comments in writing on the claims the debtor has disclosed as well as on the adjustment he has proposed. The court is not bound by the creditors' acceptance of the proposal. If the debtor's proposal is accepted the court will confirm a payment plan of maximum five years. In special circumstances there may be a plan with null payment (DAA 23, 30 ). The duration of the payment plan may exceed five years if the debtor is able to keep a home he owns in the adjustment. In that case the duration of the plan may be ten years to pay the unsecured debts and to pay the mortgages as long as originally agreed or with a minor extension (DAA 30 ). The plan may be extended by two years to pay private creditors (DAA 31a ). They are persons who have given personal guarantees for a loan and other private persons to whom debtor owes money. The debtor is required to devote all of his income that is not necessary for living expenses to pay to his creditors. The necessary living expenses are a bit higher than the minimum social aid contributions. There is a strong political favour for solutions in which the debtor can keep his home in his possession in spite of the debt adjustment. In accordance with that spirit the mortgages are included in the proposed debt adjustment. Only that part of the debt, which the value of the security covers at the moment when the procedure is opened, is considered secured. The value exceeding the value of the security is treated as unsecured. The debtor should be able to pay the secured debt according to the original contract or with a minor extension affirmed by the court. In practice longer extensions have been accepted. If he is not able to do so the creditor may seize the security. The value of the home is estimated by the court. The rise in business bankruptcies and downward trend in the value of real estate have caused a number overindebted consumer cases in which the amount of unsecured debt is very large when compared with the value of the home and mortgages. This situation typically occurs when the debtor has been a personal guarantor to a loan of some other person but there may be other like situations as well. There are often very difficult considerations of justice and equity intertwined in these cases. The law tries to tackle these problems with a model that protects the debtor's home

8 against the unsecured creditors. The home is given a certain protected value, determined by the court, which cannot be used to pay the unsecured debt. The protection value is measured by the reasonable standard of living of the debtor's household. He is not allowed to keep that value as a whole, but is supposed to pay its interest during the five year payment plan to the unsecured creditors. As a consequence, the prize of keeping one's home is quite high. Since this method is used only when the value of the home exceeds the secured debt, it has not been applied very often in practice. After confirmation The court may confirm the plan irrespective of the views of the creditors. The plan has to be detailed and give detailed instructions of payments. It was not enforceable originally. In the 1997 reform the plan was made enforceable if the debtor s payments were due by three months. Then the creditor may apply for the enforcement of the whole amount this creditor is entitled to according to the plan. In practice this means that the debtor can not fulfil the plan. If the debtor does not pay according to the plan a creditor may apply to the court for the annulment of the plan (DAA 42 ). The annulment does not take place if the delay in payments has been corrected or if the reason for it has been a substantial change in the circumstances not attributable to the debtor himself. In the last mentioned case the plan may be changed. The modification of the payment plan has been a continuous source of problems. In the beginning, the plans were changed frequently because income increased or decreased and living costs changed. In the law reform 1997 the change of plan was made difficult. Also, the debtor was allowed to keep one fourth of the increase in income. After the 2003 reform she may keep one third of increase in income (DAA 61a ). In the reforms of 1997 and 2003 the debtors were made responsible for calculating whether a change in their situation makes them liable to additional payments to creditors. This is a task many debtors hardly can accomplish. Often they do not even understand that there has been a change that makes them liable for additional payments. If additional payments are not

9 made, the creditors may file to court for an annulment of the discharge. If the debtor's payment capacity decreases, the plan may be changed but only in hardship. Also, when an increase in income is calculated, the rise in living costs is not fully appreciated. This situation has lead to great uncertainty among the debtors. A null payment plan means that if circumstances change the plan can be changed to a payment plan during its existence. Schemes for personal guarantees In chapter 10 of the law a special procedure is set up for the cases in which a private person has given either personal guarantees for another person's debt or has given his private home as a guarantee for another person's debt. If the guarantor has no other means but his home to pay this loan he can apply for this special procedure. In this procedure the court may change the liability to a payment plan. The duration of the plan is five years or the original schedule of the loan. The capital of the loan can not be reduced but the interest can be changed to a fixed, lower rate. If the guarantor is not able to pay the loan on these conditions his only possibility is to apply for the debt adjustment 4 Conclusion The debt adjustment law has now been in force for fifteen years. It has been quite successful in the solving of the debt crises of the early 1990s. A great number of cases have been processed in a relatively efficient manner. There have been technical problems and different local practices, but the overall functioning of the law has been satisfactory. Today the additional payments when the debtor s income increases during the payment plan are probably the biggest problem. Also the low and inflexible standards of living costs cause problems in many cases, not least for families with children. Even tough many thought in the beginning of the 1990s that the need for debt adjustment would

10 be temporary, today few people doubt that a credit society needs also discharge from debt. The debt crisis of the early 1990s was not completely solved with this law. In the beginning of the 2000s, there were still many debtors who had not qualified for debt adjustments because of their business activity or because they are excluded from the society. Two special programs during the 2000s targeted these debtors attempting to facilitate negotiated debt settlement between these debtors and major credit institution. In 2006 the Finnish Parliament decided that the debts will only be enforced during a 15 year period after they were incurred and with the new Debt Enforcement Code (705/2007) sets all debts under a new statute of limitations after 15 or 20 years. Thus, the debts of the last recession have been largely settled before the new economic crisis of 2008 started. References RP 181/1992 - Regeringens proposition till riksdagen med förslag till lagstiftning om revidering av förmånsrättssystemet RP 182/1992 - Regeringens proposition till riksdagen med förslag till lagstiftning om sanering av företag RP 183/1992 - Regeringens proposition till riksdagen med förslag till lag om skuldsanering för privatpersoner RP 132/1997 - Regeringens proposition till riksdagen med förslag till rättshjälpslag och därtill ansluten lagstiftning RP 37/2000 - Regeringens proposition till Riksdagen med förslag till lag om skuldrådgivning och vissa lagar som har samband med den RP 178/2007 - Regeringens proposition till Riksdagen med förslag till lagar om ändring av lagen om skuldsanering för privatpersoner och lagen om preskription av skulder

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