knowledge 6 November 2017 |

Loan Portfolio Sales and their Interplay with the Personal Insolvency Act

In the case before the court, the personal insolvency practitioner (“PIP”) had formulated interlocking Personal Insolvency Arrangements (“PIAs”) on behalf of a married couple. The principal debt was a mortgage over their family home. This had been purchased by an investment fund company, Shoreline, as part of a portfolio of mortgage loans. With respect to the mortgage debt, the PIA proposed:

• a write-down of the loan balance from €323,626 to €190,000 (the value of the property);
• interest-only payments during the 6 years of the PIA;
• extension of the remaining mortgage term from approx. 18 years to 27 years;
• interest rate to be fixed at 3.65% for the entire remaining 27 year term. 

The PIAs had been rejected by Shoreline at the creditors’ statutory meeting on the grounds that the proposals relating to the mortgage debt were unsustainable on a long-term basis. Shoreline argued that the proposal to fix the interest rate for 27 years was completely unheard of in banking practice and unfairly prejudicial to that creditor. The Circuit Court upheld the creditor objection. The debtors appealed to the High Court.

On appeal, Baker J was satisfied the proposal was sustainable. In considering the issue of sustainability, she said that while the Personal Insolvency Act does not expressly require the court to examine the likely circumstances of a debtor after the six-year term of a proposed PIA, the court could not, if it had evidence before it, disregard the likely or reasonably likely circumstances that would exist at the end of that period or for the reasonably foreseeable future thereafter. However, the further one moved from the present and from the six-year term of the PIA, the less scrutiny was possible or desirable as the court ought not to engage in conjecture and prediction. The degree of scrutiny of future events which was possible would depend on the facts of an individual case.

The judge discounted the creditor's argument that the proposed PIA should be rejected as it could result in the debtors living below the prescribed level of reasonable living expenses at some far future date. The Personal Insolvency Act prohibited formulation of a proposal which provided for expenditure below that prescribed level within the period of the PIA but it did not prohibit this outside of its six-year term.

Baker J was satisfied that the legislation permitted a PIA to include a term providing for the change of the basis on which interest was paid. For example, interest rates could be changed from a variable rate to a fixed rate or a rate could be fixed at a margin above or below a reference rate. Many proposed PIAs involved the fixing of interest for an identified period, usually for the duration of the PIA or to include a short period thereafter. However, the legislation did not limit the period of time for which this could be done.

The creditor argued that it was unfairly prejudiced as it would be impossible for it to borrow an equivalent sum to the restructured mortgage at a 3.65% fixed rate over a 27-year period. However, Baker J was not satisfied that the creditor had applied the correct test here. The objecting creditor was not a bank but an investment fund and while there was a risk that a “lender” might suffer loss were interest rates to be set at a low level over a long period and not be fixed in relation to, or some way track ECB rates, the creditor had not provided evidence that it would require to return to the market to meet its capital needs in the future to fund the investment.

The mortgage debt would not be refinanced but restructured. Therefore, the test for the court in considering the reasonableness of a long-term interest rate was not always to test the rate against the projected future borrowing needs of a mortgage lender. The fairness of the rate should be tested in the light of the actual circumstances of the objecting creditor. The loan was an asset of the objecting creditor secured over real property and the proposal offered a fixed, albeit long-term, return on the investment with repayments proposed at an amount certain over the term.

In the circumstances, the asset value might perhaps be more accurately compared to that of a bond. The objecting creditor should establish that the return from such an investment was unfairly or prejudicially low by reference to an investment or bond market, and not to interest rates. 

The legislation envisaged circumstances where, a court might be prepared to accept as not unfairly prejudicial a long-term fixed interest rate where the court would test the reasonableness of such rate having regard to factors other than those that would be in the mind of a lender granting finance. A court could take various factors into account including the fact that the benefit of the secured loan was owned by an investment vehicle and not a commercial bank, that the loan remained secured and that should the real property on which the loan was secured come to be sold in the future at a price greater than that on which a proposal was predicated, there was a statutory provision for claw back in the legislation.

Baker J then considered the likely return in bankruptcy to the objecting creditor. If the return under the PIA was less than this amount, this could point to unfair prejudice for the creditor. She said that the question of fairness should not be tested on a wholly mathematical basis. Rather the Act required that all the circumstances should be taken into account. This included whether the proposed PIA created a reasonable prospect that a debtor could continue to occupy or own his or her principal private residence. Another factor was whether it would enable the debtor to resolve his or her indebtedness without recourse to bankruptcy and enable creditors to recover debts due to them to the extent that the means of the debtor reasonably permitted. The legislation envisaged this as the preferred option. This meant that a proposed PIA was not of itself unfairly prejudicial merely because the likely return on bankruptcy could be marginally better. The financial profile of the objecting creditor was again relevant to this part of the court’s analysis. The fact that it was not a lender meant that unfair prejudice needed to be assessed in light of investment returns and not the cost of its future capital needs.

Comment

According to statistics published by the Central Bank of Ireland on 12 September 2017, non-bank entities now hold 48,199 mortgage accounts for PDH and BTL combined. Of this number, 63 per cent are held by regulated retail credit firms, with the remainder held by unregulated loan owners. Some 41 per cent of PDH accounts held by unregulated loan owners are in arrears of over 720 days, compared to 17 per cent of accounts held by retail credit firms. For such long-term arrears accounts, personal insolvency may be the most realistic option for the debtors.

This case demonstrates that the Irish courts are willing to sanction PIAs which provide for fundamental and long-term changes to a mortgage loan contract, especially where this will help to protect the interest of a debtor in the principal private residence. The test of unfair prejudice for a loan portfolio purchaser will be applied having regard to the purchaser’s financial profile: if it is an originating lender, such as a bank or retail credit firm, then the cost of its future capital needs will be taken into account; if it is an investment vehicle, then the test will be seen in light of investment returns such as by comparison to bonds.