No private business would arrange its service delivery in such a way that the cost to customers knowingly exceeded the budgets of its target market. And no private business would knowingly allow its service-provider employees to refuse to accept customers unable to pay a multiple of the quoted service fee as a kick-back to the employees. But the classic jokes about government have proven true once again, as Russia did just this when it finally introduced a personal bankruptcy procedure (for small entrepreneurs and consumers) in October 2015.
My paper reviews the sad and stunning facts of this government financial blunder, and it surveys the various other approaches to funding personal bankruptcy institutions in Europe and North America, finding a surprising parallel and a potential path toward a solution to this Russian problem...in Canada.
This is really two papers for the price of one, telling two independent but closely related stories about the business of government finance, and financing the business of treating the casualties of consumer and small business failure.
First, the Russia story. The new Russian personal bankruptcy law ‘on the books’ seems perfectly well structured, efficient, and fairly accessible: For a very small application fee and a demonstrated inability to service personal and business debts, Russian individuals can now join their counterparts in Europe and North America in asking a court to open a bankruptcy case and appoint a private, self-regulated trustee to administer a simple asset liquidation. In exchange for relinquishing to this trustee a fee of about US$1000 and all nonexempt assets and income acquired during a nine-month case administration period, debtors can obtain a refreshing discharge of their remaining debt burden. Indeed, this has been the happy conclusion in some 95% of cases that have gotten this far in the first three years of operation of the new Russian procedure.
However, the real story of the Russian law ‘in action’, as is often the case, is quite different and much less rosy: Odd but classic Russian formalism makes applications more expensive and difficult. For example, (1) debtors must obtain and file a certification from the merchant registry confirming that the debtor is not an entrepreneur (though consumers and entrepreneurs alike are admitted into the system), (2) debtors’ word as to their household situation is not sufficient; rather, marriage and birth/adoption certificates are required, (3) a transcript of all activity in any bank account for three years must be obtained (often at significant expense) and filed, and most puzzling (4) announcements of the case must be purchased and published in both expensive paper and inexpensive electronic case filing systems (so much for the efficiencies associated with modern commerce).
The key problem, however, has been paying for the private administrator (trustee), especially the decision to freight impoverished debtors with that burden. Since individual debtors by-and-large have asset-poor estates, the traditional business bankruptcy model of enticing and remunerating trustees with a cut from estate assets doesn’t work. Worse yet, Russian trustees are self-regulating and not controlled by the court or an insolvency supervisor, so they can and do refuse to take low-value cases for the official fee of 25,000 rubles (about US$1000 PPP), leaving many debtors without access to the procedure for the ironic reason that they can’t afford to fund their own bankruptcy. Moreover, as in the US, even debtors who can afford the trustee fee are likely to face difficulty completing their complex applications correctly—many have been denied or rejected. Also as in the US, and unlike in most other places, Russian private lawyers have stepped into this breach. But they have done so by combining services with trustees in an unregulated market for bankruptcy access, costing a minimum of 100,000 rubles (about US$4000) and for any but the simplest of cases, much more than that.
The disappointing result has been a very slow uptake of filings (barely a fraction of the projected population of deeply distressed debtor ‘clients’) for a very expensive new service-delivery system.
Now, the government finance story. I wondered how other personal insolvency systems overcome this Russian problem. How do they balance financing administration and ensuring access for a high volume of low-value personal bankruptcy cases? I found a surprising variety of approaches and a bewildering array of moving parts in internal financing structures in various systems, stretching east from Central and Western Europe to North America.
The details must be left to the paper, but two major paradigms are notable: A centralized European one, and a decentralized North American one. The Russian approach clearly but surprisingly resembles the latter.
Throughout Europe, governments generally maintain central control of trustees, no private lawyers are needed to access this relief system, and state funding is provided (or advanced and possibly later forgiven) to ensure wide accessibility and treatment of personal financial distress.
England represents a transition, taking a hybrid approach, with mostly central control, but decentralized funding via user fees, essentially relying on a large cut of big business assets to subsidize low-value cases and ensure that the user fees, while substantial, are not as prohibitive as those in Russia.
Arriving in North America, we find two surprisingly contrasting paradigms of decentralized trustees and private lawyer fees: The United States presents two particularly salient contrasts with Russia: (1) private panel trustees are quasi-regulated, required to accept case assignments but otherwise not publicly micro-managed, and (2) paid only $60 per case, from the filing fee. How does this system recruit trustees? In a surprising variety of ways, including the English excise of the unpredictable large-asset case, pursuing avoidance actions and retaining their own law firms, appealing to their sense of virtuous dedication to public service, offering a platform for marketing and networking, but most importantly, by allowing for routinization and the production of a certain and steady income from high-volume practice. Trustees need spend only an hour or two per case in a system relatively light on red tape formalities. None of this is true in Russia, where trustees don’t have to take cases assigned to them, and formalities for both debtors and trustees are vigorously and rigidly policed. $1000 is not worth the hours and trouble to administer these simple cases.
Mirabile dictu, it turns out that Canada has developed a functioning system extremely similar to Russia’s. Debtors require a licensed insolvency trustee (LIT) to advise and administer cases as trustees, the fees for advice and administration are combined but market-determined, and some debtors have been shut out of system as they struggled to pay enough to attract a trustee. The contrasting solution settled upon in Canada is an all but global agreement by private trustees, brokered by the bankruptcy system regulator (the Office of the Superintendent of Bankruptcy, or OSB), for the trustees to accept installment payment plans (up to 12 months post-discharge) offering a maximum fee of CA$1800 (a more affordable amount set by the OSB, who licenses LITs and derives most of its income from licensing fees). This solution might work in Russia, but for, again, no central regulation of trustees and an inability to routinize case complexity and reduced trustee cost, as in Canada, with LITs spending only a few hours per case, and no heavy-handed formalism and oversight by OSB.
I conclude with three takeaways: First, successful decentralized system funding models today seem to rely on large-asset business cases. Personal bankruptcy is not self-funding, and building that system separate from the business bankruptcy system (as at least one country is currently considering) is asking for funding trouble.
Second, it is not sensible to rely on personal bankruptcy trustees who can freely refuse cases. Either implement an industry norm of accepting low-value cases for an agreed/regulated affordable single fee or require trustees to take on low-value cases in exchange for the monopoly privilege of administering large-value business cases.
Finally, the key to both of the foregoing is the classic business mantra: KISS. Keeping it simple (, stupid!), with a minimum of crucial formality, allows for routinization, cost-reduction, and affordability. This KISS approach should not be limited to low-debt cases, as in the English DRO approach, but to all cases not presenting the level of complexity seen in large corporate bankruptcies around the world. Too much heavy-handed regulation of trustees or complex administration, and it’s no longer worth it for trustees to engage. This results in a lack of access by the people for whom the system is designed, as Russia demonstrates.
How much complexity is worth it? Why make debtors pay for relief that ultimately benefits society? Perhaps we should rethink the entire funding structure. This is probably politically infeasible, but simplifying is an easy answer to all that ails the new personal bankruptcy system in Russia, as well as many others that are in development at this very moment (I’m looking at you, China!).
Jason J. Kilborn is Professor of Law at the University of Illinois at Chicago John Marshall Law School.