Smoke and mirrors of the debt industry

Read incisive new judicial analysis of how professionals work with debtors to dodge the intended results of voluntarily declaring oneself insolvent, and you could find yourself in awe.

Awe that people are so clever at finding ways round the law and that professionals are so consistently adept at finding ways to profit hugely.

You might also ask some questions, such as why lawmakers have not closed the gaps in legislation exposed by the courts, thus allowing the debt industry to continue inflating like a hot air balloon. And why it is that you, and presumably millions of others, are constantly plagued by unsolicited offers of apparently infinitely extendable credit, particularly since the cases show that creditors get pitifully little out when debtors voluntarily surrender themselves.

Sadly I can’t answer any of these questions, but if they trouble you, too, then you may want to know more about a decision by Judge Lee Bozalek in the High Court, Cape Town, last month (in Ex parte: Concato).

The case concerns five people who applied for the ‘voluntary surrender’ of their estates. Another judge had earlier raised uncomfortable questions with the attorney handling the applications and the matter was postponed for the attorney to file more information about the way such applications were handled.

Judge Bozalek took over when the matter next came to court and, impressive though his resulting analysis may be, it’s far from the first time that a judge has expressed concern about how the system operates.

What makes this case a bit different is that Judge Bozalek requested the attorney involved to provide a detailed analysis of exactly how the system works in relation to the clients that he represents. The results were amazing.

Judge Bozalek’s colleague who first dealt with the matter ‘expressed doubt, if not outright scepticism’ about the merits of the five applications, given their astonishing similarity, including the fact that in each case, a dividend of either 16 or 17 cents in the rand would accrue to creditors.

It was postponed so Cape Town attorney Etienne Genis could file an affidavit dealing with some of the court’s concerns. Genis strongly denied being involved in a ‘scam’ and said it was ‘purely coincidental’ that in all five cases the projected dividend was either 16 or 17 cents. The coincidence probably arose, he said, because the estates of the five were the same size.

He explained at length how he handled such cases – a full consultation with every client, a qualified valuator estimating each client’s assets and, based on this information, Genis himself calculating the provisional dividend from a voluntary surrender. His firm ‘usually’ tried to limit its fees to R9 000 per application, but there were ‘disbursements’ to be paid as well.

Let’s pause here to consider the arithmetic. He said that over the past four years he had handled between six and 15 such cases a month. Even allowing for a couple of months’ down time, you can see that this is a valuable market, generating fees of between R500 000 and R1.4-million a year, for the last four years at least.

Faced with this affidavit, Judge Bozalek said the courts had previously explained that voluntary surrender required applicants to provide a good deal of relevant financial detail. However, as he worked his way through the five applications it became clear that this was not provided.

Judges from other divisions had referred to the ‘fledgling cottage industry’ forming around voluntary surrenders, with a small set of attorneys specialising in these applications, using a standard form with almost identical circumstances. They could have been talking about the Western Cape, said Judge Bozalek.

Still troubled by the striking similarities as well as the ‘formulaic and often superficial nature’ of the five applications before him, he decided to push for more information, like what had happened in past cases after the court approved a debtor’s voluntary surrender.

He therefore asked Genis for specific information about all the voluntary surrender applications brought by his firm in the last court term of 2013 and the first term of 2014.

The picture that emerged from the information provided by Genis was troubling, said the judge. To start with the whole system was plagued by lengthy delays at the Master’s Office, with required publication in the Government Gazette adding to the problem.

Another disturbing picture emerged from the 90 cases in which the firm applied for voluntary surrender orders in the last two months of 2012, the final terms of 2013 and the first term of 2014. The projected dividend to creditors was never more than 22 cents or less than 14 cents in the rand, but in well over 70 percent of cases it was either 16 or 17 cents.

In the great majority of cases the insolvent person bought back the assets in the surrendered estate, almost always via instalment payments, and at the ‘forced sale value’ provided by the valuator.

According to Genis it was better for the debtor to buy back the assets than to sell the goods on auction because of the risk that the goods would not sell and the creditors would thus get nothing at all.

The judge expressed his concern about these buy-back arrangements, carried out on the scale shown in the information provided by Genis. The goods were bought back by the debtor at the low ‘forced sale value’ – a value intended for an auction that was never held – and paid for via extended instalment payments. Thus ‘life goes on virtually unchanged for the insolvent’ because the way the system is applied means that he or she is effectively ‘immune’ from claims by creditors.

In fact the whole voluntary surrender process served the interests of the professional people involved – the attorneys, the valuator and the trustees – as much as their insolvent clients, with little benefit for the creditors. The professionals ‘earn fees’, while their clients ‘are able to retain all their assets and purchase them back, over time, at the forced sale valuation. This they achieve without being pestered by their creditors’ or having to make the rigorous repayment arrangements demanded under the National Credit Act.

Why was the ‘forced sale valuation’ always used to decide the purchase price of the insolvent person’s goods when there was no such sale, he asked. Why was there no negotiation with the insolvent person to pay a higher price when buying back goods? And how was it possible for debtors to find the money to buy back the goods when according to the court papers they had none? Given the information that had come to light, said Judge Bozalek, the bona fides of the applications was ‘open to serious doubt’.

The first of the five applications, for example, involved a woman who stated that after legal and other costs she could only pay her creditors ‘the inevitable 17 cents in the rand’. She had liabilities of almost R300 000 from ‘short term credit extensions’. Her attorney’s costs would be more than R14 000.

Her papers showed a number of ‘puzzling’ elements, including omissions of crucial information such as the amount of commission she was paid at work. She referred to compulsory insurance, including cover for a car, as part of her monthly expenses, along with R2 500 monthly petrol expenses. She also spoke about ‘once having had’ a car that was re-possessed by the bank. So what car was insured? – one that was given to her by her brother. This car, however, was not included in her list of assets, and no explanation was given for why it was excluded, the judge pointed out.

The valuator listed furniture and other goods in her home worth R79 800 – including four TV sets and duplicates of a number of domestic appliances, including two microwaves and four fridges or freezers. And like other applicants, much of her statement was taken up with personal details that had nothing to do with her financial position. ‘The nature and quantity of this type of irrelevant personal material leaves one with the distinct impression that its purpose is simply to evoke sympathy’.

Having examined all five cases in some detail the judge said he had no reason to doubt that if the voluntary surrender orders were granted, the five would simply repurchase their assets, over time, at the low ‘forced sale’ valuation. Moreover, there was an overwhelming probability that the applications were brought with exactly this outcome in mind.

The result would be that while the five would continue to ‘enjoy possession and use of their assets’ they would get rid of their creditors. And in each case the estate realised through the court action would be substantially reduced by the fees paid to the professional parties involved. The applications were not made in good faith and orders of voluntary surrender would not be of any advantage to creditors, he concluded.

So what will happen to these applicants and their families? Good question. I imagine they will be handed over to another set of benefitting professionals – one of several firms of attorneys who increasingly act as national debt-collectors. But even before that particular final solution, there will be fees payable for this abortive case, and these five debtors will be pushed into an even deeper hole.