Consumers and Retail Insolvencies – Can They Get a Better Deal?

07 September 2016

Although relatively uncommon, the insolvency of a large, well-known High Street retailer tends to attract more attention than other insolvencies. This isn’t surprising: not only do these insolvencies mean potentially thousands of jobs and the future of a familiar brand name are at risk, but ordinary consumers face losing money, too. Many may be holding vouchers that may no longer be accepted, while others may have placed deposits on items that may not be delivered. The position of these ‘involuntary’ creditors can lead to questions about the wider insolvency regime and how it works.

We’ve written about vouchers and deposits in insolvencies before. The problem with trying to better protect consumers in insolvencies is that doing so comes at a cost, either for the business of which consumers are customers or for that business’ other creditors. We identified a few ways consumers could be offered more protection, but it’s not clear any of them would lead to better outcomes overall than the current situation.

Over the past year or so, the Law Commission has also been attempting to crack this particular nut, and has just published its report. It recommends some potentially significant changes.

The report won’t have an immediate impact on the insolvency regime: it’s up to the government to decide whether to follow the Commission’s recommendations or not. We expect the government to respond in the autumn and there would be further consultation before the possibility of legislation.

However, if the Commission’s recommendations are adopted, they could have just as big an impact as some of the other changes happening in the insolvency regime at the moment (such as the government’s corporate insolvency reforms) so it’s worth understanding a bit more about what has been suggested.

What’s been proposed?

The Commission’s basic position is that when retailers fail, more should be done to ensure consumers are not left out of pocket.

The justification for making changes is that, the Commission argues, consumers tend to be left in a relatively more exposed position than other creditors when a retailer enters an insolvency procedure. Consumers owed money (if they have put down a deposit for a sofa or bed, for example) come towards the bottom of the pile, alongside suppliers or business customers, when it comes to repaying creditors, while consumers are not as ‘sophisticated’ as other creditors and may not understand the risks that come with making a deposit (or purchasing vouchers) in the same way a trade supplier would understand the risk of extending credit to another company.

The Commission also makes the valid point that it is the most vulnerable consumers who have the least protection in insolvency situations. While consumers can usually reclaim deposits made by credit card or some debit cards from the card issuer after an insolvency, those who have paid in cash – perhaps because they have been refused credit or a bank account – get no protection at all.

Other arguments made by the Commission include the claim that consumer losses in retail insolvencies hurt consumer confidence, and that some struggling retailers take larger deposits in the lead-up to insolvency to try and improve their cash flow knowing that these orders may never be fulfilled.

The Commission’s report does recognise that completely protecting consumers is impracticable, but has called for changes to offer more protection in ‘the most serious cases’. Recommendations discussed in the Commission’s paper include:

• Requirements in specific sectors that consumer deposits are protected via insurance, trusts, or bonding (Christmas savings schemes are proposed as a candidate for such protections); more information on the risks of purchasing vouchers, and more information about how to reclaim money via debit and credit card providers;
• Improving consumers’ position in the hierarchy of creditor repayments in insolvencies where they have made a deposit over £250 within six months of the start of the insolvency procedure and are not protected by any other means (for example, by not having paid for the deposit by credit or debit card). Under this proposal, such claims would rank behind secured creditors and some money owed to employees, but above floating charge holders and unsecured creditors;
• And, finally, changes to the rules on ‘transfer of ownership’, to make it clearer when exactly a consumer ‘owns’ the item they placed a deposit on.

Will these proposals work?

Some of these proposals are relatively straightforward. We believe that the Commission is right to limit its recommendations with regards to calling for more information to be given to consumers about the risks of purchasing vouchers, for example. While the treatment of vouchers in insolvencies is an emotive issue, consumers should understand that purchasing a voucher means swapping paper money backed by the Bank of England for paper money backed by XYZ Retailer Ltd. It’s a risky thing to do.

In recent major retail administrations, administrators have (for commercial or ‘goodwill’ reasons) tended to accept gift vouchers, at least partially, but the decision to do so is not guaranteed. When retailers enter an insolvency procedure, there is by definition not enough money to go around and refusing to accept vouchers could be the fairest way of treating the retailer’s body of creditors as a whole. The more information consumers have about the risks of vouchers, the better.

The Commission’s recommendation for administrators and card issuers to give consumers more information about ‘chargeback’ and how to claim for card refunds is welcome, too. Many insolvency practitioners already provide such guidance, but others have reported concerns about being seen to be favouring one group of creditors (consumers) over another (the card providers who would be providing the refund). Clear guidance on information that can be provided would be a good thing.

Likewise, the Commission’s suggestion for better consumer protection in specific ‘problem’ sectors, such as savings schemes, is welcome (although this sort of government intervention should be a last resort, and plenty of consultation would be required before these powers are used).

The tricky bit is the detail. Size matters, for instance. Extra regulations might be appropriate for large, commercial savings schemes (like Farepak) but not for small, local schemes. Who exactly would police adherence to the regulations is not covered by the Law Commission, nor is the precise form any protection should take: the Commission suggests insurance, trusts, or bonds being required for consumer deposits but each comes with its own drawbacks (our analysis suggests that an insurance scheme would be the most practical and efficient option of the three though).

Should consumers get more support than other creditors?

While the sentiments behind some of the Commission’s recommendations are laudable, not all of the suggested solutions appear workable or needed, and could come with unwanted side effects.

Changing the rules on transfer of ownership, for example, would not necessarily improve things for consumers, and would instead set up a clash with existing legislation (such as the Sale of Goods Act), the principles of retention of title (where suppliers own the material used to make a good until it is paid for), and case law.

More importantly, moving otherwise unprotected consumers up the hierarchy of creditors may lead to a better deal for them, but it may not be fair on other groups of similarly vulnerable creditors. More money back for consumers after an insolvency will mean less money is available for others, including a retailer’s trade suppliers. Losing money as a result of an insolvency is bad enough for a consumer, but for a small business it could be terminal. According to R3 members, the failure of another company is a primary or major cause in around one-in-five corporate insolvencies.

To change the order of priority to benefit consumers needs a better justification than that offered by the Law Commission. Many of the same or similar arguments to those made in consumers’ favour could apply to a retailer’s small suppliers, too. These businesses, for example, may not have a choice about trading on terms generous to their larger counterpart and may consequently be left exposed in the event of the larger company becoming insolvent, even though the supplier may be more ‘sophisticated’ than a consumer. If a retailer is taking higher deposits from customers as it struggles financially, it will probably be looking to extract extra credit from suppliers as well. And every sofa or bed handed over to a consumer under the Commission’s proposal may be made of wood, stuffing, or fabric for which suppliers have not been paid.

Even without these objections to the Commission’s recommendations, there are practical concerns, too. It could be both difficult and costly for insolvency practitioners to administer a new subcategory of claims and work out exactly who, out of potentially thousands of deposit holders, is eligible for a priority claim.

What next?

The fact is that people are always very likely to lose money in an insolvency and if you take any one group of creditors and look at their position in isolation it’s possible to see it as ‘unfair’.

Where the Commission’s proposals are practical and wouldn’t have a potentially unfair impact on other creditors, they are clearly worth considering. The more consumers know about their existing rights (and risks), for example, the better.

However, any proposal to change the creditor hierarchy must look at all creditors together rather than focusing on just one group. The Commission’s report looks at insolvencies from the perspective of consumers, but a report from the perspective of trade suppliers might come to different conclusions.

The government needs to tread carefully with any reform based on the Commission’s report. A better deal for consumers will mean a worse deal for others – and that may not be a ‘good thing’.