Bankruptcy You Say?
I can’t tell you how many times (too many to count) where I have had people come into my office and tell me that they filed a bankruptcy years ago, but that they are still in bankruptcy and cannot afford to get out of their bankruptcy. Yes, you read that right. Bankruptcy can be very expensive depending on the individual’s situation.
Something else that tests my patience, is when I hear that someone filed bankruptcy on say $15,000 of credit card debt, but upon examination, I can see that a proposal to their creditors would have cost them the same money as a bankruptcy, yet forgo some of the challenges and potential future challenges with filing bankruptcy.
Myth: Bankruptcy is the easy way out:
I hear people say to me almost daily “I’m just going to file bankruptcy, it’s easier.” I understand what they are saying, however, in most cases the individual making this statement is making a presumptuous determination at best.
I also hear people say; well I need to get out of debt but I don’t want to file a bankruptcy. To which I respond, “I agree, bankruptcy may not be a good option for you, but do you know why it is not a good option?”
You see, when we meet with people and look at all the options available to them in order to get out from under the overwhelming burden of debt, bankruptcy is just one of the options we go over with them, and we do so in relatively robust detail. The reasons that we go over what a bankruptcy would look like are:
1. We are obligated to explain all options to our client (Of course this is a good thing).
2. More importantly, we review a bankruptcy scenario with our clients in order for them to be able to make a fully informed, objective, financial decision, as to why they may not want to file a bankruptcy. Further to that, they are able to properly contrast the other options available and how some of those options might stand head and shoulders above the bankruptcy option.
So let’s take a high-level look at the difference between a consumer proposal and bankruptcy. You should be able to see for yourself why less than 1% of clients in our office end up filing bankruptcy.
Bankruptcy Is Not The Easy Way Out
While in bankruptcy, your income is monitored. The reason for the monitoring? You are required to pay 50% of any income that you earn over the government standard limit for someone who is bankrupt. The amount of income that you can earn before going over the standard is based on your family size. As of the writing of this article, a family of 3 is allowed to make a combined net income of $3372 per month, including the Canada Child Benefit. For our example here, let’s say a family of three was burdened with high credit card debt, call it $50,000. We’ll say that the credit card debt is in both mom’s and dad’s names, and in such a case there would need to be two bankruptcies filed, one for each party. If dad made $2200 net income per month, and mom made $2200 net income per month, and the CCB was $250 per month, they each would have a bankruptcy payment of $302 per month.
Now, this is just the start. The issue with the above income guideline is not just the payment amount, but it also determines the bankruptcy duration. If neither party has had a previous bankruptcy, they each would be making the bankruptcy payment of $302 for 21 months (If they had a previous bankruptcy, they would be making the payment for 36 months – 3 Years). So in this scenario, first time bankrupt, $302 x 21 months = $6342 each. A combined household cost of $12,682 as a projected base cost for the bankruptcy. If the debtor has the opportunity to work overtime or receives a raise during the bankruptcy timeline, their payments into the bankruptcy would increase. In the same respect, if income were to decrease, the bankruptcy payment amount would reduce. However, let’s face it, most of us are hopefully working towards advancement.
But wait there’s more! If an income tax return is due to either or both of the debtors, they would lose those, and if the bankruptcy were to last 21 months, they would lose two tax returns each, so four in total. All of this is still just the beginning of what bankruptcy could cost. For time sake I won’t get too much further into it. In short; assets such as your child’s education fund, investments, home equity, inheritances, etc., could all end up being received or collapsed by the licensed insolvency trustee.
Quick note: A Licensed Insolvency Trustee (LIT) is an officer of the court who administers bankruptcy proceedings. They do not represent the debtor. They are simply required to carry out their statutory duties. Even if you like them or they are your friends, they cannot act arbitrarily. The rules are the rules and a LIT is required to apply them.
Further future complications or unknowns can also come along with bankruptcy, which I won’t delve into right now.
Based on the above scenario, a bankruptcy that is simply income and income tax return based, no assets, our hypothetical couple could have paid almost 13k in surplus income, and let’s say each had modest income tax refunds of $1000 for both years, they are almost at a grand total of $17,000 to go bankrupt. So, we have established that bankruptcy is not free. Plus given the duration, monthly scrutiny of income and expenses, this basic bankruptcy scenario does not appear to be the “easy way out” either.
A consumer proposal is a formal legal process in Canada. The debtor still receives protection from their creditors. In short, the creditors agree to a fixed monthly payment with no interest, for a period of time not to exceed 60 months. Upon final payment of the proposal, the original debt and all interest is discharged. A proposal can also be paid out early with no penalty should the debtor come across the funds. In our office, client’s proposals are generally a small fraction of what they originally owed. Many times a proposal can actually cost the debtor less than what bankruptcy would have cost, yet the creditors still receive more money because the creditor representative on the file, the licensed insolvency trustee, receives less of the proposal money and therefore creditors receive more.
For our example, we are going to assume that the party in question has a joint credit card, loan and line of credit with the debt totalling $50,000, as per the previous bankruptcy scenario. To keep apples compared with apples, we will also assume that income and assets are identical to the previously described bankrupt scenario. By joint debt, I simply mean that both parties are liable to pay the debt and this is quite common in an indebted household.
A quick breakdown for you:
In the above bankruptcy scenario each party is paying $302 x 21 months = $6342 plus 2 x $1000 income tax returns = $8342 each for a total household bankruptcy cost of $16,684. From this point forward I will round numbers for ease of reading. Of the $16,700 paid by the debtor into the bankruptcy, the Licensed Insolvency Trustees fees are roughly $10,000, plus there are some additional fees and HST was taken out before creditors receive a return. The amount creditors receive in this scenario is about $5350 of the entire $16,700.
If the same debtors were to have one proposal filed together for let’s say $225 x 60 months = $13,500, the Licensed Insolvency Trustees fee would be approximately $4600 plus some additional fees and HST within the court tariff, therefore leaving the creditors with a return of roughly $8500. To quickly sum it up, in the bankruptcy scenario, which is a commonplace example, by the way, creditors would receive $5350 of the $16,700. In a proposal scenario which in our hypothetical would cost the debtor $13,500, the creditors would receive around $8500 or 60% more than the bankruptcy, yet the debtor paid $3200 less than what it would cost them to go bankrupt, and they didn’t have the immediate nor long term challenges that can come with bankruptcy.
Although a lender does not want to take a haircut on funds leant, and a consumer does not borrow with the intent of entering into a proposal with the creditors, the latter scenario described, that being the proposal, means that everyone comes away with something. The proposal has greater benefits to both the creditor and the borrower when compared to the bankruptcy.
In a proposal, none of the debtor’s assets vest with the trustee. They do not have to give up investments, have their income monitored, nor liquidate assets, and they get to keep their income tax return. Further to that, a proposal to creditors is less aggressive on the credit bureau than a bankruptcy. In the bankruptcy scenario described above, where there is a husband and wife as joint debtors, they are able to file one “joint’’ proposal, whereas in the bankruptcy they would have had to file two separate bankruptcies.
At the end of the day, there is a reason why our clients choose a proposal over a bankruptcy 99 times out of 100. If done properly, and by properly I mean to the benefit of the debtor as much as reasonably possible, a consumer proposal can be the best way to deal with overwhelming debt in Canada. Bankruptcy is not the easy way out, and it certainly is not free.
As mentioned, there is no way to properly unpack all of the possible bankruptcy scenarios in a simple article. The previously described scenario is just one small example. There are potentially many pitfalls that can arise in bankruptcy. That’s not to say that bankruptcy is never a good option, but in most cases, from my experience, it would appear that there are usually better options.
Seeking advice from a qualified professional who does not have an obligation to the creditors, who can represent solely your best interest, is an absolute must (although not a requirement) when looking to deal with your debt in Canada. Don’t just take my word for it, check out the Canadian Debtors Association at debtorsvoice.org. The whole purpose for their existence is to make sure the debtor is aware they do have a voice and a choice when dealing with overwhelming debt.
Thanks for reading!
Ryan Brown is not a licensed insolvency trustee. Instead, Ryan has chosen to take the side of debtor representation. He is with 4 Pillars Consulting Group and has been helping his clients navigate insolvency options and get out of debt since 2010. 4 Pillars has been in operation since 2002 and has 63 locations across Canada.