Since the start of the pandemic, many individuals and businesses have managed to weather the storm thanks to various government assistance programs. However, it is very likely that some will have to consider bankruptcy once these “cushions” are no longer available. Therefore, it is important to understand the various options available to them.
The term “bankruptcy” can be considered frightening to many. Bankruptcies and restructurings are indeed disruptive. However, they can be beneficial for individuals and the economy as they are designed to preserve value and prevent the waste of valuable assets. Our clients often feel embarrassment, defeat and even shame when they find themselves in a context of insolvency. These are completely normal emotions. On the other hand, it is important to know that the purpose of bankruptcy is to:
– Promote economic stability;
– Establish a balance between liquidation and reorganization;
– Ensure fair treatment between creditors; and
– Ensure a transparent and predictable process.
What is bankruptcy?
In order to benefit from bankruptcy protection, a person must be considered “insolvent” as defined under the Bankruptcy and Insolvency Act (BIA). An insolvent person is defined as someone who, not being bankrupt, is indebted for more than $1,000.00, has ceased or is unable to meet his obligations as they become due or whose property has a net asset value that is not sufficient to cover his debts. Bankruptcy is the legal avenue for individuals or corporations to pursue relief from these unpayable levels of debt. When a business or a consumer finds themselves in this situation, they may:
I. File for bankruptcy under the BIA, a process by which the debtor’s assets are vested in a Licensed Insolvency Trustee to be liquidated for subsequent distribution to the creditors. The BIA also provides a mechanism for individuals or corporations to avoid bankruptcy by negotiating settlements with creditors to reorganize the debtor’s financial affairs; or
II. Reorganize the insolvent company (however this option is only available for corporations with debts of over $5,000,000), to compromise creditor’s claims through a plan of arrangement under the Companies’ Creditors Arrangement Act (CCAA).
This article will focus mainly on the BIA for individuals and small businesses.
The initiation of the process
Whether a personal or corporate bankruptcy, the procedures are essentially the same. The process is initiated either by:
- Voluntary assignment
The debtor assigns its assets for the general benefit of the creditors after fulfilling the following criteria:
i) The person must be insolvent as defined in the BIA, because he/she has ceased or is unable to meet his/her obligations as they become due or because the net asset value of the property is not sufficient to cover his/her debts;
ii) The insolvent person must be carrying out business and reside in Canada or hold property in Canada;
iii) The insolvent person’s debts must exceed $1,000; and
iv) The person must not already be bankrupt.
2) A creditor’s initiation
Creditors with a provable claim of over $1,000 may apply to the court for a bankruptcy order against its debtor by proving:
i) That it has a provable claim in excess of $1,000 that constitutes an ordinary (unsecured) claim;
ii) The debtor is defined as an insolvent person or a person under the BIA who, at the time he committed an act of bankruptcy, was a resident or carrying on business in Canada;
iii) The insolvent person has committed an “act of bankruptcy” as defined in the BIA, six months prior to the filing of the application.
3) The failure of a proposal or notice of intention to file a proposal to the debtor’s creditors
This situation is related to the failure of the restructuring process under the BIA.
The steps in the bankruptcy process
After initiation of the bankruptcy process, the main steps in the unraveling of the process can be summarized as follows:
- The insolvent person becomes bankrupt for reasons previously stated (either voluntarily or forced);
- The insolvent person must submit a balance sheet and list of creditors to the trustee within five days following the bankruptcy;
- At this point in time, there is a “stay of proceedings” for all proceedings undertaken by creditors. This means that creditors cannot start of continue legal action against the debtor to recover debts. This levels the playing field so that one creditor does not gain an advantage over others for repayment of debt. However, the rights of the bankrupt’s secured creditors are usually not affected which include, but are not limited to, hypothecs on the debtor’s property or liens on business equipment.
- The creditors are notified of the bankruptcy and convened to a meeting of creditors;
- At this first meeting, the creditors receive an initial report form the trustee, can question the bankrupt, confirm or change the trustee and appoint inspectors;
- The trustee receives and processes the evidence of claims, subject to the right of unsatisfied creditors to appeal to the court;
- The seizable property of the bankrupt is sold;
- The trustee distributes the net proceeds of the liquidation of the bankrupt’s property to the creditors according to the order of distribution prescribed in the BIA;
- Lastly, the trustee shall apply to the court for the Bankrupt’s discharge.
Note that small businesses that are not incorporated, such as a sole proprietorships or partnerships, will be treated in the same manner as a personal bankruptcy would. In other words, the assets of the business are not held independent from the owner’s personal assets.
For incorporated corporations filing for bankruptcy, the owners are protected from liability, and only the business’s assets will be forfeited. However, this rule finds exception where the owner has put up any personal assets such as personal property or a home as collateral or security for any of the business’ debts. Directors of a corporation may also be held personally liable for certain unpaid governmental debts.
Disadvantages of bankruptcy
Another common misconception is that after one is liberated from bankruptcy, the bankrupt is released from all prior debts. However, there are certain amounts owed that a bankrupt will never be discharged from, including fines, alimony, fraud, liability for a claim that was not disclosed to the trustee and student debt. Moreover, in a corporate bankruptcy, the company may not apply for a discharge unless it has satisfied all the claims of its creditors in full.
After emerging from bankruptcy, the individual’s credit score will be very low. This can hinder on one’s ability to obtain credit cards, mortgages, or loans for years to come. After a first bankruptcy, a record can be kept on your credit report for up to 6 years, and for any subsequent bankruptcies, for up to 14 years.
Furthermore, a bankrupt person cannot be a director of a corporation and some professional orders prohibit undischarged bankrupt persons from practicing as directors.
Advantages of bankruptcy
One of the main advantages of bankruptcy is that it gives the debtor time and space. The automatic stay of proceedings prevents creditors from taking any action to collect debt. It therefore puts a stop to evictions, seizures and lengthy court proceedings which can be stressful.
Although a bankruptcy remains registered for a number of years, this time can be used to improve credit ratings and to learn how to live within one’s income to prevent future financial problems. Through this process, the bankrupt will also learn through mandatory credit counseling from a qualified counsellor who has obtained a certificate from the Office of the Superintendent of Bankruptcy, how to rebuild credit and develop new and effective financial habits.
The benefit to creditors is that the BIA provides strong protections, requiring debtors to disclose important information about their operations and imposing strict controls on the debtor’s actions. As a result, it is more likely that a creditor will recover his or her claim through the bankruptcy process rather than through the judicial process, which can be more cost efficient.
Bankruptcy should not always be seen as a failure, but as an opportunity for a fresh start. Whether you are an individual or a corporation, be sure to carefully weigh all your options before filing for bankruptcy and contact a professional to assist you in the matter.
Cautionary note: This document provides an overview of insolvency proceedings in Canada and is not intended to communicate specific advice applicable to any particular factual situation. Readers are cautioned against making decisions based on this material alone. This document should not be used as a substitute for professional advice on the circumstances of any individual case.