4 things to know before declaring bankruptcy

“People are afraid of bankruptcy. Under stress, they experience their circumstances as a shameful failure, often not even telling their spouse,” says CPA Pierre Leblanc (Getty Images/pixelfit)

Although the COVID-19 pandemic is likely to create more financial distress for Canadians, consumer bankruptcies seem to be on the decline. As recent statistics from the Office of the Superintendent of Bankruptcy Canada (OSB) show, “there was a record decline in the number of consumer insolvencies filed in the second quarter” of 2020. Similarly, the Canadian Association of Insolvency and Restructuring Professionals (CAIRP) reports that “nationwide, consumer insolvencies were 38.4 per cent lower than in October 2019, but up 6.2 per cent compared to September 2020.”

However, there is often a long delay between when people start to recognize the severity of their debt problems and when they take action, warns CAIRP.

CPA Pierre Leblanc, president of bankruptcy trustee firm Groupe Leblanc Syndic Inc., has seen this play out over the past 20 years: “People are afraid of bankruptcy. Under stress, they experience their circumstances as a shameful failure, often not even telling their spouse,” he says. “Out of fear of losing everything, they sometimes wait two years before reacting.” [Learn more about dealing with financial hardships with the podcast Money and shame: Counselling Canadians out of debt]

Unfortunately, the pandemic has hit some Canadians hard.

“A pandemic can cause loss of jobs, marriage break ups, long-term illness, death,” says CPA Sandy Lyons, a licensed insolvency trustee at Grant Thornton. “We see people who have done well and who have circumstances that suddenly disrupt their plans. Carrying high levels of debt into retirement is something we see quite often right now.”

Leblanc agrees.

“Deprived of income, some Canadians have spent more than they could afford. Many also took advantage of payment deferrals,” says Leblanc. “But that’s coming to an end, and [Canadians] should watch for warning signs, such as difficulty paying a bill or a credit card balance.” As of November 25, 2020, 99 per cent of the 686,000 individuals who benefited from deferred mortgage had resumed payments, explains the Canadian Bankers Association. However, it is too soon to be definitive because many mortgage deferrals ended only in October, so many homeowners may have fallen behind on those payments until the end of the year or early 2021.

So what should you do if you’re struggling financially and are thinking about declaring personal bankruptcy? Here are four things you can do.

1. GET EXPERT ADVICE

Consulting an expert can help you avoid certain mistakes, such as making withdrawals from a Registered Retirement Savings Plan to pay off a credit card. Creditors cannot seize retirement investments—except for the contributions of the past 12 months—which is why they should never be touched. “The goal is not to remedy the past by making a mistake that will impact the future,” says Leblanc.

The same applies for those who pledge their home as security, when it is exempt from seizure, or who blindly endorse a person or take out a joint credit card. “We have to find ways to protect our assets so that a loved one, even if they get sick or lose their job, doesn’t drag us down financially,” he says.

“By drawing up a balance sheet of the person’s assets and liabilities, we get a picture of their situation,” explains Leblanc. “Young parents who are office workers don’t have the same goals or priorities as an entrepreneur who has personally guaranteed a business loan.”

2. BEWARE OF THE DEBT SPIRAL

“Past due amounts are far from being exorbitant in all cases, but can have a big impact, such as leading to the closure of an electricity account,” explains Leblanc. “It’s often 30 or $40,000 on cards and lines of credit, which requires paying large monthly instalments with no leeway left over. When they reach their credit limit, most clients accept the limit increases proposed by their financial institution and go further into debt.”

The figures speak for themselves, says Leblanc: “By making minimum payments only, they don’t realize that $30,000 may cost them up to nearly $65,000 in principal and interest over 30 years. They sometimes carry debt they could pay off using a home equity line of credit or HELOC, but they’re unaware of it, and they often confuse declaring bankruptcy [with] making a [consumer] proposal.”

3. MAKE A PROPOSAL

If you’re an individual whose total debt (excluding your mortgage) does not exceed $250,000, you can make a consumer proposal—an offer to reimburse your creditors. “This simplified procedure allows you to suspend the proceedings instituted against you by your creditors; keep most of your property; retain your right to professional practice, if applicable; [and] repay some of your debts interest-free.” explains Justice Quebec. “A consumer proposal may be completed quickly if it is based on a single lump-sum payment (generally through a loan made on condition that your creditors accept your proposal).”

For debt in excess of $250,000 or for business owners, a Division I proposal is available. Bankruptcy should be your last recourse, says Lyons.

“A proposal should always be looked at first,” insists Lyons. “The idea is to figure out what your cash flow will accommodate for repaying creditors, based on OSB rules, and give them something more than they would get in a bankruptcy.”

With a consumer proposal, all creditors are bound in a single file that is submitted to the OSB. From the moment the proposal is made, unsecured creditors can no longer demand direct payments or seize wages and must cease any legal proceedings. They have 45 days to accept the proposal or request changes to it. If it is accepted, payments are made to the trustee, not to the creditors.

“This is by far the most advantageous solution for everyone, including creditors, who could lose even more in the event of bankruptcy,” says Leblanc. “An individual who owes $30,000 could repay $20,000 interest free under a proposal at $400 per month for five years, the maximum term. Another consumer may repay $12,000. It all depends. In all cases, consumers will be required to attend two counselling sessions to learn how to better manage their finances.”

4. REBUILD YOUR CREDIT

Consumer proposals make it easier to rebuild your credit reputation quickly. “If you’re able to settle your proposal in less time than expected, your [credit] score will improve faster, which is not the case with bankruptcy,” explains Leblanc.

“In addition to providing some financial certainty for the [person], who knows going forward what their fixed payments will be over the next five years, a consumer proposal is always a better option because it has a lesser impact on their credit rating,” adds Lyons. Once the consumer proposal is completed, no debts will be reported as R7 after three years.

The “R” set by Equifax and TransUnion stands for revolving credit, which mean credit accounts that can carry a running balance and on which you are required to pay only a portion each month. R1 is the best credit rating you can have when you pay your credit account on time, and R9 is the worst. Between both, you have a range for “R” referring to how many days late you pay: R2 for 30 days late, R3 for 60 days late, R4 for 90 days late, R5 for 120 days late (R6 is not used). Once you get a R7, getting credit could be difficult and expensive, but still possible.

A first bankruptcy lasts nine months, but if your monthly income exceeds certain OSB-established low-income cut-offs, you’ll be deemed to have surplus income, which will change the length of your bankruptcy (to 21 months) as well as the amount of your payments. For a family of four, the cut-off is set at $4,168 (many examples of calculations are available here). If you declare bankruptcy a second time, you won’t be discharged for 24 to 36 months.

Once you’re discharged from your bankruptcy, R9 ratings stay on your file for six years (or 14 years after a second bankruptcy). If you have debts reported as R9, you will be unable to get credit or loans and may have to dispose of assets to pay off your creditors. Your car, home, furniture, personal items or tools necessary to your work would fall under that category; the value of what you’re entitled to keep depends on your province. Despite these consequences, bankruptcy still accounted for 40 per cent of the 137,178 consumer insolvencies filed with the OSB in 2019.

Some people do try to game the system by making large purchases in the weeks before declaring bankruptcy, transferring funds to a third party or selling their home to invest the money collected in their spouse’s name, but the culprits often pay the consequences: a transfer of property to a stranger can be deemed a void transaction if it occurs less than one year before bankruptcy or less than five years when made to a family member.

But these cases are rare. “The majority of people who end up in debt default are acting in good faith,” says Leblanc. “Often, they’re just unlucky and unfortunately lack the necessary financial knowledge.”

LOOKING FOR FINANCIAL ADVICE?

Listen to the latest season of the Mastering Money podcast, which touches on debt-related topics, including the state of debt in Canada and debt traps to avoid. And find out how to get on the right side of debt before it gets ahead of you.

If you are struggling to manage your household debt, there are several not-for- profit credit counselling agencies that exist to help individuals and families sort out their personal finances. Many of these agencies provide highly qualified support at little or no cost. For more information, visit Credit Counselling Canada and Credit Canada.