Bankruptcy in Canada
If you find yourself significantly behind on your bills and all other attempts to manage debt have proven futile, the last resort is declaring bankruptcy.
What is Bankruptcy?
Bankruptcy is a legally mandated process of forced debt settlement. When an individual declares bankruptcy in Canada, the court convenes all unsecured creditors to assess the debts owed. The court scrutinizes the individual’s assets and formulates a plan to distribute funds to settle as many debts as possible.
The type of bankruptcy filed determines the process. However, once the courts determine the total possible repayment, all outstanding balances on debts are discharged (cancelled), and creditors are prohibited from further collection attempts. It’s important to note that not all debts are dischargeable through bankruptcy; mortgages, car loans, student loans and taxes owed may remain unaffected under certain circumstances.
The bankruptcy types are named after the chapters in the Bankruptcy Code. In Canada, individuals can file for either Personal Bankruptcy or a Consumer Proposal.
Bankruptcy and Credit
While bankruptcy discharges debts, it also has a severe impact on credit. A bankruptcy record remains on the credit report for an extended period, typically between 7 and 10 years. During this time, especially within the first three years, obtaining new lines of credit, including credit cards, car loans, or apartment rentals, becomes extremely challenging. If a creditor agrees to lend or rent, substantial security deposits are usually required. Bankruptcy is a last resort after exhausting all other debt management plans.
Personal Bankruptcy
Personal Bankruptcy is the quickest and most direct method, usually taking about 6 months from start to finish.
In a Personal Bankruptcy, a trustee is assigned to manage the individual’s debts. The trustee’s role is to liquidate assets, including bank accounts, property, investments, and valuable personal items, to repay as much debt as possible. Once the trustee distributes the cash to creditors, any remaining debt is discharged, and creditors can no longer pursue collection.
Eligibility
To be eligible for Personal Bankruptcy, individuals must pass a “Means test”, earning less than the median income in their area. Only unsecured debt, excluding student loans (NTD also Government debt is excluded), qualifies for a Personal Bankruptcy.
Secured Debt
Personal Bankruptcy applies solely to unsecured debt, such as credit cards and medical bills. For secured debt like mortgages or car loans, there is no bankruptcy protection, as secured debt involves collateral. If one falls behind on mortgage payments, the lender can foreclose on the property. However, this does not always mean you get to keep your home or car…
Personal Bankruptcy and Your Home
With a Personal Bankruptcy, any value you have built up in your home or car CAN be used as an asset to pay off other debts, even though your mortgage or car loan itself is not subject to bankruptcy.
For example, if you have a $200,000 home and it is ½ way paid off, you have $100,000 in equity. Your trustee can determine that you must sell your home to access that $100,000 to pay off your other debts. A trustee is unlikely to force a home sale if you do not have much equity (like if you just bought your home or just re-financed your loan), but it is their sole decision.
The same applies to cars. If you have a very expensive car (with an outstanding car loan), your trustee can force the sale of your car, even though your car loan is not part of the bankruptcy. This is usually only required for expensive or luxury vehicles, as the trustee does not normally force you to sell a purely utilitarian vehicle you need to commute to work.
Consumer Proposal
A “Consumer Proposal”, known as “restructuring,” is a lengthier process, typically taking 3 to 5 years to finalize.
Unlike Personal Bankruptcy, a Consumer Proposal does not involve selling off assets. Instead, individuals must create a payment plan and submit it to the court for approval. Over the plan’s duration (3 or 5 years), most income goes directly to the court, which then distributes it to creditors according to the approved plan. Any remaining debt is canceled after the plan concludes.
Eligibility
The Consumer Proposal requires individuals to earn a higher income and pass a “Means test”, ensuring that income over the 3- to 5-year period exceeds what could be obtained through asset liquidation.
Secured Debt
The Consumer Proposal is designed to preserve assets, including mortgage and car payments. Individuals continue making monthly payments and retain ownership of their homes.
Your Payment Plan
The payment plan, the core of Consumer Proposal, outlines the individual’s disposable income per month and how it will be allocated to creditors. Disposable income is the net income minus reasonable living expenses, including secured debt payments. The plan is submitted to the courts for approval, and all disposable income is paid directly to the courts, which then distributes it to creditors according to the plan.
Conclusion
Bankruptcy is a lengthy process, and the last alternative to getting out of debt that cannot be repaid. The consequences are serious – with your main goal of mastering Personal Finance to be avoiding bankruptcy altogether.