The worlds of finance and law are overridden with jargon that may as well be Klingon to most of us. And like many topics that are beyond our daily scope, there’s a lot of bad information out there. Bankruptcy is one of these topics, flush with myths and nightmares that don’t actually help us understand the subject any better. We wanted to clear some of this up, so we asked our friends at Adamson & Associates to share their expertise.
1. What is bankruptcy? What does it mean to “declare bankruptcy”?
Once a person declares bankruptcy, they are no longer responsible for the debt obligations they incurred prior to becoming bankrupt. A great analogy to describe someone declaring bankruptcy is “being financially born again,” but without the burden of debt, so they can obtain a fresh start.
Bankruptcy is a legal proceeding where a person or a corporation assigns (gives) their property to a Licenced Insolvency Trustee and obtains a discharge or release from their debts. Although a person assigns their property, there are certain assets that a person is allowed to keep.
2. What is bankruptcy NOT? Could you please clear up any common myths?
For many people, it’s not an easy decision to file for bankruptcy. There is often a feeling of embarrassment, failure, and guilt. Bankruptcy shouldn’t be viewed as a failure. It should be viewed as a clean slate for someone who is overwhelmed with debts. A common myth is the belief that declaring bankruptcy means a person will lose everything, which is not the case. In Ontario, for example, there are exemptions which allow people to keep household furniture, personal effects, pensions and RRSPs, and low value vehicles. Additionally, people typically keep their financed or leased vehicles and their homes (although they would have to settle with the bankrupt estate for any equity in the property).
"Once a person declares bankruptcy, they are no longer responsible for the debt obligations they incurred prior to becoming bankrupt."
3. How can I avoid bankruptcy? Should I be budgeting a certain way?
Sometimes, financial problems are unavoidable. For example, it’s pretty difficult to plan financially for a pandemic. That said, budgeting is crucial to financial success. Having some savings set aside, and incurring minimal debt goes a long way. A budget is nothing more than a spending and savings plan. Many Canadians live paycheque to paycheque, and don’t (or simply can’t) save money, given their circumstances. . Unfortunately, this becomes a cycle of debt which can be difficult to break.
The most crucial, and arguably toughest, component to developing a financial plan is a change in spending behaviour. To start, a person should write down every expenditure they make in a month, including small purchases. Then they should determine which expenditures are essential. Remember, what a person doesn’t spend is money available for savings, investing, paying off debt, etc. Then, on a weekly basis, look at what money comes in, and plan essential expenditures from that income. Once a person has determined this, they are well on their way to developing a solid budget. If you need a place to start, KOHO’s Ultimate Budget Template is fantastic!
4. What is a licenced insolvency trustee? What do they actually do?
Licenced Insolvency Trustees (LIT) used to be called Trustees in Bankruptcy. Given that LITs do more than just bankruptcy, the title was updated. LIT’s are experts in the area of bankruptcy, proposals, receiverships, and restructurings. LIT’s are licenced by the federal government, and are the only professionals qualified to perform consumer proposals (more on that soon), division one proposals, bankruptcies and receiverships in Canada. Therefore, a person looking to file bankruptcy or do a consumer proposal must seek the services of a Licenced Insolvency Trustee.
"The most crucial, and arguably toughest, component to developing a financial plan is a change in spending behaviour."
5. What is a consumer proposal? Is a consumer proposal better than bankruptcy?
A consumer proposal is an offer from a debtor (a person who owes money) to their creditors, to settle their debts without declaring bankruptcy. The offer (proposal) must be made through a Licenced Insolvency Trustee. As long as a majority of the unsecured creditors accept the proposal (by dollar value), it is forced upon the creditors who didn’t accept the proposal. Consumer proposals allow a person to stop the interest on their debts, term out the debt into a more manageable payment cycle, and in most cases, the person only has to repay a portion of their debt to the creditors.
Although each person’s situation is different, consumer proposals are most often a better option than bankruptcy. They allow for greater flexibility in dealing with assets and a better credit rating than a bankruptcy.
6. If I declare bankruptcy, what will I lose?
When considering the assets you may lose when filing for bankruptcy, remember the fundamental difference between a bankruptcy and a proposal is that a proposal is an offer from a person to their creditors to settle the debt. Unlike a bankruptcy, a person’s rights to their assets, do not vest (pass) to the Licenced Insolvency Trustee. Accordingly, a person maintains control of their assets in a proposal. That being said, proposals are not right in every situation. Therefore, in such cases where bankruptcy is the preferred option, in the Province of Ontario the following assets are exempt from seizure: Necessary clothing of the debtor and the debtor’s dependants, household furnishings and appliances that are of a value not exceeding $13,150. Tools of the debtor, used for earning an income, up to a value of $11,300. The principal residence of the debtor if the value of the equity in the principal residence does not exceed $10,000 and medical devices and aids required by a debtor to assist with a disability. In addition to these common exemptions, there are exemptions for certain types of insurance products, pensions, and Registered Retirement Savings Plans (RRSP) provided the contributions to the RRSP were made more than 12 months prior to bankruptcy.
7. How long will a bankruptcy stay on my record? How does it affect me?
There are two main credit reporting agencies in Canada. They are Equifax and TransUnion. Both agencies collect data about a person’s credit history. Lenders often access reports from these agencies, and use this information to determine whether or not to lend to a person, and at what interest rate.
Equifax reports a first bankruptcy for 6 years from the date of the bankrupt’s discharge and TransUnion reports a first bankruptcy for 7 years from the date a person is discharged from their bankruptcy. Both agencies report repeat bankruptcies (a second or third) for 14 years.
8. Let’s say I’ve just declared bankruptcy. How long does it take to rebuild a good credit rating? What do you recommend to achieve this?
We often hear people say they never want credit again. There certainly are benefits to not using credit, and we understand suffering a debt cycle leading to bankruptcy leaves a bad taste. A prepaid credit card, such as a KOHO reloadable prepaid Visa, can help to alleviate that bitter taste. Prepaid cards can be used like a regular credit card, except they don’t lend you any credit. In other words, with a prepaid card you can only spend the money you load onto it, thus avoiding any debt. The unfortunate reality, however, is that the only way to increase your credit score, is to obtain credit again (sorry).
In today’s world, having some form of credit is becoming more crucial as we transition to a digital world. When rebuilding credit there are a few factors at play. Lenders prefer to lend funds to someone with consistent employment and a good income, rather than someone with a lower income, and less employment stability. Other lenders will prefer a homeowner over a renter. To be clear, however, building credit is not solely based upon homeownership and income. A damaged credit rating will hurt even those with high incomes. There is no magic overnight fix to repairing a person’s credit rating, and people should be weary of anyone promising such fixes.
After a bankruptcy or a consumer proposal, your credit rating will be damaged. In order to remedy this, it’s crucial to demonstrate a positive and correct credit history. After a bankruptcy or proposal, it’s always a good idea to order a copy of your credit history from both TransUnion and Equifax. It is important to review these reports and ensure that the information reported is correct (If there are things on the report that are incorrect, write to the credit reporting agency and have them investigate and correct the report).
Remember that the goal is to create a positive history on your report which will take some time. To do this, you need credit. Ideally, you’d want some type of instalment payment, where the payment is the same each month, such as a term loan, car payment, furniture payment etc. To accomplish this, people often obtain a secured credit card. In essence, the credit card company holds a deposit as collateral and issues a credit card. It is important to make the payments on time and to obtain a credit card from a company that reports to the credit reporting agencies. Building your credit rating doesn’t happen overnight, stay disciplined and give it time. You’ve got this!
"The unfortunate reality, however, is that the only way to increase your credit score, is to obtain credit again (sorry)."
9. At what point of having money problems should I contact a Licensed Insolvency Trustee?
People often believe a Licenced Insolvency Trustee is the last person they should contact. On the contrary, a LIT is one of the first people someone experiencing debt problems should contact. All too often, people experiencing financial challenges seek help from people who are unqualified to correct the situation, or they attempt to solve a financial problem by borrowing more money, which often makes the situation worse (particularly if you turn to payday lenders).
Even if a bankruptcy or consumer proposal is not right for you, a LIT is a qualified, regulated expert who can review your situation and provide you with information regarding alternatives such as refinancing, informal arrangements, and credit counselling.
10. Any final words of wisdom to share?
Like any issue, financial problems are always easier to resolve when dealt with sooner than later. Unfortunately, many wait until the situation is dire, leaving less options available to remedy the issue. If you are having a financial challenge, seek the advice of an LIT early. The problem won't get better by waiting, and we’re here to help!
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John Adamson, CPA, CMA, LIT, is the founder of Adamson & Associates Inc. a Licensed Insolvency Trustee firm that provides insolvency and restructuring services throughout Southwestern Ontario.