Nine times out of ten the answer is definitely not. Most Canadians experiencing debt problems do not need to go bankrupt. Canadians who are struggling financially have a wide array of options for dealing with their debt. By reading this article you will learn the following:
- When bankruptcy is available
- Financial triage options
- Array of debt relief options
- Why it costs twice as much to eliminate $1 of debt using credit counselling compared with a consumer proposal
When is bankruptcy available as an option to a Canadian?
A Canadian might find that he or she would like to take advantage of two debt-resolution procedures available under the federal Bankruptcy and Insolvency Act (BIA). These are bankruptcy and the consumer proposal. Later in this post I will describe these more in greater detail.
Under federal bankruptcy law neither bankruptcy nor a consumer proposal is available to an individual unless they can satisfy both prongs of a two-prong insolvency requirement. Firstly, he or she cannot meet their short-term financial obligations as they become due. Most people experiencing serious financial problems satisfy this requirement. The second requirement—total liabilities must exceed total assets can sometimes be much more problematic, particularly for Canadians with some equity in their homes. Many Canadians with significant equity in their homes are not insolvent under federal law because if they were to sell their house they could use the sale proceeds to pay off one hundred percent of their creditors.
Financial triage might be available to avoid bankruptcy
There are a number of steps that a consumer can take which might serve to drastically improve their debt situation. Some of these actions might be described as conservative financial decisions and others might be described as more radical actions. These include the following:
Reduce or eliminate debt through sale of assets
Some—but certainly not all Canadians—can avoid major debt problems by simply selling some of their current assets. This might include the sale of a home, cottage, rental property, recreational vehicle, boat or snowmobile. The proceeds from the sale of these asset can be used to pay off existing debts.
Make dramatic life-style changes to improve monthly cash-flow position
Debt problems might be the result of a major loss or interruption in income or facing major expenses. In some instances, a Canadian might be able to improve their debt situation by taking steps to improve their monthly cash flow. There are three different scenarios when it comes to improving cash flow:
- Reducing monthly household expenses
- Increasing monthly household income
- Combination of the above
Make oneself judgment proof
Not everyone who owes monies to their creditors is in serious jeopardy. This is particularly true for individuals who are judgment proof. People are judgment proof if they owes monies to their creditors and if all their creditors were to sue the person the creditors would not be able to recover any monies from the consumer. The best example of someone who is judgment proof is a senior citizen who does not own any real property whose sole income is a government or company pension and whose retirement assets are in an RRSP.
Make a consumer proposal to one’s creditors
Under federal law a person can make a consumer proposal to their creditors. Under a consumer proposal an individual will typically repay their creditors—via monthly installment over a period not to exceed five years—a fraction of what they owe to their creditors. This amount is usually somewhere between 25 percent and 50 percent of monies owing to creditors.
Hiring a firm to represent you when you make a consumer proposal
When an individual makes a consumer proposal he or she will do so through a federally-licensed Licensed Insolvency Trustee (LIT). There is a growing trend in Canada, however, for Canadian consumers to hire a firm to represent them at the time they choose to do a consumer proposal. Unfortunately, LITs have a conflict of interest when doing a consumer proposal. Not only is the person doing the consumer proposal not their client but also it is in the LITs financial best interests for a consumer to pay as much as possible under a consumer proposal.
Furthermore many Canadians like the idea of having a firm that has represented a significant number of people doing consumer proposals represent them at this difficult time in their life.
Like any industry or profession, not all consumer proposal representation firms are created equal and some are much better than others.
Going for credit counselling
Some debt-challenged consumers will contact a non-profit credit counselling agency when they are experiencing debt problems. Unfortunately, credit counselling is an incredibly expensive way for a consumer to eliminate debt. At a minimum, it is twice as expensive to eliminate debt by way of non-profit credit counselling compared with doing a consumer proposal.
An example involving Joe who owes $35,000 in credit card debt will help illustrate this difference. If Joe were to do a consumer proposal then he would not pay more than $17,500 to eliminate his debt,—and potentially much less—by way of monthly installments over a period not to exceed five years. In contrast, if Joe were to go for credit counselling he would pay approximately $37,500—by way of installments over a period of three to five years.