All Debts Are Not Created Equal

The following post is a primer on the types of debt and how they are dealt with in the context of a bankruptcy.

There are two types of debt: (1) unsecured; and (2) secured.

Unsecured debt is not secured by an asset. The bank provides the debtor with a loan and she signs a promise to repay.

A secured debt is debt secured by an asset. The bank provides the debtor with a loan and she signs a promise to repay, but she also agrees to give the bank security over an asset. If the loan isn’t repaid, the bank has the right to sell their security and use the proceeds to pay down the loan.

Examples of unsecured debt would include credit cards, bank overdrafts, lines of credit, and personal income taxes.

Examples of secured debt would include a home mortgage and a car loan.

An insolvency filing (i.e., personal bankruptcy or consumer proposal) will not affect a secured loan so long as the loan continues to be paid by the debtor. So if the debtor has a car loan and wants to keep the car, she’ll need to continue making the loan payments. Likewise, if the debtor has a mortgage and wants to keep the home, she’ll need to continue making the mortgage payments.

An insolvency filing affects only the rights of the unsecured creditors. That is: (1) they cannot continue chasing the debtor for payment after an insolvency filing (the debtor is under bankruptcy protection, called a “stay of proceedings); and (2) whatever debts are owed to the unsecured creditors will be discharged at the end of the insolvency engagement.

Special situations

Debt owing for child support or spousal support is an unsecured debt. However, this type of debt is not discharged in insolvency proceedings. Furthermore, the stay of proceedings does not stay collection action this type of debt. Therefore, an organization such as the Family Responsibility Office can continue garnisheeing a debtor’s wages for unpaid child support, notwithstanding that an insolvency proceeding has been filed.

A debt incurred from incurring an offence under any law, such as tickets for traffic violations, is an unsecured debt. However, this type of debt will not be discharged in insolvency proceedings. These types of creditors are subject to the stay of proceedings until the trustee has closed the debtor’s file. Once the file has been closed, the debtor will be liable to pay the fine.

A student loan borrowed under a government program (e.g., Canada Student Loans Act or OSAP) is another type of unsecured debt. However, this type of debt will not be discharged unless it has been more than 7 years since the debtor last attended school prior to her filing an insolvency proceeding. However, student loan creditors are subject to the stay of proceedings until the trustee has closed the debtor’s file. Once the file has been closed, the debtor will be required to repay the student loan.

Any debt that was proven in a court of law to have been incurred through fraud or misrepresentation will not be discharged in an insolvency proceeding. The most common example is where someone applies for a loan and gets the loan after providing false information regarding their income, assets, employment, etc. That is, the bank would never have provided the loan if they were aware of the debtor’s true financial situation. The onus is on the creditor to prove in court that fraud or misrepresentation was committed by the debtor. If they cannot prove that, then the debt will be discharged.

Often, a personal will go into business and incorporate a company. If that person is a director of the corporation, she will be personally liable for any unpaid GST, PST, payroll taxes (income tax, CPP and EI deducted from employees’ wages), wages and vacation pay in arrears. Although these are business debts of the corporation, they are linked to the debtor personally because of various income tax and employment laws which hold the director personally responsible. If the debtor files an insolvency proceeding for herself personally, then these debts will be discharged. They are also subject to the stay of proceedings.

This blog post is an overview rather than a complete analysis. Before applying any of these suggestions, please contact us to discuss your situation with us. We’ll be more than happy to speak with you.

© Copyright Fong and Partners Inc 2010.

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