VII – Dealing with Debt

There are two legal avenues one can take to deal with excessive debts. Both are proceedings under the Canadian Bankruptcy and Insolvency Act, and are explained below.

PERSONAL BANKRUPTCY

Personal bankruptcy laws exist to allow honest but unfortunate individuals to remove the burden of crushing debts. This enables them to become productive members of society.

Sounds good, right? It sure does – but not without a cost:

ASSETS

First, the act of filing for bankruptcy divests a debtor of his assets. With certain exceptions, his assets will become the legal property of the bankruptcy trustee, who is required to liquidate these assets and distribute the proceeds to his creditors. The exceptions (i.e., what you can keep) in Ontario, Canada are:

• personal use vehicle up to $5,650
• RRSPs, however any contributions made within 12 months prior to filing bankruptcy are seized by the trustee
• pensions
• tools of trade up to $11,300
• personal effects up to $5,650
• household furniture up to $11,300
• life insurance policies with a cash surrender value if the beneficiary is the child, grandchild, parent or grandparent of the debtor

Fortunately, most people only have assets that fall within the above categories,  so losing any assets is a non-issue. However, there are two types of asset situations which are quite common and require further explanation.

The home

If you own a home and you happen to own it “free and clear” (i.e., it’s mortgage-free), the trustee will have to realize on it. He’ll do this in one of two ways: (1) he’ll sell it; or (2) you’ll find some way to buy him out so you can keep the home. For example, you may have a family member that can help you pay the trustee the fair market value of the home so you don’t lose it.

If you own a home with a mortgage, the trustee will calculate if it has any equity by obtaining the fair market value of the home and the current mortgage balance. If there is no equity (i.e., mortgage plus selling costs >  fair market value), the trustee will have no interest in the home. If there is equity (i.e., fair market value > mortgage plus selling costs), you’ll have to pay the trustee the difference in order to keep the home. Again, you can obtain the assistance of a friend or family member to pay the trustee this equity amount.

So now you’ve dealt with the trustee – now, what about the bank? So long as your mortgage payments are current, you won’t have any problems with your bank in keeping the home, even if you are bankrupt. They do not want your home – they want to keep making money off you by charging you interest on the mortgage loan. Therefore, so long as the mortgage payments are current, they are happy.

The car

As stated above, you can keep a personal use vehicle if its fair market value is less than $5,650. What happens if it’s worth more than that? Well, it depends….

If the vehicle is owned free and clear, the trustee will be required to liquidate it. He’ll either: (1) sell it; or (2) you can buy him out by getting help from a friend or family member.

However, more often than not, a car will either be leased or financed.

A leased vehicle is property of the leasing company and does not belong to you. Since it wasn’t your property to begin with, the trustee has no interest in it. Furthermore, so long as your lease payments are current, the leasing company will not care if you’re bankrupt. They don’t want the car – they want to keep making money off you from the interest they charge on the lease payments. So no worries there.

On the other hand, a vehicle that is financed DOES belong to you, and the trustee may have an interest in the vehicle. Whether he does or not will depend on the fair market of the vehicle and the balance on the loan. If the fair market value > loan balance plus estimated selling costs (i.e., the vehicle has equity), then you’ll have to pay the trustee the difference in order to keep the car. If it does not, then the trustee won’t have any interest in this vehicle.

That’s it for assets. Now let’s talk about what you’ll be paying to the trustee.

PAYMENTS

What you are required to pay will depend on your monthly net income (that is, income after taxes are deducted from your pay).

There is a concept in bankruptcy law called “surplus income”. The philosophy behind this concept is this: if you’re taking advantage of personal bankruptcy laws to get rid of a lot of debt, you are required to pay a portion of your net monthly income to the bankruptcy trustee for the benefit of your creditors.

How much you’ll be paying is determined by a “monthly living allowance” guideline established by the Office of the Superintendent of Bankruptcy, called the Superintendent’s Standards. Here are the Standards for 2010:

Single person     $1,884

Family of two     $2,345

Family of three  $2,883

Family of four     $3,501

Family of five      $3,971

Family of six       $4,478

Family of seven $4,986

Hence, a single person should be able to live on monthly net income of $1,884 per month and pay for his food, shelter, and entertainment.

So if Joe Smith, who earned a monthly net income of $3,000 had to file for bankruptcy, he’d be required to pay $558 for every month he’s bankrupt. This is calculated as follows:

(Net income – Superintendent’s Standard) x 50% = Required Payment

($3,000 – $1,884) x 50% = $558

As another example, let’s say Joe Smith and Nancy Smith (who’s net income per month is $2,000) were a married couple, were both in debt, and had to file bankruptcy together. They’d be required to pay $1,328 per month:

($5,000 – $2,345) x 50% = $1,328

So how long does this have to be paid? If the above calculation formula results in a Required Payment amount of at least $100, you will be required to make payments for 21 months. You’ll be discharged from bankruptcy only when you’ve completed your 21 required payments. If the Required Payment amount is less than $100, you’ll only be in bankruptcy for 9 months.

If you are filing bankruptcy a second time and the Required Payment amount is at least $100, you’ll be required to make payments for 36 months. If the Required Payment amount is less than $100, you’ll be in bankruptcy for 24 months.

OTHER THINGS TO KNOW

• The trustee is required to prepare and file your personal income tax return for the year of bankruptcy. Therefore, if you filed bankruptcy in 2010, he’ll be required to file your 2010 tax return. In the event there is a  refund, you will lose the refund, as it will be sent to the trustee’s office by the Canada Revenue Agency. The trustee distributes the refund proceeds to your creditors.

• You are required to keep a monthly income/expense statements and attend two financial counselling sessions during the bankruptcy.

• Filing bankruptcy does not actually get rid of your debts; it only protects you from legal proceedings by your creditors (i.e., wage garnishments, liens, etc.). Your debts are extinguished only when you obtain your discharge from bankruptcy, and you will only be discharged if you’ve (1) cooperated with the trustee in realizing your assets; (2) made the required surplus income payments; (3) prepared monthly income/expense statements and attended financial counselling.

• A record of your bankruptcy stays on your credit file during the time you are bankrupt and 6 years after the date of your discharge from bankruptcy. However,  notwithstanding your credit record, you can start rebuilding your credit immediately after your discharge. The most efficient way to do this would be to obtain a secured credit card.

• The trustee’s fees are paid from the trust funds which resulted from realizing your assets, collecting your surplus income payments and processing your income tax refund. His fees are calculated according to a tariff in the bankruptcy act.

CONSUMER PROPOSAL

Let’s say you have a lot of debt and for one reason or another, you don’t want to file personal bankruptcy. There is a legal proceeding in the Canadian bankruptcy act called a Consumer Proposal, which allows you to consolidate and settle your debts. This may be a good option for you if you meet the following criteria:

• Your debts (excluding your mortgage if you own a home) do not exceed $250,000
• You are able to pay your monthly living expenses and still have money left over to finance a proposal.

To illustrate how this works, let’s use the following example:

Jan has $80,000 in credit card debt, and she has fallen behind on her minimum payments. She can no longer pay off her debts.

She makes a good income and her living expenses are reasonable. Here is her monthly budget:

With the assistance of a bankruptcy trustee, Jan puts together a consumer proposal in which she offers to pay to her creditors $60,000 over 60 months, or $1,000 per month x 60 months. As you can see from her budget, she can afford to make these monthly payments to the trustee, who holds the funds in trustee for Jan’s creditors. This proposal would provide Jill’s creditors with a return (before the trustee’s fees – see below) of 75% of what they’re owed ($60,000 / $80,000 = 75%), which both Jan and her trustee feel is a fair settlement.

You shall also note that Jill has no credit card payments in her budget. Upon filing her consumer proposal, she stops paying her creditors – they can only be paid through the proposal.

Some things you should know:

• Upon filing a proposal, your credit rating will be the same as that of a bankruptcy individual. This goes away once the proposal has been completed.

• The maximum length of a consumer proposal is 60 months. It cannot exceed this length of time.

• The trustee’s fees are paid out of the trust funds, and are calculated pursuant to a tariff in the bankruptcy act.

• Filing a consumer proposal does not actually get rid of your debts; it only protects you from legal proceedings by your creditors (i.e., wage garnishments, liens, etc.). You debts are extinguished only upon the completion of the proposal. Should you default on your proposal payments, your creditors will be able to recommence their collection activities.

• Upon filing a consumer proposal, interest stops accruing on your debts. Therefore, your settlement would be based on the debt as at the date of filing the proposal.

So as you can see, a consumer proposal is almost like an interest-free debt consolidation which doesn’t even require you to pay your debts in full. This is an excellent alternative to filing for personal bankruptcy if you have assets you wish to keep and you have sufficient income to finance the proposal payments.

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