Bankruptcy: What is it? How does it work? How much does it cost? Is it worth it? Should you file one?
Are you considering filing bankruptcy but are not sure of the ins and outs? Our offices have assisted thousands of Dartmouth, Halifax, and Nova Scotia residents navigate the most common questions we get asked. These are What is a bankruptcy, how does it work, how much does it cost, is it worth it, and should you file one? In our experience, bankruptcy should be used as a last resort as it is often more damaging and unforgiving than other available options. Our goal in this article is to shed light on a very complicated topic. Let’s first shed light on what bankruptcy is:
Bankruptcy is a legal process that is filed by a licensed insolvency trustee (formally bankruptcy trustee). In this process, a consumer surrenders their non-exempt assets to the trustee who subsequently sells them for the benefit of the creditors. The bankrupt individual will also be required to make payments according to their household size and income and attend financial counselling sessions. The length of a bankruptcy for a 1st bankruptcy is 9 to 21 months. For a 2nd bankruptcy, the length is 24 to 36 months. The cost is based upon several factors such as household income, household size, what type of assets the consumer has, and if they opt to buy them back from the trustee.
Bankruptcy in Canada is complicated, let’s cover off the various topics that are relevant.
Youtube – Companion video on Bankruptcy in Halifax
Looking for a quick way to review how bankruptcies in Halifax work? Look no further, we have created a companion video to this article. While not as in-depth as this bankruptcy article, it does give a board overview.
How does surplus income in Bankruptcy work?
Surplus income forms one of the three costs of bankruptcy. Not everybody that files bankruptcy will be required to pay surplus income, however, it is very common that this payment will be required.
Surplus Income is based upon your household size and household income you will have to pay a percentage of this income. It is based upon take-home, after-tax, income. A single individual that does not have non-discretionary expenses (such as daycare costs, prescription expenses, child support, alimony, etc) would be allowed to make $2,203 per month in 2019, according to the Surplus Income Guidelines. Half of any amount of money that is earned above and beyond the guideline amount would be the required payment in bankruptcy. If this person made $2,403 per month they would be required to make a payment of $100 a month for the duration of the bankruptcy.
In the event, there are multiple people the amount payable is based upon the person that is filing prorated amount of income.
This calculation can become quite complicated so I have included a couple of examples below the Surplus Income Guideline chart in the next section.
Surplus income also determines the length of bankruptcy. Anytime an individual earns more than $200 above the income guidelines listed below they will have their bankruptcy extended. How long bankruptcy extends depends on whether they’ve been bankrupt before or not. An individual who has never been bankrupt before would have their bankruptcy extended from 9 to 21 months. An individual that has been bankrupt before will have their bankruptcy extended from 24 to 36 months. When someone goes bankrupt more than two times they actually have to go to court to receive a discharge.
Surplus income is a moving target that is calculated on a monthly basis while you are bankrupt. In the event you make more money, make less money, your family situation changes, etc you may be required to modify your payment. Near the end of your bankruptcy, the trustee will calculate the average amount of surplus income you should have paid. If you have overpaid, they will generally refund this (if you are not buying back assets), and if you have underpaid you will generally have to pay this amount prior to receiving your discharge.
These are expenses that receive special treatment when someone files bankruptcy. These expenses get added to the guideline amount.
Please see the chart below that lists the most common non-discretionary expenses:
|Child Support Payments||Self Explanatory - But can also involve other court ordered payments in relation to child support.|
|Spousal Support Payments||Self explanatory|
|Child Care||Daycare, after school programs, etc|
|Medical Condition Expenses||Prescriptions, eye-wear, etc|
|Payments towards Fines/Penalties imposed by a court||Speeding tickets, etc|
|Expenses as condition of employment||Any employer required expense you are not reimbursed for.|
What are the Surplus Income Guidelines and Limits in 2019?
2019 Income Surplus Guideline Chart
|Family Size||Income Threshold|
Bankruptcy Surplus Income Examples:
Example # 1
For the first example, we will look at a family of three. A husband and wife, with a young child. The Husband has debt and intends on filing bankruptcy. His wife does not intend on filing bankruptcy. They have daycare costs of $500p/m. He makes $2,500 per month, and she makes $1,750 per month after taxes. They receive $400 per month for their Canada Child Benefit (CCB). He has unfortunately been bankrupt before.
The surplus income guideline for a family of three allows them to make $3372 and an additional $500 per month for the daycare costs for a total of $3,872 per month. The first step of calculating surplus is to calculate the difference between how much they make as a household and the guideline, including non-discretionary expenses. In this example, the difference is equal to $778. This number is known as the ‘Household’s Surplus Income’.
Once you have the household’s surplus, you must pro-rate it to be proportional to the individual filing bankruptcy. In this case, the Husband’s income. He makes 53.7% of the household’s income ($2,500 divided by $4,650 multiplied by 100). So now you take the $778 and multiply it by his percentage of the income. This yields a result of $417.79. This is the Husband’s surplus income. Once you have this you can calculate how much would be paid in bankruptcy for the Surplus Income portion of his payment by dividing this number by two. $417.79 divided by two would have him paying $208.90 per month.
Because he has filed a bankruptcy in the past and his surplus income is above $200 per month, he is required to stay in bankruptcy for a period of 36 months.
Example # 2
For our second example, we will look at a family size of two. A couple who have joint debt who are considering filing a joint bankruptcy. They each make $2,000 per month for a total household income of $4,000 per month. They have no non-discretionary expenses. This is their first bankruptcy.
The surplus income guideline for a family of two allows them to make $2,743 per month. The difference between their household income and the guideline is $1,257. This is their surplus income. As they are both filing, their household income represents 100% of the income of those that are filing. No pro-rated calculations are required.
You simply divide $1,257 by 2 to obtain the amount of money they would be required to pay in bankruptcy. $1,257 divided by 2 is equal to $628.50.
Because this is their first bankruptcy, they would be bankrupt for a period of 21 months because their surplus income is above $200.
As you can see – in both of these situations the payments can become quite sizeable especially when you factor in the cost of living. There are an infinite amount of ways bankruptcy can look. If you are not sure how to do your calculation. Drop us an email or leave a comment and we can help.
What happens when I file a Bankruptcy?
When you file bankruptcy there are two things that occur. First, a bankruptcy estate is created and the second thing is any assets that you own vest with the trustee. Technically speaking, when you file bankruptcy you are surrendering all of your assets to the trustee. When your assets vest with the trustee, the ownership of those assets belong to the trustee, for the benefit of the creditors.
Normally, before this occurs you will have already decided which assets you wish to outright surrender and which assets you wish to retain in bankruptcy. The assets you wish to retain, if they have any value and are not exempt, must be ‘bought back’ from the trustee. Keep reading as we have included a section on this. Assets you wish to surrender will be sold and the proceeds from the sale will be given to the creditor after the trustee takes their cut.
You will also be required to submit monthly income and expense reports. These reports record all the income that you made on a monthly basis as well as all the expenses that you spent. You generally must provide back-up for income earned and non-discretionary expenses you incurred. The numbers that you report on these forms will be used to determine your Surplus income as described above. Although the sheets ask for your expenses, they do not impact your bankruptcy payment. Only the non-discretionary expenses do. We do recommend that people who file fully complete the forms as tracking income and expenses is a good habit.
Something to note – Technically speaking your debts are not released (cancelled, nullified, etc) when you file a bankruptcy. This only occurs when you receive your discharge. I’ve included a detailed section on discharges below.
What are the costs of Bankruptcy?
There are 3 costs associated with bankruptcy generally bundled into a single payment. They are:
- The cost of the Licensed Insolvency Trustee,
- The Surplus Income obligation, if any, and
- The amount to ‘buy-back’ assets, if applicable and if you opt to retain assets.
The Cost of the Trustee
The cost of the Trustee is based upon a Tariff – a fee structure imposed by the bankruptcy and insolvency act. This fee typically ranges anywhere from $1500 as a base fee upwards of ~$9400 (tax inclusive) in Nova Scotia. The fee is based upon how much you pay back to creditors in accordance with your income surplus calculation as well as any assets you buy-back. This fee is paid in one of two ways: either directly out of pocket if you are not in surplus and have no assets to buy back, or it is paid out of the amount of surplus income or asset buy-back amounts as described below.
LegalLine, a non-profit, a free legal resource for Canadians is very clear that there is a potential conflict of interest between a consumer and a Trustee because of how they are paid. To quote them:
“It is important to note that LITs have a potential financial conflict of interest in consumer proposals and bankruptcies, in that the more money that a debtor repays to the creditors under a consumer proposal or bankruptcy, the greater the financial compensation earned by the LIT.”
Because of this potential conflict, it is very important to obtain unbiased independent advice. We’d love to be that resource for you. If you approach someone else we will gladly give you a free second opinion.
The Surplus Income Obligation
As described above, you may be required to pay surplus income into your bankruptcy estate. In the event you need to a part (or all) of your payment will include a portion to go towards the trustee.
The cost to ‘Buy Back’ assets
In the event you wish to retain assets that are not exempt from a seizure that also have equity in them you will be required to buy them back. While you are bankrupt your assets ‘vest’ with the trustee. In essence, the Trustee owns the asset and their job is to recover the value of the asset to then give the proceeds to the creditors. They generally have two choices; they either sell the assets or you can buy the asset back. Both achieve the same result which is cash for the creditors.
If you have a car that has $5000 worth or realizable value, you will be required to pay that $5000 over the period of your bankruptcy.
In certain instances, the cost to buy-back assets exceeds what most could afford on a monthly basis over the standard 9-36 month window. In these instances, most insolvency trustees are OK with you paying them over a longer period of time. If you are considering this you should strongly consider a consumer proposal. I wrote an in-depth article on consumer proposals here. The reason is a proposal is designed for exactly this purpose.
Licensed Insolvency Trustees, Formally Bankruptcy Trustees
Licensed insolvency trustees are federally regulated and licenced individuals who can administer the Bankruptcy and Insolvency Act. Anyone that files a consumer proposal or bankruptcy in Canada must see a licensed insolvency trustee. Insolvency trustees represent the interests of the creditors and protect the rights of the debtor, however, their role is not one of an advocate for either. They are simply the referee to the process and ensure all sides are treated fairly and in accordance with the law.
A trustee has certain statutory duties that they must perform. Their primary role, out of administering the bankruptcy and insolvency act, is to investigate the affairs of the consumer to ensure the consumer is not committing fraud. They are also there to ensure the consumer’s rights are respected. That is – to ensure creditors stop collecting, calling, etc.
Will I lose my house in Bankruptcy?
A common myth is that if you file bankruptcy you will lose your house. This is not the case in most situations. In fact, even if you file a bankruptcy, no one can force you to give up your house. If you wish to retain the property and it has equity you simply have to pay for the equity. The amount that you have to pay to retain your house really depends on the amount of equity. If there is no equity in your property then you’ll be required to pay nothing to retain your property. However, you will have to continue paying the mortgage.
For example, if you have a property that has $5,000 equity in that you’ll have to pay $5,000 over the course be bankruptcy in order to retain your property. In the event you do not maintain these payments it’s technically the trustee’s duty to seize the house and sell it for the benefit of your creditors.
You must certainly consult with a professional to determine what makes sense and what doesn’t make sense as it relates to properties with potential equity. The real concern is if you decide to retain your property and cannot make the payments it is a very real possibility that you will lose your house.
Will I lose any other assets?
The only assets you lose in bankruptcy are the ones you decide to surrender or those that you are unable or unwilling to pay for.
For example, if you have a boat that’s worth $10,000 but you simply cannot afford to pay for and/or do not want you can decide to surrender it. If you surrender the asset in bankruptcy the trustee will sell it and give the creditors the money after they take their fees. If you wished to retain the boat you would simply pay back the $10,000 to the trustee and ‘buy-back’ the asset.
There are certain assets that are exempt in bankruptcy which I’ve listed below.
Exempt Assets in Bankruptcy
|RRSP||Everything except for the last 12 months of contributions||$100,000 total RRSP value. Consumer contributes $10,000 per year. Only $10,000 would be taken into account.|
|TFSA||No exemption.||Unfortunately, entire TFSA value is used.|
|RESP||No exemption. However, only the amount you can withdraw is used.||Family has a $10,000 RESP of which if they were to withdraw it they would receive $8,000 (The remainder is government grants, etc) would be available.|
|Whole Life, Universal Life, or other life insurance contracts with cash value||Exempt if beneficiary is a preferred beneficiary (One-off relative, excluding siblings). For example: Mother, Father, Children||Someone has a whole life insurance policy with a cash surrender value of $50,000. If they beneficiary were their brother the $50,000 would not be exempt. If the beneficiary were their mother, it would be exempt.|
|Motor Vehicles||A single $3000 for a motor vehicle, or $6,500 if required for work.||If someone were to have a vehicle worth $5,000 and required it to get to and from work it would be completely exempt. If someone had a vehicle worth $10,000 and didn't require it for work only $7,000 would be taken into account.|
|Houses||No Exemption||Equity, depending on Trustee, can be calculated in a variety of manners.|
|Stocks/Bonds/Other Investments held in non-registered accounts||No Exemption||Entire amount taken into account, generally net of taxes. Example: $100,000 of IBM stock, tax estimate of $30,000 - value used is $70,000.|
|Pensions/LIRAs/Locked-in Retirement Accounts,||Completely exempt||Value is completely protected.|
Bankruptcy Discharge Dates
As mentioned above, bankruptcy is generally 9 to 36 months in length depending on your income and if you have been bankrupt before. For those with surplus income above $200, you will either be bankrupt for 21 months; if you have never been bankrupt before, or 36 months if you have been bankrupt once in the past. If you are not in surplus you will be bankrupt 9 months if you have not been bankrupt in the past, or 24 months if you have. If you have to go bankrupt more than twice in your life you will, unfortunately, have to go to court to obtain your discharge and it is not uncommon for someone to remain bankrupt longer than the periods listed above.
This does assume that you have completed all of the requirements of your bankruptcy. These are – submitting your monthly income and expense reports to your trustee, attending your two counselling sessions, and making your required payments for the duration of your bankruptcy. If you do not complete all of these it is very possible that a trustee will oppose your discharge and you will be forced to remain bankrupt longer.
In the event, a licensed insolvency trustee opposes your discharge they will almost always charge you additional fees. The average across Halifax, Dartmouth and Nova Scotia are $500.
In the event, you are behind on bankruptcy payments every trustee treats things a little differently. Some will allow you to make monthly payments towards your arrears but many will want a lump-sum payment for the total amount in arrears, especially if they have removed themselves from your file. The reason for this is the cost of re-opening a file is quite expensive. Generally speaking, you will not receive your discharge until all payments are made.
Can I keep my credit cards in Bankruptcy?
No. When you file a bankruptcy you are required to cut up your credit cards. However, shortly after you file bankruptcy you can obtain a secured credit if you are 100% ready for it. We generally discourage this though until you are truly ready to utilize credit.
For those that are ready we generally recommending with a small-limit secured credit card and using it appropriately for 3-6 months prior to obtaining anything else.
Do I lose my income tax refund in bankruptcy?
Yes. Your income tax refund is an asset of your bankruptcy estate meaning that the trustee is obliged to seize it (in fact, CRA generally sends the refund directly to the trustee) and after they take their fee, they send it to the creditors. Bankruptcy is the only option where you lose your income tax refund.
What are the negatives of filing bankruptcy?
There are negatives when you file a bankruptcy. The most obvious one is the credit impact that ultimately follows you after discharge. For a first time bankrupt your credit is impacted for a period of 6 years past your date of discharge and if you’ve been bankrupt before in the past then your credit will be impacted for a period of 14 years after being discharged. Compared to other options the long term consequences of bankruptcy are very severe.
The other negatives have to do with the way surplus income is calculated. When you file a bankruptcy you’re required to submit monthly income expense reports. For the duration of the process, you have to submit the amount of income you earn which is then used to calculate your surplus income. In the event your income increases for the duration of your bankruptcy it is possible that you could end up paying a substantially higher amount of money than initially estimated.
For example, as mentioned above, the guideline for a single individual is $2,203. If an individual starts with their at income $2,000 they would not be required to pay any surplus income. The negative happens in the event that their income increases. Let’s imagine it increases to $3,203. If this occurred they are required to pay $500 a month for the period of time that their income increased. It is common practice for most trustees to only confirm this number near the end of the bankruptcy. In the event the consumer wasn’t aware of this, they could get slapped with a very large bill.
Should you file bankruptcy?
Filing bankruptcy is something that shouldn’t be taken lightly. Knowing whether or not to file depends on several factors. But here are a few reasons NOT to file bankruptcy:
- You have a smaller debt load – Because of the long term consequences of bankruptcy, someone with a smaller debt load may want to avoid bankruptcy. The reason for this is because the alternatives usually do not cost much more. For someone who would only pay the base trustee costs when filing may still benefit from an alternative like a consumer proposal. It would certainly be more expensive but the extra cost is almost always worth it when you consider the consequences.
- You have a large amount of non-exempt assets – For a first time bankrupt who has even $10,000 worth of non-exempt assets would be forced to pay a significant amount of money on a monthly basis to retain them. Even if they had the full 21 months to pay it back they would incur an additional $476p/m payment on top of their surplus payment, whatever that may be. Other options would most certainly provide a lower monthly payment which would be far more flexible.
- You have a high monthly income – Similar to the reason listed for assets. If you have a large take-home income and a lower household size bankruptcy can be very expensive. We have had clients who earn a few thousand over the guideline obtain significantly smaller payments than they would be forced to pay in bankruptcy through other options.
- You expect to earn more income during the term of bankruptcy – Because surplus is calculated on a monthly basis if you earn more money you can end up paying significantly more.
Now when does a bankruptcy begin to make sense?
- If you have a very high debt load – at a certain point, you might have too much debt where bankruptcy starts to make sense. This largely depends on your income. For some, this might be $80,000 and others might be $200,000.
- You are on a fixed, long-term income, and have little need for credit in the future – This generally applies to the senior’s category, albeit not always. If you have little need for credit in the future, know your income won’t increase and have little assets a bankruptcy can sometimes make sense.
We haven’t listed every single reason of course. There are too many to list but the list above is a good starting place to determine whether filing bankruptcy or not is a good idea.
What are other options than just Bankruptcy?
The most common option to avoid bankruptcy is a consumer proposal, which we have referenced a few times. Other options include credit counselling, which is by far the most expensive debt restructuring option that exists in Canada. We have also written on debt consolidation, debt settlement, and a great guide on how to implement effective budgeting strategies to get you debt-free quickly. That article is here – 5 Steps to get debt free fast.
Bankruptcy is certainly the right option in a variety of cases, but what we have found is that when people understand the real pros and cons of every option they opt for solutions other than filing bankruptcy. Unfortunately, in Nova Scotia people jump to bankruptcy as the only option available to them. While it can assist there are usually better options out there.
It is clear that bankruptcy is a very complicated topic. I believe this to be the most in-depth article on bankruptcy that has been written and we have only scratched the surface. If you are reading the article and are confused please reach out for professional help. We’d love that to be us. But, in the event it isn’t us we are always available for a second opinion.
When choosing any debt restructuring option the goal is to solve the situation once and for all. With an estimated repeat rate of nearly 1 in 4, you don’t want to have to do this all over again simply because you rushed into a decision.
Feel free to email us or leave a comment with any questions you may have. We monitor our site often and will respond as soon as we see them!
This article was written by David Moffatt. A Senior Debt Relief Specialist with 4 Pillars Halifax. 4 Pillars has assisted in creating plans that have helped save Canadians over $1 Billion dollars of consumer and tax debt since 2002. We believe that no consumer should have to struggle with the stress of overwhelming debt. Our debt restructuring plans can help you cut your debt by up to 80% with less than 3% of our clients ever getting into deep financial difficulties again. If you are struggling with debt please reach out. It hurts to continue to suffer financially.