Consumer Proposal vs Bankruptcy: The ultimate comparison
When we assist clients in reviewing their debt consolidation options we can often tell that our clients wonder whether or not they should file bankruptcy. We try and make this as easy as possible by visually showing them the difference in a face-to-face appointment. Knowing the pros and cons of a consumer proposal vs bankruptcy is extremely important. Making regular payments through a special arrangement to settle your debts. We know this question is on the mind of many of our clients before they even come to see us so that is what we are going to cover today.
We would recommend that you first read our individual posts on both a Consumer Proposal and Bankruptcy. Understanding how they individually work will really help in determining which option is best suited for your situation. Once you have read those come back to see a side-by-side comparison. Our goal with this article is to understand the difference between a consumer proposal and bankruptcy.
We will be covering the largest differences and some of the minor details that can make a difference in your particular situation.
Let’s dive into a consumer proposal vs bankruptcy!
What happens to my assets
In bankruptcy, you either surrender any assets that have value or you re-purchase them from the Trustee. Your assets vest with the Licensed Insolvency Trustee for the term of the bankruptcy and they ultimately control what happens to them in that period of time. If you do not make your asset buy-back payments, the trustee will have no choice but to seize the asset and sell it for the benefit of your creditors.
In a consumer proposal, this ‘vesting’ process does not occur. You retain ownership of all of your assets. You can, however, still surrender assets if you so choose.
Verdict: When comparing a bankruptcy to a consumer proposal as it pertains to assets it is clear that a consumer proposal is the clear winner.
What happens to my credit
In bankruptcy, your credit will report as a Bankruptcy – R9. This will remain this way for 6-14 years past your date of discharge. This depends on whether you have been bankruptcy in the past or not.
In a consumer proposal, your credit will report usually as a Bad Debt – R9 for the duration of the repayment plan. Once paid it will be listed as an R7 – Making regular payments through a special arrangement to settle your debts. Based on the new Equifax rules, this will only report for 3 years past the date of the last payment OR 6 years from the date of filing, whichever comes first.
From a practical standpoint is there any major difference? Yes and no. Long-term a consumer proposal is a far superior option because you can honestly answer ‘No’ to any of the questions that ask if you have been bankrupt in the past. In the short-term, both options will limit your ability to obtain new credit. I have discussed this further in-depth in this article.
You can also start to effectively rebuild credit during the term of the proposal whereas it is extremely difficult, if near impossible, to begin rebuilding credit while bankrupt.
Verdict: When comparing the credit impacts of a consumer proposal vs bankruptcy I give a slight edge to a consumer proposal based upon the ability to begin rebuilding credit while in the consumer proposal and the fact that the long-term consequences are lower.
How much they cost (Monthly payments)
An interesting fact that a lot of people are unaware of is that in most instances a bankruptcy, on a monthly basis, costs more than most other debt consolidation methods.
A bankruptcy is calculated based upon a formula which I have covered in-depth in my bankruptcy article (linked above). This calculation doesn’t change just because you have high expenses (unless they are a non-discretionary expense). Because of this, we have often found bankruptcy to be unaffordable for most consumers.
Imagine a family of two that makes $4,500 per month clear. If they went bankrupt they would be required to pay $878.50 for a period of at least 21 months (assuming they never were bankrupt in the past) for a total of $18,448.50. I can almost guarantee you that with this level of income, assuming they had a house and each had a vehicle and the related expenses for all of that would not be able to afford a near $900 per month payment. Most of our clients are in similar situations.
A comparable proposal payment might be $350 x 60 for a total repayment of $21,000. This is less than half the cost of the bankruptcy. Yes – the proposal costs more overall and is longer but the client can actually afford it. More importantly, with a payment of $350 per month, there is a very high chance that the clients could also afford to put aside a small amount to set up an emergency fund. This would allow them to safeguard against future insolvency.
As a side note – bankruptcy repeat rates nationwide are estimated to be about 20-25% currently. I was recently speaking with a local Licensed Insolvency Trustee who guessed in his firm that the repeat rates were closer to 30-40% here in Nova Scotia. This is an alarming statistic. I would hazard a guess that the required monthly payments being so high in bankruptcy might have something to do with it.
Verdict: A consumer proposal is substantially ahead of bankruptcies when it comes to the required monthly payments in most instances. There are of course cases where bankruptcy is cheaper on a monthly basis but this is becoming rarer.
How much they cost (Overall)
Bankruptcy, at face value, will always be your cheaper option. This is why it is the most severe option. However, it is not always the cheapest option. There are a few reasons for this:
- Trustee fees – Until a consumer proposal offers your creditors approximately more than $25,000 the fees a Trustee charge is higher in bankruptcy than in a proposal. What this means is that in some instances, because of how a Licensed Insolvency Trustee is compensated you could offer your creditors less in a consumer proposal than you would pay in a bankruptcy.
An example of this is someone who is worth, for example, $12,000 in bankruptcy. If they were to offer $9,000 in a consumer proposal the creditors would actually receive more money than if the individual were to go bankrupt. For the most part, all creditors care about is the money they receive at the end of the day so these pass all the time.
Buyer beware – most Licensed Insolvency Trustees refuse to file consumer proposals for less than someone is worth in bankruptcy.
- Change in circumstances – Bankruptcy is based upon the value of your assets at the time of filing (and any post acquired assets) but more important to note is the amount of money you make. The amount of money you make is tracked for the duration of your bankruptcy. If you begin to make more money after you file bankruptcy your payments will most likely change and you will begin having to pay more. Most people consider filing bankruptcy when they have had a life-changing event. The most common ones are health emergencies, loss of employment, separations, etc. Most of the time these situations cause significant disruption. In our experience, it is these types of disruptions that cause people to fall into financial difficulties.
When you deal with these problems (through debt consolidation, restructuring, etc) they usually are short-lived from a financial impact perspective. What we see occur time and time again is when people are struggling financially they are looking for the quickest way to get out of their current situation. This is why bankruptcy is such a popular debt relief option. Usually shortly after someone files and they reduce the stress and their overall struggle their life begins to move forward again. This often comes in the form of pay-raises, a better job (or getting a new job if unemployed), etc.
It is because of this occurrence that we see a lot of clients be unhappy about their decision to file bankruptcy after it occurred. The end result can also mean people are struck in bankruptcy for a longer period of time.
Verdict: As it comes to the overall cost of a consumer proposal vs bankruptcy I have to give the edge to a consumer proposal. A consumer proposal is fixed and can 100% be planned for, from the beginning.
Income tax refunds
In bankruptcy, your income tax refund becomes a post-acquired asset. The Licensed Insolvency Trustee is required to seize this, take their fee, and send it to the creditors.
In a consumer proposal, your income tax does not form an asset of your estate. Because of this, you get to keep it.
Verdict: Although this isn’t a major issue, it can determine whether or not filing a proposal or a bankruptcy makes sense. Because there is literally no negative to a proposal I am giving a slight edge to a consumer proposal in this section.
The risks of filing bankruptcy really have nothing to do with when you actually file. They all have to do with what can potentially happen to your life after you file. As mentioned above, if your income changes you could end up paying more originally thought. There are also post-acquired assets – Any post-acquired asset, during the term of bankruptcy, is subject to seizure by the Trustee. These are items like income tax refunds, inheritances, gifts, lottery winnings, etc.
The biggest risk, however, is in the event the cost of your bankruptcy increases due to your income increasing (or a post-acquired asset you wish to retain but have to pay for). The risk is that you are not able to pay the required amount of money during the term of your bankruptcy. If this occurs your bankruptcy will be extended and you will be bankrupt longer. Further compounding the negative impacts.
A consumer proposal, on the other hand, has a risk of failing. It is a negotiation between you and your creditors. Because it is a negotiation it is possible that the two parties (you and the creditors) will not come to terms. This happens in very rare instances but it is still a possibility.
Verdict: I think the risks, for what they are, are both equal. Someone who wants to file a consumer proposal would be equally upset over having to file bankruptcy because they couldn’t come to terms with their creditors as a bankrupt individual who’s bankruptcy got extended because they made more money during the term of bankruptcy. I will say the risks are tied for both,
Risk of non-payment
I am separating this risk from the other risks as this risk deserves its own section.
If you file a bankruptcy and another life event impacts you causing you to not be able to make payments there are several impacts/repercussions.
- The first impact is that the amount you are supposed to pay accrues in arrears. Meaning that you will have to make the payments up at some point.
- If you are unable to make the payment up during the term of bankruptcy, your bankruptcy will be opposed and conditions will be placed upon you. The condition for not making payments is usually to bring those payments up to date. Unfortunately, if you never do this, you will be stuck in bankruptcy for a very long time. We have one client who filed bankruptcy in the late 80s/early 90s who was still technically bankrupt when he came in saw us. After further review, it was only over $60 not paid.
- You really have little options except to work with your Trustee, who technically doesn’t have to cooperate except to enforce the conditions.
A consumer proposal is significantly more forgiving and has a few mechanisms in place to assist in periods of down-turns.
- If you fall 3 payments into arrears, your proposal goes into default. This sounds bad but a Trustee can revive it in the event it was a temporary setback. For example, a short-term layoff, etc.
- In the event, your life event is a long-term problem you can always look at amending your proposal. This is where you re-negotiate the remaining term of the proposal at a reduced rate. This technically opens everything up for negotiation again and can technically fail. However, in our experience they almost never do.
- If a proposal is still technically not affordable, even with an amendment, you can always file bankruptcy.
Verdict: A proposal allows for more flexibility in the event you come into struggles in the future. I give the advantage to the consumer proposal.
Conclusion – Bankruptcy vs Consumer Proposal
Knowing which option to file really depends on your individual circumstances. If you have no assets, make little money (and don’t expect to earn more) a bankruptcy can be a very good option. However, when weighing the pros and cons of a consumer proposal and bankruptcy I think it is clear that a proposal is in almost every instance a far superior option. At the end of the day, a proposal only has three negatives – a. It affects credit, b. It generally costs more than a bankruptcy (usually by a small margin) and c. If you do not make your payments you got back to owing everything you owed.
The list of negatives to bankruptcy is extensive. It is for that reason the majority of our clients ultimately choose to file a consumer proposal over bankruptcy when they truly understand the pros and cons of the two.
Because every situation is different we always recommend that you meet with a professional about debt. Unfortunately, there are no ‘do-it-yourself’ debt relief options that exist in Nova Scotia. This is even truer when it comes to consumer proposals and bankruptcy. As always, we would love for that to be us, but in the event it isn’t we are always available for a second opinion.
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.