Consumer Proposal: What is it, how does it work, what are the costs and should you file one?
Are you considering filing a consumer proposal but are not sure precisely what a proposal even is? We receive a significant number of inquiries as to what a consumer proposal is, how do they work, what are the costs, and if you should file one. We will dive into all of these questions in this article.
A consumer proposal is a legal process where a consumer negotiates with their creditors to come to a settlement. It is a legislated debt forgiveness option governed by the Bankruptcy and Insolvency Act which is administered by a Licensed Insolvency Trustee. The cost and repayment amount of a proposal are determined by several factors such as household size, income, certain expenses as well as provincial exemptions; every situation is unique. Only after reviewing all other available debt relief options should a proposal be filed. It is essential to understand every pro and con before making a decision.
Consumer proposals can be complicated, and everyone’s situation is unique. Let’s explore the most common questions we receive.
How does a consumer proposal work?
As described above a consumer proposal is a legal process in which the consumer negotiates with their creditors to come up with a settlement. Before this process even begins a review of the client’s circumstances is required. A calculation known as a Hypothetical Bankruptcy Value is completed based upon the client’s assessment. This value is the calculated value of how much an individual would end up paying, hypothetically, if they were to file a bankruptcy. A consumer proposal should return to creditors more than that creditors would receive in the event the consumer went through a bankruptcy. This rule isn’t always the case; however, for this article, we will assume this.
The Hypothetical bankruptcy value is determined by calculating the Surplus income obligations a consumer would be required to pay. The calculation also involves valuing the consumer’s assets while taking into account provincial exemptions. An example of a provincial exemption would be to look at a vehicle exemption. Let’s assume a consumer has a vehicle worth $10,000 that has no loan secured against it. Nova Scotia provincial exemption for vehicles if required for work purposes is $6,500 so if you subtract $6,500 from $10,000 you receive a realizable value of $3,500.
Surplus income is based on household size. For example, a family of one is allowed to make $2,203 net per month, in 2019. Half of any amounts of money that is made above and beyond this would be available in their bankruptcy estate. For example, an individual that would make $2,503 a month would be $300 above the income guideline. Half of that would be $150 a month. This amount would be the required surplus income payment. The duration of bankruptcy, in this case, would be 21 months for a first time bankrupt or 36 months for a second-time bankrupt. If this number were lower than $100, then the bankruptcy terms would be 9 or 24 months for a 1st or 2nd-time bankruptcy, respectively. We will be writing another article specifically on bankruptcy shortly.
For simple circumstances, the hypothetical bankruptcy value calculation can quickly be completed at home. The table below outlines the income guidelines for 2019. In the next section – What happens to my assets in a consumer proposal there will also be a chart for the various exemptions for assets. For more complex situations, things can get a little bit confusing, so it’s highly recommended that you sit down with an expert to assist you in calculating your numbers.
2019 Income Surplus Guideline Chart
|Family Size||Income Threshold|
Once the hypothetical bankruptcy value is known, the consumer is able to make an educated decision as to how much they’re going to offer the creditors. This is often challenging for many consumers as knowing what to offer creditors depends on which creditors a consumer has, the amount of debt each creditor is owed compared to the others, and the circumstances surrounding why the consumer got into debt. As a general rule, the larger the spread between a consumer’s hypothetical bankruptcy value and their consumer proposal offer, the higher the chance the offer will be accepted by creditors.
What happens to my assets in a consumer proposal?
Unlike a bankruptcy, your assets in a consumer proposal do not ‘vest’ with the Trustee. Meaning that unless you want to surrender the assets you do not have to nor are you obligated to buy them back from the Trustee. Because a consumer proposal is based upon your hypothetical bankruptcy value your assets are already taken into account. For example, if you have a savings account with $10,000 in it, this amount would get taken into account in your hypothetical bankruptcy calculation. The value of this calculation would form the basis for your offer. Not all assets are treated equally in this calculation though. Some calculations are exempt from seizure, meaning that their value isn’t included in the calculation. I have included the most common assets we receive questions on and whether or not they are exempt from seizure.
|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.|
What are the costs of a consumer proposal?
The costs of filing a consumer proposal are based upon two components. The first component is the fees that the Licensed Insolvency Trustee charges. The second cost is the cost of the actual payment plan that is negotiated between the consumer and creditor. A Licensed Insolvency Trustee charges a percentage based upon how much is recovered for creditors. The Bankruptcy and Insolvency Act determines the amount and percentage the Trustee collects as their fee.
Consumer beware – Licensed Insolvency Trustees have a potential conflict of interest in that their fees are directly tied to how much a consumer pays back in a consumer proposal. The more that is paid by the consumer, the more than the Trustee earns. LegalLine – a free legal resource for Canadians is very clear on this in their article.
Should I file a consumer proposal? Is it worth it?
Knowing if you should file a consumer proposal or not depends on your circumstances. Whether you have complex assets, high-income, or a complicated situation will influence whether or not filing a consumer proposal is a good idea. All variables must be taken into account before making a decision. If you are unclear about whether or not to file, please contact an expert. If it is us, thank you! If not, reach out if you have any questions about what advice and a second opinion will cost you nothing.
One of the most significant factors as to whether or not you should file a consumer proposal or not is based upon which creditors you have. Some creditors, like CRA, can be challenging to negotiate with. The risks become even higher if you owe more than 50% of your debt load to the CRA. This doesn’t mean a proposal will not work. It does mean that your negotiations will be considerably more tense and you may ultimately have to file a bankruptcy but this can often be avoided. Consulting a professional in these instances is a must.
A consumer proposal often comes with a lower monthly payment than would be obtained in a bankruptcy. This lower payment is because bankruptcy payments are generally required to be paid over a shorter period of time – anywhere from 9 to 36 months and a consumer proposal is often structured over 60 months. Someone worth $8,000 in a 1st-time bankruptcy could potentially pay upwards of approximately $380 over 21 months. This payment of $380 also assumes they would be bankrupt over 21 months. Someone who would be a 9-month bankruptcy could potentially be required to pay upwards of $888 per month — contrasting that to a proposal where a $12,000 offer could be paid at a rate of $200 per month over 60 months.
If you are struggling with debt and want to avoid bankruptcy, a consumer proposal may be your best bet.
How does a consumer proposal affect my credit?
How a consumer proposal truly impacts credit depends on the individual circumstances before and after the actual filing of the proposal. A consumer that had a significant history of missed payments should expect to see their credit drop into the low-to-high 400s. Someone who only missed 2 or 3 missed payments prior to filing could make out OK with a drop into the low 500s.
When people ask this question, they are often concerned about their credit score – but the credit score is only a numerical calculation. The real-world impact of a consumer proposal depends on what you are looking to do with your credit score in the near future. For example, purchasing a house will become significantly more challenging to do unless you have a sizable down payment. However, most consumers are not able to buy a home without dealing with their debt first. This concept is a hard one to grasp as we are generally taught that a credit score is the only thing that matters.
Purchasing a vehicle is generally not an issue for the most part. Our clients are able to obtain vehicle financing with relative ease, even immediately filing a proposal if circumstances require it. It should be noted that the closer to the date of filing you attempt to obtain financing the higher rate you will pay on interest.
According to Equifax and Transunion, a consumer proposal arrangement should sit on your creditor report as an R7 for individual creditors. However, in our experience, creditors often report proposals as an R9 – Bad Debt, despite Equifax and Transunion’s guidelines. We have tried assisting our clients in disputing this to an R7, but unfortunately, the credit bureaus support the creditors choice to list it at an R9. Once the proposal is paid off, creditors do change this to the proper rating of R7.
Can I keep my credit cards when I file a consumer proposal?
Unfortunately not. In accordance with the Bankruptcy and Insolvency Act when you file a consumer proposal, you’re required to cut up your cards. This requirement doesn’t remove access in the future for credit, however. As long as you’re informing creditors in the future that you filed a consumer proposal, you are generally able to apply for credit. Secured credit cards are typically recommended for the credit rebuilding purposes but only when used correctly. A secured credit card requires a deposit and the credit card often issues you a credit card with a limit in the amount of the deposit.
What debts does a consumer proposal pay off?
A consumer proposal can deal with nearly every type of debt except for those outlined in section 178 (1) of the Bankruptcy and Insolvency Act. These debts include, but are not limited to, fines and penalties, debts arising from bodily harm, debts from lying/cheating/stealing, and debts related to alimony/child support. The two other types of debts that can be restructured are unsecured and secured debts.
Unsecured debts are easily handled by consumer proposals and include things like personal loans, lines of credit, credit card, income tax debt, payday loans, to name a few. An easy way to know which debts are unsecured is to think what would happen if you stopped paying it. If you stopped paying it and you know the lender would come and take something (like a vehicle, house, or other forms of collateral) then it is a secured debt. Any debt where if you stopped paying it and nothing would happen is an unsecured debt.
Contrary to popular belief, secured debts can also be included in a consumer proposal. Items like mortgages, car loans, or other secured loans can be dealt with a proposal. However, to re-negotiate the debt, you must give up the asset. If you want to restructure your mortgage, for example, you must be prepared to surrender the property. You can also opt to continue to maintain payments on your secured debts as well. If you decide to keep the asset, they will not be reduced like unsecured debts.
Although giving up an asset is often something that most people do not want to do, it can be worthwhile. Things like costly car loans can be easily surrendered with potentially new financing obtained fairly easily to save on costs. Properties that are significantly underwater can also be surrendered for a positive benefit. When looking to surrender assets, the important thing to understand is the costs without the asset. For example, if you surrender a car that costs $1000p/m and you can then finance something for $350p/m it makes a lot of sense. But surrendering a car that costs $250p/m will not make sense if the alternative is a $350p/m vehicle.
Do I lose my tax refund when I file a consumer proposal?
No. Your income tax refund is not seized when you file a consumer proposal, unlike a bankruptcy. This can often be a deciding factor as to whether or not filing a proposal is the right decision or not.
A consumer proposal is a very effective solution when dealing with debts. For individuals who are past the point where a traditional bank can assist them, it is often the best option to deal with debt. It carries fewer long-term consequences of bankruptcy yet all of its benefits. The real only negative is you have to pay more than you would otherwise pay in the event you went bankrupt. This is a compromise that many are willing to make when properly reviewing the pros and cons.
Whatever option you decide, we strongly recommend speaking with an expert before deciding. We would love to be that resource. We believe that every Canadian deserves to live life without the stress of debt weighing them down. We offer a free consultation where we will discuss your situation in detail and outline an actionable plan to get you on the road to debt freedom in 5 years or less.
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.