12. Introduction to Bankruptcy
There are different types of bankruptcy within the Bankruptcy Act of Canada and similar statues at the provincial level that businesses can use depending on their unique situation. In the USA they are identified by the chapter number in the bankruptcy code; typically referred to as chapter 7 and chapter 11. In Canada, we often hear those terms, but under the Canadian system, there are two main types: Division 1 and Division 2 which are described below in greater detail.
Division 1 Proposals
A Division 1 Proposal in Canada is a legal binding contract between a debtor and creditors. It is a provision in the Bankruptcy and Insolvency Act that allows an individual with debt to make a formal offer to their creditors to pay a portion of their debt over a specific period of time. Once an agreement is made, the creditors are legally bound to accept the payment plan. In return, creditors are prevented from taking any legal action against the debtor for the rest of the debt.
The process is fairly straight forward, a person or business submits a notice of intention to file a proposal. The person can then stop making any payments directly to any unsecured creditors, all salary garnishments should stop and any lawsuits against the debtor by creditors will be stopped. Within five days of filing, a copy of the notice of intention is sent to all known creditors of the debtor. The proposal itself must then be filed within 30 days after the notice of intention, unless the Court has granted an extension.
Once the proposal has been submitted, the creditors have the ability to accept or reject the proposal. At least two thirds of the creditors in terms of dollar value owed and at least 51 percent of eligible creditors must approve the proposal. It should be noted that only secured creditors can vote; all unsecured creditors are bound by the proposal once it is accepted by the secured creditors.
The proposal then goes to the court for approval. Assuming it is accepted, by the creditors and the court, the debtor will be responsible for adhering to any conditions in the proposal (lump sum payment, asset sale, monthly payments, etc.); at which point they will be legally released from the debts included in the proposal.
Division 2 Proposal (Consumer Proposals)
A Division 2 Proposal is a legally binding settlement between a debtor and their creditors that allows a debtor to pay back a portion of their debt over a period of time. It is available to individuals, sole proprietors and partnerships in Canada who are unable to meet their financial obligations. The debtor must have a steady source of income, and a proposal must be approved by a majority of creditors and the court. The proposal must include a plan for the debtor to repay their debt and can include a lump-sum payment, monthly payments or a combination of both. The debtor must make all payments under the proposal, and if they fail to do so, the court may declare the proposal void and the debtor may be declared bankrupt.
Regardless of the type of bankruptcy, there are some important terms under bankruptcy law. A debtor is the individual or business entity who owes money to others. Debtors either file a bankruptcy petition (in a voluntary bankruptcy) or a petition is filed against them (in an involuntary bankruptcy). A claim is the right of payment from the debtor. A creditor is an individual, business or governmental entity to whom money is owed by the debtor. Therefore, a creditor has a claim against the debtor.
Discharge of debts through bankruptcy is a privilege and should not be abused. Generally, debtors are protected from collection efforts while they are involved in creating plans for reorganization and repaying debts. Creditors are protected from assets being transferred to prevent payment of debts and the inequitable distribution of assets among creditors. These conditions often create peace of mind for those involved in the process.
However, there are situations where a debtor is not eligible for bankruptcy relief. If a court finds that the individual or organization has any of the following, the court could deny the bankruptcy:
- Insufficient Means Test: To be eligible for bankruptcy in Canada, an individual must pass a means test, which determines the amount of disposable income available to creditors. If the court finds that the individual does not pass the means test, the court can deny a bankruptcy claim.
- Misrepresentation of Assets or Debts: If the individual filing for bankruptcy has misrepresented assets or debts, the court can deny the claim.
- Unpaid Child Support or Alimony: If the individual filing for bankruptcy has unpaid child support or alimony payments, the court can deny the claim.
- Deliberate or Fraudulent Activity: If the court finds that the individual filing for bankruptcy has engaged in deliberate or fraudulent activity, such as concealing assets or obtaining loans for fraudulent purposes, the court can deny the claim.
- Discharge of Bankruptcy Obligations: Bankruptcy is not a way to avoid paying obligations; it is a way to restructure debt and repay creditors over time. If the court finds that the individual filing for bankruptcy is not making a good faith effort to pay back the debt, the court can deny the claim.