Canada’s bankruptcy and consumer proposal laws are changing this Friday, September 18.
Among other things:
It is becoming more onerous to file a bankruptcy if a consumer has "surplus" income or is a 2nd-time bankrupt
Automatic discharge after 9 months will no longer be an option for those with surplus income. The minimum is going up to 21 months.
The ceiling for streamlined (Division 2) consumer proposals is rising to $250,000 (other than any principal mortgage) from $75,000.
From a mortgage perspective, one obvious implication is that many people will need to wait longer to get a mortgage after declaring bankruptcy.
We had an opportunity to speak with Eric Putnam, a Senior Financial Coach with BDO New Beginnings, for more details on how the new law will play out. Eric is an expert on insolvency rules and regularly advises Canadians coast-to-coast on how to deal with debt and improve their finances.
CMT: Eric, as of today, first-time bankrupts get automatically discharged after 9 months, correct?
Eric: Yes, assuming they comply with their duties as a bankrupt and no opposition is received from a creditor, the Trustee or the OSB.
CMT: Under the new law, is it true that first-time bankrupts with surplus income will now be required to pay surplus income to the trustee for 21 months?
Eric: Yes, minimum discharge time for debtors with surplus income will be 21 months versus 9 months. New surplus guidelines define monthly surplus income as $200 vs. $100 under the old rules.
CMT: For layman readers, what is "surplus income?"
Eric: The federal government’s Superintendent of Bankruptcy office each year determines guidelines used in a consumer bankruptcy to determine the amount of family income that a debtor can sustain himself and his family on. Income earned in excess of this limit is considered surplus income.
The surplus income guideline is the same regardless of location within Canada and is based upon the debtor’s NET (after tax) income from all sources. Only non-discretionary expenses are allowable expenses for calculating the net income. An example of such expenses are child support, alimony, court imposed fines, etc.–basically, expenses the debtor has no control over. Expenses such as rent, a mortgage, and car lease payments are not allowed, as these are discretionary.
Additionally, the allowable net income varies by the number of dependents supported by the debtor’s income. As an example, for a single adult, the amount in 2009 is $1870 a month net. For a family of four, it is $3474 per month.
In a bankruptcy, the act requires the consumer to provide monthly income and expense statements supported by pay stubs each month. Any amount earned in excess of the guideline per month, the debtor would be required to contribute a minimum of 50% to the the bankruptcy estate for the benefit of his creditors until he is discharged. If the debtor disagrees with the surplus income calculation he may apply for mediation.
CMT: You note that the new law defines monthly surplus income as $200.” Does this mean a single first-time bankrupt could earn $1870 + $199 after taxes and not be considered to have surplus income?
Eric: Yes. Minimum surplus income under the new guidelines is $200, meaning a single person would have to make $2,070 net per month to qualify as having surplus. His monthly payment would then be $100 ($200 x 50%). From what we are told the new guideline is strict and does not leave any room for interpretation by the Trustee.
CMT: What is the present rule on surplus income–in terms of how it relates to being automatically discharged after 9 months?
Eric: As noted, the consumer must contribute surplus income earned as per the Superintendent of Bankruptcy guideline until he has received his discharge. Currently the minimum time for a first-time bankrupt to receive his discharge is 9 months. If surplus income remains outstanding after 9 months, he will not receive his automatic discharge.
Currently, the Trustee may grant the bankrupt an additional 12 months to pay the outstanding amount due as at the ninth month, after which the Trustee can grant a "Conditions Met Discharge".
CMT: Then does that mean this first-time BK could still be discharged in 9 months under the new rules (post-Sept. 18)? Or do the new rules state that the minimum discharge is 21 months for all first-time BKs?
Under the new amendments, if the bankrupt does not have surplus income he is still eligible for discharge within the first nine months. However, if the bankrupt’s income becomes such that surplus income is available during that 9 month period then he will begin paying surplus and fall under the 21 month discharge rule.
To calculate whether a bankrupt has surplus, post filing, the Bankruptcy and Insolvency Act ("BIA") stipulates:
"In completing the review of the bankrupt’s financial circumstances, trustees will determine the bankrupt’s average monthly income based at a minimum on the monthly income and expense statements for the entire period up to two months prior to the end of bankruptcy or to the filing of Form 82 (Report of Trustee on Bankrupt’s Application for Discharge). The average monthly income is to be used to determine the amount the bankrupt is required to pay to the bankrupt’s estate."
CMT: Under the new rules, is it possible that a person would not receive automatic discharge after 21 months if he still earned surplus income at that time? If so, then when does it end? In other words, when will a person with surplus income ever get discharged?
Sorry, let me explain that a little better. It is not whether the bankrupt continues to have monthly surplus income at the time of his discharge, it is whether the bankrupt has paid up to date all the outstanding surplus income as required under the BIA. If it is determined he is required to pay $200 a month, then the Trustee should receive that $200 up to and including the 21st month. If the bankrupt arbitrarily stopped paying the Trustee in the 15th month then he will have surplus arrears.
CMT: If I’m reading this correctly, these new rules will cause bankrupts with surplus income to wait longer to get a mortgage since lenders typically require 1-2 years of re-established credit after a BK. Is that right?
Eric: True. In the case of a bankruptcy, previously they were discharged in a minimum of 9 months. Now it will be a minimum of 21 months for a first time bankrupt with surplus income.
CMT: Regarding consumer proposals, the new law allows people to now include up to $250,000 of unsecured debt in consumer proposals (versus $75,000 currently). Is that right?
Eric: There are two types of proposals to creditors under the Bankruptcy Insolvency Act (BIA). More streamlined filings are referred to as Division 2 or "Consumer" Proposals, and up to Sept 18 /09 were limited to cases where ALL debts–other than a primary residential mortgage–was less than $75,000 in total. This $75,000, limit has been increased to $250,000 based on each individual in a household.
In the past, if debts (if debts besides the primary residence’s mortgage) exceeded $75,000, the consumer had to file a Division 1 which has it’s own set of requirements. That $75,000 maximum is being raised to $250,000 as of September 18th.
CMT: Will there be any options under the new law for eliminating debt that is secured against their home (like a mortgage or LOC)?
Eric: No. There are no new options to eliminate debt secured against the home. For Debtors who walk away while being fully encumbered, any shortfall upon sale will fall to the bankruptcy/proposal.
However, there are many situations where consumers can file a proposal or bankruptcy and can still keep their home. Depending upon province of residency, the consumer may be allowed to keep some of the equity in a home in a bankruptcy (for instance in Alberta the law allows for the first $40,000 in the equity of a primary residence to be exempt from seizure. In Newfoundland it is a $10,000 exemption. In Ontario there is no exemption and all equity in a bankruptcy would benefit creditors in a bankruptcy after subtracting real estate commissions for sale, mortgage and penalty owing as well as legal fees for sale of the home.
In a consumer proposal the creditors must always receive more in repayment than they would receive in a bankruptcy. In a bankruptcy all creditors are included–secured and unsecured—whereas, in a proposal, only unsecured creditors are included.
With a consumer proposal, the consumer has up to five years to pay a percentage of the debt owed that the creditors have voted to accept by majority of proof of claims filed. All payments are administered by a party licensed by the federal government (usually a trustee) and the trustee is compensated for his services by a tariff as per the BIA.
CMT: Are there any other major mortgage-related implications (for lenders or borrowers) that you can think of with this new law?
Eric: With the pending legislative changes as of Sept 18th, creditors can no longer call in a secured line of credit or mortgage (or other secured debts like an auto loan or lease) that is in good standing simply because the consumer filed a proposal to his creditors under the Bankruptcy and Insolvency Act, and where the consumer wants to keep the asset and is able to make the required payments to the creditor.
More About Eric: Eric Putnam is a a former lender, having been national director of mortgage underwriting and funding with Wells Fargo as well as a manager with Bridgewater and Xceed. As mortgage broker, he was a founding director of CIMBL (the predecessor of CAAMP) in 1994, representing Atlantic Canada. For the past four years, Eric has managed a unique national program for BDO Dunwoody – BDO New Beginnings- which assists Canadians to rehabilitate their credit and better manage their cash flow.
BDO New Beginnings has recently launched a new site www.debtcoach.ca that is open to the public to help with budgeting and credit education. There is a free basic membership and other resources are available as an affordable monthly membership including webinars and personal one on one coaching delivered by phone and online across Canada. BDO also offers free educational webinars on a regular basis to mortgage professionals across Canada seeking to learn how to best advise their clients on options to address their financial challenges.
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