Think Bankruptcy is Free? Think Again!
Bankruptcy! Yeah, I know what that is…you get rid of all your debts, you walk away, your creditors get zilch, and you’ll never get a credit card again as long as you live!
Your brother in law has spoken! Case closed.
Well, that is unless you’d actually like to learn about what really happens in a Bankruptcy? There are many facets to a Bankruptcy and the Bankruptcy process. For now, I’m going to discuss what is possibly the most commonly held assumption about Bankruptcy – that it’s Free!
Bankruptcy is NOT Free.
Let me repeat that…
Bankruptcy is NOT Free. Everyone is worth something in a bankruptcy. Sometimes, a person’s value in a Bankruptcy is miniscule. Other times, the value is enormous.
If I had to sum up Bankruptcy in one phrase it would be this: “What’ve you got?”
A personal Bankruptcy is a legal process available to individuals who are insolvent – they are unable to pay their bills as they come due, cannot obtain loans to pay off their debts, and do not possess sufficient income or assets to offset the amounts they owe. They’re legally broke.
A person who goes Bankrupt is essentially signalling to his/her creditors that a fresh start is required, and they’re prepared to disclose all income, assets, liabilities, etc. in order to get out of debt. This comes at a cost.
In a Bankruptcy, income and assets determine what is paid to creditors. Even though the bankrupt individual is legally broke, creditors are still entitled to certain amounts of money. Income and Assets help determine how much is taken.
Income
Under the rules of Bankruptcy, your income is compared to a standard. This standard is determined by the size of your household. Do you live alone? Perhaps you’re married and there are two people in your home? Perhaps you’re married with children…3, 4, or more people in the home. If your income exceeds the standard then you are required to pay a certain amount of the excess to a Trustee in Bankruptcy. The trustee then takes a portion of this money for himself (the Trustee’s Tariff) and the remainder is distributed to creditors.
The more you make, the more the trustee is entitled to take. The more the trustee receives and the more your creditors receive.
Got that?
So, you work overtime and make more money! The trustee can take a portion of that.
You receive a bonus at work! The trustee can take a portion of that.
You receive a tax refund! The trustee takes all of that.
You inherit money! The trustee takes all of it or at least as much as he can until the debt is paid.
As you’ve no doubt realized at this point, going the extra mile to earn more or seeking cash win-falls is not advantageous in a bankruptcy. Why would you work overtime just to pay more money?
How much can these payments be? They can get mighty expensive. A single individual who lives alone and makes $60,000/year will pay approximately $815/month in a Bankruptcy! This lasts for 21 months in the case of a first time Bankruptcy. In that case, 21 months x $815 = $17,115
That’s hardly free…but it gets better…
Assets
The trustee still has to consider assets. Examples of assets include:
- Stocks
- Bonds
- TFSAs
- RRSP contributions over the last 12 months
- RESPs (that’s right, your child’s education savings are up for grabs)
- RDSPs (that’s right, your disabled child’s savings are up for grabs)
- GICs
- Properties/Houses
In a Bankruptcy, the bankrupt individual’s assets vest with the trustee. That’s a fancy way of saying the trustee is entitled to seize your assets and distribute the proceeds to creditors. An individual who goes bankrupt will either have to turn over assets, or ‘settle’ on the assets by providing an acceptable amount of cash to creditors.
Let’s stick with our example above, the single guy who makes $60,000/year and has to pay $815/month. If this guy has $5,000 in mutual funds and made $1200 worth of contributions to his RRSP over the last year, he now has to fork over $6,200.
$17,115 + $6,200 = $23,315
This individual will pay $23,315 in a Bankruptcy.
Now, the good news is that if this guy owed $75,000, he now only owes $23,315. This is obviously much lower than $75,000. However, $23,315 is a far cry from “Free”. Moreover, the monthly payments of $815 are still very high as they represent approximately 22% of his income. It’s no wonder that many people who enter into a Bankruptcy find themselves remaining in Bankruptcy several months after their 21 month term has expired.
Sometimes, a Bankruptcy is the best option. Every year, many individuals will find themselves in a situation where their debt is so immense, there is no other option but to take the Bankruptcy route. However, there are many situations where a carefully structured Consumer Proposal done with the debtors interests as the priority is a more reasonable, palatable, and feasible option. In either case, 4 Pillars can help clients determine which option works best for them, and we can work with clients to ensure they pay only what’s required and avoid pitfalls that would result in them having to pay more.
Oh…and you can also get a credit after going Bankrupt…it just takes some time. 4 Pillars can help with that as well.
About the Author:
Zach Brull operates the 4 Pillars Markham, On and Scarborough, On and North York, On Debt Restructuring office. To contact him directly visit his website or call him directly at : (416) 222-6772
