What is Bankruptcy? How to File, Declare and Avoid

The word “bankruptcy” can conjure images of dread and failure, but it is not an acknowledgement of giving up. While bankruptcy is best avoided due to its serious consequences, this legal tool can provide a much-needed financial reboot for those experiencing overwhelming debt.

What is bankruptcy?

Bankruptcy is a formal legal process that allows certain borrowers to be legally discharged from their unsecured debts, including outstanding balances on credit cards, lines of credit, personal/payday loans, unpaid bills and tax debt.

To declare bankruptcy, borrowers must acknowledge that they:

Owe more than $1,000
Are unable to pay their debts when due
Don’t have sufficient assets to cover their debts

In exchange, debtors give over any non-exempt assets to their creditors and must also make monthly bankruptcy payments, as explained in more detail below.

» MORE: Know the basics of how debt works

How to file for bankruptcy

A bankruptcy must be administered by a licensed bankruptcy and insolvency trustee, who makes sure that both the debtor and creditors follow the laws set out by the Bankruptcy and Insolvency Act of Canada (BIA). The debtor must surrender any non-exempt assets (most personal belongings are excluded — see “Assets debtors may get to keep” below), which are converted into cash and put into a trust. Then, it’s the trustee’s job to distribute the money to creditors.

It’s also the debtor’s responsibility to make specified monthly payments during the term of bankruptcy. These include the base cost of the bankruptcy set by the provincial government (usually a minimum of $1,800 total, or $200/month over nine months), plus any surplus payments required because the debtor’s income is above the provincial minimum allowable threshold.

In all cases, a debtor must:

Disclose all assets to the bankruptcy trustee
Give all credit cards to the trustee
Report income and expenses each month to the trustee
Provide tax returns, insurance policies or any other documents requested by the trustee
Attend credit counselling (so they hopefully don’t find themselves in the same position again)

When are you discharged from bankruptcy?

A discharge is the end goal of bankruptcy. It means you are no longer required to pay the disclosed debts, and your creditors can no longer attempt to collect.

Most people are automatically discharged from a first bankruptcy (and their unsecured debts) in nine months. If, however, your surplus income is high, it can extend to 21 months. For a second bankruptcy, it can take 24-36 months, depending on surplus income.

You will not receive an automatic discharge if you haven’t completed your duties, as outlined above. Your discharge can also be challenged by creditors if they think you are guilty of misconduct under the BIA, or if the proposed payment arrangement doesn’t satisfy them and they think they can get more money in court. You also will need to go to court to get discharged if this is your third bankruptcy.

What you can keep and what you must pay

Not all debts are expunged once you are discharged from bankruptcy, but you won’t lose everything because of bankruptcy.

The provincial government where the bankruptcy is filed sets what kind of debt is exempt from bankruptcy and what assets cannot be distributed to creditors. While there are differences between provinces, here’s what may be included across Canada:

Assets debtors may get to keep

Pets
Home equity (up to a certain limit set by province)
Vehicle equity (up to a certain limit set by province)
Essential food, fuel and clothing (all or up to a certain dollar or annual limit, depending on the province)
Tools necessary for one’s job (all or up to a certain limit, depending on the province)
Household furnishings and goods (up to a certain limit set by province)
Medical devices (either all or only what’s required, depending on the province)
Registered Retirement Savings Plan (RRSP) and Registered Retirement Income Fund (RRIF) (except contributions made in the 12 months before filing for bankruptcy)

Debts creditors must continue to pay

Legal fines or judgements (including child support and alimony)
Student loans (if it has been less than seven years since you were a student)
Secured debts (such as a mortgage, a car lease payment or secured line of credit), unless you give up the asset that’s securing the debt
Tax debt for which the CRA has already placed a lien on your property.

Consequences of bankruptcy

While bankruptcy does offer a fresh start financially after discharge, there are several long-term consequences to the filing.

During bankruptcy proceedings, you cannot borrow more than $1,000 without notifying creditors that you’re currently bankrupt. If you don’t, you could face fines or jail time. After discharge, a bankruptcy filing remains on your credit file for six or seven years, depending on the credit bureau.

It can then be tough to get approved for any form of credit, especially immediately after bankruptcy, when your credit score will be in the lowest possible range. But it’s not impossible.

For example, you could get approved for a secured credit card, which requires a cash deposit that becomes your credit limit. If you pay it off regularly and on time, it can raise your credit score enough to possibly qualify for an unsecured credit card.

» MORE: How to get a credit card when you have bad credit

Alternatives to bankruptcy

Instead of bankruptcy, there are several ways to get out from under overwhelming debt that has fewer long-term consequences:

Consumer proposal

A consumer proposal is a lower cumulative monthly payment on a fixed schedule that never goes up and covers all your debts. It’s negotiated with the help of a licensed insolvency trustee, allows you to keep your assets, and your creditors stop calling.

Debt consolidation loan

A debt consolidation loan, provided by a bank, private lender or credit union, covers all your debt for one monthly payment at a potentially lower interest rate for secured loans. These loans require a high credit score, collateral and can have high interest if unsecured.

Debt management program

Consolidates all your credit card, unsecured loan and line of credit payments into one monthly bill paid to a credit counselling organization that distributes the money to your creditors. Your creditors have to agree to enter the program. If they do, they usually offer low or zero interest to a non-profit credit counsellor and regular interest to a for-profit credit counsellor. Fees through non-profit agencies are lower and spread out, whereas they are higher and upfront via for-profit counsellors.

Orderly Payment of Debts (OPD)

If you live in Alberta or Nova Scotia, you can get this service where you pay back the full amount of your unsecured debts, usually over three years, at a rate of five per cent interest. Your creditors must agree to the program and can’t take your assets. The courts must approve the arrangement.

» MORE: How to get a better credit score