What Is Insolvency?

How Insolvency Is Different From Bankruptcy

Insolvency means you are unable to pay your debts. While insolvency often precedes bankruptcy, it doesn’t have to — there are other ways to get out of debt.

Insolvency is a financial state in which borrowers cannot pay their debts, or their debts total more than their assets.

Nearly half of Canadians (46%) are on the brink of insolvency — within $200 of defaulting on their bills — according to the MNP Consumer Debt Index, a quarterly survey of Canadians’ feelings about debt.

Here we explain more about what insolvency means, how you can avoid it and how it’s different from declaring bankruptcy.

There are two types of insolvency: consumer insolvency, which applies to individuals, and commercial insolvency, which applies to businesses.

Insolvency is not the same as bankruptcy. Bankruptcy is a legal process that discharges you from your unsecured debts, so you no longer have to pay them back. Insolvency is usually the state you are in before you declare bankruptcy. At this point, there are still many options available to you, including filing for bankruptcy, to get out of debt and become solvent again.

If you still have assets that you could sell to pay off all your outstanding debts, you are not insolvent — even if a lack of cash flow means you cannot pay your debts on the day they are due.

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The role of a licensed insolvency trustee

A licensed insolvency trustee will help you assess your financial situation and decide what options might work best for you. They are qualified professionals who are legally and ethically required to offer unbiased advice. A licensed insolvency trustee will consider the actual value (and not the potentially inflated value) of your assets and your debts, as well as your after-tax income and living expenses.

You are income insolvent if you don’t earn enough income to cover your living expenses. If the actual total value of your combined assets can’t cover the combined amount you owe, you are asset insolvent.

» MORE: Understanding your debt-to-income ratio

What to do if you are insolvent

You may be able to budget your way out of insolvency by increasing your cash flow and curbing your spending. But, if you can’t, the following options are available and your licensed insolvency trustee can help you evaluate them:

Consumer proposal

A consumer proposal is a legally binding plan to pay back your creditors a portion of your debt, to take longer to pay it back, or both. It’s available to people with less than $250,000 in debt. You’ll work with your licensed insolvency trustee to negotiate with your creditors to come up with a lower monthly payment. Consumer proposal payment plans last a maximum of five years.

The advantage of a consumer proposal is that you don’t have to declare bankruptcy and you get to keep your assets, such as your car or home, as long as you follow all the terms of the contract.

Informal debt settlement

You may be able to negotiate with your creditors to settle your debt at a lower amount than you owe, especially if your debt is old and you’ve been paying it for a long time. Many creditors offer options to lower your minimum payments or pause payments. You can ask a licensed insolvency trustee to help you with these conversations.

Debt management plan

Reputable non-profit credit counsellors can negotiate a lower single payment for some of your unsecured debts, like credit cards. Then, you pay the credit counsellor for an agreed-upon period of time and they distribute the funds to your creditors. You must usually pay your debts in full with a debt management plan, but perhaps at a lower (or zero) interest rate. There is no debt forgiveness with this plan.

Debt consolidation loan

A debt consolidation loan allows you to combine multiple debts into a single loan. Instead of paying multiple minimum payments to multiple creditors, you’d have just one. Make sure to shop around to find interest rates that are lower than those on your current debts, and ask which types of debts you can combine, such as credit card balances and personal loans.

Bankruptcy

As a last resort, you can consider filing for bankruptcy. Your licensed insolvency trustee must review all other options with you, but if you can’t manage your debt any other way, they can help you file for bankruptcy. They are the only people who can do so.

This legal process can wipe the slate clean and allow you to start over financially. However, your trustee will take over most of your assets, including your savings, home, vehicle, etc., though some assets like pension plans and personal items like clothing are exempt. Your trustee will sell these assets to help repay what you owe your creditors. You must also surrender any credit cards for cancellation and attend two financial counselling sessions.

Filing for bankruptcy has long-term effects. First, the process takes between 9 and 21 months for a first bankruptcy (subsequent bankruptcies take longer). The bankruptcy will also stay on your credit report for six or seven years, which will affect your ability to access new credit. It can be expensive, especially if you have to make surplus income payments toward your debt based on your household income.

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