Discover the difference between bankruptcy and insolvency

When you're trying to find options to deal with unmanageable debt, it can sometimes feel like you have to learn a brand new language just to make sense of your options. Bankruptcy, insolvency — what's the difference — and, more importantly, which one will help you get the financial fresh start you need and deserve?

Insolvency is a financial state in which a person cannot meet debt payments on time. It’s not having enough money to meet your obligations. Bankruptcy is a legal process that happens when a person declares he or she can no longer pay back his or her debts to creditors. It’s a solution when you don’t have enough money to meet your obligations.

In essence, the state of insolvency can lead you to declare bankruptcy. However, insolvency does not necessarily lead to bankruptcy. There may be other ways of dealing with insolvency, depending on your unique circumstances.

What leads to insolvency?

There are many reasons why an individual may find that he or she cannot make debt payments on time. Loss of employment, an increase in housing costs, unexpected health problems, and living outside of our means are a few common examples.

In the past, lifestyle debt was a major issue for many. People were simply spending more than they could afford. But today things have changed. Millions of Canadians are struggling with insolvency as a result of employment and health issues related to COVID-19, as well as skyrocketing gas and utility prices. Six out of 10 people in Alberta are concerned about rising interest rates, with 35% saying it could move them toward Bankruptcy.

Insolvency can happen to anyone at any stage of life. Without this understanding, people may hide the state of insolvency from their creditors and families and allow it to go on until Bankruptcy is the only option. Being open about insolvency early on gives you the broadest range of ways to move forward and reduces feelings of stress, guilt, and overwhelm.

When is Bankruptcy the best option?

Bankruptcy is a government legislated, legal process that provides immediate relief to an insolvent person or business. It provides for a fair and orderly distribution of the bankrupt’s non-exempt property among the unsecured creditors.

Upon filing an assignment in Bankruptcy, the Licensed Insolvency Trustee takes possession of your assets, except for those that are legally exempt. You and the Licensed Insolvency Trustee will review your assets prior to filing to decide what, if anything, must be liquidated for the benefit of your creditors.

In a Bankruptcy, the Licensed Insolvency Trustee will also have an interest in assets the debtor acquires up until the date of discharge. Examples are tax refunds, inheritances, and lottery winnings.

A significant advantage of filing for Bankruptcy is that your creditors cannot refuse — they are legally bound to the process. They are also unable to negotiate the terms of the Bankruptcy. Income tax and other government debts are included and student loan debt may be included. If it is your first time filing for Bankruptcy, you may be released from your debts in as little as nine months.

Options other than Bankruptcy for dealing with insolvency

Bankruptcy does have its downsides. First, it requires comprehensive monthly reporting of your income and expenses. Your monthly payment will also increase if you make more money or receive some kind of financial windfall.

Other disadvantages of Bankruptcy are that your creditors can oppose discharge, leading to a court hearing. Given these and other disadvantages, it may be better for you to explore other options for dealing with insolvency.

Consumer Proposal

A Consumer Proposal is a government legislated, legally binding arrangement with your unsecured creditors to settle your debt. You can qualify for a Consumer Proposal if you are insolvent, are a Canadian citizen or permanent resident, and owe between $1,000 and $250,000 excluding the mortgage on your principal residence.

A Consumer Proposal allows you to negotiate the terms of your debt and the amount to be repaid. If accepted by the majority of your creditors, you will have one fixed monthly payment to make that will ideally fit within your budget.

Income tax debt and student loan debt may be included in a Consumer Proposal. Another advantage is that the damage to your credit rating will be less severe than if you filed for bankruptcy.

Of course, there’s also a downside to filing a Consumer Proposal. For instance, if the majority of your creditors reject it, your Licensed Insolvency Trustee can file an amended proposal, but if it’s rejected, you may have to file a Bankruptcy.

Most Consumer Proposals require you to make monthly payments for five years, whereas a Bankruptcy can be completed in as little as nine months. And if you miss three payments, the proposal is annulled and the original debt, minus the payments you’ve made, is reinstated.

Debt management plan

A debt management plan is a third option for dealing with insolvency that can keep you out of Bankruptcy. This is an informal settlement with your creditors that is usually administered by a credit counselor.

With a debt management plan, you’ll pay the full outstanding value of your debts, but you’ll significantly reduce or even eliminate interest costs. To make life easier, you’ll make one monthly payment to your credit counselor who will then pay your creditors.

Debt management plans are voluntary — for you and your creditors. However, they do not include income tax debt or student loans and, because you don’t need all creditors to agree to the plan, they don’t necessarily stop collections and other creditor actions. Creditors may opt out at any time.

Debt management plans make sense when you have few outstanding debts, are currently in good standing with your creditors, and when interest costs are the primary cause of your financial difficulties. They’re also good if the risk of one or more of your creditors backing out of the plan would not immediately affect your ability to manage your monthly bills and debt obligations.

Impact of debt relief on your credit rating

If you’ve gone bankrupt for the first time, it will stay on your record for six years. If you’re declaring bankruptcy for the second time the first bankruptcy will also reappear and last for 14 years.

If you file for a Consumer Proposal, it will affect your credit rating for three years after the completion of the proposal, which takes a maximum of five years. However, a Consumer Proposal offers the benefit of being able to start building up your credit record even as you are completing the proposal.

A debt management plan will not have an impact on your credit rating while you pay off the debt over a maximum of five years.

Permanent debt relief

If you choose to deal with insolvency by filing a Consumer Proposal or Bankruptcy, you will receive financial and credit counselling from a Licensed Insolvency Trustee. This gives you tools you can use to ensure that you are able to pay your bills while building up savings that can help in the future.

You don’t have to be committed to filing a Consumer Proposal or Bankruptcy to talk to a Licensed Insolvency Trustee. If you’re struggling financially and having a hard time staying on top of your debts, a Free Confidential Consultation with someone who understands can relieve some of the stress.

Talking about money can be hard, but it doesn’t have to be. A Licensed Insolvency Trustee understands what you’re going through and will use their in-depth knowledge to help you identify a clear path forward that works for you.

Depending on your situation, your Licensed Insolvency Trustee might refer you to a credit counselor or other professional.

Ready to get started? Check out our debt calculator. It considers the value of your assets and debts, with interest rates and repayment schedules, to help you determine the best option for you. Once you’ve narrowed down your options, schedule a Free Confidential Consultation to talk about our Life-Changing Debt Solutions and say goodbye to debt and hello to financial freedom.