Module 1 – Assessment of the Situation PDF

Module 1 – Assessment of the Situation Overview You learned in the Introduction to Insolvency course that a CIRP/LIT1 is a problem solver for individuals and entities experiencing financial difficulties or, in some cases, their creditors. CIRPs/LITs possess the knowledge and experience to effectively review a debtor’s situation and provide viable options to address and/or resolve their financial difficulties. A key component of the insolvency process is for the LIT to gather as much information as possible to assess the situation to provide viable options. This module will build on what you learned about the first step in the insolvency process, namely assessing the situation. You will learn, in greater detail, the steps involved in assessing the situation and its importance in the efficient unfolding of the rest of the process. Lack of or incorrect information at the assessment stage can lead to a number of problems in the subsequent steps as well as a less than optimal outcome for all stakeholders. This module will also provide examples that will demonstrate the assessment process in the case of an individual debtor and in the case of a corporate/commercial debtor. You will note that the types and sources of information may differ in both cases as may the number of stakeholders involved. However, as is the case for all the steps in the insolvency process, it does not matter whether the debtor is an individual or a corporation, the process is substantially the same. 1 A CIRP-designated CAIRP member may not necessarily have challenged the OSB’s Oral Board of Examination to become a Licenced Insolvency Trustee (LIT). However, in order to accept formal appointments pursuant to the BIA or CCAA (Trustee, Receiver or Monitor), a CAIRP member must be licenced as an LIT. Accordingly, for ease of reference throughout the remainder of this module and to reflect that formal appointments may only be undertaken by LITs, the CAIRP member is referred to as an LIT, regardless of the role discussed. CQP - Insolvency Principles, Processes and Practice Course 1 Learning Objectives Understand the key elements applicable to assessing a debtor’s financial situation. Understand and explain the role and duties of the LIT in their role as trustee in assessing the situation of the debtor. Understand the application of the code of ethics with regard to the pre-engagement considerations. Explain the difference between the date of bankruptcy and the date of the initial bankruptcy event and the implications of each date. Determine the estimated net realizable value of assets for an individual debtor. Assess the amount of any surplus income obligation, if applicable to an individual debtor. Explain the impact of surplus income obligation on the debtor’s discharge from bankruptcy. Explain when mediation is appropriate in the context of surplus income. Apply professional skepticism to the determination of surplus income obligations. Analyze, and explain to the debtor their available options under the BIA. Determine any other information required from the debtor to complete the assessment, including transfer of assets prior to a proposal or bankruptcy. Ensure that all relevant issues and possible outcomes have been discussed with the debtor. Determine an appropriate solution balancing the debtor’s goals, their financial situation and the return to creditors. Understand the fee structure for the various BIA options. Assess an individual debtor’s situation using the information from the example. Understand the similarities/differences in the initial assessment of a corporate/commercial file compared to an individual debtor file. Perform an initial assessment of a corporate file under two different circumstances. Explain the purpose and process of business reviews. Understand the role of the LIT in assisting the debtor in choosing an option when the debtors’ goals may not be achievable. Competencies A2.1, A3, A6, D 1.1, D1.2, D1.4, D1.7, E2 CQP - Insolvency Principles, Processes and Practice Course 2 Topic 1.1 : Assessing the Debtor’s Financial Situation Learning Objectives Understand the key elements applicable to assessing a debtor’s financial situation. Required Readings Directive 6R: Assessment of an Individual Debtor The initial step in the assessment process is to obtain information from the debtor to determine their financial situation and their immediate concerns. That information will lead to a general discussion of what options are available to them and what the ramifications of each option are. While there are usual, and differing, paths of inquiry for individual debtors compared with corporate/commercial debtors, there are common objectives. The LIT should determine (precisely) who the debtor is: o What is the proper legal name of the debtor? o Does the debtor use a trade name that is different from the legal name? o Where is the debtor located (address)? o Is there a stream of income? o Does the debtor have any special status (e.g., is the debtor a person to whom the Indian Act applies?). determine what assets/property the debtor owns or has rights in: o Are the assets/property owned or leased? o What is the general location of the assets/property? (Consider whether there are any unique circumstances applicable to the location of the debtor’s property (e.g., the restriction on realization of property on a reserve under Section 89(1) of the Indian Act).) o What is the debtor’s view of the realizable value of the assets? o Are the assets subject to a security interest? o Are there other stakeholders claiming an interest in the property? (Is the property in shared ownership?) determine the names and amounts owed to each creditor: o Are there any government debts? o What are the types of creditors? CQP - Insolvency Principles, Processes and Practice Course 3 ▪ secured creditors ▪ trade creditors, including any critical suppliers ▪ priority creditors ▪ employees ▪ contingent claims (environmental, severance, litigation, post-employment benefits, etc.) ▪ any creditors having potential lien rights (e.g., builders, subcontractors, landlords, municipalities) determine what the debtor’s revenues and expenses are (irrespective of whether that represents income and expenses from the employment of an individual debtor or the cash flows of a corporate/commercial enterprise) determine if there are any third parties who might be affected by an insolvency proceeding: o Are there any joint owners of assets/property? o Are there any joint debts and/guarantees of debt? determine if there have been any transactions with closely related parties determine if tax returns and other filings up to date determine if there have been any previous insolvencies The above represents some basic information that you should seek out. It is in no way exhaustive in nature. LITs should be cautious to collect as much pertinent information as possible at this stage because incorrect or insufficient information at the beginning of the process can result in serious ramifications if the wrong option is selected later. Consider the list of questions above more closely. Note that the nature of the question is the same, regardless if the debtor is an individual debtor or a corporate/commercial debtor. You need to know the proper name and whether there is a stream of income from employment or commercial operations across Canada. You need to know what the assets are and what they’re worth, and so on. The point here is that the assessment of the situation, like all steps in the insolvency process, is about the process — not about whether the debtor is an individual or a corporation. CQP - Insolvency Principles, Processes and Practice Course 4 Topic 1.2 : Role of the Trustee and pre-engagement considerations Learning Objectives Understand and explain the role and duties of the LIT in their role as trustee in assessing the situation of the debtor. Understand the application of the code of ethics with regard to the pre-engagement considerations. Required Readings BIA s. 13.5 BIA Rules 34-52 Directive 6R CAIRP Rules of Professional Conduct No. 4 Topic 1.2.1 : The role of the trustee In the course of the assessment process, it is critical that the debtor understands the extent of, and the limitations to, the role of the trustee in an insolvency. That role is clearly outlined in the readings. The trustee: represents neither the debtor nor the creditors — trustees are appointed by the Official Receiver and are officers of the Court administers the provisions of the BIA as they apply to the rights and interest of all parties concerned is subject to affirmation or substitution by the creditors must maintain a high standard of conduct and ethics by complying with the Code of Ethics and CAIRP Standards of Professional Practice must be honest, impartial, and transparent in all dealings, and provide full and accurate information must not assist, advise, or encourage any person to engage in any illegal or dishonest behaviour must avoid any engagement that impairs or appears to impair their professional judgment (conflicts of interest) CQP - Insolvency Principles, Processes and Practice Course 5 Topic 1.2.2 : Pre-engagement Considerations In the process of conducting the assessment of the debtor and the assessment of the end game, the LIT reviews pre-engagement considerations. Conflicts of interest/independence Prior to accepting an engagement, the LIT must consider a number of key questions. While the answers to each question may not necessarily be documented by memos or supporting information in the LIT’s engagement files, the LIT should consider the following: Is this an appropriate mandate to accept? Is it possible to comply with all the provisions of the law and the various rules of ethics to which the professional is subject? Are there conflicts of interest issues (real or perceived) that might be seen to impair the LIT’s professional judgment? Are there any relationships that need to be disclosed to all stakeholders before accepting the engagement? Are there specific statutory provisions that may affect a potential appointment (i.e., Sections 13.3 and 13.4 of the BIA, Section 11.7 of the CCAA, etc.) In the administration of an insolvency of an individual debtor, conflicts of interest are less common, but the LIT should ensure they comply with BIA Section 13.3, BIA Rules 34–53 and CAIRP Rules of Professional Conduct and Interpretation No. 4. Skills The LIT must consider whether they have the appropriate level of skills to complete the mandate being considered. Insolvency professionals are called upon to work in areas of activity that are often very diverse and so they adapt to those scenarios. It is, however, always possible that some mandates go beyond the individual’s abilities, or the abilities of their team. Given the level of professional responsibilities relating to a mandate, the professional must recognize the situations in which they are less comfortable and either seek help or decline the engagement. CQP - Insolvency Principles, Processes and Practice Course 6 Sufficient resources The LIT must consider whether their office has the necessary resources to manage the scope of the tasks that will/might be encountered while administering the mandate. If, for example, the file deals with a national retail business chain with stores in multiple jurisdictions across Canada, it is important to assess whether resources are sufficient to accept such a mandate. In an individual’s file, does the individual live in the same community (and OSB office and Court jurisdiction) as the LIT office? Similarly, is there anything unique about the debtor’s circumstances that might present difficulties in administering the mandate. An LIT in a small firm should consider these factors before accepting such a mandate. The necessary resources are an important issue and not accepting a file/mandate could be justified. Who initiated the engagement? Does the mandate come from the debtor, a creditor, the Court, or a regulatory body? The perspective and therefore the approach and the recommendations could, of course, be different in each situation. Equally important is to properly identify the debtor’s legal name. In the instance of an individual debtor, a birth certificate or passport is best as those documents will provide the complete legal name of the individual. In the instance of a corporation, the minute book or a copy of the articles of incorporation would be best. In addition, with respect to corporations, the LIT should obtain proper identification from the person who is being authorized on behalf of the corporation to execute the insolvency related documents. It is possible that certain recommended courses of action may be in the best interests of the debtor corporation but may conflict with the interests of the directors and/or shareholders. In such instances, the LIT should recommend that the directors / shareholders obtain independent legal advice. Risks associated with the case/fee security/indemnification. The LIT should endeavour to identify and assess any risks related to the file and identify any available means of controlling or reducing those risks. Risks, such as reputational or financial loss, should be considered before accepting an engagement. Where the insolvency engagement such as an application for a bankruptcy order or the appointment of a receiver is initiated by a creditor, the LIT should consider requesting an indemnification from the appointing creditor. Appointing creditors may be reluctant to provide a broad indemnity or may be reluctant to provide any indemnity at all. In such cases, the LIT should CQP - Insolvency Principles, Processes and Practice Course 7 consider and make prudent inquiries as to the financial strength of the creditor and, further, the LIT should be satisfied as to the integrity and the bona fides of the creditor. Possible liability issues for the LIT (environment, successor employer, legal proceedings) The insolvency professional is expected to analyze a mass of data in a very short time and make sound decisions under the circumstances, with imperfect information. This is a considerable challenge. There are some provisions of the BIA and CCAA that protect the professional against liability; however, the risk is still high and it must be managed. LITs are protected from some environmental claims, but caution must be exercised to avoid successor employer issues or becoming a defendant in a lawsuit. (Further detail will be provided in later modules.) Availability of appropriate outside expertise There are many sections of the BIA that enable, and in some instances compel, the LIT to prepare and submit materials to be placed before the Court for its consideration in adjudicating a matter. In some instances, the materials and the process of serving copies of the documents to others are clearly defined. Documents relating to a bankrupt’s discharge and certain procedures within Division I and II proposals are examples. It is a matter of professional discretion whether the LIT proceeds with the preparation and submission of these documents on their own or seeks the assistance of legal counsel. For matters that might involve legal counsel, the LIT should ensure that appropriately experienced counsel is available. Before accepting an engagement, LITs should consider whether there will be sufficient assets in the estate to pay legal fees, otherwise the LIT themself personally liable for same. Other matters where the LIT should consider the use of outside professionals might be with respect to asset valuation, building condition and/or environmental matters, complex tax matters, and matters related to any regulatory bodies to which the debtor may be subject. CQP - Insolvency Principles, Processes and Practice Course 8 Topic 1.3 : Determination of date of bankruptcy and the initial bankruptcy event Learning Objectives Explain the difference between the date of bankruptcy and the date of the initial bankruptcy event and the implications of each date. Required Readings BIA s.2, 50.4(8)(a), 57(a), or 61(2) Once the pre-engagement issues have been considered, the LIT must determine whether the debtor meets the definition of an insolvent person under Section 2 of the Act. If the debtor does not satisfy the definition, the LIT cannot use the provisions of the Act. (Recall that “person” under the Act includes corporations.) Once insolvency has been established, the LIT will then examine, together with the debtor, which alternative (bankruptcy or a proposal) is more suitable to the debtor’s situation and whether a formal filing is warranted in the circumstances. This will include an estimate of the value of the debtor’s assets and liabilities, an assessment of surplus income in the case of an individual debtor, and a review of other matters related to the debtor’s financial affairs. Topic 1.3.1 : Date of Bankruptcy You will note that the process of being appointed as a trustee in bankruptcy, a trustee under an NOI or a Division I Proposal, an administrator under a Division II proposal, a receiver (Court-appointed or private), or a monitor under the CCAA involves the filing of documents with the Official Receiver and receiving back from the Official Receiver certain appointment documents confirming those appointments. Included in the information confirmed by those documents is the date of bankruptcy. CQP - Insolvency Principles, Processes and Practice Course 9 The date of bankruptcy is one of two significant dates in an insolvency proceeding. The other is the date of the initial bankruptcy event. Here’s the difference: The date of the bankruptcy, in respect of a person, means the date of the granting of a bankruptcy order against the person. A bankruptcy order is granted only after a creditor has made an application to the Court for that order. the filing of an assignment in respect of the person An assignment is made when an insolvent person completes the assignment documentation with the LIT and is confirmed by the Official Receiver, or the event that causes an assignment by the person to be deemed. Events that cause a deemed assignment Under Division I Proposals failure to file the cash flow statements and reports within the requisite time period following the filing of an NOI failure to file a proposal within the requisite time period following the filing of a NOI creditors refuse the proposal Court declines to approve the proposal Court annuls the proposal for any reason Under Division II Proposals when a consumer proposal made by a bankrupt is deemed annulled. The date of bankruptcy is confirmed by the appointment documents from the Official Receiver. The significance of this date is that a variety of time limitations flow backward and forward from this date. Here are a few examples: Notice of bankruptcy has to be sent to the creditors within five days of the date of bankruptcy. Where called, a meeting of creditors has to be held within 21 days of the date of bankruptcy. Claims provable under Section 121(1) are “All debts and liabilities, present or future, to which the bankrupt is subject on the day on which the bankrupt becomes bankrupt ….” An individual bankrupt’s eligibility for an automatic discharge is measured from the date of bankruptcy. A high personal tax debtor cannot apply for a discharge hearing until three years after the date of bankruptcy. CQP - Insolvency Principles, Processes and Practice Course 10 Whether a student loan is dischargeable or not is measured in the time between the date of cessation of being a student and the date of bankruptcy. Topic 1.3.2 : Date of initial bankruptcy event The date of the initial bankruptcy event, in respect of a person, means the earliest of the day on which any one of the following is made, filed, or commenced, as the case may be: (a) an assignment by or in respect of the person (b) a proposal by or in respect of the person (c) a notice of intention by the person (d) the first application for a bankruptcy order against the person, in any case i. referred to in paragraph 50.4(8)(a) or 57(a) or subsection 61(2), or ii. in which a notice of intention to make a proposal has been filed under Section 50.4 or a proposal has been filed under Section 62 in respect of the person and the person files an assignment before the Court has approved the proposal (e) the application in respect of which a bankruptcy order is made, in the case of an application other than one referred to in paragraph (d) (f) proceedings under the Companies’ Creditors Arrangement Act In the instance of (a) or (b), the date of bankruptcy and the date of the initial bankruptcy event will be the same date. There would have been no BIA proceeding initiated ahead of the assignment or the filing of a proposal. However, (c) refers to a notice of intention being filed ahead of the filing a proposal. For (c), the date of the initial bankruptcy event would be the date of filing the NOI because that’s the earliest date of the commencement of a proceeding. However, if a creditor launched an application for a bankruptcy order and then the debtor files an NOI, the date of the initial bankruptcy would be the date of the filing of the application for a bankruptcy order. Likewise, for (d) and (e), where a creditor initiates an application for a bankruptcy order, the date of that application will become the date of the initial bankruptcy event. If the Court grants the bankruptcy order, the date of the order becomes the date of the bankruptcy, but the date of the initial bankruptcy event is the date of the application by the creditor. CQP - Insolvency Principles, Processes and Practice Course 11 The definition in (d)(i) refers to subsections 50.4(8)(a), 57(a), or 61(2) of the BIA: Subsection 50.4(8)(a) refers to an insolvent person failing to file the cash flow statement within the requisite time period after having filed an NOI or, having filed an NOI, failing to file the proposal within the requisite period of time (as extended in that is the case). In either case, the insolvent person is deemed to have made an assignment in bankruptcy. The date of bankruptcy would be the date that the insolvent person was deemed to have made the assignment in bankruptcy (i.e., the date of failing to file the cash flow statement or the date of failing to file the proposal), whereas the date of the initial bankruptcy event would be the date of filing the NOI. (Note that for this subsection to apply, the insolvent person has to have filed an NOI.) Subsection 57(a) refers to the creditors refusing the proposal, whereupon the insolvent person is deemed to have made an assignment in bankruptcy. The date of bankruptcy would be the date that the insolvent person was deemed to have made the assignment in bankruptcy (i.e., the date of the creditors’ meeting at which the proposal was refused), whereas the date of the initial bankruptcy event would be the earlier of either the date of filing the NOI, if an NOI was filed, or the date of filing the proposal if no NOI was filed. Subsection 61(2) refers to the Court refusing to approve a proposal that had been approved by the creditors, whereupon the insolvent person is deemed to have made an assignment in bankruptcy. The date of bankruptcy would be the date that the insolvent person was deemed to have made the assignment in bankruptcy (i.e., the date the Court refused to approve the proposal was refused), whereas the date of the initial bankruptcy event would be the earlier of either the date of filing the NOI, if an NOI was filed, or the date of filing the proposal if no NOI was filed. The definition in (d)(ii) contemplates that the insolvent person makes a voluntary assignment in bankruptcy after the date of filing the NOI but before the filing of the proposal, or after the date of filing the proposal but before the date that the Court approves the proposal. CQP - Insolvency Principles, Processes and Practice Course 12 The date of bankruptcy would be the date that the insolvent person made the assignment in bankruptcy, whereas the date of the initial bankruptcy event would be the earlier of date of filing the NOI, if an NOI was filed, or the date of filing the proposal if no NOI was filed. The definition in (f) contemplates that an application for a proceeding under the CCAA is initiated by a debtor company, prior to an assignment or deemed assignment under the BIA. In that instance, the date of the initial bankruptcy event is the date of that CCAA application. The significance of the date of the initial bankruptcy event is that certain transactions are reviewed from the date of the initial bankruptcy event rather than from the date of bankruptcy. Where those two dates are the same, there is little consequence. Where those dates differ, the date of the initial bankruptcy event may be significant. For example: The locality of the debtor is determined at the date of the initial bankruptcy event. The time frame covering certain claims under Section 81 is measured from the date of the initial bankruptcy events. The time frame for preferential payments and transactions at under value is measured from the date of the initial bankruptcy event. The time frame covering certain bankruptcy offences and facts under Section 173 is measured from the date of the initial bankruptcy event. For certain matters relating to bankrupts’ discharges (and pre-bankruptcy conduct), the timelines are measured from the date of the initial bankruptcy event. Consider the following examples where the date of bankruptcy and date of the initial bankruptcy event differ. Example 1: An insolvent person files an NOI on June 1. Insolvent person fails to file the cash flow and reports on June 11. Insolvent person is deemed to have made an assignment in bankruptcy June 11 (Section 50.4(8)). The date of bankruptcy is June 11. The date of the initial bankruptcy event is June 1. CQP - Insolvency Principles, Processes and Practice Course 13 Example 2: A creditor makes application for a bankruptcy order on August 3. The hearing date is set for August 15. Insolvent person files an NOI August 12 and files the cash flow statement and reports within the required time. Insolvent person files the proposal September 10. The creditors’ meeting is scheduled for September 30. Creditors refuse the proposal and the insolvent is deemed to have made an assignment in bankruptcy September 30 (Section 57(a)). The date of bankruptcy is September 30. The date of the initial bankruptcy event is August 3. When assessing the situation of a debtor, it is important to keep the distinction between these dates in mind as it may impact the treatment of certain transactions the debtor was involved in prior to initiating their own insolvency proceeding. CQP - Insolvency Principles, Processes and Practice Course 14 Topic 1.4 : Assessment of the situation -Individual debtor Learning Objectives Determine the estimated net realizable value of assets for an individual debtor. Required Readings BIA s.67, 71, 178(1) BIA Rule 59 Appendices A and B Directive 6R While the process of assessing the situation is essentially the same regardless of the type of insolvency (individual or corporate/commercial), the type and sources of information may be different, as will be some of the considerations may only apply to one or the other type of file. This topic and Topics 1.5-1.7 address the particularities encountered in an individual debtor engagement. Identify, Acquire, and Assemble Debtor’s Information The assembly of basic information is a critical step to informing the debtor of the options available to deal with their situation and how they will be impacted by each of the different options. In an individual debtor’s situation, the LIT will look for the following information (and, where possible, supporting documentation): Proper identification of the debtor: Normally a birth certificate, passport, or baptismal certificate is preferable. Caution should be exercised using identification such as driver’s licenses and health cards since these do not always display the proper legal name of the debtor. If there is any doubt about the debtor’s proper name, or the name by which the debtor is (or may be) known to creditors, the practitioner should consider adding additional names for the debtor, noting them as an alias or an “also known as.” Assets: Includes bank accounts, furniture, personal effects (jewellery, clothing, etc.), investments (term deposits, RRSPs, RESPs, stocks, crypto currencies, etc.), real property CQP - Insolvency Principles, Processes and Practice Course 15 (house, cottage, land), motorized vehicles (car, truck, motorcycle, etc.), recreational assets (cottage, mobile home, etc.), and any other assets the debtor might have. Liabilities: Locate statements, if available, for all creditors and, as well, identification of those who might have security on any of the debtor’s assets. Average monthly income: Acquire copies of paystubs, statement of income and expenses (if self-employed), and copies of bank statements, and identify any non-employment sources of income (e.g., child tax benefit, pension, annuity, etc.). Average monthly expenses: A list is generally sufficient for this unless the expense is a non- discretionary expense, in which case supporting documentation is required. Non- discretionary expenses will be discussed later in this topic. Other information relevant to the debtor’s financial affairs: This could include recent payments to creditors, transfer of assets, prior insolvency filings in Canada, and cause of financial difficulties. The sum of this analysis will allow the LIT to estimate what the outcome might be of an assignment in bankruptcy by the debtor. The reason for using the bankruptcy scenario as a base line is that it usually represents the worst-case scenario for debtors. As an example, the situation for a debtor might look something like this: Assets Household effects $5,000 RRSPs $12,000 Car (net of selling costs) $30,000 House (net of selling costs) $270,000 $317,000 Liabilities Unsecured creditors $50,000 Bank A – car loan $25,000 Bank B – house mortgage $250,000 $325,000 CQP - Insolvency Principles, Processes and Practice Course 16 (You should review the material in Introduction to Insolvency – Module 2 for a discussion on property of the bankrupt that is exempt from seizure (exempt assets).) With this example, in assessing the aggregate value of assets available for creditors, the LIT would determine the extent of any RRSP contributions in the past 12 months, would review the exempt assets applicable in the jurisdiction, and would make an estimate of net assets that might be available to the creditors. Let’s say that RRSP contributions in the past 12 months were $1,200 and exemptions applicable in the jurisdiction include $5,000 for household effects, $6,000 for one vehicle, and $10,000 for a principal residence. Based on this information, the estimated net asset realizations are calculated as follows: Household effects (fully exempt) 0 RRSPs (contributions in the past 12 months) $1,200 Car Estimated value $30,000 Bank loan ($25,000) Equity $ 5,000 Exemption ($5,000) Estimated Realization $ 0.00 House Estimated value $270,000 Mortgage ($250,000) Equity $20,000 Exemption ($10,000) Estimated Realization $10,000 Net realizable assets $11,200 So, the LIT could reasonably surmise that, in a bankruptcy scenario, the bankrupt estate would have a realization of $11,200 for the assets of the estate. CQP - Insolvency Principles, Processes and Practice Course 17 Topic 1.5 : Individual debtor: Surplus Income Learning Objectives Assess the amount of any surplus income obligation, if applicable to an individual debtor. Explain the impact of surplus income obligation on the debtor’s discharge from bankruptcy. Explain when mediation is appropriate in the context of surplus income. Required Readings BIA S 66.13(2)(b), 67, 68, 69, 69.1, 69.2, 69.3, and 69.31, 157.1, 168.1– 173, 178 BIA Rule 105 Directive 1R, 11R At this point in the process, the LIT should make a calculation of Surplus Income. While the term may sound like the excess of income over expenses, it is not. It has a specific meaning in the Act and is based on standards set by the OSB. Section 68 of the BIA, together with Directive 11R, detail the process of calculating Surplus Income. The concept behind surplus income obligations is that, where a bankrupt has monthly income in excess of the Superintendent’s Standards, the bankrupt is required to contribute half of the surplus monthly until they are discharged from the bankruptcy. Directive 11R describes the Superintendent’s Standards as follows: “The Superintendent’s Standards are derived from the Low Income Cutoffs (LICO) released by Statistics Canada.” These standards are revised and published annually. Consider the following example of a surplus income calculation for an individual debtor in a household of one: Total net monthly family income $3,000 Less: medical expenses ($300) Available family income $2,700 Less: OSB Standard ($2,100) Surplus income $600 Monthly obligation 50% $300 CQP - Insolvency Principles, Processes and Practice Course 18 In this example, provided the bankrupt’s income and medical expenses were consistent through the entire bankruptcy, the bankrupt would be required to pay that surplus income for a period of 21 months, thus paying a total of $6,300 in surplus income. Let’s delve more deeply into Section 68, Directive 11R, and the topic of Surplus Income. Surplus income is one of the most consequential aspects of an individual insolvency. It is consequential because the calculation of surplus income forms a critical part of the assessment of whether a proposal under either Division I or Division II of Part III of the BIA is appropriate in the circumstances it impacts the payments a bankrupt is required to make to the estate over the course of the bankruptcy it impacts the duration of the bankruptcy failure to pay surplus income provides grounds for a creditor to oppose the bankrupt’s discharge and the bankrupt may be ineligible for an Absolute Discharge if the bankrupt chooses to make an assignment and surplus income is sufficient to make a proposal a viable option, Section 173 could result in an opposition to the bankrupt’s discharge and the bankrupt not being eligible for an Absolute Discharge Consider further that surplus income offers the possibility of mediation should there be a disagreement between the trustee or the creditors and the bankrupt. And, in the event of material changes in the bankrupt’s financial situation, there is a requirement for the trustee to determine the surplus income requirement and advise the Official Receiver and any creditors requesting that information of the calculation. Surplus income is defined under Section 68(2) of the Act. Total income is broadly defined to include revenue of any nature from any source that is received by the debtor between the date of the making of the assignment in bankruptcy (being the date of bankruptcy, not the date of the initial bankruptcy event) and date of discharge, specifically excluding revenue that is referred to in CQP - Insolvency Principles, Processes and Practice Course 19 Section 67 of the Act, namely goods and services tax credits (Section 67(1)(b.1)) and prescribed payments relating to the essential needs of an individual (Section 67(1)(b.2)). The LIT has a duty to determine whether an individual debtor has surplus income based on the Superintendent’s Standards laid out (and updated annually) in Directive 11R and the debtor’s personal and family situation. This determination is initially made at the time of assessing the situation as it has a significant impact on the resolution that the individual debtor selects. Topic 1.5.1 : Calculation of surplus income At the assessment stage, the calculation of the surplus will be based on average monthly amounts. Directive 11R provides the guidelines and examples to assist in determining what payments are required for surplus income. The calculation of surplus income is a formula, which contains the following components: the family unit the family unit’s total monthly income non-discretionary expenses Superintendent’s Standards Let’s look at what comprises each of these components. The family unit includes the debtor and anyone who lives in the same residence and benefits from the expenses or income of the debtor. It also includes anyone not residing in the same household who benefits from or contributes to the expenses of the debtor. Thus, a family unit can include the debtor’s spouse, children, including any living away from home, relatives, any other person who may live in the debtor’s residence, etc. The list can be quite broad. The family unit’s total monthly income is simply the aggregate of the total income of all members of the family unit, adjusted, in the case of employees, for statutory withholdings or, in the case of self-employed individuals, as the gross income less expenses including amounts allowed under the Income Tax Act. A self-employed individual may also deduct income tax instalments that have been paid; it is not sufficient to calculate what might be owed — the instalment has to have been CQP - Insolvency Principles, Processes and Practice Course 20 made. For individuals receiving pensions and similar income, the total income would be reduced by payments made for income tax. To verify the total monthly income, the bankrupt would provide paystubs, statements, and proof of statutory payments where the individual is not an employee. In the event that a member of the debtor’s household other than a spouse refuses to disclose their income, that person is not considered to be a member of the family unit. If a spouse refuses to disclose monthly income, the spouse is still considered to be a member of the family unit but only 50% of the Superintendent’s Standards is used in the calculation of the debtor’s surplus income payment. Where there are more income earners in the household besides the bankrupt, the household income is apportioned, and that apportionment is applied to the surplus income calculation. For example, let’s look at a family of four, with both parents and one child earning income. Bankrupt’s average income $4,000 Less: bankrupt’s medical expenses ($ 200) Bankrupt’s available income $3,800 Spouse’s income $2,000 Eldest child’s income $1,000 Total family income $6,800 Less: OSB Standard for family of ($4,168) Total surplus income $2,632 Bankrupt’s portion of income 56 % (3,800/6,800 = 55.88%) Bankrupt’s apportioned surplus income $1470 ($2,632 x 55.88%) Bankrupt’s required payment (50%) $735 (50% of surplus as per Directive 11R) Irregular income There are situations where bankrupts are not earning a regular income. In some cases, income varies considerably from month to month. Real estate agents, commissioned salespeople, and those with seasonal employment are just a few examples of debtors who do not have a regular income. In addition, some debtors earn significant overtime, which can vary from month to month. CQP - Insolvency Principles, Processes and Practice Course 21 Even though it may be difficult to determine an amount of contribution when the income stream is irregular, where there is surplus income, the trustee is expected to realize on it for the benefit of the unsecured creditors. In such a circumstance, the trustee and the debtor calculate the required payment from surplus income based on a reasonable estimate of the average monthly income. Directive 11R requires a bankrupt to provide the trustee with monthly income and expense statements, along with proof of income and proof of payment for income taxes on self- employment and non-discretionary expenses, for the entire period of bankruptcy. It is prudent for the LIT to monitor these reports closely to determine that the bankrupt is keeping up with surplus income obligations. A special situation occurs where the irregular income stream is caused by a lump sum payment that relates to the pre-bankruptcy period (e.g., a pay equity award or a settlement amount related to wrongful dismissal). In such a case, the Office of the Superintendent of Bankruptcy takes the position that the entire amount (instead of 50%) of the lump sum payment must be paid to the estate, without an averaging calculation, except for a small adjustment if the bankrupt’s income is below the standard set in the directive. According to the Office of the Superintendent of Bankruptcy, if the bankrupt’s income is below the standard set in the directive except for the lump sum payment, then the bankrupt is entitled to an automatic discharge on the date of the automatic discharge as it stood prior to the receipt of the lump sum. There are five separate examples of surplus income calculations covering various scenarios in Appendix B of Directive 11R. Non-discretionary expenses are monthly expenses that are essentially outside the control of the individual. These might include the following: child support payments spousal support payments childcare expenses expenses relating to a medical condition payments relating to Court-imposed fines or penalties (that are in the process of being paid) debts where the Court has allowed payments to continue despite the filing of a bankruptcy or proposal interest on debts that are not dischargeable under Section 178 of the Act CQP - Insolvency Principles, Processes and Practice Course 22 An individual is allowed to deduct these expenses from their total monthly income. To deduct these amounts, the individual will have to provide proof of actual payment. Normally, proof of payment will be a receipt for the expense. However, in the case of child or spousal support, it may be a deduction from the individual’s pay cheque. Once payment of the expense is proved, it is deducted from the total monthly income resulting in an amount called the available monthly income. Superintendent’s Standards are standards set by the OSB to assist in the calculation of the surplus income of the debtor. The Standards are derived from the Low Income Cutoffs released by Statistics Canada and are adjusted annually. They specify what portion of a debtor’s income is required for reasonable monthly household expenses and thus may be retained by the debtor based on the number of persons in the debtor’s family unit as per Directive 11R. This amount is deducted from the family unit’s available monthly income to determine the total monthly surplus income. Topic 1.5.2 : Impact of surplus income on eligibility for automatic discharge The calculation of surplus income is consequential to the analysis of the most appropriate course of action. Part of that consideration is that surplus income determines the minimum period of time that a debtor will be in bankruptcy before being eligible for an automatic discharge. The table below summarizes the various circumstances (current at 2023): Type of Debtor Eligibility for Automatic Discharge If Eligibility for Automatic Discharge If There There Is No Surplus Income Is Surplus Income 1st-Time Bankrupt 9 months from date of bankruptcy 21 months from date of bankruptcy (d.o.b.) (d.o.b.) 36 2nd-Time Bankrupt 24 months from d.o.b. months from d.o.b. 1st-Time High Tax Debtor hearing may be held after 9 months hearing may be held after 21 months from from d.o.b. d.o.b. 2nd-Time High Tax Debtor hearing may be held after 24 months hearing may be held after 36 months from from d.o.b. d.o.b. CQP - Insolvency Principles, Processes and Practice Course 23 Note: In addition to a bankrupt’s surplus income obligations, their eligibility for an automatic discharge will be impacted if the bankrupt has failed to complete any duties or refused or neglected to attend counselling, or if the discharge has been opposed by the trustee, a creditor, or the Superintendent of Bankruptcy. Also, bankrupts who have had more than two previous bankruptcies are not eligible for an automatic discharge and the trustee is required to apply for a discharge hearing for those bankrupts. The trustee may not apply for that hearing before three months from the date of bankruptcy and must apply before one year from the date of bankruptcy. Topic 1.5.3 : Use of Mediation The LIT is required to inform the debtor about the availability of mediation with respect to the surplus income calculation. Rule 105 details the mediation process. There are three instances where the LIT is required to make a calculation of surplus income (Section 68(3): at the initiation of the bankruptcy (Form 65 – Income and Expense Statement) whenever the trustee becomes aware of a material change in the bankrupt’s financial situation whenever the trustee is required to prepare a report under Section 170(1) The LIT will be alerted to a material change in the bankrupt’s financial situation through a monthly review of the bankrupt’s monthly income and expense statement (Form 65). The LIT will be alerted to the requirement under Section 170(1) if the bankrupt had a surplus income obligation and refused or neglected to make payments, or if the bankrupt filed an assignment in bankruptcy when they could have filed a viable proposal (Section 173(1)(m) and (n)). Whenever the trustee makes a determination with respect to surplus income, the trustee is required to inform the Official Receiver, and every creditor who has requested such information, as to the result of that calculation. The reason for informing the Official Receiver and the creditors is to apprise them of the result of the calculation and to enable the Official Receiver to recommend a different amount, in the circumstances enable the creditors to request mediation Mediation is also available where the trustee and the bankrupt do not agree on the amount. CQP - Insolvency Principles, Processes and Practice Course 24 If the matters that are referred to mediation under Sections 68 or 170.1 are not resolved by the mediation, the matter is referred to the Court for resolution (Section 68(10), Section 170.1(3)). CQP - Insolvency Principles, Processes and Practice Course 25 Topic 1.6 : A Case for Professional Skepticism Learning Objectives Apply professional skepticism to the determination of surplus income obligations. Required Readings BIA s 68(10) and 68(11) Directive 11R Knowing how consequential surplus income is to determine how much, if anything, a bankrupt is required to contribute to their bankruptcy and how long a bankrupt remains in bankruptcy before they are eligible for an automatic discharge, it stands to reason that (some) bankrupts may be motivated to understate their monthly income or overstate their non-discretionary expenses. Accordingly, professional skepticism should be applied to reviewing a debtor’s monthly income and expense statements. An LIT should inquire as to the debtor’s relationship with their employer. Is the employer a large corporation or a small business or proprietorship? Is the debtor related in any way to the employer? Is there any way to manipulate the debtor’s reported income? Does the bankrupt have a close relationship with anyone who is receiving payments regarding any expenses that might be non- discretionary? Let’s look at some possibilities for manipulating total family income: Banking overtime: Consider the possibility of a debtor (or other family members whose income is included in the surplus income calculation) and the employer having an agreement to bank overtime, particularly in seasonal businesses. Periods of employment could span the busy season, with banked overtime paid out during the off-season. This could impact the accurate determination of total family income and surplus income. Debtor is related to employer: Consider the situation where a debtor (or other family members whose income is included in the surplus income calculation) is employed by a friend or a person to whom they are related. Such non-arms length relationships give rise to the CQP - Insolvency Principles, Processes and Practice Course 26 possibility of manipulating rates of pay during the period of bankruptcy, which would result in understated family income and an understated surplus income calculation. Sections 68(10) and 68(11) recognize that possibility and allow the trustee to apply to the Court to fix the amount to be paid for surplus income. In making that application, the trustee would have to provide satisfactory evidence to the Court that the income was understated (or that expenses were overstated — see below). That the debtor is related to the employer is not a problem in and of itself; however, the trustee needs to ascertain whether the debtor would perform the same work for an unrelated employer for the same remuneration. If the answer to that question is no, then further inquiry will be required to ascertain a fair rate of remuneration, on the basis of which the trustee will then make the surplus income calculation. Income from self-employment: Income from self-employment is often difficult to prove or disprove. Bankrupts are expected to act honestly and to report their monthly income and expenses honestly. Directive 11R requires that the bankrupt provide proof of income. The trustee can request and review the debtor’s past tax returns and can (and should) compare the reported income with the expenses and consider whether the bankrupt’s income matches their lifestyle. In the appropriate circumstances, the trustee could request that the bankrupt be examined under oath and, if different information arises from that examination, the LIT (or the bankrupt) can request mediation. If mediation fails, the trustee can apply to the Court to fix the amount that the bankrupt is required to pay. Part-time work and irregular pay cycles: Where a debtor has gig work or irregular part-time work, they may overlook reporting that income. Similarly, debtors often estimate their monthly income to be their bi-weekly pay x 2, overlooking the effect of the two months each year where they in fact have three pay periods. For this reason, practitioners should check monthly income and expense statements against bank statements and should compare the sum of monthly income and expense forms with T4 income tax slips. Tips and gratuities: Debtors employed in the hospitality industry (or other industry where gratuities are received by employees) may or may not accurately report the amount of gratuities they receive. It is normally sufficient if the trustee inquires as to the income tax reporting of those earnings and makes detailed notes of the response. CQP - Insolvency Principles, Processes and Practice Course 27 When the trustee is reviewing the file for the bankrupt’s discharge, a comparison should be made between income reported on the income and expense forms, and other data sources such as T4s and related income tax returns. Now let’s look at some possibilities for manipulating expenses: With respect to overstating non-discretionary expenses generally, paragraph 5 of Directive 11R details how surplus income is calculated. Subparagraphs 5(2) and 5(3) detail the non-discretionary expenses that may be deducted from the family income. Subparagraph 5(2) details the allowance for statutory deductions deducted by an employer from an employee’s pay. Those statutory deductions are for income tax, pension, and employment insurance, but the subparagraph also allows for other mandatory deductions, such as union or association dues, and mandatory health and welfare deductions. The trustee should verify that any of these deductions from income are indeed mandatory and not voluntary. Examples of voluntary deductions might include such things as social fund contributions, savings contributions, and share purchases (where there is such a plan). Subparagraph 5(4) sets out the requirement that the bankrupt provide proof of income and proof of payment for any of the non-discretionary expenses. It would be difficult, though not impossible, to overstate any of the expenses delineated in paragraph 5. For example: Child/spousal support payments: Where a bankrupt is claiming child/spousal support payments as a non-discretionary expense, proof of actual payment of the amount is required. It is not sufficient that the bankrupt has the obligation to pay: the requirement is that the bankrupt has actually made the payments. There may be circumstances (and in some cases it is the general practice of LITs) that the trustee will require the bankrupt to produce a copy of the Court order of the separation, divorce, or support detailing the child or spousal support obligations. Informal separation or support agreements are not sufficient, however. In such cases, the bankrupt or the trustee can put the matter to mediation to resolve the matter. Failing resolution, the trustee can apply to the Court to fix the amount of the payment (Section 68(10). CQP - Insolvency Principles, Processes and Practice Course 28 Child-care expenses: Where a bankrupt is claiming child-care expenses as a non-discretionary expense, proof of actual payment of the amount is required. This will usually take the form of a receipt from the service provider. If the bankrupt cannot provide receipts, the expense should not be allowed. If there is disagreement between the trustee and the bankrupt, the matter should be put to mediation. Expenses associated with a medical condition: Not all purchases made at the pharmacy relate to a medical condition. The allowable non-discretionary expense applies only to expenses associated with a medical condition. If there is disagreement as to whether an expense is allowable in this category, the bankrupt or the trustee can choose to resolve the matter through mediation. Failing resolution, the trustee can apply to the Court to fix the amount of the payment (Section 68(10). Fines/penalties in the process of being paid: The key phrase here is “in the process of being paid.” The bankrupt is required to provide proof of payment of such items. That proof could be a receipt, proof of e-transfer, or cancelled cheque. LITs should always maintain well-documented notes of file reviews, and challenges to income or expense reporting for discretionary or non-discretionary expenses. The assessment process up to this point involves estimating the net realizable values of the assets and any surplus income obligation that the debtor might have in a bankruptcy scenario. This assessment of estimated net realizations from assets and surplus income then becomes the starting point for considering what options are available to the debtor to deal with their financial situation and which option is most appropriate in the circumstances. CQP - Insolvency Principles, Processes and Practice Course 29 Topic 1.7 : Options Available to the individual Debtor Learning Objectives Analyze, and explain to the debtor their available options under the BIA. Required Readings BIA s.67, 69 Directive 6R OSB Form 21, 33, 47 With the foregoing information in hand, the trustee will review the options available to the debtor. Directive 6R: Assessment of an Individual Debtor, lists the topics that should be covered when informing the debtor of the options available and the consequences of each option. The same four options are available to all individual debtors: Do nothing. Engage in a debt-management program. File a Proposal (Division I or a Division II). Make an assignment in bankruptcy. Of these four options, the first two are non-legislative debt-settlement arrangements. Let’s briefly consider the meaning of each option. Do nothing is not a realistic option for many except for those who are judgment proof — those who have no assets that can be seized, have no income that can be garnished, and are unconcerned about having judgments registered against them or about receiving harassing telephone calls and letters from collection agencies. But it is an option and the LIT is required to discuss that option with the debtor. Engage in a debt-management program is an appropriate option for some debtors. Whether it’s a viable option depends on the level of the debtor’s income, the size and nature of the debt, the duration of any repayment plan, and the debtor’s attitude toward paying the creditors in full. An LIT will advise a debtor that CQP - Insolvency Principles, Processes and Practice Course 30 there is no stay of proceedings in a debt-management program the creditors’ participation in a debt-management program is voluntary and they can opt out at any time there is no facility to achieve a settlement in the amount owed interest or late payment charges are only waived if the individual creditors agree to do so the debtor’s credit history and rating will be damaged Debt-management programs have been successful for debtors who are motivated to pay their debts and have sufficient income available to repay them in a reasonable period of time. Debt- management programs are generally run by not-for-profit organizations and a wide array of private fee-for-service advisory agencies. In November 2022, the OSB and CAIRP jointly released a consumer alert regarding unlicensed, unregulated debt advisors File a Proposal (Division I or Division II) is another appropriate option for some debtors. There are several reasons why an individual debtor would consider filing a proposal rather than making an assignment in bankruptcy. For example, the debtor may: work in a regulated industry (LIT, financial advisor, stockbroker, realtor, lawyer, CPA) from which they may be barred in the event of making an assignment in bankruptcy be a director of a corporation and would otherwise be disqualified from acting as a director have significant assets/surplus income, the sum of which may exceed their unsecured liabilities have the capacity to complete a proposal in a reasonable period of time be involved in litigation, control of which they would lose in the event of making an assignment in bankruptcy have been previously bankrupt and would be facing an extended period before being eligible for a discharge want to avoid the stigma of an assignment in bankruptcy As described earlier, while gathering information from the debtor about their assets and liabilities, the LIT can make an estimate of what, if any, equity the debtor has in any of the assets. The LIT must take into consideration which, if any, of the assets are exempt property (Section 67) or CQP - Insolvency Principles, Processes and Practice Course 31 subject to interests of secured creditors. The result of this calculation enables the LIT to estimate what assets might be available to the creditors in a bankruptcy and what, if any, equity the debtor will be giving up in a bankruptcy. The LIT will also have reviewed the debtor’s household income and expenses to ascertain whether the debtor has any surplus income as contemplated under Section 68 and Directive 11R. The result of this calculation will be taken into account in the consideration of the debtor’s capacity to successfully complete the terms of a Proposal. The LIT will then review with the debtor any transactions between the debtor and the creditors or any related parties that may be subject to review or attack under the BIA. Again, the LIT will make an estimate of which, if any, of these transactions might result in a recovery for the creditors in a bankruptcy and what, if any, actions might be taken within the terms of a Proposal to mitigate that recovery. The LIT will then lay out the results of that analysis to the debtor for the purposes of comparing the outcomes of a Proposal versus a bankruptcy. A proposal filed pursuant to Division I or Division II will be based on the assets, income, and conduct of the individual debtor. Where there is surplus income, it is nearly always better for the debtor to choose a proposal rather than a bankruptcy. However, there are some circumstances where that would not be the case. Consider the situation where the debtor has significant non-dischargeable debts, such as student loans or child support or Court-imposed fines recently received notice of termination of employment or a significant change in remuneration had a recent change in the family structure, such as a newborn child, adult children moving home, elderly parents becoming economically dependant, or a separation or divorce The terms of a proposal generally involve the periodic payment of certain sums of money (usually monthly) for a period of (usually) 36–60 months. In a bankruptcy, surplus income and the redemption of assets usually has to be completed before the discharge of the bankrupt. Debtors CQP - Insolvency Principles, Processes and Practice Course 32 may be able to make a like contribution to a proposal but over a longer period of time, lowering their monthly payment. Make an assignment in bankruptcy is in fact a realistic option for many debtors, but it is usually a last resort. It may be the most appropriate option when the debtor’s household income does not meet the Low Income Cutoffs the debtor has no surplus income obligation the debtor has no unencumbered or non-exempt assets available to the bankrupt estate the debtor has significant unsecured debt the debtor is subject to harassing telephone calls and collection activities the debtor is subject to Court judgments that result in the garnishment of wages the debtor has had a significant change in the family structure The LIT is expected to explain to the debtor what the bankruptcy process is, including how the debtor and their assets will be dealt with and what the discharge process will look like. When an insolvent person makes an assignment in bankruptcy, the wording of the assignment itself is the following: Whereas the debtor is insolvent and desires to assign and to abandon all his or her property for distribution among his or her creditors, in pursuance of the Act. This indenture witnesses that the debtor does hereby assign to the trustee all the debtor’s property for the uses, intents and purposes provided by the Act. (Form 21) The LIT will explain to the debtor what a stay of proceedings is, which assets are exempt from seizure, what the discharge process is, the rights of creditors, and the rights of the trustee (or the creditors) to attack any improper transactions. CQP - Insolvency Principles, Processes and Practice Course 33 Topic 1.8 : Other information required to complete the assessment of the individual debtor Learning Objectives Determine any other information required from the debtor to complete the assessment, including transfer of assets prior to a proposal or bankruptcy. Ensure that all relevant issues and possible outcomes have been discussed with the debtor. Required Readings BIA s.67(1)(c), 69, 95-101, 158-160, 168.1-173, 198-200 CCAA s.19(2) ITA s 128 Appendix 1.3 Information may come up in the initial assessment that would necessitate covering the following topics as well. This information is NOT unique to an individual debtor situation, and LITs must ensure debtors are aware of their obligations regarding these areas. After Acquired Property Property of the bankrupt divisible among their creditors includes any property that the bankrupt acquires or that devolves upon them (such as significant gifts, awards, or an inheritance) prior to their discharge. The bankrupt is at liberty to acquire and dispose of such property at will, until the trustee intervenes. There is an onus on the bankrupt to report such a material change in their financial situation to the trustee so that the trustee has the opportunity to intervene (Section 158(n.1)). Asset Transfers Prior to Bankruptcy or Proposal During the assessment of the situation, it may come to light that a debtor has transferred an asset to a relative or sold it to a friend for significantly less than it was worth. The corporate debtor may have paid one particular supplier or made severance payments to managers that seem excessive. These are known as transfers at undervalue and preference payments and are discussed in Sections 95–101 of the Act. CQP - Insolvency Principles, Processes and Practice Course 34 A preference occurs when an unsecured creditor has sold goods or lent money to a debtor without taking security and, before bankruptcy, receives payment or takes security or a transfer of property from the insolvent debtor, and the other creditors are not afforded the same treatment. A transfer at undervalue (TUV) is essentially a disposition of property or provision of services for which no consideration is received by the debtor, or for which the consideration received is conspicuously less than the fair market value of the consideration given by the debtor. The trustee may attack or inquire into: a dividend payment (other than a stock dividend) or a redemption or a purchase of its own shares by a corporate bankrupt done during the period that starts one year before the date of the initial bankruptcy event and ends at the date of bankruptcy. The transaction must have occurred at a time when the corporation was insolvent, or the transaction must have rendered the corporation insolvent. any transfer of corporate assets that should be retained for the creditors’ benefit to shareholders via dividend distributions and by redeeming or repurchasing shares. a payment of excessive severance, termination, incentives, and benefits of directors, officers, and managers by a corporate bankrupt done during the period that starts one year before the date of the initial bankruptcy event and ends at the date of bankruptcy. In specific instances, these transfers can be reversed under the Act or under various provincial legislation. In summary, they include the following transactions: payment to a non-related party within 3 months prior to the date of the initial bankruptcy event payment to a related party within 12 months prior to the date of the initial bankruptcy event transfer of asset at less than fair market value to a non-related party within 12 months prior to the date of the initial bankruptcy event transfer of asset at less than fair market value to a related party within 12 months prior to the date of the initial bankruptcy event, which is extended to 5 years if the debtor would have CQP - Insolvency Principles, Processes and Practice Course 35 been insolvent without the asset. The conditions under which these transaction would be evaluated are detailed in BIA 95 and 96 and are discussed comprehensively at Appendix 1.3. It should be noted that, at the assessment stage, the LIT is not required to make a determination with respect to any of these matters, but rather simply explain to the debtor how they would be dealt with. Where an LIT identifies and is successful in recovering a preference payment or a transfer at undervalue, the amount recovered will be added to any recovery from assets and surplus income. You can therefore see how this could also impact a debtor’s decision on how to proceed to address their financial difficulties. More detail on preferences and transfers at undervalue can be found in Appendix 1.3. In addition to assets, debts, surplus income, and asset transfers, other matters that the LIT will discuss with the debtor at the initial assessment include the following: The debtor’s view of the current situation including specific issues of concern and expectations from the insolvency process: These may include the cause, in their view, of the insolvency, threats of creditors, garnishment on their wages, effect on family members, the desire to keep their house or carry on the business, protection of employees, not wanting to file bankruptcy, and so on. The possible outcome of the discharge from bankruptcy: The LIT should explain what is required for a bankrupt to maintain their eligibility for an automatic discharge. The LIT should also explain that, where the bankrupt is required to have a discharge hearing, and where any of the facts under Section 173 are proven against the bankrupt at that hearing, the Court cannot issue an absolute discharge and so must either refuse the discharge, suspend the discharge, or grant a discharge subject to terms and conditions. The significance of the discharge: The discharge is the bankrupt’s legal release from debts, other than those in Section 178. It is equally interesting to note that when a Certificate of Full Performance is issued, the insolvent person is released from their debts and liabilities, but it does not release the CQP - Insolvency Principles, Processes and Practice Course 36 insolvent person from any debt or liability under Section 178 unless the proposal specifically calls for the compromise of that debt and the affected creditors vote in favour of the proposal. A first- or second-time bankrupt who has completed all duties required during the bankruptcy is entitled to an automatic discharge unless they have personal income tax debt exceeding $200,000 which exceeds 75% of the total unsecured proven claims (Section 172.1(1), as at 2023). The timing of an automatic discharge was discussed above. If the debtor has filed more than two previous bankruptcies, the discharge will be determined by the Court. The bankrupt’s discharge can be delayed if they haven’t completed their duties under the Act resulting in an objection to discharge from the trustee or if a creditor or the OSB objects to the discharge (Sections 168.2 and 170(7)). Discharges will be discussed in greater detail later in this course. The requirement for an individual debtor to attend two counselling sessions: These sessions are required for anyone who files an assignment in bankruptcy or a consumer proposal or has been deemed bankrupt due to the creditors’ rejection of or annulment of a Division I proposal. It is interesting to note that there is no requirement in the BIA for counselling sessions for a debtor who has filed a Division I proposal that has been accepted by the creditors. The counselling sessions deal with budgeting, money management, root causes of insolvency, and future financial planning. While Directive 1R specifies the information to be delivered during the counselling session, it leaves the details and timing of the information to the trustee, who must ensure by the end of both sessions that the required information, applicable to the debtor, has been discussed. The effect of any other relevant credit or insolvency matters applicable to the debtor’s situation: For example, creditors may be threatening legal action, or may already have sued the debtor, obtained a judgment, and are garnishing wages. Canada Revenue Agency (CRA) may be threatening to seize assets as well as garnish wages for arrears under the Income Tax Act (ITA). Unlike other creditors, CRA does not need a court order to carry out any seizure as the ITA contains provisions that allow them to simply issue a Requirement to Pay. These creditor issues are very stressful for the debtor who wants to know how to stop the creditors. The BIA contains provisions for a stay of proceedings (Section 69–69.31), which prevent creditors from commencing or continuing any action for collection against the debtor. What this means is that upon the filing of a bankruptcy, proposal, or other formal filing under the BIA, the CQP - Insolvency Principles, Processes and Practice Course 37 debtor will no longer have to worry about a creditor seizing assets or garnishing wages. There are exceptions to this stay that include but are not limited to: a secured creditor whose security interest is valid a creditor who applies to the Court for relief from the stay and is successful child support and alimony CRA and similar provincial tax agencies in specific circumstances The duties imposed on a debtor: When a debtor chooses to use the BIA to address their insolvency issues, certain duties are imposed upon them. It is necessary at the assessment stage that the debtor is fully aware of what is expected of them. As well, the debtor needs to be informed of any actions taken by them, before and during the bankruptcy or proposal, that might constitute an offense under the BIA. There are 18 duties discussed under Section 158 of the BIA. These generally require the debtor to be truthful and honest and comply with any requests of the LIT regarding the requirements for the administration of the respective filing. Where the debtor is a corporation, the officer executing the documents for the filing is required to satisfy the duties. Bankruptcy offences by a debtor: Offences are discussed under Sections 198 and 199 of the BIA and generally relate to situations where the debtor has acted fraudulently or dishonestly prior to or after the date of the initial insolvency event (see definitions in Section 2 of BIA). In the case of a business, failure to keep proper books and records (Section 200) is also an offence. A debtor who is convicted of an offence under the BIA faces serious consequences, which include fines and/or imprisonment. The magnitude of these consequences varies with the nature of the offence, with the range as follows: summary conviction: up to $5,000 and/or imprisonment up to 1 year conviction on indictment: up to $10,000 and/or imprisonment up to 3 years Income tax refunds and returns: Debtors are often concerned about losing their tax refunds and for how long. Income tax refunds are included in the definition of property under Section 67(1)(c) of the BIA. Therefore, if a debtor has not received an income tax refund for any year prior to the date of bankruptcy, as well as any refund they are entitled to for the year of bankruptcy, it is considered an asset of the bankrupt’s estate to be realized upon by the CQP - Insolvency Principles, Processes and Practice Course 38 trustee. However, for the year of bankruptcy, Section 128 of the ITA imposes a deemed year- end on the day preceding the date of bankruptcy. This results in two partial year tax returns (a pre-bankruptcy and a post-bankruptcy return) being filed for the year of bankruptcy. Any refund on either return for the year of bankruptcy is considered property in a bankruptcy unless the refund is subject to a pre-existing garnishee for child support and/or alimony that has been served by the taxation authorities. The trustee will often find that a debtor has not filed income tax returns for prior years. Whether there are anticipated refunds or not, Section 22 of the BIA imposes a duty on LITs to file certain returns. While this section is worded in the negative, it is easier to understand if we turn it into the positive. The section says that a trustee is responsible for filing any income tax return that the debtor was required to file in the calendar year prior to the date of bankruptcy as well as any returns required to be filed up to the date of bankruptcy. Let’s look at an example. Suppose Eric filed an assignment in bankruptcy on March 1, 20X5, and had not filed income tax returns for three years. The trustee will be responsible for filing the 20X3 tax return that was due in 20X4, because it was due in the calendar year preceding the year of the assignment in bankruptcy. The trustee will be responsible for the 20X4 return that was due in 20X5 because it is a prior year return and is due in the year of bankruptcy. The trustee will be responsible for the pre-bankruptcy return for the period from January 1 to the date of bankruptcy in 20X5. Thus, the LIT would be responsible for filing three income tax returns for periods preceding the date of bankruptcy. The LIT is not responsible for filing outstanding returns for years prior to 20X3 because the legislation limits the trustee’s obligations to those returns required to be filed up to a year prior to the commencement of year of bankruptcy. The trustee may file, however, if refunds are expected that would increase the recoveries for the creditors. Filing outstanding returns may also give rise to GST/HST refunds and eligibility for other tax credit programs. Similarly, the trustee is not responsible for filing the bankrupt’s post bankruptcy return, however, with the debtor’s authorization, the trustee may choose to do so to ensure that any refund is recovered. CQP - Insolvency Principles, Processes and Practice Course 39 Topic 1.9 : Completing the Individual Debtor assessment – determining the best option Learning Objectives Determine an appropriate solution balancing the debtor’s goals, their financial situation and the return to creditors. Understand the fee structure for the various BIA options. Required Readings BIA S 49, 60, 170(7), 147 Rules 123, 132 Directive 6R Circular No. 2R2 We are now ready to review the debtor’s goals and desired outcomes to assess which, if any, insolvency proceeding is going to produce the desired outcome and complete the assessment phase for the individual debtor. Debtor’s Goals An individual debtor’s most common immediate goal when meeting with an LIT is generally to get rid of creditor calls about overdue account payments. While this may be the reason that prompts the initial meeting, a debtor may also have other goals, such as retaining control of a house or recreational property or other assets, wanting to get through any insolvency process as quickly as possible, keeping family members out of the process, avoiding a repeat bankruptcy, and avoiding any publication of the proceeding. For example, a debtor who wants to keep their house may prefer to file a proposal rather than an assignment in bankruptcy where they could lose the house. Alternatively, a debtor may not want to spend the next 3 to 5 years making payments in a Division I or a Division II proposal but would rather file an assignment in bankruptcy to get through the insolvency process faster. The LIT must take the debtor’s goals into consideration and clearly advise the debtor of the merits and consequences of the options available under the BIA to assist them in selecting the most appropriate option. CQP - Insolvency Principles, Processes and Practice Course 40 Pros and cons of the Options Topic 1.7 outlined the options available to the individual debtor. Table 1 provides a more detailed comparison of the merits and consequences of filing an assignment in bankruptcy versus a proposal. Table 1 - Bankruptcy vs. Proposal Merits and Consequences for the Individual Debtor Bankruptcy Proposal Acceptance of the Merit: An eligible debtor has the right Consequence: Debtor can file a filing to file an assignment. Creditors have proposal with the Official Receiver no control over this. but creditors control its acceptance. Rejection of a Division I proposal results in a deemed assignment in bankruptcy. There is no deemed assignment in the rejection of a consumer proposal but the stay of proceedings is ended and the debtor must look at other options. Treatment of assets Consequence: All property vests in Merit: Debtor retains control of their the trustee and debtor loses the assets. No requirement to include ability to deal with their assets, after-acquired assets unless the including assets that devolve on proposal contains a clause to include them (after-acquired assets) between them. the date of assignment and date of discharge, subject to any exemptions (per S. 67(1)(a), (b), (b.1), (b.2) and (b.3)). Payments Consequence: Payments vary Merit: Payments are based on depending on debtor's surplus amounts accepted by creditors in the income. proposal and do not vary with changes in income. CQP - Insolvency Principles, Processes and Practice Course 41 Bankruptcy Proposal Non-payment of Merit: Bankruptcy continues but Consequence: Non-payment results in required amounts discharge is delayed until all amounts annulment of the proposal and the are paid. Thus, no effect on stays of stay of proceedings is no longer in proceedings. effect. The annulment process differs significantly for a Division I proposal and a Division II proposal. Discharge Consequence: Creditors, the trustee, Merit: Upon completion of terms of and the OSB can object to discharge proposal, certificate of full resulting in additional payments performance issued pursuant to terms and/or a delay in the issuance of a of proposal as accepted by creditors. discharge. Effect on credit rating Consequence: Bankruptcy notation Consequence: Proposal notation on on credit record for 6 years credit record for 3 years after date of (increased to 14 years for a repeat certificate of full performance. bankruptcy) after date of discharge. Merit: Credit rating raised from level 9 No increase in credit rating from to level 7 on completion of proposal. level 9. Weighing the Options The realizable value of a debtor’s assets, the level of their debts, surplus income, and financial transactions prior to any filing under the BIA will assist in determining which options would be available to the debtor. Recall that the LIT represents neither the debtor nor the creditors but must balance the desires of the debtor with the rights of the creditors. Therefore, in addition to looking at the debtor’s issues, you must also consider the potential return to the creditors. To do so, you have to consider the estimated fees and disbursements with each option. The readings provide you with more detail on the actual calculation of these amounts. For some debtors, you will find there may be more than one possible option that can be used, while for others, there may be only one option. CQP - Insolvency Principles, Processes and Practice Course 42 Topic 1.10 : Example -Individual debtor assessment Learning Objectives Assess an individual debtor’s situation using the information from the example. Required Readings None Sandy is single and has never made a filing under the BIA. Sandy earns a salary of $3,000 per month and has average living expenses totalling $2,800 per month, including $300 per month for medical expenses. After paying all the monthly living expenses, Sandy has $200 left, which is insufficient to make the required payments on the unsecured debt. You obtain the following information about Sandy’s financial situation: Assets Household effects $5,000 RRSPs $12,000 Car (net of selling costs) $30,000 House (net of selling costs) $270,000 $317,000 Liabilities Unsecured creditors $50,000 Bank A – car loan $25,000 Bank B – house mortgage $250,000 $325,000 You easily determine that Sandy is insolvent and cannot make the debt payments as they become due. In assessing the aggregate value of assets available for creditors, you determine that RRSP contributions in the past 12 months were $1,200 and exemptions in Sandy’s province include $5,000 for household effects, $6,000 for one vehicle, and $10,000 for a principal residence. Based on this information, the expected net asset realizations are calculated as follows: CQP - Insolvency Principles, Processes and Practice Course 43 Household effects $0 fully exempt RRSPs $1,200 contributions in the past 12 months Car $0 value less secured loan less exemption House $10,000 asset value less mortgage less exemption Net realizable assets $11,200 The other component for this analysis is the amount of surplus income. Assume the OSB standard for one person is $2,100. Sandy’s surplus income would be calculated as follows: Total net income $3,000 Less: medical expenses ($300) Available monthly income $2,700 Less: OSB Standard ($2,100) Surplus income $600 Monthly obligation 50% $300 Total estimated surplus $6,300 (first-time bankrupt – 21 months’ obligation) While the estimated amount required for surplus income is included in property of the debtor, it is not part of the determination of the net realizable value of assets and thus not a determining factor in whether an assignment in bankruptcy would be filed as an ordinary or summary administration. It is, however, required in the determination of how much the debtor would have to pay in a proposal to ensure that the creditors receive a better return than they would receive in a bankruptcy. Let’s now look at how the four options would apply in Sandy’s case. To do this, we need to prepare an estimated statement of receipts and disbursements and percentage return to the creditors. Only a rough estimate is required at the assessment stage. The preparation of this statement will be discussed in more depth later in the course. Assume that the total trustee fees and administrative disbursements for an ordinary administration bankruptcy or a Division I proposal would be $15,000. In a summary administration bankruptcy or a Division II proposal, fees and disbursements would be based on the respective tariffs for those filings. In addition to the receipts and the fees and disbursements of the trustee, there is one other CQP - Insolvency Principles, Processes and Practice Course 44 component involved in determining how much is available for the creditors: the OSB is entitled to a levy, which varies according to the type of filing. Table 2 presents a comparison of the estimated return to creditors in each of the options available for addressing Sandy’s debts. Although Sandy’s realizable assets are in excess of $15,000 (which, according to Rule 130 and Circular 2R, is the current limit for the trustee to administer the estate as a summary administration), the trustee may elect to limit their fees to the tariff under Rule 128 applied as though the realizations were $15,000. This is shown in Table 2 under the heading Summary Administration. Sandy is eligible to file a Division II Consumer Proposal because the debts, excluding mortgage, are less than $250,000. The other two options — an Ordinary Administration bankruptcy and a Division I Proposal — are demonstrated for comparative purposes. Note that the trustee’s fees and disbursements are higher in the ordinary administration and Division I proposals primarily due to the additional professional time required to manage the various creditors’ and inspectors’ meetings and required court appearances. Note too that the Court appearances may require the assistance of legal counsel. Table 2 also assumes that the total receipts would be equal for each option. CQP - Insolvency Principles, Processes and Practice Course 45 Table 2 Comparison of Sandy’s Options Ordinary Summary Division I Division II Administration Administration Proposal Proposal Receipts RRSP 1,200 1,200 House 10,000 10,000 Surplus income 6,300 6,300 Payments under proposal 17,500 17,500 Total Receipts 17,500 17,500 17,500 17,500 Less: Fees and disbursements Filing fee (150) (75) (150) (100) Court fee (150) 0 (150) 0 Counselling fee (170) (170) 0 (170) Administration costs (100) Trustee fees and administration costs (15,000) (15,000) Trustee fees – tariff (7,834) (4,646) Net available for distribution 2,030 9,321 2,200 12,584 Less: Levy (102) (200) (110) (643) Net available for creditors $1,928 $9,121 $2,090 $11,941 Estimated return to creditors 3.9% 18.2% 4.2% 23.9% Note: “Estimated return to creditors” is based on $50,000 of unsecured

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