Proposal or Bankruptcy – the pros and cons

Tom Locke - Insolvency Trustee in London, Ontario
May 2, 2022

Proposal or Bankruptcy, there are pros and cons for each, in this blog, we will discuss both sides of the decision.  Many consumers gravitate to proposals because they would rather not file a Bankruptcy in some instances, erroneously believing they will somehow be better off.

Proposals and Bankruptcies must be filed by a Licensed Insolvency Trustee, debt consulting companies can only make referrals to LITs, they cannot do the work of a LIT.  Whether filing a Bankruptcy or a Proposal the decision is the Debtor’s. The LIT’s role is mostly advisory.  Having said that, a LIT can refuse to take on an estate if the LIT believes the Debtor is not acting in good faith, if there is some conflict of interest or if the LIT simply doesn’t want that particular file.

There are no hard and fast rules dictating how much must be paid under a Proposal.  Some LIT’s like to use formulas such as 30% of the total outstanding debt, but there is no legislative requirement for that ratio.  The most basic premise is that the Proposal must make sense to the two main parties, the Debtor(s) and the Creditor(s).  Another commonly used principle is that the proposal “must” offer more than the Creditors would get from a Bankruptcy – which is not necessarily true.

Credit Report:

The purge rules for Equifax indicate that a Proposal is removed from a credit report three (3) years after the Proposal is completed.  Meanwhile a “first-time” Bankruptcy is purged six (6) years after the Bankrupt is discharged, and second or subsequent Bankruptcy is not purged for fourteen (14) years after completion.

When we look at the overall times for the credit report to note the insolvency, there is some less obvious variability with a Proposal.  Most Proposals call for monthly payments and typically over a sixty-month (60) term.  Therefore, the Proposal doesn’t get purged until three (3) years following the completion date which itself may be five years (5), in that case the Proposal stays on the report for a total of eight (8) years.  However, if the Proposal is paid down more aggressively and completed in three (3) years it will only show up on the credit report for six (6) years.

Accessing Credit – re-establishing:

Most people filing Bankruptcies and Proposals find their credit report bounces back quite quickly after their proceeding has been completed, typically one (1) to two (2) years.  We are also seeing increasing numbers of insolvent individuals, still under administration, who are accessing various forms of credit – each reporting to the Credit Bureaus.

Cost differential:

Proposals can be cheaper to administer than Bankruptcies, but they usually involve significantly less work by the LIT office.  A Bankruptcy that generates $10,000 would have LIT fees of $6,397.42 while a $10,000 Consumer Proposal would generate fees of $3,885.72.  The bottom line being that Creditors get a better return from a Proposal than from a quid-pro-quo Bankruptcy.  The trade off is that there is far less work for the LIT in administering a Proposal (than a Bankruptcy).

Counselling provisions:

The counselling provisions for a Bankruptcy and a Proposal are identical, in either case the Debtor must be in attendance for two counselling sessions that target budgeting, money management and credit handling.  More sessions can be arranged if necessary but will be billed separately to the Debtor.

Income tax filing:

In a Bankruptcy the LIT is required to complete two tax returns for the year of Bankruptcy and the prior year return if it remains outstanding.  Since the LIT is not usually running businesses for Bankrupts or Proponents, the Debtor remains responsible for ongoing returns and remittances.

Surplus income – monitoring:

Surplus income is an amount of income that exceeds a threshold value – if the Debtor’s income is more than the threshold, the debtor, under a Bankruptcy must pay a portion of his/her income above the threshold for the benefit of the creditors.  There is no similar monitoring requirement under a Proposal.

The pros and the cons:

For the LIT, Proposals are easier to administer, they require less work than a Bankruptcy and the LIT can draw available fees anytime s/he wants.  However, the fees can be less than for a Bankruptcy.  A Bankruptcy on the other hand pays the LIT higher fees (on smaller Bankruptcies) but require more work.

From the Debtor’s perspective, Proposals are usually more expensive than Bankruptcies and linger longer on credit reports.  Make sure you get all the information and choose the right option for you and your family.