Bankruptcy – things that increase the costs
Bankruptcy doesn’t work the same way it used to; it may have become a very different creature than it was intended to be. There are two (main) things that increase the costs of filing and leave people stranded with no viable way out. Over the years the legislation has changed many times, sometimes in small, subtle, ways and sometimes with broader strokes. There are a number of changes that have a huge impact on the decision to go bankrupt.
Surplus income is based on a schedule provided by the Office of the Superintendent of Bankruptcy (“OSB”). The schedule, referred to as the Superintendent’s Standards sets out an income level, based on the number of people in the family unit, that is exempt. The base amount, derived from the old Low Income Cut Off, or LICO, is deemed to be necessary for the family unit to live a normal average Canadian lifestyle.
In fact, the LICO falls far short of being sufficient – for example the threshold for a single person is $2,355 per month. When one considers the average rent in the City of London is $1,820 per month that leaves the individual with $535 per month to cover the costs of everything else necessary to live. In the most simplistic terms, should the individual earn an extra $500 per month ($2,855 in total) they are deemed to have “surplus income” and must pay 50% of the surplus portion to their LIT for the duration of their bankruptcy plus an additional 12 months.
A first time bankruptcy is administered for 9 months unless there is surplus income payable, then an additional 12 months is imposed for the debtor to make payments. In the case of a second time, or more, bankruptcy the debtor will be bankrupt for a minimum of 24 months and if they have surplus that time is extended out to 36 months.
For people who are really struggling to get ahead and who may have improved their employment, this can appear to be quite punitive. Under the old regime, the LIT had the discretion to increase the time for making payments of surplus income for up to an additional 12 months, now that change applies to all bankruptcy files. The positive part of that is it eliminates competition between LITs, some of whom would recommend shorter terms of let’s say 3 months while others would seek 12 months of payments, and thereby standardized the process.
For debtors who are upwardly mobile, surplus income is a major consideration in deciding between a bankruptcy and a proposal. In a proposal the payment schedule is set at the beginning and remains the same throughout the administration. If the debtor’s income improves it enures to their own benefit and not to the creditors.
The way that property has been dealt with has also changed very significantly one might argue unfairly. Legislative changes in Ontario allow debtors who own real estate to claim an exemption on their principal residence for up $10,783. The wording of the Execution Act confers the exemption on debtors not on the property per se. In the case of multiple debtors jointly owning property it appears that they may each claim the exemption. If there are four joint tenants, they are each entitled to claim their respective exemption of $10,783 x 4 = $43,132.
It used to be that LITs would value property at the time of the bankruptcy and that valuation would prevail until their discharge. But recent court cases have changed that, now, the LIT must value the property at the beginning of the filing and again at the time of the bankrupt’s discharge. If the property has appreciated in value. the appreciation is called “after acquired property” and the bankrupt must pay that amount over to the LIT. During the past four years property values across the country have increased up to 400% if that applies to a bankrupt individual, they will have to pay over their share of equity that exceeds their exemption. After acquired property has always been in the BIA but the courts have intervened, at the behest initially of the CRA, to clarify that increased equity is after acquired property.
Potentially a bankrupt individual could be on the hook for hundreds of thousands of dollars in “after acquired property” as a direct result of our runaway housing market. Some of the problems with the way that regime works include an increased burden on the bankrupt as their housing costs leap. The worst part is that if house prices correct, and they are likely to do that, there is no credit back for a diminished value of the real property.
An individual bought a house that was purchased for $250,000 four years ago and has a remainder balance of $230,000 on their mortgage. They live alone and at the time of going bankrupt three years ago had income that fell below the threshold. At the time of bankruptcy, the house value had increased to $265,000, after negotiating a settlement for equity in the property at the time of the bankruptcy the LIT allowed notional (selling) costs and the exemption – the bankrupt agreed to pay $10,000 for the equity.
After one year the bankrupt’s income unexpectedly increased after being laid off from one job and hired for another. Now the bankrupt is going over the threshold by $1,000 per month and is required to pay $500 to the LIT as surplus income. Add to that the bankrupt’s house doubled in value and is now worth $530,000 and there is some $265,000 that is deemed to be after acquired property. From a legal standpoint that makes perfectly good sense, but from a sociological perspective it appears unjust.
The debtor cannot qualify for a mortgage to pay that amount and while their mortgage payments were $1,200 per month and barely manageable, they would increase to about $3,000 per month and the house would be unaffordable. The bankrupt would be forced (there is no other choice) to sell their home and increase their housing costs by about $600 per month. On top of that they would still be required to make payments of surplus income. In fairness, the bankrupt never signed up for this, in spite of acknowledgements they signed and that are relied upon by the court. Had they had the foresight to see where the housing market and their income was heading, they probably would have made a different decision.
In summary, these are some of the reasons debtors are choosing proposals over bankruptcies at a ratio of four to one. Proposals lock down monthly payments with creditors, unless stated in the proposal, without unexpected increases. For more information call the office: 519-646-2222