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Proposals to Creditors

March 26, 2019

Proposals to creditors are more popular than bankruptcies, in fact more than half of all insolvency filings are proposals.  But why the surge from behind?  Until about five years ago most consumers chose to file bankruptcies over proposals.

Several things have happened to bring about the change, recidivism, surplus income, property valuation and trustee fees are four important factors.

Recidivism:

As time moves along more and more people are filing second and more insolvency proceedings.  Second time bankrupts will be bankrupt for at two years and third (or more) time filers may be bankrupt for even longer periods of time depending on if or not they have surplus income and whether there are oppositions to their discharge or conditions imposed by the courts.  There are no oppositions to the completion of a proposal and there are no additional terms to be imposed beyond those contractually agreed with the creditors.

Surplus Income:

While the concept of surplus income is not new, the guidelines did change a few years ago imposing a more burdensome regime upon higher income earners.  Although mediation may be used to reduce the amount payable or to set terms for the payment of surplus income it may not be being used as often as it could.

The most basic formula compares the bankrupt’s income with a standard value, established by using the Low Income Cut Off (“LICO”), any monies received above the threshold are deemed to be surplus to the bankrupt’s basic needs and therefore 50% payable to the trustee for the benefit of creditors.

An upwardly mobile bankruptcy filer may find that as their career improves, they must pay more money, and for an extended time, to the trustee.  This is not the case in a proposal the payment is set at the beginning of the file but either a proposed and agreed value or an amended value established through communication with the creditors.

Property Valuation:

In a bankruptcy real property must be valued twice, at the commencement of the proceeding and again at the end.  If there an increase in value in the property, which in our volatile market has often been the case, the bankrupt may have to pay over the increase in equity to the trustee.  Again, this is not the case in a bankruptcy.

Trustee Fees:

Trustee fees are set by a tariff both for bankruptcies and for proposals.  The tariff under a proposal is typically more generous than under a bankruptcy because the trustee has less administration and monitoring to do throughout the proceeding.  The trustee may also draw its fees from a proposal whenever it wants but sometimes waits for years to get its fees from a bankruptcy.

Credit Reports:

Although bankruptcies stay on credit reports from 6-14 years following discharge mot folks find they can get credit despite such an impediment.  Proposals make it very challenging to get credit during the proposal, often 5 years of payments, and linger for 3 more years after completion.  In either case, bankruptcy or proposal there is little advantage to either in terms of credit rebuilding.