Surplus Income: How the New Rules Could Extend the Cost of your Bankruptcy in Canada
August 24th, 2009 by A Licensed Insolvency Trustee
New bankruptcy rules will come into force in Canada on September 18, 2009. Last week I reviewed What You Need to Know About the New Bankruptcy Rules in Canada. Today I’d like to comment on the most radical change: how your income will impact on the length of your bankruptcy in Canada.
When you go bankrupt, you are required to report your income to your trustee each month. The more you make, the more you are required to pay. This rule exists based on the theory that a wealthy doctor that goes bankrupt (perhaps due to a bad business investment) should be required to contribute more to his creditors than a single mother with minimal income.
The government sets limits on how much you can earn, and if you earn more than that amount you pay a portion of your surplus income into your bankruptcy estate. Each month that you are bankrupt you are required to send copies of your pay stubs and proof of other income to your trustee, and your trustee then determines what you must pay. For example, in 2009 the limit for a single person is $1,870 per month. If your take home pay is more than $1,870 per month, you are required to pay half of the amount you are over the limit to the trustee. So if you earned $2,270 this month, you are $400 over the limit, so you would pay an extra $200 this month to the trustee, who would then include that money in the funds to be distributed to the creditors.
As I described last week, under current rules you are only required to pay for nine months, unless you were bankrupt previously, or have excessive income, or if a creditor objects to your discharge.
If you file bankruptcy after September 18, 2009 and if you have surplus income, you will be automatically bankrupt for 21 months, or 36 months if you were previously bankrupt. That means that for many Canadians what would have been a 9 month bankruptcy may now be a 21 or 36 month bankruptcy, with the payments based on your income continuing for 21 or 36 months. In other words, for Canadians with surplus income, the cost of bankruptcy just went up. Way up.
Why did the government decide to make bankruptcy more expensive? It may be because they don’t want bankruptcy to be seen as an “easy” way out of financial trouble. If you have low income the rules don’t change, but if you earn a lot, bankruptcy will be much more costly.
It’s also possible that by making bankruptcy more expensive, the government hopes to encourage more consumer proposals as an alternative to bankruptcy. I agree with exploring all alternatives to bankruptcy, and I agree that for many Canadians a consumer proposal is a better option. Was it necessary to change the rules to encourage more consumer proposals? Perhaps, although perhaps education instead of punitive new rules would have proven just as effective.
Regardless, the rules are changing, so how should you proceed if you need to go bankrupt?
First, make sure you understand all of your debt management options. Bankruptcy may be more expensive, so it should be the last option you consider, not the first.
Second, be sure you fully understand exactly how surplus income will be calculated during your bankruptcy. Ask your trustee to do the calculation with you before you file bankruptcy. Here’s an example of why the precise calculation will be so important:
Your trustee is required to calculate your surplus income each month. Before the end of the eighth month of your bankruptcy (if this is your first bankruptcy), the trustee will take the average of your surplus income. If, on average, your income was more than $200 per month over the limit, your bankruptcy is automatically extended from 9 months to 21 months. If your income is the same each month, averaging won’t make a difference.
However, most Canadians get paid either bi-weekly or weekly, meaning that in a typical month they get 2 or 4 paycheques, but depending on how the calendar falls they could receive 3 or 5 paycheques, which will obviously increase their income. In some cases it may be wise to file bankruptcy in the month after your extra paycheque month, so that your average income is lower during the bankruptcy period, potentially resulting in a shorter bankruptcy.
If your employer pays an annual bonus, perhaps in the summer or before Christmas, it may also be prudent to delay filing the bankruptcy until the month after you have received the bonus.
If you can’t wait to file, it may be prudent to file a consumer proposal and avoid the implications of surplus income altogether.
My point is that these new rules won’t simply require a bankrupt to pay more, but they may also require you to pay more for an extended period of time, so it is critical that you fully understand the new rules. Make sure your trustee has fully explained all of the implications. If you don’t understand the explanation, ask again, or find another trustee.
Do your research on the new bankruptcy rules, and then contact a licensed bankruptcy trustee to review your situation and explain to you in detail how the new surplus income rules will impact on your bankruptcy.