Should I choose consumer proposal or bankruptcy?

Reviewed by:

Monique Bourgeois, CFC™ Content Manager

If you’re dealing with a lot of debt and you can’t seem to get ahead, there are solutions. You may have heard of bankruptcy and consumer proposal before, and know that they are strategies to get out of debt. However, what you may not be aware of is how they differ and the implications of one over the other. Let’s take a closer look at what to consider when choosing between bankruptcy and a consumer proposal.

What is Bankruptcy?

Personal bankruptcy is a legal proceeding for when someone is insolvent and unable to pay back their debts. Non-exempt assets are relinquished in exchange for a discharge of debts. In Canada, bankruptcies are filed with a bankruptcy trustee, otherwise known as a licensed insolvency trustee. Bankruptcy trustees act as the referee between the debtor and their creditors to ensure everyone adheres to the laws.

The trustee must have a license from the Office of the Superintendent of Bankruptcy (OSB). The OSB is responsible for making sure all parties involved comply with the Bankruptcy and Insolvency Act.

Choosing Bankruptcy

“Bankruptcy is sometimes seen as an opportunity to start over with a clean slate, but it isn’t as simple as that,” says Jeff Schwartz, executive director of Consolidated Credit Canada. “It’s a drastic financial move that will impact your finances for years into the future. Because of this, bankruptcy really should only be an option of last resort.”

Assets

Bankruptcy is done with the help of a Licensed Insolvency Trustee (LIT). A LIT is a financial professional who provides services for people with debt issues. The LIT takes possession of all their clients’ non-exempt assets. They then use funds raised from the sale of these assets to pay off as much of the client’s debt as possible. Throughout this process, they are required to adhere to the Canadian Government’s finance laws.

Federal and provincial laws determine which assets are exempt and which are not. For example, secondary homes are typically not exempt, but Locked-in Pensions or Registered Retirement Savings Plans (RRSPs) typically are. This, however, is a generalization. Asset allocation is always determined on a case-by-case basis.

Debts

It’s also important to know that not all debts can be included in a bankruptcy. These debts are secured debts, car loans, mortgages, or student debts (with some conditions). Also, things like alimony and child support cannot be included in the sum.

Timeline and costs

It takes anywhere from nine to 21 months to complete a first bankruptcy and discharge all the debts. There’s also a cost. Licensed Insolvency Trustees are paid a fee for their services, which is not covered by the funds recovered. In addition, creditors are paid out a portion of any surplus income. How much surplus income depends on income level and the size of the family.

Bankruptcy deeply damages credit and can prevent qualifying for future credit for a long time. A first bankruptcy will remain on a credit report for six years from the date of discharge. Second bankruptcies are reported for up to 14 years. Bankruptcy is a legal record that can even impact employment options.

What is a Consumer Proposal?

A consumer proposal is a legally binding debt settlement agreement. They are the only debt settlement program the Government of Canada sanctions. They centre around offering to settle debts with creditors for a lesser amount than what is owed. Many consumer proposals settle on around 30% repayment for full debt forgiveness. Like bankruptcy, only a licensed insolvency trustee can file a Consumer Proposal.

Monthly payment amounts are typically part of consumer proposal negotiations. Generally, they are based on what the debtor can afford to pay back and what creditors expect to receive. The Trustee does an analysis of the debtor’s financial situation to assess a reasonable starting offer to the creditors.

Offering 30 cents per dollar of personal debt is relatively common in a consumer proposal. However, each person’s financial situation is different. It largely depends on how much is owed and the income level.

Monthly payments can be spread over a maximum of five years. Generally, once a consumer proposal is accepted, interest on the debts stops accruing, and any legal actions are halted.

Choosing a Consumer Proposal

Unlike bankruptcy, where creditors eliminate debts, doing a consumer proposal means paying back a portion of the debts. In exchange, creditors agree to forgive the remainder of the debt. 

One of the benefits of selecting a consumer proposal over declaring bankruptcy is that it is less damaging to a credit rating. Consumer proposals are noted as an R7 rating. Bankruptcy, on the other hand, is noted as the more serious (and long-lasting) R9 rating.

Another compelling reason to select a consumer proposal is that assets don’t get seized in a consumer proposal, as they would in bankruptcy. Also, in contrast to bankruptcy, where you need to pay fees, the cost for doing a consumer proposal is rolled into the payments.

Making the choice

“There is no one-size-fits-all when it comes to managing your debts,” says Schwartz. “That’s why you need to understand your options fully, and how your decisions today will impact your financial health in the future.”

Who Can File for Bankruptcy or a Consumer Proposal in Canada?

Not everyone is eligible to file a bankruptcy or a consumer proposal.

In Canada, you can claim bankruptcy if:

• You’re a resident
• You owe more than $1,000 in personal debt
• You are insolvent (you owe more than you own, and you’re not able to meet your debt obligations)

Bankruptcy is ideal if you’re looking for immediate financial relief and protection from legal action from your creditors.

You can file a consumer proposal in Canada if:

• Your debts are not greater than $250,000. (not including your mortgage.)
• You’re able to afford to pay back a portion of your debts.
• The majority of your creditors must accept your consumer proposal 

Consumer Proposals are ideal for people who are struggling, but have a little wiggle room in their budget.

How Long Does Bankruptcy and a Consumer Proposal Last?

Bankruptcies tend to have a more negative impact on your credit report than a consumer proposal. However, you can complete bankruptcy in less time. A first bankruptcy can be completed in as little as nine months. However, if there’s a need to make a lot of surplus income payments, bankruptcy can stretch out to 21 months.

With a consumer proposal, there’s more flexibility. The ability to stretch payments out can make Consumer Proposals more affordable. The maximum is five years or 60 months. The caveat being that this can only happen if the creditors agree. Monthly payments for a consumer proposal depend on the amount of debt, any assets, and income level. For creditors to agree to a consumer proposal, they typically want to see that they will get more money back that way than in a bankruptcy.

How Does Personal Bankruptcy and a Consumer Proposal Impact Your Credit Score?

One of the most common questions before filing for bankruptcy or a consumer proposal is the impact on your credit score.

Bankruptcy results in credit reports showing an R9 credit rating notation. This is the worst credit rating that will, unfortunately, stay there for seven years.

A consumer proposal credit rating is slightly less severe. Instead of an R9 credit rating, credit reports will show an R7 credit rating. This indicates that a debt settlement was made with creditors. A consumer proposal usually stays on a credit report for a shorter period than a bankruptcy. The R7 rating remains on a credit report for three years after payments are complete or six years after filing. Are you running out of ways to pay your debt? Still can’t decide whether to choose bankruptcy or a consumer proposal? We can help you weigh your options. Call us at (844) 331-7315or start with our online debt analysis.