In 1992 changes to Canada’s Bankruptcy and Insolvency Act were meant to reduce the number of insolvency cases, but many sleazy financial advisers regularly recommend filing for personal bankruptcy. There are alternatives to going belly up.
In the 1990s, Gail Winkelmann became co-owner of a commercial and residential garbage disposal business in Surrey. The client list, which included construction companies, grew steadily during the first two years, generating enough work to lease five trucks and hire five full-time employees. But a series of unfortunate circumstances involving a partner resulted in thousands of dollars being siphoned out of the company. The bills mounted and when Winkelmann and her partner finally split up in April 2000, the company’s debt load was $180,000, owed largely to the GVRD for landfill fees and to the Canada Revenue Agency for unpaid taxes. Winkelmann’s house in Surrey was in foreclosure. She was now a single mother with four kids aged five to 18 to support and the sole owner of a company whose finances were bled dry. Given her staggering debt, she wondered if she could salvage the business without forfeiting the family home. A trustee she found in the Yellow Pages said that wasn’t possible and offered her only one option: abandon the business and declare personal bankruptcy. “He told me how to go bankrupt and open the business the next day under another name,” she says. “[But] it seemed crooked to me. Even though I knew people did it, I didn’t feel safe.” Every year, thousands of British Columbians find themselves in Winkelmann’s shoes: wallowing in debt, unable to pay bills racked up through reckless personal spending and/or the failure of a business they either own or agreed to become liable for when they were named a director or signed a loan guarantee. For many of these debtors, “easy” credit solutions beckon like neon signs on the Vegas strip. The Internet is rife with sites offering painless solutions to becoming debt-free. “Never repay what you owe, legally,” promises one popular spam email. In its television ads, the Canada Debt Hotline proudly displays a Canadian flag and states, “You are protected by the laws of Canada,” a reference to the federal bankruptcy act. And just in case credit counsellors and debt poolers can’t reach you on the Internet, radio or TV, ads for their services are plastered all over Vancouver’s SkyTrain cars and stations. Ironically, given that the changes made in 1992 to Canada’s Bankruptcy and Insolvency Act were meant to reduce the number of insolvency cases, sleazy financial advisers regularly recommend filing for personal bankruptcy. They earn a flat fee for very little effort; their clients end up in R7 purgatory (the lowest possible credit rating) for years, all their assets seized and sold. Thousands of people declare personal bankruptcy every year in this country. From 1966 to 2002, the number of insolvency cases filed with the Office of the Superintendent of Bankruptcy Canada increased an average of 8.8 per cent annually. Since the mid-’70s, most of those have been personal or consumer bankruptcies rather than business bankruptcies, in which the assets of an insolvent corporation (as opposed to an individual) are liquidated for the benefit of the creditors. In B.C. in 2004, out of 10,642 total cases reported, 8,378 were personal bankruptcies. That represents a 56-per-cent increase in consumer cases in this province in the past decade (4,747 British Columbians declared personal bankruptcy in 1996). As defined by federal law, bankruptcy refers to someone whose debts exceed his or her assets or ability to pay. Facing complete financial ruin, the bankrupt person agrees to a legal proceeding in which his or her financial affairs are placed into the hands of the bankruptcy court. A trustee is appointed. The credit bureau is notified. Assets are liquidated. Creditors line up to receive whatever remains after the Canada Revenue Agency (CRA) gets its share. The bankrupt person receives counselling. Barring objections from unhappy creditors, an automatic discharge of the bankruptcy takes place after nine months, cancelling any remaining debts. At least five more years must pass before the bankruptcy proceeding is wiped from the credit bureau record. Winkelmann, though, was reluctant to throw in the towel, largely because she knew what losing the family home in a bankruptcy proceeding would mean to her children. “I also thought down the road something would come back to haunt me. Ninety per cent of my business is with property management companies and I didn’t want to do anything that would affect them. I was afraid that I would lose their contracts because they could just go somewhere else.” Time for a second opinion. A friend took Winkelmann to Deane Gurney, a trustee at Sands & Associates in Surrey. Gurney pointed out that her garbage-collecting business was still viable and would produce sufficient cash flow to qualify her for a form of debt relief known as a consumer proposal. If she kept her customers and revenues remained steady, over time her first-in-line creditors (the CRA and the GVRD, among others) would receive a significant return on the $180,000 owed, as opposed to minimal return if she filed for personal bankruptcy. And most importantly, Winkelmann would avoid the emotional and financial blow of losing her home. [pagebreak] Winkelmann reopened the business under her own name, after convincing one of her secured creditors to transfer the truck leases to her. With no assets left to sell in the original company, the minor creditors backed off and swallowed their losses. “There were no credit cards in the [original] company, but I had a few personal cards,” Winkelmann says. “[Gurney] went over everything with me and decided I should do a proposal rather than a bankrupt, because then I could keep the business operating.” In a nutshell, a consumer proposal allows you to pay back a portion of your debt with interest over a period of time and to secure agreements from your creditors to forgive the rest. For your proposal to be acceptable to your creditors, it must give them more money than they would get if you filed for bankruptcy (a 50-per-cent return on the amount owed, for example, as opposed to 10 per cent). In addition, you must be employed and earning enough income to cover daily living expenses and you must have a third party willing to guarantee the proposal (see “How a consumer proposal works,” p.135, for details). Over three years, Winkelmann was able to repay $108,000 of the total amount owing. She wrote a $3,000 cheque to Sands & Associates each month, a portion of which paid the trustee’s fees with the remainder distributed to proven creditors on a percentage basis according to the indebtedness that was claimed. She was able to make her $1,200 mortgage payment each month. Part of her debt was forgiven by the GVRD, the CRA and some smaller businesses. In total, $72,000 of debt was forgiven by her creditors; she made her last payment to the trustee in June of 2004. “It was tough at times,” Winkelmann admits, “but I survived. It had been tougher before the proposal when there was not enough money to pay the bills. There was often no money for groceries. I had been doing without for a long time, so now that I had control of the money, it was better. I knew what I had to live on and I could control it.” If her business and personal creditors hadn’t agreed with the proposal, Winkelmann would have been forced into personal bankruptcy. The CRA would have seized her assets to recover the GST she owed, leaving slim pickings for the remaining creditors. And she certainly would have lost the family home. Canadian bankruptcy cases once consisted mainly of small business owners and farmers, because those were the only individuals to whom banks would lend large amounts of money. “We’re talking about the past here, where lending criteria by the banks were far different than what it is today,” says Gurney. In 1968, the Chargex credit card (renamed Visa in 1977) was introduced and $300 of instant credit was suddenly available to almost everyone. Low- and middle-income earners began to accumulate personal debt. Spending habits changed dramatically. In 1975, the national consumer debt load was $16 billion; by 2005 it had ballooned to $210 billion, not including mortgages. Fully 46 per cent of Visa and MasterCard cardholders now carry a balance from month to month. Stanley Kershman is an Ottawa-based lawyer and specialist in bankruptcy and insolvency law, and the author of Put Your Debt on a Diet. He observes that most people who find themselves deep in debt have underlying problems and spend to satisfy low self-esteem. “Whether it’s a big car or diamonds, expensive clothes or luxury vacations, shopaholic disease is a common trait and it accounts for about 20 per cent of all [personal] bankruptcies,” says Kershman. “Marital breakdown is [another] reason, next job loss, then disability and emotional problems due to death of a spouse or child.” Personal troubles can certainly lead to financial woe. But Canada’s 40-year low in interest rates may be the key factor in our rush to take on a heavier debt load. The personal savings rate – what’s left over each month after the bills have been paid – declined to one-half per cent in the second quarter of 2005, the lowest rate since the 1920s. Skyrocketing housing prices in the Lower Mainland have also impacted debt loads. “There are many people overextended. People are leasing vehicles because they don’t want to put down a deposit,” says John DeRose, a senior branch manager at Vancity. An increase in leasing means a higher debt load. “Even though leasing allows them to lower their monthly obligations, the downside is that you are renting. You don’t have an asset at the end of the day.” DeRose is also seeing a lot of members taking equity out of their homes to pay debts accrued through charge cards. “Debt consolidation is scary because what if interest rates go up a few per cent? Will [they] be able to pay?” A three-per-cent rate hike looks small on paper but could easily put people in a financial bind, DeRose says. Bonita Lewis-Hand, an insolvency lawyer at the Vancouver firm Lawson Lundell, thinks that personal bankruptcies may also be on the increase due to the competitive nature of lending. “Fifteen years ago, if you had a bad credit rating, it stopped lenders from lending to you. Today, because of all the competition, you can [still] get credit, due to the money paid on high interest charges,” she says. In other words, credit companies are willing to take a risk because everyone is a moneymaker. [pagebreak] Even after consumers exceed their limits and drop into the debtors’ abyss, there is money to be made on their misfortune. Many will resort to some dangerous and complex ways to try to get out of debt. They’ll turn to money marts for payroll loans or to credit-card companies that offer to consolidate debts, but the interest rates of up to 28 per cent accompanying these services only make the situation worse. “All of them are short-term solutions to long-term problems,” says Vancouver trustee David Wood. Kiting is also pervasive: taking cash advances from one credit card to make minimum payments on another. “People don’t realize that you pay interest from the date of the cash advance,” Wood explains. “So in reality, they are becoming worse off. They think they are making headway but are losing ground.” There is a difference between a trustee and a credit counsellor. Debtors must hire a trustee in order to file for bankruptcy or make a consumer proposal. Credit counsellors, on the other hand, are not authorized to do either. Instead, they will pool debts and set up a schedule of payments. And they will amortize payments based on a person’s income, living expenses and what he or she can afford. These payments (including a commission, often as much as 15 per cent of every dollar paid to a creditor) are made directly to the counsellor, who then disburses the money to credit-card companies and other creditors. There are no official certification programs, diplomas or degrees required to be a credit counsellor. Their commissions are often higher than the fees charged by trustees. Some of them have banking or finance backgrounds. Some may not. In B.C., the Business Practices and Consumer Protection Authority issues licences to debt-poolers, but regulation of the industry is slight. Nevertheless, Kevin Galloway of Vancouver’s 4 Pillars Consulting Group recommends using a credit counsellor when personal debts reach the four-digit mark. “A trustee will generally not recommend proposals under $8,000,” he says, “because the amount to creditors will be so minimal. It is better to just pay it off in full or use a credit counsellor to negotiate and lower the interest.” With larger amounts of debt, trustee David Wood advises consumers to beproactive rather than reactive. For example, most banks will give customers repayment options on request before their homes enter foreclosure, but loan officers are less likely to be flexible once the foreclosure papers are drawn up and delivered. “The same goes for creditors,” says Wood. As a trustee, “there are more goodies in my tool bag now, and I would rather do a proposal over a bankruptcy. It’s better for everyone.” Consumer proposals aren’t always the answer. In 1996, Terry Forester (a pseudonym) was a successful Vancouver developer with a multimillion-dollar business. When he was struck that year by a series of health problems that eventually necessitated 13 separate surgeries, he was grateful that the provincial health-care plan paid for his medical bills. But his lack of disability insurance meant there was no coverage for lost wages (in the U.S., half of all personal bankruptcies are related to medical expenses). Forester began to use his seven credit cards to pay for groceries, car loans and operating expenses for his company. It didn’t take long to max the cards out; within five months his credit-card interest payments alone hit $3,250 a month. Forester sent a letter to the credit-card companies explaining his predicament. He asked them to consider lowering their interest rates to allow him to pay down the principal, not just cover the interest. None of them replied. Finally, after six months of growing insolvency, he approached David Wood. “I was embarrassed to knock on David’s door and reveal the extent of my misery,” he explained. But he knew he couldn’t get out of financial trouble by himself. Wood advised him to go the bankruptcy route, “So you and your wife can get some sleep and get a fresh start.” For Forester, a proposal wasn’t feasible, mainly due to his age – he was 62 at the time – and his health issues, not to mention that he no longer had an income. Fortunately, the family home was in his wife’s name, as were most of the couple’s assets. “My concern was that I would wake up in the morning and actually make some money and have the creditors take it all. If I died, what would happen to my wife? I knew that the only way I could leave my wife with anything was to declare bankruptcy. If I hadn’t gone bankrupt and did die, the insurance would have gone to the creditors.” The biggest loss he incurred was the damage to his self-esteem, Forester told BCBusiness, but that slowly came back. Bankruptcy meant a “huge, huge weight off my shoulders,” he observed. “I lost the ability to have credit for a long time but that isn’t necessarily a bad thing.” Forester worked hard to recover his business of 35 years, which was pretty much in tatters. “I have the greater majority of my investors back, although a few would like to shoot me,” he said early last fall. “When your career is a gamble and you take risks, the leap to bankruptcy is not that wide.” Insolvency lawyer Bonita Lewis-Hand says whether it’s an individual or a small firm that goes belly up, society is more understanding of financial failure now than it was a few decades ago. The prevailing wisdom is that people make mistakes, learn from them and carry on. “There are honest but unfortunate mistakes, and [a proposal or bankruptcy] can be a wonderful tool that is available for unfortunate debtors. But for that, people would be in strangleholds, burdened for the rest of their lives,” she observes. After 25 years in the business, both in Ontario and other provinces, fellow lawyer Stanley Kershman agrees. But he warns that personal bankruptcies are on the rise – thanks to easy credit, huge student loans, rising divorce rates, the cost of living and the burden of carrying huge mortgages. “After you are discharged [from a bankruptcy or proposal] it is hard to get a new loan,” says Kershman, and therefore it’s an uphill climb to regain a reasonable credit rating. Provided they follow terms of the agreement, most people can get a credit card “but the only people who should get a card are [those who] need to use it for travel, renting a vehicle, [purchasing an] airline ticket or a hotel. If someone has been discharged from bankruptcy or proposal, they shouldn’t get a card,” he warns. “They will get caught in the same trap, looking for another lifeline.” Unlike Gail Winkelmann, few of the trapped or once-trapped are willing to discuss their financial difficulties publicly. But Winkelmann wants people to know that they can file for a consumer proposal or a bankruptcy and maintain a semblance of dignity and self-esteem. Today, Winkelmann has her home in Surrey, her scaled-down garbage disposal business (three trucks, residential clients only) and three full-time employees. Owning and operating the business without a partner has been a challenge, and her stress level was high when her consumer proposal was first enacted. “I sat my kids down and told them that these are the choices: rent an apartment and make a lousy hourly wage or give this [proposal] a go.” She still has to be careful with her money. But because she finally got her finances under control, “I feel secure and don’t have the worries that I did. I know I can feed my kids.”