While the terms bankruptcy, insolvency, and default all relate to debt and are often used interchangeably, they do not share the same meaning. This difference is important to understand as it can determine whether you are eligible to file for bankruptcy in Canada or even need to declare bankruptcy at all. It can also have implications as to which consumer insolvency solution, bankruptcy or consumer proposal, makes sense for you.
Qualifying for Bankruptcy: Understanding the Solvency Test
Bankruptcy is a legal process where you, as the debtor, make an assignment of your assets for the benefit of your creditors, in exchange for which your debts are eliminated.
To be eligible to file for bankruptcy you must be insolvent. Being insolvent means that you are unable to meet your debt obligations as they come due, either because you are short of money when your bill payments arrive, or because you owe more to your creditors than your own.
What does insolvency mean?
Under the Bankruptcy & Insolvency Act the definition of insolvency is the financial state of being unable to meet your debt obligations as they come due. This is legalese for what your finances look like right now. Are your debts larger than your assets? Is your cash flow bad enough that you cannot pay your bills.
It is important to understand that being in default on your loans does not mean you are insolvent. Default is what happens to a credit account when you are behind on payments. People miss payments all the time, sometimes by accident, sometimes because they are short of cash. Scrambling to pay your monthly bills or missing a payment or two does not mean you are insolvent or a candidate for bankruptcy.
Someone can be insolvent but not bankrupt; however a bankrupt must, by law, be insolvent. In other words, contrary to popular belief, someone can’t file for bankruptcy to get rid of debts if you have enough money or assets to pay those debts on your own.
This solvency test is not the same as the means test used in United States bankruptcy law, where eligibility is based on income. In the US, your income must fall below a median income limit for a household of your size to be able to declare bankruptcy. In Canada, there is no means test. You qualify if you owe more than $1,000 in debts and are insolvent.
Types of Insolvency Proceedings in Canada
Bankruptcy trustees in Canada are now called Licensed Insolvency Trustees. In addition, the legislation governing bankruptcy law in Canada is called the Bankruptcy & Insolvency Act.
This is because in Canada, there are two government administered insolvency options available to deal with your debts: personal bankruptcy and consumer proposal. Both options can only be administered by a Licensed Insolvency Trustee and they both provide debt relief, as well as, protection from creditor legal action.
Do you need to file insolvency?
To determine if you are insolvent and a candidate for filing insolvency, ask yourself the following questions:
- Are you repeatedly behind on your bill payments?
- Do you owe more than the value of what you own?
- Are you continuously using credit to meet your basic living needs such as rent and groceries?
- Do you consistently fall short on cash at the end of each month and can’t catch up without debt?
- Are your debt balances growing each month because you use debt to pay for debt?
- Do you owe more money than you can ever repay?
If you answered ‘yes’ to most of these questions, then you might benefit from meeting with a Licensed Insolvency Trustee to determine whether or not a bankruptcy, or a consumer proposal, is the right insolvency for you.