This pandemic’s cold hard reality is that many Canadian small businesses won’t survive the economic fallout from COVID-19. Given the virus’ unprecedented circumstances and sometimes haphazard government support for small business owners, there was bound to be collateral damage beyond skyrocketing infection rates.
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Small business bankruptcies on the rise
Back in March, when COVID-19 uncertainty wreaked havoc across the globe, the number of small businesses filing bankruptcy in Canada declined significantly.
As with the decline in consumer insolvencies during COVID-19, the drop in business bankruptcies was due to the array of government support programs and a closed court system. Businesses were on hold, but so too were their debt payments and actions by their creditors.
However, supports won’t last forever. They also don’t eliminate the underlying problem many small businesses face – a drop in revenue and an increase in debts due to COVID-19.
We are already seeing a rise in small business insolvencies. The Office of the Superintendent of Bankruptcy began reporting on individual versus corporate bankruptcies in their 2019 online statistics. Those stats show an uptick in individual businesses filing insolvency beginning in the fall of 2020. We expect these numbers to rise significantly in 2021 as more restaurants, local stores, hair salons, tradespeople, and other small businesses close permanently because of losses incurred during extended social distancing and lockdowns.
That means now is the time for struggling Canadian business owners to familiarize themselves with small business bankruptcy nuances.
The more you know about the bankruptcy process, and the earlier you reach out to a debt professional for advice, the less stressful and financially damaging it will be. There’s even the chance that you can keep your business alive.
With that said, read on as I discuss the notion of filing for bankruptcy if your business debts are overwhelming and what your options are if your small business closes.
What happens to debt when a business closes?
If your business closes and it owes money, does this mean you need to file personal bankruptcy? The answer depends on whether you are personally liable for business debts.
The type of business you operate will partially dictate whether business debts become personal debts as well.
Sole Proprietorship or Unlimited Partnership
Sole proprietors and unincorporated partnerships don’t have separate legal status from the business. As a sole proprietor, you do not have limited liability. Business creditors can pursue your personal assets in addition to any business assets.
A sole proprietor assumes all business risks and is personally liable for all business debts. In a partnership, although you may share profits based on your partnership agreement, each partner can be held personally liable for 100% of any business debts.
If your sole proprietorship or partnership closes its doors, your business creditors can and likely will look to you personally for payment. To eliminate that debt, you may need to file for personal bankruptcy. Filing for personal bankruptcy eliminates both the business debts and any personal debts you may have.
It’s worth noting that bankruptcy does not deal with secured debts. If you have business or personal assets pledged as security for a business loan, the bank may take possession and realize on those assets to recover the loan balance. They can then pursue you for any shortfall, which can be included in your personal bankruptcy.
Many small businesses fall into this category. They are unincorporated. In this situation, a small business bankruptcy is treated in the same manner as a personal bankruptcy.
It’s not uncommon for a sole proprietor to mix personal and business debt. For example, they often use personal credit cards to fund their business. This is another reason why personal bankruptcy becomes necessary to gain a fresh start. Both personal and business debts can be taken care of through the same filing.
A business that is incorporated is a separate legal entity on its own. If a corporation files bankruptcy, its assets are sold, subject to any rights of secured creditors, and the money is distributed in satisfaction of any business debts. A corporate bankruptcy is costly (professional fees can be $20,000 or more) and usually involves both a Licensed Insolvency Trustee and a bankruptcy lawyer.
An incorporated business can be closed without filing bankruptcy if there are no assets involved. The business can simply close and walk away from any company debt. This is the case for many incorporated small businesses that are not asset-heavy (for example companies in the service industry or trades) and something we see often.
Whether your business was incorporated or not, you are also personally liable for any business debt you have personally guaranteed.
Directors can also be held personally liable for specific statutory obligations, including unremitted HST or GST under the federal Excise Tax Act, unpaid payroll source deductions under the federal Income Tax Act and certain wages under provincial Employment Standards Acts. These types of debts are typically called Director’s liabilities. Businesses that have been using tax remittances as operating cash often cannot catch up on these obligations before the business ends up failing.
Can you restructure the business?
Suppose your business is viable but struggling with a lot of debt (which will be common after COVID-19). In that case, it is possible to restructure your debts through an insolvency proceeding and carry on operating your business.
Declaring bankruptcy or making a proposal to creditors can provide you with creditor protection while restructuring and reorganizing.
For an unincorporated business, we once again look to personal insolvency options to restructure.
If your total debts (both personal and business), not including your home mortgage, fall below the $250,000 debt limit, you may be able to file a consumer proposal. Under this option, you make a deal to repay a portion of your debts to your creditors. If your debts exceed this limit, it is still possible for an individual business owner to file a Division I Proposal to creditors. A Division I proposal has the same result in terms of restructuring your debts but has a slightly different administration structure and, if not accepted by your creditors, it has the added risk that you will automatically be declared bankrupt.
Since a bankruptcy or consumer proposal does not deal with secured debt, you will want to ensure you can keep up with secured payments if you file insolvency to deal with unsecured creditors. While your car loan lender and mortgage lender cannot demand payment of your loan just because you filed bankruptcy, this is not always the case with a secured business loan. Read your loan agreement carefully for any default clauses that might need to be addressed.
A corporation can also restructure its debts via a Division I Proposal or by filing an arrangement under the Companies’ Creditors Arrangement Act. This process is much more expensive, involving the courts, a bankruptcy attorney, and a Licensed Insolvency Trustee.
Avoid creating preference payments
If you are facing financial difficulty and your business is at risk, it’s important not to pick and choose your favourite creditors to repay.
Under bankruptcy law, a trustee is required to inquire into payments, or transfers of property, made in the three months prior to the date of insolvency (12 months in the case of non-arm’s length transactions). Make a payment to one creditor in preference to another, and your trustee may ask to have this transaction set aside. Such an act is called as a preference under the Bankruptcy & Insolvency Act, and can jeopardize your discharge.
If you have some business assets and are thinking of filing personal bankruptcy, discuss the right course of action with your trustee. They will help you decide if you should liquidate these assets at fair market value before filing with the funds distributed in proportion to your creditors to maximize returns or whether it is best to surrender these assets into your bankruptcy. In either case, be aware that all transactions immediately prior to your filing will be under review, so talk to your trustee before making any decisions.
This is also why it is key to seek advice from a debt professional as early as possible if you are struggling. It is usually much easier to prevent a bad move than it is to try to undo one.
Can you file bankruptcy for government debts?
Almost all small business bankruptcies involve tax debts. The reason is simple. As stated earlier, often the first payments to be deferred for cash flow purposes are GST or HST remittances and payroll deductions.
Government debts are considered unsecured debt in a bankruptcy or consumer proposal and are dischargeable business debts. The key is to act before Revenue Canada places a lien on any assets converting an unsecured debt into a secured debt.
CEBA loans and CERB
What about debts related to COVID-19 support programs? The federal government provided several programs to help businesses through the pandemic, notably the Canada Emergency Business Account or CEBA loan and Canada Emergency Wage Subsidy. Some small business owners (or self-employed workers) may also have collected CERB while their business was subject to shutdown restrictions.
It is possible to include CEBA loans and other government pandemic debts in your bankruptcy as long as those payments were not received through fraud.
We have already filed our first small business insolvency with a CEBA loan and expect to see a significant number of self-employed workers file insolvency for CERB repayment and taxes owing on CERB income.
Can you still run your business after filing bankruptcy?
Yes, people who file for personal bankruptcy can still run their own business.
First and foremost, you make your living running your business. Taking that away from you wouldn’t be fair. The whole idea behind bankruptcy in Canada is to give you a fresh start. That can’t happen if you’re no longer allowed to earn the only way you know how to.
It’s not all cut and dry, however. You’ll need to re-evaluate if it’s possible to get your business back on track. What caused the business’s financial difficulty? For many business owners in 2021, their business was probably thriving before COVID-19. They may only be facing a business closure due to the prolonged negative impact of shutdowns designed to control the coronavirus. As I said earlier, it’s possible to file personal bankruptcy or a consumer proposal to eliminate or restructure debts accumulated during the pandemic and start over.
One problem that stems from filing for personal bankruptcy and running your business is you may struggle with access to new credit. Suppliers may or may not be willing to offer financing options since you’re no longer classified as a trustworthy borrower. It’s something to consider before filing. You may be able to change vendors, and you will be able to take steps to restore your credit once your debts are eliminated.
What are the implications of filing personal bankruptcy?
Province-to-province, the rules differ. But regardless of where you live, there are consequences to filing insolvency.
First, you may lose some personal assets. There are provincial and federal bankruptcy exemptions, including essential personal and household assets (e.g., clothes, furniture, other personal items), a small car and most RRSP and pension savings. However, if you have equity in your home or non-registered investments, these will need to be liquidated to satisfy your creditors. In these situations, most people choose to file a consumer proposal as an alternative to bankruptcy as a consumer proposal allows you to keep possession of all your assets.
If you are a shareholder in a company and file personal bankruptcy, your shares become property in your bankruptcy estate to be sold for the benefit of your creditors. This may be a consideration if you own other companies.
One area of concern for tradesperson is tools of the trade. Most provinces have exemptions that allow you to keep a certain dollar value of tools and equipment or business assets necessary to operate your business and earn a living. In Ontario, you can keep up to $14,405 in tools and equipment (at resale value, not new cost).
Most provinces, including Ontario, have legislation prohibiting someone who is bankrupt from being a director of a company until they are discharged. Upon filing bankruptcy, you must resign. Once you are discharged, you may be appointed as director again. You can file a consumer proposal and remain a director since you are not bankrupt.
Pragmatically, you’ll face fulfilling specific duties during the bankruptcy process. For instance, you must report your income to your trustee each month. The government sets a level of what you’re allowed to earn – and if you go above this amount, you must pay more. These extra earnings are called surplus income. If your future income is uncertain, discuss this with your Licensed Insolvency Trustee. They will help you with the decision of whether it makes more sense to file bankruptcy or a consumer proposal to better structure these surplus income payments over a longer period, reducing your monthly payments.
And as noted, either a personal bankruptcy or consumer proposal will be reported on your credit report and will affect your ability to gain new credit for a short period of time.
The main advantage of filing for bankruptcy, of course, is that your problem debts are eliminated.
How do I file personal bankruptcy for business debts?
If your business is struggling financially due to excessive debts, talk with a Licensed Insolvency Trustee about your options. Your accountant can give you a picture of what your balance sheet and cash flow will look like, but a trustee can advise if eliminating old debt through a bankruptcy or consumer proposal is a good option for you.
Sole proprietors and partnerships with nowhere to turn, mounting debts, and non-existent revenue for the next while might have no choice but to file for personal bankruptcy or make a proposal to their creditors.
The key here is that every situation is unique and often complicated. A Licensed Insolvency Trustee will ask questions to help you narrow down the options and possibilities. They will explain the implications of filing insolvency and help you determine the most appropriate way to move forward. They will help you achieve your goal to either close the business and walk away with a fresh start or start over with a restructured balance sheet that will ensure your business returns to profitability down the road.