If you’re facing financial challenges – either on a personal level or regarding your business – the terms insolvency and bankruptcy may come to mind.
You may wonder: is insolvency the same as bankruptcy? What are your options to bounce back? Know their differences and the processes involved when you become insolvent or file for bankruptcy.
What is the difference between insolvency and bankruptcy?
Insolvency and bankruptcy are two related, but different, terms that involve individuals and businesses that go through financial distress.
Under Canadian law:
- insolvency: refers to a financial condition, such as when a person or company cannot pay their debts on time
- bankruptcy: refers to a legal status, such as when a bankruptcy order has been issued against a person or company
Insolvency happens first. Here, the insolvent person realizes that their current assets are not enough to cover their debts. Then, they stop paying their creditors after these debts are due.
Bankruptcy may follow next. Here, either the insolvent person or their creditors may apply before the court for a bankruptcy order. This is a legal process with the goal of paying the insolvent person’s debts and discharging them from bankruptcy.
An insolvent person also has other options aside from filing for bankruptcy. Being insolvent does not mean that a person or company is bankrupt.
What are insolvency and bankruptcy under Canadian laws?
The main federal law regulating insolvency and bankruptcy in Canada is the Bankruptcy and Insolvency Act (BIA).
There are also other federal laws that are involved in the process of insolvency and bankruptcy, such as:
- Companies’ Creditors Arrangement Act (CCAA)
- Wage Earner Protection Program Act (WEPPA)
- Winding-Up and Restructuring Act (WURA)
While the BIA applies to both insolvent individuals and corporations, the CCAA, WEPPA, and WURA only apply to corporations, businesses, or employers.
Becoming insolvent in Canada
Under the BIA, a person or a corporation becomes insolvent only when their debts amount to $1,000 or more, and:
- they cannot pay their debts or obligations as these become due
- they stopped paying their creditors as these became due
- their assets are not enough to pay all their debts (those that already due and those about to become due)
When a person or a business falls under this definition, they will have many options to pay their creditors and recover from debt.
Becoming bankrupt in Canada
The ways to become legally bankrupt are different from the grounds of becoming insolvent.
Under the laws on insolvency and bankruptcy, an insolvent person can become bankrupt through:
- voluntary assignment: where insolvent individuals assign all their belongings to their creditors
- involuntary assignment: when the creditor of an insolvent files a petition for a receiving order against the insolvent’s assets
- deemed bankrupt: when an insolvent fails to comply with the requirements for filing a Division I proposal or the proposal’s conditions after it was filed and accepted
Here’s a video that explains the process of bankruptcy and what to expect:
To know more about insolvency and bankruptcy, reach out to a lawyer in your area. If you’re in Edmonton, contact the best insolvency lawyers for litigation in Alberta as ranked by Lexpert.
What happens when you claim insolvency in Canada?
Under the laws regulating insolvency and bankruptcy in Canada, an insolvent has these options to recover from a financial crisis:
- Consumer proposal: for insolvent individuals whose debts do not exceed $250,000, excluding their mortgage
- Division 1 proposal: for insolvent individuals or businesses but with no limit on how much debt they owe; follows the same process as Consumer proposal
- Business restructuring: for insolvent corporations with debts of $5 million or more; follows the proceedings under the CCAA
- Bankruptcy filing: if the other options do not apply, or a proposal was denied by the creditors or the court
These options may differ between individuals and corporations. When faced with such a situation, seek advice from an insolvency lawyer.
Consumer and Division I proposal
In both a Consumer and a Division I proposal, a Licensed Insolvency Trustee (LIT) will assist the insolvent person or business. The proposal will be offered to the insolvent’s creditors, which they must accept.
Once accepted, and after complying with the terms of the proposal, the insolvent will be legally released from their debts.
Restructuring
During restructuring, the corporation is temporarily protected from their creditors for 30 days through an initial order. This will give the corporation some time to restructure itself.
By filing for restructuring, a corporation avoids becoming bankrupt and having its assets seized.
A Plan of Compromise or Plan of Arrangement will be prepared by the corporation and must be accepted by its creditors.
Bankruptcy
Bankruptcy is the last resort for insolvent people or businesses. Here, creditors deal directly with the insolvent’s LIT.
The LIT will then sell the insolvent’s assets to satisfy their debts. The insolvent may also continue clearing their debts through "surplus income" payments.
How long does insolvency last?
The period of insolvency will depend on how quickly a person or corporation acts to solve the issue.
An insolvent person may choose other options other than filing for bankruptcy. However, if a person has been discharged from bankruptcy, we can say that they are also “discharged” from insolvency.
Getting a bankruptcy discharge will usually take about nine (9) months or longer. This also depends on the cooperation of the bankrupt person or corporation and the "surplus income" payments required.
Can insolvency lead to bankruptcy?
According to Canadian laws, insolvency may lead to bankruptcy. Filing for bankruptcy is one of the solutions so that an insolvent person can pay off their creditors. There are legal processes that must be followed so that the insolvent person or corporation can be declared bankrupt.
While insolvency signifies an inability to pay debts, bankruptcy is a legal process to resolve that situation. Insolvency doesn't automatically mean bankruptcy. Options are available under the law before considering bankruptcy as a last resort. An insolvency lawyer can help find the best solution to achieve financial stability.
Got more questions on insolvency and bankruptcy? Reach out to any of the Lexpert-Ranked best insolvency lawyers for litigation in Canada.