Myths About Filing Personal Bankruptcy

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    10-Apr-2018

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    MYTHS ABOUT FILING PERSONAL BANKRUPTCY

    There are several rumours and myths perpetuated in the general public about theconsequences of filing for personal bankruptcy. As a result, the most common questionswere asked are:

    1. Will I lose everything that I own?

    2. Do I have to wait for 7 years to get credit again?

    3. Does a trustee work for the creditors against me?

    Lets address these questions one by one

    WILL I LOSE EVERYTHING THAT I OWN?

    The general rule of thumb is this: if someone files bankruptcy, she is assigning her assetsto the trustee, who becomes the legal owner and must liquidate them for the benefit of hercreditors. However, there are some very important exceptions to this general rule:

    The home

    There are 2 types of situations: (1) the value of the debtors home is less than themortgage balance; and (2) the value of the home is more than the mortgage balance. Inthe first case, there is no equity. In the second case, there is equity.

    If there is no equity in the home and the debtor files for bankruptcy, the trustee has nointerest in the home. It would be pointless for a trustee to sell the home and not even haveenough money to pay off the mortgage. In this type of situation, the home is not affectedby the bankruptcy. Because the mortgage is a secured debt, the debtor must keep payingthe mortgage if she wants to keep the home.

    On the other hand, if there is equity in the home, the trustee has a duty to realize on theequity. The first option for the trustee is to sell the home, pay off the mortgage anddeposit the net proceeds into his trust account for the benefit of the debtors creditors.However, the more common option allow the debtor to buy out the trustees equity inthe home by making monthly payments to the trustees office.

    Lets look at some simplified examples to illustrate

    Example 1:

    Fair market value of home $200,000Mortgage balance 210,000

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    Equity: ($10,000)

    There is no equity in this home. If a debtor in this situation filed a bankruptcy, thetrustee wouldnt have any interest in her home. So long as she keeps making hermortgage payments, she can keep the home.

    Example 2:

    Fair market value of home $250,000Mortgage balance 210,000Equity: $ 40,000

    There is $40,000 of equity in this home. If the debtor in this situation filed abankruptcy, the trustee would be required to realize $40,000, as this is an asset ofthe bankruptcy estate. The trustee can sell the home and pocket the net proceedsof $40,000 after paying off the mortgage. Alternatively, the trustee can reach anagreement with the debtor to allow her to keep the home, on condition that she

    pays the trustee $40,000. The debtor can make monthly payments towards this$40,000 or perhaps she can borrow money from a relative to pay out the trustee.

    Caveat: actual situations would factor in estimated closing costs such as real estatecommissions and legal fees, but we used simple examples to illustrate the logic of what atrustee considers in dealing with a debtors home in a bankruptcy.

    The Car

    If a car is owned outright by a debtor (i.e., it is not leased or subject to a loan), she cankeep the vehicle if its fair market value is $5,650 or less. If it is more than $5,650, thenthe trustee shall be required to sell the vehicle. The Ontario Executions Act allows adebtor to keep one personal use vehicle so long as its value is less than $5,650.

    If the car is a leased vehicle, then the vehicle doesnt actually belong to the debtor. Thecar is actually property of the leasing company. The easiest way to confirm this is to lookat the car ownership certificate. There are two portions to the ownership certificate: theowner portion (left side) and the permit portion (right side). If a vehicle is truly a leasedvehicle, the name of the leasing company will be on the owner portion.

    If the car is financed through a car loan, the trustee will need to determine if there is anyequity in the vehicle. Heres an example:

    Example 1:

    Fair market value of car $7,000Car loan balance 10,000Equity: ($3,000)

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    In this case, the car has no equity. The trustee therefore has no interest in thisvehicle. Since the loan is a secured debt, the debtor must keep paying the car loanif she wants to keep the vehicle.

    Example 2:

    Fair market value of car $5,000Car loan balance 1,000Equity: $4,000

    In this case, the car has $4,000 of equity. So you would think the trustee wouldhave to realize the $4,000, right? Well, the actual answer is no. Remember that adebtor can keep a personal use vehicle if its value is less than $5,650. In this case,even though there is equity in the vehicle, its value is less than $5,650 andtherefore, the debtor can keep the car.

    Example 3:

    Fair market value of car $7,000Car loan balance 1,000Equity: $6,000

    In this case, the car has $6,000 of equity. Also, its value is more than the $5,650exemption limit. Therefore, the trustee must realize the $6,000 for the benefit ofthe debtors creditors. The trustee can sell the car, pay off the car loan and keepthe rest for the benefit of the estate. The trustee can alternatively makearrangements for the debtor to keep the car if the debtor buys out the trusteesinterest of $6,000. For example, the debtor might be able to borrow $6,000 fromher parents to pay to the trustee. Or, she may make monthly payments to thetrustee so that the $6,000 is paid out over time.

    Pensions

    A pension through work is exempt from seizure by a trustee in bankruptcy by virtue ofthe Ontario Pension Benefits Act. The debtor must provide the trustee with a recentpension statement for the trustee to confirm that is indeed a pension.

    There are situations where an employee leaves a workplace and can take her pension withher. The pension funds are usually transferred into a Locked-In Retirement Accountwith a bank or mutual fund company. A LIRA is a type of RRSP which is funded bymoney transferred in from an employees pension at her former workplace. A LIRA isalso exempt from seizure by a trustee in bankruptcy under thePension Benefits Act.

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    RRSPs

    There are 2 types of RRSPs: (1) RRSPs set up with a life insurance company; and (2)RRSPs set up anywhere else, like with a bank or mutual fund company.

    An RRSP set up with a life insurance company is also called a segregated fund. This typeof RRSP will always have a designated beneficiary if the debtor dies. If the beneficiary ofthe RRSP is the child, grandchild, parent, grandparent, or spouse of the debtor, then theRRSP is exempt from seizure by a trustee in bankruptcy under the OntarioInsurance Act.

    Under the Bankruptcy and Insolvency Act, all other RRSPs are exempt from seizure bythe trustee. However, any contributions made to an RRSP within the 12 month periodpreceding the date of bankruptcy must be seized by the trustee for the benefit of thedebtors creditors.Life Insurance

    There are 2 types of life insurance contract: (1) term life insurance; and (2) whole lifeinsurance.

    A term life policy promises to pay out the beneficiaries a sum of money if the debtor dies.There is no value to this policy unless the debtor dies, and in any case, the money goes tothe beneficiary.

    A whole life insurance policy on the other hand, usually has a cash component inwhich a portion of the insurance premium paid is deposited into an investment account.The investment account increases in value after several years. The trustee is required tocash in the money in this type of policy unless the beneficiary of the policy is the child,grandchild, parent, grandparent, or spouse of the debtor. In this case, the policy would beexempt from seizure pursuant to the OntarioInsurance Act.

    Household Furniture & Personal Effects

    Under the Ontario Executions Act, household furniture up to a value of $11,300 andpersonal effects up to a value of $5,650 are exempt from seizure. These are broadcategories that can apply to pretty much anything in the household: furniture, appliances,clothing, home computer, etc.

    DO I HAVE TO WAIT 7 YEARS TO GET CREDIT AGAIN?

    The simple answer is no. While it is true that a record of bankruptcy will remain on adebtors credit bureau file for 7 years, the time that a debtor is actually bankrupt isusually 9 months. Once a debtor finishes her bankruptcy (i.e., she gets discharged frombankruptcy), she can start rebuilding her credit immediately. In many cases, a debtor cancompletely rebuild her credit within 2 years of completing her bankruptcy.

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    The simplest way to start rebuilding credit is by applying for a secured credit card. Seethis link for details about using secured credit cards to rebuild your credit.

    DOES A TRUSTEE WORK FOR THE CREDITORS AGAINST ME?

    Some debt consolidation agencies will often tell you that a trustee works for thecreditors and not for you. This is a half-truth that these agencies will tell you to get youto sign up with them.

    If a debtor has acted honestly before or after a bankruptcy is filed, there is generallyno conflict between the interests of the debtor and that of her creditors. A trustee has anobligation to ensure that a debtors rights are protected under the Bankruptcy andInsolvency Act. For example, the trustee will prevent a debtors creditors from calling andharassing her, and will stop the commencing or continuation of legal proceedings such aslawsuits and wage garnishments. So a trustee clearly works in the debtors best interests.

    However, if a debtor engaged in questionable conduct before or during herbankruptcy, then the trustee has a duty to deal with the issue in question on behalf of thecreditors. Common examples of questionable debtor conduct are (but not limited to):

    Not disclosing assets owned by her to the trustee when she files for bankruptcy. Thetrustee would have a duty to seize and liquidate such assets for the creditors;

    Transferring an asset to a relative (like title to ownership in a home) on the eve offiling bankruptcy, with the intent to defeat her creditors. The trustee would have aduty to obtain an order from the bankruptcy court to reverse the transfer and seize theasset for liquidation for the benefit of her creditors;

    Using a credit card to make large purchases on the eve of filing bankruptcy, knowingfull well that she has no intent of repaying the funds borrowed. In this instance, thetrustee would be required to oppose the debtors discharge from bankruptcy and makeit conditional on her repaying these funds.

    A debtor had a loan from her father and repays him in full on the eve of bankruptcy.However, she does repay any of her other debts. Such a transaction is called afraudulent preference, since there is a clear intent on the part of the debtor to preferrepaying one creditor but not any of the others. The trustee would have a duty to getthat money back from the debtors father for the benefit of all of her creditors.

    So if you are an honest person and are considering filing for personal bankruptcy, dontlet this myth scare you into making the wrong decision.

    This blog post is an overview rather than a complete analysis. Before applying any ofthese suggestions, please contact us to discuss your situation with us. Well be more thanhappy to speak with you.