Canada offers two options for people facing insolvency: a bankruptcy or a consumer proposal. Both are legal processes that immediately stop creditor collections if approved and can only be administered by federally regulated professional.Chainarong Prasertthai/iStockPhoto / Getty Images
The share of Canadians who opt for bankruptcy when they can’t repay their debts has been steadily and markedly shrinking for 15 years, a development that benefits creditors and may partly be an unintended consequence of federal regulations, new research suggests.
For individuals filing for insolvency, Canada offers two options: a bankruptcy or a consumer proposal, which involves negotiating a lower debt load with lenders. Both are legal processes that immediately stop creditor collections if approved and can only be administered by federally regulated professionals called licensed insolvency trustees (LITs).
In a bankruptcy, debtors typically repay a smaller amount of money over a shorter period of time compared with a proposal. But the share of borrowers choosing to file a consumer proposal instead of a bankruptcy has risen from around 20 per cent in 2009 to roughly 80 per cent in 2023, according to government data.
The dramatic shift stems in part from the fact that federal rules largely result in proposals generating higher fees for LITs, who operate as private, for-profit entities, according to a new paper by Carleton University professor Saul Schwartz and Stephanie Ben-Ishai, a professor at York University’s Osgoode Hall Law School. With a proposal, trustees keep 20 per cent of the money repaid to creditors, in addition to flat fees adding up to $1,500. When consumers file for a simple bankruptcy, on the other hand, LIT fees usually amount to around $2,000, according to the two researchers.
The outcome is a system that has been nudging too many debtors toward consumer proposals and increasingly tilting the playing field in favour of lenders, the authors argue.
“Creditors for sure get repaid more from a proposal than a bankruptcy,” Prof. Schwartz said.
But many of the debtors who file for insolvency would be better off financially with a bankruptcy than with a proposal, he added.
With consumer proposals, borrowers repay their unsecured debts, such as credit cards and lines of credit that aren’t backed by collateral, for a period of up to five years. The payments are interest-free and often amount to less than the total principal owed. Borrowers also get to keep assets such as savings, investments, their car or their house. The arrangement usually makes sense for debtors with greater income and assets, Prof. Schwartz said.
In a bankruptcy, an LIT typically sells a debtor’s assets and distributes the money raised to creditors, though federal and provincial laws establish several exemptions.
Still, the majority of insolvent borrowers have low incomes and few valuable belongings, Prof. Schwartz noted. With a simple bankruptcy, known as a summary administration bankruptcy, which is available to those with less than $15,000 in assets, a first-time filer would have to make payments for a period of only nine months or 21 months, depending on whether their income is, respectively, below or above an official threshold. They would also typically repay less than they would in a consumer proposal.
While the profile of Canada’s insolvent debtors hasn’t changed much over the years, according to the paper, the proportion of borrowers choosing proposals has soared.
The two researchers found no evidence that LITs are systematically steering borrowers into proposals that they know their clients can’t afford. In fact, according to the paper, just 20 per cent of consumer proposals fail in Canada, while studies show a failure rate of more than 50 per cent for a similar insolvency process in the United States.
Doug Hoyes, co-founder of Ontario-based bankruptcy trustee firm Hoyes, Michalos & Associates Inc., said debtors often call him inquiring specifically about filing a consumer proposal.
The streamlined version of the consumer proposal currently available to debtors as an alternative to bankruptcy wasn’t created until 1992. Nowadays, struggling borrowers are well aware of the option, Mr. Hoyes said.
In addition to concern about keeping their assets, debtors may prefer a proposal because of the perception that it carries less social stigma than a bankruptcy and because it may enable them to start rebuilding their credit score sooner, among other factors, he added.
Elisabeth Lang, who heads the Office of the Superintendent of Bankruptcy (OSB), which regulates insolvency professionals, said the agency is currently reviewing the rules around fees for LITs.
Via e-mail, Ms. Lang also said some provisions in the Bankruptcy and Insolvency Act reflect Parliament’s intent to encourage debtors to choose a proposal over a bankruptcy if they’re able to repay additional amounts to their creditors.
“The important caveat is they have to be viable solutions for them, and that’s where LITs have that duty, under the regulatory framework, including a code of ethics and directives, to do that assessment with debtors and give them the best advice,” Ms. Lang said, speaking to The Globe and Mail in an interview.
“And by the way, that advice should include non-insolvency options,” she added.
As Ms. Lang sees it, the principal issue behind the soaring share of consumer proposals is the proliferation of unlicensed debt advisers, who promise to help struggling debtors only to eventually refer them to an LIT for steep fees.
Mr. Hoyes said predatory debt consultants seem to channel customers into proposals rather than bankruptcies because with such arrangements, borrowers usually make repayments for a longer period of time, which allows the unregulated advisers to keep billing them for longer.
In December, the Trudeau government in its fall economic statement pledged to crack down on predatory debt advisers by introducing civil remedies for non-compliance with the Bankruptcy and Insolvency Act, such as damages and restitution, as well as increasing criminal fines.
But Prof. Schwartz and Prof. Ben-Ishai say their research suggests the main driver of the surge in consumer proposals is the fee structure for LITs. To address the problem, the authors propose revising how insolvency professionals are compensated to give them a greater incentive to recommend bankruptcies where appropriate. They also suggest requiring that online advertising by LITs provide a clear comparison of fees for each option.
The paper also notes the OSB itself may have become increasingly reliant on consumer proposals as a source of revenue. The agency is self-funding and collects fees and levies linked to insolvency filings.
Data the OSB shared with The Globe show that its revenue has remained roughly the same in inflation-adjusted terms over the past 15 years, even as the share of consumer-proposal filings shot up.
But the data also show that those proposals accounted for $42.75-million in revenue in 2023-24, roughly 66 per cent of the agency’s revenue in that fiscal year. Summary administration bankruptcies, by comparison, accounted for $6.5-million in revenue.
Via e-mail, Ms. Lang said the OSB has no role in helping debtors choose among insolvency options and doesn’t benefit from any particular choice.
But Prof. Schwartz and Prof. Ben-Ishai argue that the current system has become overly focused on ensuring debtors repay as much as they possibly can, rather than striving to provide them with the best option to achieve a fresh financial start.
A more balanced approach, with more Canadians choosing bankruptcy, might also deter creditors from lending too much or at excessively high interest rates, Prof. Ben-Ishai said, because of the higher risk that, under a bankruptcy, debtors who become insolvent would pay back only a small fraction of what they owe.
“What we’ve seen over time is the democratization of credit – the expansion of the availability of credit – without the corresponding expansion of the availability of bankruptcy,” she said.
