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Honouring debts and bankruptcy.

The ever increasing number of bankruptcies reported each month, the ominousness surrounding any mention of the National Consumer Debt, and the items on insolvency now appearing in the popular press which previously showed little interest in the subject has given bankruptcy a high profile both in practice and in theory. There is still sympathy and understanding for the debtor who resorts to bankruptcy in order to solve debt problems and an acceptance of a remarkably liberal discharge policy. There is also, nevertheless, a concern not confined to the commercial community that society's obligation to assist those burdened with debt does not require the immediate and wholesale forgiveness of debt. There is, in addition, a growing body of opinion which suggests a return to a policy which advocates that the moral obligation to pay one's debts is at least as important and has as much value as society's responsibility to assist, in an appropriate system, those who, through misfortune or other special circumstances, find themselves burdened with debt.

Parliament has responded to society's concerns surrounding the debt release system. The amendments to the Bankruptcy and Insolvency Act which received Royal Assent on April 25, 1997, clearly accord with society's desire, lately evidenced, for a bankruptcy system which reflects more closely societal values of fiscal responsibility.

Bankruptcy law has historically focused on freeing the individual's future income from pre-bankruptcy claims while extending no similar protection to the individual's other assets. That is, since the amendment of 1966 which introduced S.68 to the Act, the debtor's wages did not go directly to the trustee as the bankrupt's other non-exempt property did, but could only be accessed by court order. Until an order was obtained, the bankrupt was free to receive his or her income and to use it as he or she thought fit.

Section 68 was not often used by trustees in bankruptcy for several reasons. There were no legislated standards to assist the trustee in fixing the amount of future income that could be used to pay debts. The onus was on the trustee to prove that surplus income existed. Moreover, the legal costs of obtaining such an order presented an obstacle especially in estates which usually had few assets. Trustees were reluctant to move for a payment order.

There was, then, a need for a provision which was not only inexpensive and expeditious but also mandatory. This has now been supplied by the recent amendments to the Act.

The amendments to Section 68 now put a positive obligation on the trustee to fix an appropriate level of payments from surplus income to be made during bankruptcy based upon the bankrupt's personal and family situation. Standards are to be developed by the Superintendent of Bankruptcy for determining, "the portion of the total income of a bankrupt that exceeds that which is necessary to enable the bankrupt to maintain a reasonable standard of living." There is a mechanism for mediation provided by the amendments when agreement on the amount of surplus cannot be reached, with an appeal to the court when all else fails. The failure of the bankrupt to comply with this court order can result in the refusal of a discharge and, in appropriate circumstances, in serious criminal consequences.

The Bankruptcy and Insolvency Act provides a debtor with two procedures for obtaining relief from overwhelming debt, namely, the bankruptcy procedure and the proposal procedure. The former requires the surrender and liquidation of all the debtor's existing non-exempt assets and the distribution of the proceeds among creditors in full satisfaction of pre-bankruptcy debts, while the latter permits the debtor to offer to compromise debts in a formulated plan usually funded from future income.

Proposals under the Bankruptcy and Insolvency Act, operate in an opposite fashion to bankruptcy. The insolvent person's future income is, in most cases, used to fund the provisions of the proposal while freeing the debtor's other assets from the claims of pre-proposal creditors. Historically, straight bankruptcy, in other words, affords the debtor a quick almost painless release of debts, and, since earnings after bankruptcy were largely undisturbed, little disruption to lifestyle. The proposal route, on the other hand, requires the individual, in most instances, to make periodic payments to creditors out of future income which results inevitably in the temporary diminution of lifestyle. The proposal, accordingly, contrasts unfavourably with bankruptcy, a fact which has historically militated against its wide acceptance. It need hardly be said that proposals are favoured by creditors but not always by debtors. The rate of acceptance declines among "no asset" debtors. However, the amendments to section 68 change the basic distinction between bankruptcy and proposals. Since after the amendments, payments by bankrupts are compulsory, the central attractiveness of bankruptcy is diminished while proposals, because of their inherent advantages, become more attractive.

An individual who makes a proposal never loses control of his or her assets. Thus, historically, proposals have been used most often by debtors with assets to protect. Moreover, it can never be said that in a proceeding to restructure debts in a proposal that the debtor is stigmatized. The pressure of debt can take a heavy toll on debtors and their families, and bankruptcy can cause a traumatic loss of self-confidence. The psychological benefits arising from a negotiated resolution of debts are substantial. In addition, by offering the proposal, the debtor signals to his creditors an intention to forego the quick fix of bankruptcy and indicates a willingness to modify lifestyle expenditures to honour obligations. This decision, to pay debts in whole or in part has an emotional rehabilitative significance often overlooked. The benefits flowing from proposals are otherwise equal to those obtained in bankruptcy, namely, the stay of all creditors' collection efforts, the lifting of most executions against the debtor, a moratorium on interest payments, and the discharge of most debts or the balance outstanding at the end of a successful proposal.

If the advantages of a proposal are not readily recognized by a debtor intent upon using bankruptcy to solve his or her financial problems, a consideration of the risk to the debtor who could make a proposal but who insists on filing in bankruptcy is useful. The amendment to S.170 of the Act requires the trustee in making a report to the court on the bankrupt's application for discharge to include in it "a recommendation as to whether or not the bankrupt should be discharged subject to conditions, having regard to the bankrupt's conduct and ability to make payment." In making such a recommendation, the trustee must consider whether the bankrupt, who could have made a viable proposal, chose to proceed to bankruptcy rather than to make a proposal as a means to resolve indebtedness."

Such a recommendation constitutes an opposition to the bankruptcy discharge. If the court agrees with the trustee's expressed concern, then the bankrupt must be denied an immediate absolute discharge and a monetary term as a condition of discharge may be, and probably will be, imposed.

When one considers the amendments to the Bankruptcy Act and the Bankruptcy and Insolvency Act, over the last three decades one can see a progression which reveals the continued vigour of the collection function of bankruptcy law. First, the introduction in 1966 of section 68 which removed the restriction on the availability of the debtors' wages after bankruptcy, so that the court could require payments of earnings in excess of the non-exempt portion of the bankrupt's wages. Then in 1992, the introduction of the consumer proposal with its streamlined, inexpensive, expeditious procedure which made proposals much more attractive to debtors wishing to avoid the stigma of bankruptcy or who had assets to protect. Finally, the current amendments to section 68 make the debtor's income available to the trustee based upon standards for determining the surplus amount.

In making future earnings easily available to creditors, the amendments not only restore the original intent and historical function of bankruptcy legislation but, in addition, raise the profile of proposals as a solution to financial problems.

J. Murray Ferron, Q.C. is Master & Registrar of the Bankruptcy Court, Ontario Court (General Division) in Toronto, Ontario.
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Author:Ferron, J. Murray
Date:Feb 1, 1998
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