Consider first, the well-documented quirks of human perception we know of today, and the inherent emotions which emerge when discussing chronically negative cash flow with affected clients.
Combine this with a flawed understanding of the law, outdated moral standards, hearsay from friends, and misinformation generated by unregulated third-parties, and you begin have some sense of what could be swirling in the mind of a client considering bankruptcy.
The stress can lead to any number of bad judgment calls – some of which are encouraged or exacerbated by advice from friends, and even from a client’s professional advisors. For the truly insolvent client, this uninformed advice about their situation is not only unhelpful, it can be further damaging as well.
With calculations as complex and inter-related as those made for tax-planning purposes, and personal plans more tailored than any financial planning which tends to occur for clients who fall into lower income brackets, discussing bankruptcy with clients is not something which should be undertaken in any great detail, without the help of a chartered insolvency professional.
“The worst thing I hear people say is, ‘You should never go bankrupt,’” says David Wood, CIRP (Chartered Insolvency and Restructuring Professional), licensed trustee with Boale, Wood & Co. and vice-chair of the Canadian Association of Insolvency and Restructuring Professionals.
“Instead, they should say, ‘Get some professional advice.’ Maybe you don’t need to go bankrupt, but maybe you do. A trustee will be the one to help determine that.”
When individuals become mired in debt, they can become vulnerable to any number of different interests who will promise quick relief, or a means of paying off less than what they owe, without the need to see a trustee.
“In particular,” Wood says in his whitepaper, the Bankruptcy and Insolvency Guide: Finding Solutions, Not Problems, indebted clients will “only seek the help that provides them with immediate relief, rather than dealing with their debt as a whole.”
“They’ll go somewhere, anywhere, besides a trustee,” he adds in an interview. “They’re not thinking clearly because they’re under stress from being in debt. It doesn’t matter how much that is. If you can’t pay, it’s stressful.”
Instead, he recommends financial advisors refer clients in this kind of distress, directly to a trustee who can provide advice about options.
Fear of trustees
Uninformed debtors often fear bankruptcy trustees, believing their role is solely to repossess, rather than help. “After having that first meeting though, a lot of times people will actually leave with a smile on their face,” says Angela Lock, CIRP and trustee in bankruptcy with Grant Thornton. “They’re afraid we’ll be scary or judging. Often people will be worried they need to go to court, which often isn’t a thing in bankruptcy anymore.”
Unlike unregulated credit counsellors, there are a few specific attributes trustees have in common:
- Most trustees in Canada are members of the Canadian Association of Insolvency and Restructuring Professionals.
- CIRP (Chartered Insolvency and Restructuring Professional) is the designation trustees obtain and use when delivering a number of services, including consumer and commercial insolvency administration (bankruptcy and consumer proposals), business reviews, and corporate restructuring.
- Membership in the association, and holding the CIRP designation means trustees must adhere to a code of ethics, keep up to date with current exemptions in the provincial jurisdictions where they are licensed, and up to date with legislation changes, current case law and directives.
- In advertising, a trustee must use the words “trustee” and “bankruptcy.”
- Trustees have a duty to determine, then spell out a debtor’s different options in an even-handed and objective way. If a client really needs hand-holding, not a trustee’s services, the trustee will refer them to a more appropriate professional.
- The amount a trustee can charge is governed by legislation. Trustees may not pay referral fees.
- Officer of the court – if you sold your house for a dollar yesterday, a trustee is obligated to report those details when filing the requisite paperwork.
- During federally mandated counselling sessions, trustees are required to point debtors to additional resources – for mental health problems, gambling or addiction, or to a lawyer – if the individual has other issues contributing to their insolvency.
For advisors, a few typical warning signs that a client may be experiencing difficulty can include chronic or ongoing cash flow problems, or requests to deregister their retirement funds (clients may not know these assets are generally protected from seizure in bankruptcy).
While the industry’s general focus on more affluent, up-market clients could mean some advisors never have the opportunity to see those signs, wealthier clients are still not immune to being over-indebted.
Their insolvency can lead to personal bankruptcy, but their personal liabilities can also be triggered by corporate bankruptcy. If a business owner also serves as a director, for example, their personal liabilities can explode beyond management, causing them to declare personal bankruptcy as well, if the company’s affairs are not handled properly.
Myths and misconceptions
Contrary to popular belief, simply being incorporated will not protect a client’s personal finances if the business fails.
“It’s a common misconception,” Lock says. By incorporating, a person can protect themselves from an injury lawsuit, but that protection does not extend to any personal guarantees given to creditors. Corporate taxes, payroll taxes, and unpaid employee salaries can also become personal liabilities if a client’s corporation folds.
Less directly applicable to the advisor-client relationship, but still worth knowing about, is the relationship some so-called debt counsellors will have with bankruptcy trustees.
Some advertising will cite “legislation changes,” and “government programs to help you repay your debt” or “pay less than what you owe.”
Much of this information comes from unregulated entities who will take consulting fees from the indebted – anywhere between $700 and $3,000 for the task of filling out paperwork, before referring the case to an actual trustee. Many times this part of the process doesn’t actually help the debtor at all. In a typical example of this referral process gone wrong, debtors will pay this consulting fee, only to find they would never qualify for the consumer proposal they’ve applied for in the first place.
As trustees are not permitted to pay referral fees, payment for this work comes directly from the near-bankrupt prospect. Although some will provide counselling, the assertion that government programming exists to help consumers with their debt is a myth. The program in question, is usually a consumer proposal – an amendment added to the Bankruptcy and Insolvency Act back in 1991.
“They’ll pay $750 to have someone take down a bunch of information about their assets, and debts, or they can come and see me without having to pay anybody,” says Wood.
Unlike the “services” which often refer clients, first appointments with a trustee are free. (As an officer of the court, the amount a trustee can charge is determined by the Superintendent of Bankruptcy.)
Advice for advisors
If a client is cashing out their RRSPs without explanation, an examination of their motives is almost certainly necessary.
If personal cash flow needs are the impetus for such action – the road to insolvency often includes a scramble to make payment by any means necessary – clients might take some comfort in knowing that RRSP holdings are generally exempt from seizure when declaring bankruptcy. Deregistering assets can expose them to creditor claims, if the client inevitably declares bankruptcy in the end.
Conversely, deregistering registered assets may not be the worst thing a client can do. The advice needed, however, will depend entirely on each individual’s very personal circumstances.
When declaring bankruptcy, a client has a number of obligations and duties to fulfil before their bankruptcy is discharged. One of those obligations is to make payments to the trustee (who in turn disburses amounts to creditors) if they earn surplus income.
David Wood explains that the Superintendent of Bankruptcy publishes guidelines each year, outlining how much money a bankrupt person is entitled to retain for living expenses. “Fifty per cent of any income over and above that amount must be paid into their bankrupt estate.”
Similarly, if a client expects to receive an inheritance, or court settlement, it’s quite possible that cashing in their RRSPs to make ends meet a little bit longer, will be their best course of action.
To get the most appropriate advice, clients are encouraged to be absolutely forthcoming. Withholding information about the sale of property or the receipt of an inheritance, for example, can mean creditor rights will be reinstated, allowing those creditors to return years after the fact, while the client continues to remain in bankruptcy, without those debts discharged.
“That’s the worst case scenario,” says Lock. “We are always willing to work with the individual, but things will get worse if they leave something out. It creates a mess for me and a mess for them. They haven’t been properly advised.”
By fully embracing their responsibilities, a client can have their bankruptcy discharged in as little as nine months in some cases. Avoiding those responsibilities, or “falling off the map” as Wood puts it, can mean the bankruptcy will remain on the books for years.
“We want to get them discharged,” Lock adds. “If they decide to come back, they need to deal with us. They can’t go to another trustee firm. We don’t want their file on our license for the next 20 years either.”
After working through the process, and fulfilling their obligations (attending federally-mandated counselling appointments, and making payments to their trustee, as needed), a client’s next order of business will be to rebuild their credit.
“(If you do) nothing in your life after bankruptcy, when those six or seven years are up, you’ll have no credit. It’s just like starting from when you were 18-years-old again, which is almost worse than having bad credit,” says Lock.
In rebuilding their credit histories, newly discharged clients should primarily focus on a few things:
Savings. The more collateral they accumulate, the better rates they will get in the future.
Develop a good relationship with one bank – probably not the one included in their bankruptcy.
Earn stable and predictable income. Some business owners may need to seek conventional employment.
Get a credit card. Most people can obtain one with a small limit right after being discharged. Some lenders will require a deposit to secure the card. “It’s the best way to rebuild your credit because it’s revolving,” Lock says. “It’s all in the reporting.”