Insolvency vs Bankruptcy. What Is The Difference?

While the terms bankruptcy, insolvency, and default all relate to debt and are often used interchangeably, they do not share the same meaning. Insolvency is a state of financial distress; bankruptcy is the legal process for an insolvent debtor to surrender assets in exchange for relief from debts. Someone can be insolvent but not bankrupt; however, a bankrupt must, by law, be insolvent. 

This difference is important to understand as it can determine whether you are eligible to file for bankruptcy in Canada or even need to declare bankruptcy at all. It can also have implications as to which consumer insolvency solution, bankruptcy or consumer proposal, makes sense for you.

What is Insolvency?

Insolvency occurs when you can’t meet your financial obligations as they come due. It’s a financial state where your liabilities exceed your assets or you’re unable to pay your debts in full.

You are insolvent if you can answer yes to either of these questions:

1. Are your debts larger than your assets?
2. Is your cash flow bad enough that you cannot pay your bills as they come due?

Other signs of insolvency include:

• Regularly missing bill payments

• Using credit cards to pay for necessities

• Receiving calls from collection agencies

• Feeling stressed about your financial situation

If you are solvent, meaning you have the means to repay your debts, you do not qualify to file a bankruptcy or consumer proposal in Canada. A typical example is someone who owns a home with enough equity to refinance their unsecured debts.

Being in default on your loans does not necessarily mean you are insolvent. Default happens to a credit account when you are behind on payments. People miss payments all the time, sometimes by accident, sometimes because they are short of cash. Scrambling to pay your monthly bills or missing a payment does not mean you are insolvent or a candidate for bankruptcy.

This solvency test is not the same as the means test used in United States bankruptcy law, where eligibility is based on income. In the US, your income must fall below a median income limit for a household of your size to be able to declare bankruptcy. In Canada, there is no means test.  You qualify if you owe more than $1,000 in debts and are insolvent.

Bankruptcy vs Insolvency

While insolvency describes a financial condition, bankruptcy is a legal proceeding to resolve insolvency. Not all insolvent individuals need to declare bankruptcy; depending on the circumstances, other options, like a consumer proposal or a debt management plan, may be more suitable for achieving a fresh start.

Insolvency Procedures in Canada

In Canada, the term insolvency also describes the legal procedures available to individuals under the Bankruptcy and Insolvency Act: personal bankruptcy and consumer proposals. Both are insolvency proceedings filed through a Licensed Insolvency Trustee.

Personal bankruptcy involves surrendering your assets (with some exemptions) to pay off your debts. It provides a fresh financial start but has more severe consequences on your credit report.

A consumer proposal is an offer to your creditors to pay off a portion of your debt, with the remainder forgiven once you complete the terms of the agreement. It allows you to keep your assets and has less impact on your credit score than bankruptcy.

LITs play a crucial role in both procedures. They’re the only professionals authorized to administer these government-regulated programs. The Office of the Superintendent of Bankruptcy (OSB) licenses LITs with the goal of ensuring the process is fair for both debtors and creditors.

The Bankruptcy Process

Bankruptcy is a legal action that releases you from most of your debts. Here’s how the bankruptcy proceeding works:

1. You meet with a Licensed Insolvency Trustee to review your financial situation.

2. If bankruptcy is appropriate, the LIT files the necessary documents with the Office of the Superintendent of Bankruptcy.

3. You surrender your assets to the LIT, who then sells them to pay your creditors. Most personal assets are exempt.

4. You are required to make bankruptcy payments based on your income.

5. You complete mandatory credit counselling sessions.

6. If it’s your first bankruptcy and you fulfill all your duties, you’re typically discharged after 9 months (or 21 months if you have surplus income).

Liquidation is a key part of bankruptcy. It involves selling your non-exempt assets to generate funds for your creditors. The specific assets that are exempt from liquidation vary by province but often include basic household furnishings, tools needed for work, and a modest vehicle.

Consumer Proposals: An Alternative to Bankruptcy

A consumer proposal is a formal, legally binding process that allows you to settle your debts without declaring bankruptcy. Here’s how it differs from bankruptcy:

• You keep your assets

• You make a single monthly payment for up to five years

• The impact on your credit score is less severe than bankruptcy.

• It can only be used if your total debts are less than $250,000 (excluding your mortgage)

In a consumer proposal, your LIT works with you to develop an offer to your creditors. This involves paying a percentage of what you owe. If the majority of your creditors accept the proposal, it becomes binding on all unsecured creditors.

The Role of the Office of the Superintendent of Bankruptcy (OSB)

The Office of the Superintendent of Bankruptcy is a federal agency that oversees the administration of the Bankruptcy and Insolvency Act. The OSB:

• Supervises the administration of all estates and matters under the Act

• Licenses and regulates Insolvency Trustees

• Maintains public records of bankruptcy and insolvency proceedings

• Deals with complaints against LITs

The OSB ensures that the insolvency system remains fair and efficient for all parties involved.

Making the Right Choice for Your Financial Future

Choosing between bankruptcy and a consumer proposal depends on various factors, including:

• Your income and expenses

• The amount and types of debt you have

• Your assets

• Your long-term financial goals

The best way to determine the right path for addressing your financial obligations is to consult a Licensed Insolvency Trustee.

At Hoyes Michalos, we’ve helped thousands of Canadians navigate their way out of debt. We can review your situation, explain your options in detail, and help you make an informed decision about your financial future. Contact us today for a free, no-obligation consultation and take the first step towards financial freedom.

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1. 10 Bankruptcy Definitions You Need To Know
2. Debt Consolidation vs Bankruptcy. Which is Better?
3. How Much Debt Does it Take to File Bankruptcy in Canada?
4. Is a Consumer Proposal the Same As Bankruptcy?
5. How Does a Consumer Proposal Work