Debt Relief Experts
As a self-employed individual or small business owner facing financial difficulties, understanding your Canadian bankruptcy options is crucial for making informed decisions about your future. The type of debt relief available to you depends on how your business is structured. This guide will help you understand your options based on your business structure and financial situation.
The main difference between personal and business bankruptcy is the legal relationship between the business and the owner. Personal bankruptcy affects an individual’s personal assets and debts, while business bankruptcy involves the assets and liabilities of a company, though unincorporated small businesses may have their personal and business assets treated as one during bankruptcy proceedings.
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Can Business Debts Be Discharged By Bankruptcy?
Business debts can be discharged through bankruptcy, but the process depends on the type of business and the owner’s personal involvement. This is because how your business is legally structured affects whether you are personally liable for your business debts and legal obligations:
Self-Employed and Sole Proprietorship
When you operate as a self-employed individual or sole proprietor, you and your business are legally the same entity. You are personally liable for all business debts, and both business and personal assets can be claimed by creditors or must be included in any insolvency filing.
Partnership
A partnership is similar to a sole proprietorship, but involves two or more people operating a business together. Each partner is personally responsible for all partnership debts – not just their proportional share. This means creditors can pursue any partner for the full amount of partnership debts.
Corporation
A corporation is a separate legal entity from its owners (shareholders). This separation typically protects your personal assets from business creditors. However, this protection can be lost if you’ve signed personal guarantees for business loans or failed to meet your obligations as a director.
Debt Relief Options When Unincorporated or Self-Employed
If you operate an unincorporated business (self-employed, sole proprietor, or partnership), you will use the same insolvency proceedings available to individuals under the Bankruptcy and Insolvency Act. These options include:
Personal Bankruptcy
Personal bankruptcy allows you to eliminate most unsecured business and personal debts. You can continue operating your business, but you’ll need to register for a new business number. Your Licensed Insolvency Trustee (LIT) will review which business assets you can keep and which must be sold to repay creditors. Provincial exemptions protect many essential assets including basic tools of your trade (up to a certain value), personal belongings, and a vehicle (within specific value limits). This means you can often keep the basic equipment needed to continue operating your business.
Consumer Proposal
If you owe less than $250,000 (excluding your mortgage), a consumer proposal allows you to make an offer to pay a portion of your debts while keeping all your assets. Your proposal must be accepted by all your unsecured creditors, including business suppliers and lenders. You can continue operating your business without interruption.
Division I Proposal
For debts over $250,000, a Division I Proposal offers similar benefits to a consumer proposal but follows different rules. This option requires more detailed planning and must also be approved by your unsecured creditors. If your proposal is rejected, you’ll automatically enter bankruptcy.
Debt Restructuring Options for Corporations
Incorporated businesses have different options available because they are separate legal entities:
Corporate Bankruptcy
Corporate bankruptcy allows an insolvent corporation to close its operations and liquidate assets in an orderly fashion. The corporation ceases to exist, but shareholders’ personal assets are typically protected unless they’ve signed personal guarantees.
Division I Proposal
A corporation can file a Division I Proposal to restructure its debts while continuing operations. This requires a detailed plan showing how the business will become viable and repay a portion of its debts. Creditors must approve the proposal for it to proceed.
Receivership
When a corporation defaults on secured debt, the secured creditor may seek court appointment of a receiver. The receiver takes control of business assets and sells them to repay the secured creditor. This typically ends business operations unless the receiver continues running the business during the sale process.
Companies’ Creditors Arrangement Act (CCAA)
Available only to corporations owing more than $5 million, CCAA protection gives large companies time to restructure operations and negotiate with creditors while continuing business operations. This complex process is typically used by major corporations and requires court supervision.
What Happens When a Small Business Files for Bankruptcy? FAQs
Can I continue operating my business during bankruptcy?
Yes, you can continue operating your business during bankruptcy. You’ll need to obtain a new business number. While provincial exemptions protect basic tools and equipment needed to earn a living, some suppliers may require cash payments until you’ve been discharged or have re-established your credit.
What happens to my business equipment and inventory?
Basic tools of your trade are protected by provincial exemptions up to certain value limits. Your Trustee will assess your equipment and inventory. If the value exceeds the exemption limits, you may need to pay to keep non-exempt assets or they may need to be sold.
If you have leased business assets you wish to surrender, you can do this before filing bankruptcy and include the shortfall in your bankruptcy or proposal.
Secured creditors are not included in a bankruptcy; they retain the right to seize any personal or business assets pledged as collateral for the loan.
Will I lose my business contracts and leases?
Your existing contracts remain valid unless specifically terminated. However, some contracts may have clauses about bankruptcy. Landlords have specific rights in a bankruptcy which can affect your right of occupancy if you want to carry on the business and who has a claim against business assets. If you lease a premises for your business, it is important that you discuss your lease with your trustee before you file.
How do you determine my income for bankruptcy purposes?
The length of time that you are in bankruptcy and the amount you are required to pay depends on your income level after the bankruptcy is filed. The concept is called surplus income. For somebody in a salaried position with the same pay every two weeks, it is very simple to make an accurate estimate. For somebody who is self-employed or operating a sole proprietorship your ‘income’ is based on net income. You are allowed to deduct legitimate business costs first.
How do I handle my business banking?
Your existing business bank accounts will likely be frozen when you file. You can open a new account to handle ongoing business transactions. If you owe money to your current bank through loans, credit cards, or lines of credit, you’ll need to open your new account at a different bank.
What about business debts on my personal credit cards?
All credit card debt, whether used for business or personal expenses, is included in your bankruptcy. These debts will be eliminated upon discharge, but your credit cards will be cancelled when you file.
When you file bankruptcy, credit card companies will review all transactions you have made over a minimum of the last three months, so it is important to stop using your personal credit cards for business purchases as soon as you realize that you may be filing bankruptcy.
Can I include debts owing to Canada Revenue Agency?
Filing personal bankruptcy as a small business owner can eliminate back tax debts including unpaid income taxes, source deductions and HST owing to the CRA. The exception would be if the CRA had registered a tax lien against your property prior to the bankruptcy being filed, since the lien makes the debt secured and bankruptcy only discharged unsecured debts. It is important if you owe money to Canada Revenue Agency that you file your tax returns (to determine how much you owe) and act quickly to avoid potential adverse collection actions. The CRA has strong collection powers including registering a lien on your assets, garnishing your wages (if you are now working) and freezing your bank account.
Will I have access to credit?
Because of the variable nature of income, business owners tend to rely from time to time on overdraft or a line of credit. If you’ve filed bankruptcy, the existing credit facilities are gone. To apply for new credit, you are required by law to disclose that you are in bankruptcy. It might be that you are unable to obtain new credit initially.
Can I start a new business after bankruptcy?
Yes, you can start a new business after bankruptcy. However, obtaining business credit may be challenging until your bankruptcy is discharged and you’ve rebuilt your credit rating. There are no legal restrictions on starting a new business, but some licenses or professional memberships may be affected.
What tax returns do I need to file?
In a bankruptcy or consumer proposal, you must file all outstanding tax returns. Your Licensed Insolvency Trustee will prepare a pre-filing tax return covering January 1st to your filing date – any tax owing for this period can be included in your filing. You must also complete any unfiled returns from previous years. This includes personal income tax returns with your self-employment income reported on Form T2125, all outstanding GST/HST returns, and payroll returns if you had employees. For bankruptcy, these returns must be filed within 3 months. For a consumer proposal, CRA requires returns to be filed within 10 days of your filing date, or they may vote against your proposal.
What happens if I’m a director of a corporation?
You cannot be a director of a corporation while bankrupt – you must resign immediately upon filing. This restriction applies even if you’re filing personal bankruptcy and the corporation isn’t involved. As a director, you remain personally liable for certain corporate debts like GST/HST and payroll deductions, so these amounts need to be included in your personal bankruptcy or proposal. You’ll need to file any outstanding corporate tax returns and ensure you’ve properly resigned through your provincial registry. While you can’t be a director during bankruptcy, you can still own shares in a corporation.
Get Help With Small Business Debts
Contact a Licensed Insolvency Trustee to discuss your situation. A review of your business, who you owe money too and how you want to carry forward will help you determine the best option.
