How To File a Division 1 Proposal in Ontario, Canada
An Alternative to Personal Bankruptcy
In the previous article on consumer proposals, we noted that they apply when your liabilities do not exceed $250,000. It’s a streamlined process oriented towards “consumer debtors” – i.e., individuals who get into financial difficulty usually through the overextension of credit.
The obvious question then arises: what if a person’s debts exceed the $250,000 threshold? In that situation, we turn to a process called a Division 1 Proposal.
Division 1 Proposal overview
A Division 1 Proposal, like a consumer proposal, is a legal process available under the Bankruptcy and Insolvency Act that allows a debtor to settle with their creditors and avoid bankruptcy. The Division 1 process is also available to businesses and corporations to settle debt, and can be used to reduce the amount of tax owing to the government.
To the debtor, the most important benefit of the proposal process (be it a Division 1 or Consumer Proposal) is the avoidance of bankruptcy and the attendant effect it has of pegging a debtor’s credit rating with the credit bureau at R9 for 7 years. Upon the completion of a Division 1 Proposal, the debtor’s liabilities are discharged and their credit rating is registered at R7 for a three-year period thereafter.
To the creditors, a proposal is most attractive in that they get a higher return than in a bankruptcy scenario.
The typical debtor filing a Division 1 proposal is either a professional or a business owner.
Most doctors, lawyers, and some other professionals are self-employed. Due to a variety of challenges, some either fail to pay their personal income taxes (which, with the penalties and interest, can be substantial) or invest in disallowed tax shelters leading to an income tax reassessment by the Canada Revenue Agency (“CRA”). Whatever the reason, proposals filed by these professionals are often driven by their obligations to CRA.
An owner of a failed or failing business, be it a corporation, sole proprietorship or a partnership, will be liable for certain business obligations such as Goods & Services Tax, Provincial Sales Tax, wages in arrears, and unremitted payroll source deductions. As well, the owner is often liable for guaranteed business obligations. These business owners typically have some personal assets and wish to avoid bankruptcy. A proposal would allow them to settle these business-related debts.
The Division 1 process is fairly straightforward to understand. However, unlike the consumer proposal process, the Division I process requires a substantial investment of a licensed insolvency trustee’s time.
First, the trustee meets with the debtor to assess the financial circumstances and determine what type of proposal can be made and what type of proposal will be acceptable to the creditors.
The proposal is drafted by the trustee and signed by the debtor along with other statutory documents. The trustee then files the proposal with the Office of the Superintendent of Bankruptcy. The trustee is required to schedule with the OSB a meeting of creditors to review and discuss the proposal no later than 21 days after the Proposal is filed.
The proposal and a report on the proposal drafted by the trustee is sent to the creditors by mail in anticipation of the meeting.
At the meeting, the creditors which have had their proofs of claim admitted discuss the debtor’s affairs and the proposal terms and vote either for or against the proposal. The approval of the proposal by the creditors requires the vote of: (1) a majority in the number of creditors present at the meeting either in person, by proxy or by voting letter; and (2) two-thirds in the value of the claims of those creditors in (1). If these voting criteria are not met, then the debtor is automatically bankrupt.
In actual practice, the meeting of creditors is often the time for negotiating a proposal palatable to the creditors. It is in effect a bargaining forum. If the creditors and the debtor mutually agree to amendments to the proposal, then the creditors will vote for the amended version of the proposal.
Once the proposal is approved by the creditors, the trustee arranges for a court hearing date for the proposal to be reviewed and approved by the Bankruptcy Court. The Court reviews the proposal for fairness (to the creditors and the debtor) and ensures that it complies with certain statutory requirements.
Upon the approval of the proposal by the Bankruptcy Court, the debtor proceeds to fulfil the terms of the proposal (which will be discussed below under “Most Common Proposals”). Upon fulfilling the obligations under the proposal, the debtor is issued a Certificate of Full Performance of Proposal by the trustee. That certificate is then filed with OSB and the information is sent to the credit bureaus to update the debtor’s credit file. For each loan account included in the proposal, the debtor is at an R9 rating from the date the proposal is filed until its completion, after which the credit bureaus register the an R7 rating for 3 years.
Most common Division 1 Proposals
There are generally no restrictions on what proposal can be offered to creditors – the creativity of the drafter is the only restriction. However, in my experience, the most common proposal terms are as follows:
- The debtor can make monthly payments over several years to pay off the settlement amount.
- The debtor can make a lump sum settlement by borrowing from friends and family. If there is sufficient equity in their home, the debtor may be able to take out a second mortgage, with the assistance of a mortgage broker to use as a settlement fund.
- The debtor may voluntarily liquidate assets over a period of time to finance the proposal. This type of proposal is similar to a bankruptcy scenario where the debtor’s assets are liquidated by the trustee. The key difference is that the proposal method has less of a detrimental effect on the debtor’s lifestyle and credit rating.
A Division 1 proposal offers a viable and attractive alternative to bankruptcy. It offers flexibility to a debtor, minimizes the impact to your credit rating, and encourages personal responsibility for the repayment of debts. Creditors stand to receive more money from a proposal than from a bankruptcy. Proposals have been steadily gaining popularity over the past several years.