Legalese: Understanding bankruptcy

Practising in the area of collections, I often come across debtors who are insolvent and/or have declared bankruptcy. Even if your company is financially strong, this issue is important to you because, generally speaking, these types of debtors fail to pay your invoices.

Bankruptcy and insolvency are governed by federal legislation, so the law is uniform across the country. The actual statute that governs how companies and individuals can go bankrupt is called the “Bankruptcy and Insolvency Act.” There are many companies that specialize in dealing with situations involving bankruptcy and insolvency. Bankruptcy trustees work with companies and individuals in order to comply with the provisions of the Bankruptcy and Insolvency Act. Lawyers specialize in this area of the law, as the federal legislation can be quite complex, particularly in cases involving corporate debtors.

A company or individual can be insolvent without going bankrupt. This happens a lot. The typical situation usually involves very proud people who cannot pay their bills but decide they do not wish to go bankrupt. When dealing with this type of debtor, sometimes it is best to simply work with them and accept small payments over a long period of time. If the debtor is someone of such moral character that they decides not to avail themselves of the protection of the bankruptcy laws, then there is a good chance they will eventually live up to paying your debt. Whether you take that route in any particular situation is obviously driven by the particular facts of the case, and every case is going to be different.

Applying a heavy-handed approach to an insolvent debtor may do you a disservice in the end. If your lawsuit against the person is the very thing that causes the individual to declare bankruptcy, then you will likely not collect very much on your debt. When a company or individual declares bankruptcy, any lawsuit against it is immediately halted. You are not allowed to continue your lawsuit against that bankrupt entity. The bankruptcy process begins, and the bankrupt entity must co-operate with the trustee in bankruptcy in order to obtain a “discharge.” A discharge means that the bankrupt person or corporation has fulfilled its obligations to the bankruptcy trustee and that the debts are wiped out.

The overall purpose of bankruptcy legislation is to provide companies and individuals with an opportunity for a fresh start in situations where they are clearly insolvent and unable to meet their financial obligations. One of the obligations of the bankruptcy trustee is to verify the assets and income of the bankrupt. Although bankrupt individuals will eventually have all their debts wiped out, they are not allowed to keep their money. Whatever money they have (there are some exemptions, such as personal effects) must be distributed to their creditors equally, in proportion to the amount of each creditor’s claim. For example, if a bankrupt person has $1,000 in the bank and owes three creditors $10,000, $20,000 and $30,000, respectively, then the first creditor will receive $200, the second $400 and the third $600 (each receiving two per cent of the total indebtedness).

From your perspective as a creditor, it is very important that you take the time to properly fill out and execute the proof of claim form that will be sent to you by a bankruptcy trustee. The bankruptcy trustee is obliged to pay out only those creditors who have proven the legitimacy of the debt by properly filing a proof of claim. There are specific time limits that must be observed, and those time limits will be clearly written in the bankruptcy paperwork you receive from the bankruptcy trustee.

 All of this underscores the importance of knowing as much as possible about your customers. Do they own property? Where do they bank? Do they have an employer or someone they are doing contract work for? Have they declared bankruptcy before? If it is a company, is the individual behind the company (or anyone else) prepared to sign a personal guarantee for the debts of the company?