Considering bankruptcy is never easy. It’s one of the most important – and difficult – financial decisions you will ever have to make. An added worry for some indebted Canadians might be what happens to their financial situation if they are self-employed or running a small business.
You may be surprised to learn that it’s a common concern. At my firm, approximately 1 in 10 clients filing for insolvency are self-employed or own their own small business. If you’re wondering about how to deal with bankruptcy as a small business owner, I’ve outlined six key points to help you better understand the process.
Business or Personal Bankruptcy?
First off let’s start with an important distinction: Is your small business incorporated or not?
One more advantage of a consumer proposal if you are self-employed or operating a small business is that a proposal can be paid off early. If your business is in financial trouble and is incorporated, then it is the business that will file bankruptcy because it’s a legal entity. If your business is a sole proprietorship or partnership, then from a bankruptcy perspective, it is the individual who is filing personal bankruptcy, not the business.
In this article, I will focus on issues that affect someone who is filing personal bankruptcy as an unincorporated business or self-employed person.
Not all assets are seizable
Filing for personal bankruptcy means you may lose some of your personal investments and assets related to the business. There are some assets that are exempt from seizure in a personal bankruptcy and these exemptions differ by province. In the case of a small business or self-employed worker in Ontario, there is an exemption for “tools of the trade” (equipment that you use to earn a living) for value of up to $11,300.
This can be important if you need to continue to use this equipment to operate your business going forward.
You can continue to run your business during bankruptcy
It might not be obvious, but you can continue to operate your business in a bankruptcy because you are still entitled to earn a living. The important point to consider would be is it worth maintaining your business after filing for bankruptcy. The main benefit to going through insolvency is to get debt relief. But, if your business continues to lose money, it won’t allow you to have a fresh start financially.
Tax debt can, in fact, be included in bankruptcy. If you do continue to run your business, there might be some issues you will face. For example, access to business credit may be difficult, and you are not permitted to serve as a director of an incorporated business while you are an undischarged bankrupt.
You might have a hard time accessing credit
When you file personal bankruptcy, you must surrender all credit cards. Your current credit accounts will be frozen and will be listed as creditors in your bankruptcy.
Chances are, you won’t have access to credit once you file personal bankruptcy. You are required, by law, to state on any credit application that you are an undischarged bankrupt. Some suppliers may still be willing to supply you on credit, but it will be difficult.
When you file personal bankruptcy, you must surrender all credit cards. After your debts have been cleared and you have rebuilt your credit score by taking steps like obtaining a secured credit card and making regular payments, the opportunity to access credit again will open and you will be able to re-establish yourself among lenders.
You can include tax debt in bankruptcy, depending on your situation
From my experience, one of the largest debts for small business owners is income tax. Tax debt can, in fact, be included in bankruptcy. There are exceptions including fraud or if the Canada Revenue Agency has registered a lien against your property before you filed bankruptcy, since the lien makes the debt secured. With a bankruptcy, only unsecured debts can be discharged.
A consumer proposal may be a better option
When you file personal bankruptcy, in addition to surrendering certain assets, you may be required to make payments to your bankruptcy estate, based on your income, so the more you earn, the more you may be required to pay into your bankruptcy estate while bankrupt. If you are earning substantial income, these surplus income payments can make your bankruptcy relatively expensive.
It might not be obvious, but you can continue to operate your business in a bankruptcy because you are still entitled to earn a living. If your unsecured debts are under $250,000 (excluding a mortgage on your personal residence), you may be able to file a consumer proposal as an alternative to bankruptcy. With a consumer proposal, you make a deal with your creditors to repay a portion of what you owe over a period of up to 5 years. Your total offer is based on what your assets would be worth in a bankruptcy and your potential surplus income payments, however because you can spread these payments over a period of up to 5 years, the impact on your monthly cash flow is much smaller. In addition, with a consumer proposal you get to keep all your assets and in most cases, repay a small portion of what you owe.
If your debts are above $250,000 you can file something called a Division I Proposal which also allows you to make a partial repayment proposal to your creditors.
One more advantage of a consumer proposal if you are self-employed or operating a small business is that a proposal can be paid off early. While the length of a personal bankruptcy is set by regulations and cannot be completed any faster than the rules allow, if your business and income improve while in your proposal, you can pay your proposal off sooner.
There are certainly a lot of important facts to know about how a bankruptcy can impact you as a small business owner. If you’re self-employed and worried about your unsecured debt, I’d recommend speaking to a debt help professional, like a Licensed Insolvency Trustee as early as you notice financial trouble.
Whether you qualify will depend on your circumstances, but the earlier you seek debt help, the better. In any case, a licensed insolvency trustee can help you better understand your situation, answer all of your questions, and allow you to make the best decision for you and your small business.