Reasonable and Fair Provisions in Consumer Proposals
December 5, 2016
Pursuant to s. 5(2) of the Bankruptcy and Insolvency Act (BIA), which requires that the Superintendent of Bankruptcy (Superintendent) supervise the administration of all estates and matters to which the BIA applies, the Superintendent is issuing a position statement regarding the inclusion of “discount clauses” by Licensed Insolvency Trustees (LIT) in consumer proposals.
Following review and analysis of consumer proposal filings, the Superintendent has observed that discount clauses can compromise the integrity of the administration of the insolvency process and can also lead to outcomes for debtors and creditors that are inconsistent with what would be considered reasonable and fair when the objectives and purpose of the BIA are considered.
Through monitoring activities and complaint review related to the maintenance and enforcement of the insolvency regulatory framework, the Superintendent has identified instances where discount clauses are being included in some consumer proposals filed by LITs on behalf of debtors. The discount clauses are associated with instances where a debtor pays a debt consultant for advice, prior to being directed to an LIT for assistance. The LIT then includes a clause that allows the debtor to discharge their obligations to creditors for as little as 75% of the face value of their initial consumer proposal at a time the debtor can determine.
Under this framework, discount clauses are promoted to debtors by debt consultants in the context of “financial advice” to facilitate the issuance of new, high-interest loans once a proposal is accepted. During the term of the proposal, the debtor may also be charged with what is termed “credit repair fees,” which are represented as services to improve their credit rating. In this context, a debtor may take a new loan to fund the completion of the proposal at a discount. The apparent savings to the debtor from the reduced reimbursement to proposal creditors are in fact fully absorbed by the high interest and other charges that would flow to the third party that has issued the new loan. In practice, the debtor may see no reduction in their monthly payments and will usually see a net increase in their total payment (after fees, set-up costs, and interest charges) and may be committed to debt repayment for periods exceeding the five-year statutory maximum applicable to consumer proposals. Such debtors would incur lower out-of-pocket expenses if they instead maintained their non-discounted proposal, at full value.The following is an example of this type of clause:
At any time during the term of this proposal, should the debtor be able to arrange funding and pay to the administrator an amount equal to the balance owing on the proposal less 25%, this consumer proposal shall be deemed to be complete and the proponent shall be entitled to a Certificate of Full Performance.
Lump sum payments that fulfill a consumer proposal early may not, in and of themselves, be problematic. This could, for example, include lump sum payments that arise from a debtor’s enhanced capacity to pay due to enhanced income and savings or receiving an unexpected windfall. Consumer proposal clauses that do not rely upon acquiring new debt are distinct and different from those that are premised upon the debtor acquiring new debt in order to pay off existing debt at the time of their insolvency.
Implications for the Effective Administration of Division II Consumer Proposals
Section 66.12 of the BIA allows an individual insolvent debtor who owes up to $250,000, not including a mortgage on the debtor’s principal residence, to file a consumer proposal. The purpose of the consumer proposal provisions is to permit consumer proposals to be handled quickly, efficiently and with a minimum of administration and attendant expense. The process for filing and administering a consumer proposal is streamlined compared to that of a Division I proposal. For example, a first meeting of creditors is usually not held (BIA s. 66.15(1)), and the proposal is deemed to be accepted by the creditors at the expiry of 45 days following its filing (BIA s. 66.18(1)). Also, the LIT usually does not have to apply to court for approval of the proposal because it is deemed approved 15 days after it is deemed accepted by the creditors (BIA s. 66.22(2)).
Given the streamlined framework for consumer proposals and high volumes involved, their efficient and effective administration depends, in part, on their being developed in a straightforward and predictable manner, without the need for case-by-case analysis or consultation by stakeholders. Key creditors often rely upon third-party service providers to manage their involvement in the review and approval of consumer proposals using standardized decision-making frameworks. These frameworks may not be well-suited to supporting informed consideration of non-standard elements, such as discount clauses.
As there are mechanisms available to debtors wishing to pay off a consumer proposal early, discount clauses and other non-standard clauses introduce unnecessary complexity to the administration of consumer proposals.
Implications for Creditors
Monitoring carried out by the Superintendent indicates that the presence of discount clauses in consumer proposals is contributing to decreased aggregate returns for creditors, without corresponding benefits to consumers. In the context of streamlined approvals and creditors’ reliance on standardized decision-making, in order to efficiently review consumer proposals, it is not evident whether these clauses are consistently identified and considered by creditors, particularly when the LIT’s report to creditors does not specifically address the reasonableness and fairness of this element of the proposal.
As consumer proposals with discount clauses present an incentive for insolvent debtors to acquire new debt, generally at very high interest rates, this practice may increase future default risks for other secured and non-secured creditors who are not involved in the proposal. It is also uncertain whether consumer credit reporting agencies would receive information from firms issuing loans for discounted lump-sum payouts, which would accurately reflect consumer credit risk and the reliability of credit scores of consumers who take advantage of discount clauses.
Implications for Debtors
Rehabilitation of the debtor is a fundamental purpose of the BIA. The Supreme Court of Canada notes that “rehabilitation helps the discharged bankrupt to reintegrate into economic life so he or she can become a productive member of society.”Footnote 1 The BIA is designed to facilitate rehabilitation in numerous waysFootnote 2. For example, the BIA’s discharge of debt “gives the insolvent person a ‘fresh start,’ in that he or she is ‘freed from the burdens of pre-existing indebtedness.’"Footnote 3 Further, the BIA ensures that the consumer debtor receives financial advice throughout the process to facilitate rehabilitation, including advice on the adoption of prudent financial management strategies, such as use of consumer credit and the operation of his or her consumer proposal. As a result, consumer proposals provide debtors the opportunity to pay back a portion of their debt over as long as 60 months, at a pace which they can afford. In the process, it is intended that the debtor can satisfy their outstanding debt and establish sustainable financial practices.
The inclusion of a discount clause in a consumer proposal encourages the acquisition of new debt as means for the debtor to fulfill a consumer proposal’s requirements. Monitoring has shown that insolvent consumers are counselled to resolve their existing financial problems and attempt to improve their credit rating through new borrowing. Despite the decreased amount paid to creditors when a discount clause is exercised, the consumer will typically end up paying significantly more during the period of their loan than the original face value of their proposal to creditors, over periods which can greatly exceed 60 months. In such cases, a loan provider’s interest charges, fees and penalties represent an obstacle to the restoration of a debtor’s good financial health, particularly as compared to repayment at 0% interest under the terms of a consumer proposal.
Consistency with Licensed Insolvency Trustee Duties under the BIA
Under the BIA’s consumer proposal provisions, the LIT prepares and files a “Report of Administrator on Consumer Proposal” (BIA s. 66.14 and Form 48) providing the LIT’s opinion as to whether the consumer proposal is reasonable and fair to the consumer debtor and the creditors, and whether the consumer debtor will be able to complete it (BIA s. 66.14(a)(ii)).
Discount clauses designed to facilitate third-party loans for the purpose of discharging debt encourage a continuance of unsustainable financial practices. Insofar as the inclusion of a discount clause incites a debtor to enter into new and costly loans, proposals that include discount clauses cannot reasonably be considered fair to the consumer debtor or to the creditors.
Consistency with Licensed Insolvency Trustee Code of Ethics
Given the impacts of discount clauses included by LITs in consumer proposals, the Superintendent regards them as being incongruent with the high professional and ethical standards required of an LIT. The following sections of the Bankruptcy and Insolvency General Rules are of particular relevance:
Section 34: Every trustee shall maintain the high standard of ethics that are central to the maintenance of public trust and confidence in the administration of the Act.
Section 39: Trustees shall be honest and impartial and shall provide to interested parties full and accurate information as required by the Act with respect to the professional engagement of the trustees.
Section 44: Trustees who are acting with respect to any professional engagement shall avoid any influence, interest or relationship that impairs, or appears in the opinion of an informed person to impair, their professional judgement.
Section 49: Trustees shall not, directly or indirectly, pay to a third party a commission, compensation or other benefit in order to obtain a professional engagement or accept, directly or indirectly from a third party, a commission, compensation or other benefit for referring work relating to a professional engagement.
Section 50: Trustees shall not obtain, solicit or conduct any engagement that would discredit their profession or jeopardize the integrity of the bankruptcy and insolvency process.
Based on monitoring and analysis, the Superintendent is of the view that the inclusion of discount clauses in consumer proposals represents a risk to the integrity of the administration of the insolvency process, and that discount clauses support outcomes for debtors and creditors that are inconsistent with what would be considered reasonable and fair when the objectives and purpose of the BIA are considered.
Accordingly, in instances where the Superintendent identifies a discount clause (or similar inappropriate provision) in a proposal made on behalf of a consumer, the official receiver will direct the LIT to call a meeting of creditors, to be chaired by the official receiver. The meeting of creditors will provide the LIT with an opportunity to expand on their due diligence with regard to the debtor’s insolvent circumstances, and to address how the proposal, with the discount clause, is fair, reasonable, and achievable. The meeting will ensure that creditors are aware of and have the necessary information to make an informed decision on whether to accept, reject or request changes to the consumer proposal. After a creditors meeting, in instances where the official receiver is not satisfied that the consumer proposal is fair or reasonable, the official receiver may take additional actions to protect the integrity of the insolvency process.
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