Area of Law: Credit, Debt and Bankruptcy
Answer # 0279
Business bankruptcy procedureRegion: Ontario Answer # 0279
Most commonly, businesses go bankrupt voluntarily. However, a business will become bankrupt if it makes a proposal to its creditors that is not accepted by them, or, the creditors of a business can sometimes push the business into bankruptcy by filing a petition with the court.
Partnerships and Sole Proprietorships – Small business
Legally, the people who own partnerships, or sole proprietors are considered to be the business. In other words, the business and the owners are considered to be one entity under the law. All the assets of the business are personally owned by the partners or sole proprietor.
Therefore, the procedure to file for bankruptcy under the Bankruptcy and Insolvency Act (BIA), for both partnerships and sole proprietorships is the same as the process for filing for personal bankruptcy. Both partnerships and sole proprietorships are considered small businesses. So, a small business bankruptcy has the same effect on the owners as a personal bankruptcy has on an individual.
As a result, the owner’s personal assets are included in the bankruptcy and could be sold to satisfy business debts. In addition, the business bankruptcy would:
- appear on the owner’s personal credit report, and
- have the same effect as a personal bankruptcy on the owner’s credit rating and credit score.
If two-person partnership
When one individual in a partnership, which is made up of two partners, declares bankruptcy, the partnership can no longer exist.
If more than two partners
When a partnership includes more than two partners and one declares personal bankruptcy, the partnership may continue to operate if the partners enter into an agreement.
The main feature that makes corporations different from sole proprietorships and partnerships is that corporations are legal entities separate from their owners. As a result, the corporation is responsible for its own debts, assets, and lawsuits. The legal responsibility of the shareholders, directors, officers and employees of the corporation is limited, which means that, with few exceptions, these people cannot be held personally responsible for the debts and obligations of the corporation.
Because corporations are independent legal entities, the bankruptcy process and the effects of bankruptcy are different from that of partnerships and sole proprietorships. If your business is a corporation, your business can go bankrupt without involving your personal assets, unless:
- you have personally guaranteed a loan, or
- you are a director and the company has failed to make payments to a government department, such as GST, HST, Retail Sales Tax, or remit employee source deductions.
No assets are exempt
In addition, unlike in small business bankruptcies, where the sole proprietor or partner is allowed to keep certain assets which are exempt from seizure (such as clothing, personal vehicle up-to a maximum value), a corporation must surrender all of its assets to the Licensed Insolvency Trustee ( LIT).
Corporation cannot voluntarily dissolve
A corporation cannot voluntarily dissolve if it:
- is bankrupt,
- has a trustee under a proposal, or
- has an interim receiver under the BIA.
When is a corporation bankrupt, or insolvent?
A corporation is considered to be bankrupt under the BIA if it has made an assignment into bankruptcy, or if a bankruptcy order has been made against it.
A corporation is considered to be insolvent under the BIA if:
- it is unable to meet its obligations as they generally become due,
- it has ceased paying current obligations in the ordinary course of activities as they become due, or
- the corporation’s property is not sufficient, at a fair valuation, to allow payment of all obligations (meaning that even if all the property was to be sold, there would not be enough money to pay all debts which are owed, or will soon become due).
Business bankruptcy process and consumer bankruptcies
The BIA does not generally distinguish between small business, corporate and consumer bankruptcies. Therefore, the bankruptcy process under the BIA operates the same for both businesses and individuals. The basic process is
- the sole proprietorship, partnership or corporation voluntarily seeks bankruptcy, or is forced into bankruptcy,
- all of the business assets are turned over to them LIT,
- the LIT sells the assets and distributes the proceeds to the creditors.
There are, however, a few differences, including:
- Simplified process: The simplified consumer proposal and summary administration is only available to individuals.
- Assignments: With corporations, if a receiver has been appointed, an issue can arise as to who is entitled to make a decision to make an assignment. Generally, a receiver of a business must seek leave of the Court to make a voluntary assignment into bankruptcy. This situation does not occur with an individual.
- Exempt property: For individuals (and small business owners) certain property is exempt from seizure under provincial legislation and thus exempt from distribution to creditors. This is not the case with corporations.
- Retain income: Individual bankrupts (and small business owners) are entitled to keep a portion of income earned to maintain a reasonable standard of living, in accordance with standards set by the Office of the Superintendent of Bankruptcy (OSB). Any surplus income must be paid to the LIT. In contrast, corporations must pay all income to the LIT.
- Discharge of bankrupt: All individual bankrupts will eventually be discharged from bankruptcy, although perhaps with conditions. In fact, first-time individual bankrupts are automatically discharged (if there is no opposition) after nine months. On the other hand, the BIA is not designed to give companies the same fresh start as it does for individuals. A bankrupt corporation may not apply for a discharge unless it has satisfied the claims of all of its creditors in full.
How to file for corporate bankruptcy
The general steps for corporations to apply for bankruptcy are the same as the steps for applying for personal bankruptcy and small business bankruptcy:
- Find and meet with an LIT.
- The LIT will review your situation and advise you.
- If the decision to voluntarily declare bankruptcy is made, the LIT will file the necessary paperwork with the OSB, and will notify your creditors that you are filing for bankruptcy.
- The corporation’s assets and day-to-day management will be turned over to the LIT, and if applicable to a receiver.
- Certain creditors may have special claims in priority to other creditors.
- The corporate assets will be sold and the proceeds will be distributed to its creditors.
- Your creditors may hold a meeting to request more information about the bankruptcy.
- The OSB may request an examination of the circumstances of your bankruptcy.
- The corporation may be discharged from bankruptcy only if all debts owing to creditors have been paid.
In a business bankruptcy there might be certain creditor classes that have preference over the business assets, and these creditors will be paid first and receive preference when funds raised by the sale of your business assets are distributed by the trustee.
If the business has a secured creditor, such as is often the case with a bank, a person, called a receiver, will usually be appointed to conduct the sale of the assets that are secured. In such cases, the LIT will merely monitor matters on behalf of unsecured creditors. Secured creditors will receive payment on secured assets in priority to unsecured creditors. The sale of assets is generally done through some form of public sale process, such as a solicitation of bids, tenders or auction, although private sales are also common.
Unpaid and unsecured suppliers – Right to repossess goods
Under certain circumstances, the BIA provides a right for unpaid and unsecured suppliers of a business to repossess the goods. In order to be able to take advantage of this right, however, the supplier must:
- make a written demand for repossession to the purchaser, trustee or receiver within 15 days after the day on which the business became bankrupt or became subject to a receivership;
- have delivered the goods within 30 days before the day on which the business became bankrupt or became subject to a receivership.
In addition, at the time when the supplier makes a demand to the LIT, the goods:
- must be in the possession of the business, trustee or receiver,
- must be identifiable as the goods delivered by the supplier,
- must not have been fully paid for,
- must be in the same state they were on delivery,
- must not have been resold at arm’s length (meaning that the goods have not been sold to someone else),
- must not be subject to any agreement for sale at arm’s length, and
- were not immediately paid for in full by the business, trustee or receiver after the demand was made by the supplier.
If the business LIT or receiver gives the supplier written notice admitting that the supplier does have the right to repossess the goods, the supplier must exercise that right (actually repossess the goods) within 10 days after receiving the notice. This 10-day limitation period can be extended if agreed to by the parties.
Distribution of proceeds
Under the BIA, the order in which the proceeds of a bankruptcy will be distributed is as follows:
- Funeral and testamentary expenses in the case of a deceased bankrupt (which could include a sole proprietor or partner, but does not apply to corporations), the reasonable,
- Costs of administration;
- Levy payable to the OSB under section 147 of the BIA;
- Employee wages during six months immediately prior to the bankruptcy to a maximum amount per person;
- Municipal taxes for two years immediately prior to the bankruptcy (which cannot be more than the value of the bankrupt’s share in the property);
- Arrears of rent to landlords for a period of three months immediately prior to the bankruptcy, and accelerated rent for a period not exceeding three months following the bankruptcy, if called for under the lease, subject to a limit being the value of the property of the bankrupt on the premises under lease;
- Costs for asset seizure incurred by a creditor, for seizures already underway at the date of bankruptcy, but only to the extent of the value of the property exigible (available to be legally seized or garnished under a writ of seizure and sale); and
- other claims for statutory deductions.
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