Surplus income precludes bankruptcy filing?

McDermott (Re), 2023 ABKB 387
Does surplus income preclude a bankruptcy filing because a viable proposal could and should have been made?

Overview: In this case, the Court concluded that the existence of surplus income did not preclude a bankruptcy filing because any potential proposal was not viable.

The then-married debtors owed more than $200,000 to creditors, placing a consumer proposal out of reach but leaving a Division I (or “ordinary”) proposal as a potential option. Notwithstanding that fact, during their initial consultations, the licensed insolvency trustee (LIT) concluded that these debtors could not make viable proposals, and they assigned themselves into bankruptcy.

When the bankrupts later applied for discharge, the discharges were objected to on the ground that their assets were worth less than fifty cents on the dollar of their unsecured liabilities and this was not because of circumstances beyond their control. As a result, absolute discharges were not available, and both bankrupts were discharged on conditions, including the payment of certain arrears of surplus-income payments. Eventually both bankrupts paid the required amounts and were absolutely discharged.

When the trustee later sought approval of its fees in both bankruptcies, the Office of the Superintendent of Bankruptcy (OSB) argued that viable proposals could, and should, have been filed, that the estate recoveries under such proposals would have been greater than those achieved in the bankruptcies, and that the trustee’s fees should be reduced to compensate the estates for the resulting under-recoveries. The Registrar in Bankruptcy accepted the OSB’s position and taxed down the trustee’s fees, and the trustee appealed from that decision.

The Bankruptcy and Insolvency Act refers to the concept of a “viable proposal” in various contexts, but does not define it. Accordingly, the viability of a proposal must be gauged by examining the six factors identified in s. 11 of the OSB Directive No. 6R3:

1. whether the debtor

   • has sufficient property available to make a "lump sum payment" proposal, or

   • has surplus income in accordance with Directive No. 11R2, Surplus Income, and also has the capacity at the time of assessment to sustain continued payments to a proposal for a period of time;

2. the family or personal situation of the debtor;

3. the financial situation of the debtor;

4. the number and type of creditors of the debtor, both secured and unsecured; 

5. the likelihood of acceptance of a proposal by the creditors; and

6. whether the return to creditors from a potential proposal would be greater than the return from a bankruptcy.

The OSB’s “viable proposal” analysis here keyed largely on one factor - i.e. apparently available surplus income (and the resulting perceived greater recovery in proposals versus bankruptcy). Meanwhile, the trustee’s central point on proposal viability (or lack thereof) was that the debtors could not realistically have made proposal payments at the scale suggested by the OSB. The Court found that the net family surplus was $2,080. The debtors had agreed to pay effectively that entire amount to the trustee as surplus income between the two of them. On the other hand, the suggested proposal (or one of them) from the OSB would also have called for payments at effectively the same level - i.e. $1,900 monthly for 60 months. In any event, the debtors had the ostensible ability to fund a proposal offering payments of $1,000 monthly. However, that did not mean the proposals were viable.

In holding that the proposals would not have been viable, the Court considered, among other things: 

1. the wife’s income was about to shift from full-time RCMP pay to employment-insurance-level earnings for her parental-leave year;

2. the family’s expenses were about to increase, with the arrival of their second child; 

3. serious medical issues cast doubt on the wife’s ability to return to work after her parental leave;

4. the husband had previously made, and failed to complete, a consumer proposal, and the two of them did not present as prudent money managers or as persons especially likely to adhere to any kind of payment plan; and

5. no proposals could have been approved by the court in this case without the “reasonable security” required by ss. 59(3) of the BIA as the debtors had no material assets.

All to say: even if the bankrupts ostensibly had surplus income, and even if proposals built on that income (or a material percentage of it) would have yielded more for the creditors here, the identified counter-factors heavily outweighed those (largely theoretical) factors. The debtors were very poor candidates to actually perform whatever possible-on-paper proposals might have been conceived.

Accordingly, the Registrar’s conclusion that “proposals were viable” resulted from a palpable and overriding error - i.e. with the other noted “viable proposal” factors not examined or, in any case, not expressly considered in that assessment. No proposals were viable here, and no taxing down was warranted on that ground.

Judge: Justice M. J. Lema

Counsel: Amber Poburan of Sharek & Co. for the appellant, Moses Advisory Group Inc.

George Body of the Department of Justice Canada for The Office of the Superintendent of Bankruptcy