Spring 2020 Edition
Andrew Chris, Partner, Normandin Chris LLP
Bankruptcy and Family Law: What You Need to Know

In today’s economic climate, and particularly in light of the COVID-19 global pandemic, it is expected there will be an increased number of bankruptcy filings in Ontario. If you are going through a marital separation and are aware or suspect that your spouse will be filing for bankruptcy, it is imperative that you seek legal advice. A failure to do so may result in severe financial repercussions.

Corporate and personal bankruptcies in Canada are governed by federal legislation known as the Bankruptcy and Insolvency Act (“BIA”). In Ontario, the division of matrimonial property is governed by the Family Law Act (“FLA”) . When a spouse files for bankruptcy just prior to or during a marital separation, there is a clash between the BIA and FLA that can result in highly prejudicial outcomes for the non-bankrupt spouse.

Under the FLA, family property is divided according to a process known as equalization. Equalization involves a valuation and accounting of the family property, and spouses are entitled (generally speaking), to receive one-half of the value of the property accumulated during the marriage (as opposed to the division of actual assets themselves). Notably, the process for distributing family assets differs from province to province. For example, Ontario, Prince Edward Island, and Manitoba have opted for the equalization model, while Alberta, Nova Scotia, New Brunswick, Newfoundland and Saskatchewan abide by a property division model. The property division model gives rise to proprietary and beneficial interests in the assets themselves, not just in their value. This distinction is highly relevant when considering the effect of bankruptcy proceedings on family law actions.

A Discharge from Bankruptcy will Release an Equalization Claim

Pursuant to s. 178(2) of the BIA, a discharge of bankruptcy releases the bankrupt from “all claims provable in bankruptcy.” This release includes a spouse’s claim for equalization.

Equalization gives rise to a debtor-creditor relationship in the sense that the creditor spouse obtains a monetary claim against the debtor spouse (as opposed to a proprietary or beneficial interest in the other spouse’s property). The net worth of each spouse accumulated over the course of the marriage is calculated and “equalized” by way of the spouse with the larger net family property paying half the difference to the other spouse. The assets themselves are not reapportioned: each spouse retains legal ownership of his or her own property before and after the marriage breakdown.

As an equalization obligation is a debt owing from one spouse to the other, it is a provable claim in bankruptcy. If the non-bankrupt spouse asserts his or her equalization claim prior to the discharge of bankruptcy, the entitled spouse becomes an unsecured creditor of the payor spouse. In this scenario, the entitled spouse will have no preferred or secured position over any other unsecured creditor and any remaining funds will be distributed to all creditors in the same classification on a pro-rata basis.

If the non-bankrupt spouse fails to assert his or her equalization claim before the discharge is awarded, even if the entitled spouse had no notice of the bankruptcy, they will be unable to recover the equalization payment owing to them. At that point, the entitled spouse is left with few options. They may pursue the payor spouse under section 178(1)(f) of the BIA for any dividend that he or she would have been entitled to receive on any provable claim not disclosed to the trustee. Alternately, the entitled spouse may attempt to set aside the discharge due to fraud under section 180(2) of the BIA.

Importantly, given that a discharge of bankruptcy will release a claim for equalization regardless of whether the non-bankrupt spouse was notified of the bankruptcy proceedings, bankruptcy searches should be conducted early and often if you suspect your spouse may be a candidate for bankruptcy.

Assets that are Exempt from Bankruptcy

Pursuant to section 67 of the BIA, certain assets are exempt from bankruptcy, including but not limited to property held by the bankrupt person in trust for any other person, RRIFs and RRSPs, as well as an interest in a regulated pension plan.

Notwithstanding the process of equalization in Ontario, the Court has the power under section 9(1) of the FLA to impose a legal relationship between spouses other than a debtor-creditor relationship. For example, the Court can order the transfer to, or vesting of, property in the entitled spouse to satisfy all or part of an equalization claim. This may result in an Order that the bankrupt spouse is holding all or part of their interest in an asset in trust for the entitled spouse by way of a constructive or resulting trust. Alternatively, the Court can order a charge against property in favour of the entitled spouse as security for the equalization payment.

In order for these strategies to be effective, it is imperative that they are employed before the bankruptcy has been discharged and before a final judgement in the matrimonial case has been granted. Notably, upon a spouse filing a notice of intention under the BIA, section 69.3 of the BIA provides for an automatic stay of proceedings. In the event a stay is imposed, the spouse seeking to access the exempt assets must first apply to lift the stay of proceedings and obtain leave to pursue a remedy against the exempt assets.

A Discharge from Bankruptcy will not Release the Bankrupt Spouse from Paying Support

Unlike Part I of the FLA, which deals with family property and applies only to married spouses, Part III of the FLA addresses child and spousal support and is available to both married and common law spouses. Pursuant to section 29 of the FLA, a “spouse” for support purposes includes both married spouses, and two persons who are not married to each other but have cohabited continuously for a period of not less than three years, or who have cohabited “in a relationship of some permanence” if they are the natural or adoptive parents of a child.

In contrast to property claims, the BIA protects child and spousal support obligations and debts. An insolvent party cannot simply ignore or discharge a spousal or child support Order. Specifically, section 178(1) of the BIA provides that a discharge from bankruptcy does not release child and spousal support obligations; section 69.41 provides that the BIA does not automatically stay claims for support; and section 136(1) of the BIA gives lump sum support arrears and up to one year of unpaid periodic support arrears priority over other unsecured claims. In addition, costs that are ordered by a Court with respect to a support proceeding are not extinguished by a bankruptcy or proposal. That being said, it is critical that counsel for the support recipient ask the Court to specify in the cost Order that the costs are enforceable as an incident of support.

In order to enforce a support Order against a bankrupt spouse, the recipient spouse can choose to file their Order or Agreement with the Family Responsibility Office (“F.R.O.”), which has the ability to enforce support Orders and Agreements pursuant to the Family Responsibility and Support Arrears Enforcement Act. The F.R.O. has substantial remedies at its disposal to enforce support arrears, ranging from garnishing wages, seizing passports and driver’s licenses, and even imprisoning a payor for up to 180 days. The F.R.O. can be utilized to enforce not only child and spousal support payments, but also cost Orders that are denoted as enforceable under the provisions of the Family Responsibility and Support Arrears Enforcement Act.

An insolvent spouse who seeks to reduce or expunge support arrears or prospective support has the same options available to them whether or not they have made an assignment in bankruptcy or filed a proposal.  The most common avenue is to bring a motion to vary, rescind or suspend support, prospectively or retroactively, pursuant to section 17 of the Divorce Act, or pursuant to section 37 of the FLA.

While the Courts cannot transform an equalization payment into a lump-sum spousal support payment, there have been instances where the Court has ordered lump-sum spousal support in an effort to mitigate inequities arising from a bankruptcy. That said, the spousal support claim must be made on its merits and will not be awarded simply to defeat the effects of the BIA.

This article provides a brief overview of the intersection between family law and bankruptcy law. The information detailed above is a non-exhaustive summary of issues to consider. If you are experiencing or expect to experience any of the above circumstances, it is recommended that you reach out to the appropriate professionals to ensure your rights are protected.

About the Author

Andrew Chris is a Partner at Normandin Chris, devoted to all aspects of family law. Andrew has served as a contributing author of the Income Tax and Family Law Handbook, published by LexisNexis Canada and as an adjunct professor of the “Lawyer as Negotiator” course at Osgoode Hall Law School.