One of the stranger phenomena during the pandemic was the rock-bottom number of insolvencies in Canada. It defied intuition, because the economy contracted so severely in early 2020.
Economists offered a few explanations. One was that near-zero interest rates kept debt payments manageable, at least for a while. Another was that small business owners simply walked away without formally filing for bankruptcy. And then there were the billions of dollars of government subsidies that kept businesses alive, at least on paper.
The era of low insolvencies is coming to an end. The federal Office of the Superintendent of Bankruptcy reported business insolvencies in February were up 66 per cent from the lows of February, 2021, and roughly back to February, 2020, levels. Economists expect the number to keep rising.
Insolvencies can be a good thing. A dynamic economy needs unsuccessful businesses to fail so that new, innovative ones can grow. Canada is better off without so-called zombie firms – dead enterprises animated only by the thick ichor of subsidies flowing through their veins.
But new businesses can only take root if unsuccessful entrepreneurs are not unduly punished. There may be ways to streamline the rules to give entrepreneurs a shot at a second chance – a good idea with a potential recession looming.
Ottawa has used an economic downturn to reform insolvency laws before. In 2009, during the Great Recession, it passed legislation to make it easier for Canadians to file proposals instead of bankruptcies.
Proposals and bankruptcies are two options under the Bankruptcy and Insolvency Act. A proposal creates a plan to pay off a reduced amount of debt over a few years; if followed successfully, it has less impact on a person’s ability to access credit in the future. A bankruptcy absolves someone of debt, but in some cases they may have their wages garnished and find it nearly impossible to get credit again for at least seven years.
A 2016 study by Bank of Canada researchers found the 2009 reforms were successful in pushing Canadians into proposals instead of bankruptcies, meaning they faced fewer personal repercussions. It also found that financial institutions recovered more money as proposals became more frequent. A win-win for both parties.
Ottawa could look at ways to make the bankruptcy process even less onerous. For example, it could open up the faster summary administration process to business owners; it’s now only available in personal bankruptcies. It could also explore whether seven years is too long for a bankruptcy to remain on a credit report; two or three years for a first bankruptcy might make more sense.
But reforms aren’t needed only for federal bankruptcy law. There are areas of provincial responsibility, too.
Canadians who have only signed residential leases may be shocked at the lack of protections for those signing commercial ones. When an entrepreneur starts a small business, they often have to sign a 10-year agreement with a personal guarantee. If that business fails, the entrepreneur may still be personally responsible for that lease for years.
Insolvency trustees say entrepreneurs are often driven to bankruptcy just to remove the lease millstone from around their neck. That’s unnecessary. Provinces should level the playing field between commercial tenants and landlords by re-examining personal guarantees, or at least establishing more options to get out of leases.
And finally, as businesses struggle with pandemic debt, Ottawa could look at whether the repayment schedules for emergency government loans should be eased, at least in the hardest-hit sectors. A large portion of the Canada Emergency Business Account loan is set to be forgiven if a business pays it back by Dec. 31, 2023. But if the deadline is missed, the whole thing is due – paradoxically meaning businesses with the most cash on hand get the most benefit.
Industry group Restaurants Canada has proposed a series of deadlines so businesses can still access some forgiveness past Dec. 31. It may even help Ottawa recover the loans by giving businesses more incentive to repay.
None of this should shield debtors from the consequences of insolvency. Those who run up large debts must be held responsible for them. But there are ways that Canadians are overly punished by the bankruptcy process. Sensible reforms could help them, and the economy as a whole.