Creditors/Insolvency/Bankruptcy

RRSP treated as LIFO in bankruptcy

At issue

Insolvency is generally the condition of not being able to meet one’s debts as they come due. In turn, bankruptcy is the legal status under which such a person’s insolvency may be managed through the courts.

Bankruptcy rules balance the interests of creditors seeking their just due, against the policy goal that no person should be condemned to an inescapable spiral of debt. By going through this process, the bankrupt looks forward to an eventual discharge in order to make a clean start.

It is for these reasons that full and frank disclosure must be made of a bankrupt’s finances. This disclosure also helps identify property such as RRSP and RRIF savings that are protected from bankruptcy, dependent in part upon timing issues.

Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3 (“BIA”), s. 67(1)(b.3)

It benefits our whole society to have individuals take responsibility to provide for their own retirement income. The BIA formally reinforces this public policy interest in s.67(1) where certain assets are exempt from division among creditors, including:

(b.3) … property in a registered retirement savings plan or a registered retirement income fund, as those expressions are defined in the Income Tax Act, or in any prescribed plan, other than property contributed to any such plan or fund in the 12 months before the date of bankruptcy. [Emphasis added.]

The 12 month look-back protects against a person manipulating this privilege by making a large deposit immediately prior to a planned assignment into bankruptcy.

If the dealings with the RRSP/RRIF were only one way during that preceding 12 months – ie., deposits only – the application of this constraint is straightforward. However, how does it apply if both deposits and withdrawals occur over that period?

Re Miadovnik (2), 2013 ONSC 1758

Sheldon Miadovnik had been making regular withdrawals from his RRSP in 2008 and 2009 to fund living expenses while going through separation proceedings from his wife. In February 2009 when his RRSP balance was about $100,000, he contributed a further $15,000, allowing him to reduce his taxable income for 2008. The withdrawals resumed in March and April, totaling to approximately $15,000, and a voluntary assignment into bankruptcy was made on May 1.

The bankruptcy ended up before a Master who was tasked to interpret s.67(1)(b.3). (It is the Master’s emphasis in the judgment that is repeated above.) The trustee claimed that the $15,000 deposit should be available to it, and it also claimed the balance of a bank account which the Master found comprised the net proceeds of the subsequent withdrawals.

Having no case authorities as guidance, the Master faced a conundrum as to whether the RRSP withdrawals were to be considered FIFO (first-in-first-out), LIFO (last-in-first-out), or some kind of proportionate calculation.

Conscious of the potential for double-counting assets, the Master determined that “LIFO should apply and the funds removed thus be regarded as withdrawals of the most recent contributions.” This conclusion rested on the history of Mr. Miadovnik’s withdrawals and the legitimate intention to reduce 2008 taxable income by making the February 2009 RRSP deposit.

Practice points

Generally, RRSP deposits made in the 12 months preceding an assignment into bankruptcy will be available to a bankruptcy trustee to satisfy creditor claims.
Where there are RRSP withdrawals as well as deposits, an analysis of the circumstances will be necessary to determine what may be claimed by the trustee.
The LIFO determination in Miadovnik rested on the particular facts, and should not be assumed to be apply in all circumstances.

Discharge of a deceased bankrupt

At issue

As one of its main objects, bankruptcy law seeks to provide relief to those who might otherwise face an interminable condition of debt servitude. The bankruptcy process fosters their rehabilitation to again be effective economic contributors.

Under the Bankruptcy and Insolvency Act (BIA), insolvency is the state of being unable or unwilling to pay one’s debts as they come due. Alternatively it can be measured as having less net realizable assets than one’s current and accruing debts.

Bankruptcy is the legal status of a person who has either him/herself made an assignment, or against whom a bankruptcy order has been issued, following which that person’s assets generally form the bankrupt estate. Discharge is the step whereby a person is released from the legal status of being a bankrupt.

How then might a discharge be reconciled where a bankrupt estate is that of a deceased person?

Re Simoes, 2011 BCSC 63

In this set of four applications before a registrar sitting in bankruptcy chambers, all of the subject bankrupts were deceased. As the judgment details, the law surrounding discharge of a deceased bankrupt is thin, and therefore the registrar took it upon himself to research the matter in order to provide context for the decisions, and guidance in future matters.

There are three competing interests involved in a discharge application, being those of the bankrupt, the creditors and the public’s faith in the integrity of the system. Rehabilitation of the bankrupt is obviously moot where the bankrupt is deceased. With respect to creditors and the public interest, the personal representative of the deceased could be called upon in appropriate circumstances to make a payment into the bankrupt estate to ascertain a conditional discharge.

In three of the cases before the court, the registrar determined that the respective bankrupt was in substantial compliance with his or her legal obligations, and an absolute discharge was granted. In the fourth case, the trustee had filed an objection, but the registrar could find no evidence that the shortcomings were willful, so ordered a brief one-week suspension before granting the discharge.

Bankruptcy of Lyle Coleman, 2011 MBQB 300

Lyle Coleman died in March, 2009. His daughter was appointed as administrator of the estate in February 2011, and shortly thereafter in March 2011 she obtained leave from the court for an assignment of the estate into bankruptcy.

In support of the present application for discharge, the bankruptcy trustee reported to the court that “all of the assets of the deceased have been liquidated and distributed in conformity with the provisions of the BIA.”

The judge lauded praise upon the daughter for her “commendable behaviour” as estate administrator in undertaking the bankruptcy assignment “without any possibility of personal benefit to herself.”

Still, he distinguished the Simoes cases under which the living person made the assignment, as compared to the present estate administrator’s initiation. Further, he emphasized that there is no practical effect of the BIA‘s rehabilitative objective if a bankrupt is deceased.

The judge then declined the discharge based in the main on the possibility that there may be “pay equity benefits, unknown but now valuable fractional mineral rights” and other potential future receipts. Of note, he earlier acknowledged that “the assets and debts could be considered as modest”, with the realized assets having been $17,000 for distribution among eight creditors claiming $23,000.

Practice points

Clearly an estate administrator should tread carefully before making a bankruptcy assignment, lest the result be an open-ended commitment as in Coleman.
It should be emphasized to a person in the midst of debt problems how important it is to maintain existing life insurance in force. The proceeds could obviously provide direct estate liquidity. As well, where the estate contains assets that have emotional value, a direct insurance beneficiary could nonetheless choose to contribute into an estate to secure a conditional discharge, rather than allow those assets to be liquidated in order to pay out creditor claims.

RRSPs, RRIFs and insolvent estates

At issue

Where there is a beneficiary designation on a RRSP or RRIF, the funds in the respective account at the annuitant’s death will be paid to the named beneficiary. Specifically, it is the gross funds that the financial institution will pay out, with the associated tax liability being borne by the estate of the deceased. If the estate does not have sufficient assets to pay the tax liability, the Canada Revenue Agency can seek payment of the associated taxes from the beneficiary.

Depending on circumstances, this can cause troublesome complications for a beneficiary, and also for the executor of such an estate.

2011-04022391I7 (E) – Insolvent Estate of a Deceased RRSP Annuitant

A deceased’s estate has primary liability for the income tax associated with inclusion of RRSP proceeds in the deceased’s terminal year income. Under ITA s.160.2(1), a beneficiary is jointly and severally liable, and CRA may look to the beneficiary to pay the proportional taxes when an estate is insolvent.

This liability applies whether the beneficiary is a Canadian resident or non-resident. The law cannot however be enforced against a non-resident, as courts of one country will not generally enforce the revenue laws of another country.

2011-0429101C6 (E) – 2011 STEP Conference – Q20 – Insolvent Estates

CRA responded on a series of questions involving insolvent estates.

The Crown has priority over other general estate creditors, though it will stand behind secured creditors. Once an estate is assigned into bankruptcy however, the Crown priority ceases to apply.

With respect to a RRIF that is paid from a financial institution to one or more named beneficiaries, any personal liability of the executor of the deceased’s estate will be limited to the assets under his or her control and that he or she has distributed. Presumably a direct payment to a plan beneficiary from the institution without intervention of the executor would not be determined to have been under the executor’s control.

Where an executor contemplates using estate assets to object to an income tax assessment, there is a risk that the executor could be liable for taxes if the estate is or becomes insolvent. If the executor engages an accountant on behalf of the estate for this purpose, there is a risk that the executor could be personally liable for that cost. Similarly, if the executor engages an accountant using his/her personal funds, there is no certainty that the estate will be obliged to reimburse the executor. A suggested alternative in this CRA letter is for the executor to assign the estate into bankruptcy, leaving it to the bankruptcy trustee to decide whether to object or appeal.

Practice points

A named beneficiary should bear in mind the potential tax implications when receiving RRSP or RRIF proceeds. Before committing those received funds to a large expenditure (eg., travel, a capital purchase or lump sum mortgage payment), the beneficiary should have an understanding of the deceased’s financial circumstances. Such a beneficiary should proceed cautiously if there is a concern about the deceased’s solvency and/or the realizability of assets now held in the estate.
Prior to accepting the role, a named executor may wish to look into the financial status of the deceased, and in turn the prospects for the estate. To the extent the estate is or becomes insolvent, the executor may merely be acting to realize assets for the benefit of estate creditors, and not estate beneficiaries.