April 28, 2017
- Prevalence of LIT business practices involving debt consultants
- Overview of typical LIT administration and service provision involving debt consultants
- Statutory and estate documentation
- Conclusions and forward direction
In May 2016, the Office of the Superintendent of Bankruptcy (OSB) initiated a review of Licensed Insolvency Trustee (LIT) business practices in relation to administration of Division II consumer proposalsFootnote 1 pursuant to the Bankruptcy and Insolvency Act (BIA), related regulations and OSB Directives. Over the past decade, consumer proposals have come to represent a large share of total insolvencies in Canada and in 2016 comprised more than half of all insolvency filings.
The purpose of the OSB's review was to identify and assess potential risks associated with the integrity of some aspects of the consumer insolvency process, particularly in cases where LITs have entered into business relationships (or, relationships) with fee-charging third parties, referred to hereafter as debt consultants.Footnote 2 Aspects of particular interest included the LIT's assessment of the debtor, counselling for the debtor provided or arranged by the LIT, statutory documentation filed for the insolvency and other service delivery included in the insolvency process.
This report presents the OSB's observations related to consumer insolvencies filed by those LITs whose filing patterns demonstrate a frequent and sustained relationship with debt consultants. In conjunction with its standard compliance monitoring activities, the OSB undertook additional quantitative reviews and analyses of filing data for these LITs, and interviews and examinations under oath with debtors. Information provided to the OSB by LITs with respect to industry practices was also included in the review.
Observations presented in this report are considered to be representative of common practices of LITs who have established relationships with debt consultants; however, the observations do not apply in every instance to such LITs and should not be considered applicable to the general population of roughly 1,000 active LITs.
This document is intended for LITs who, by virtue of their qualifications and experience, are expert and knowledgeable in BIA requirements, related regulations, OSB Directives, the Code of Ethics for Trustees and standards of practice to ensure integrity, objectivity and accuracy in the administration of an insolvency. Accordingly, and for brevity, those requirements are not repeated nor explained within this report.
Prevalence of LIT business practices involving debt consultants
This review focused on LIT relationships with debt consultants with respect to filing Division II consumer proposals. It was observed that debtors who were involved with a debt consultant prior to meeting with an LIT overwhelmingly pursued consumer proposals rather than bankruptcy. In 2016, in 17 % (9,660) of all Division II filings, the debtor reported having paid for financial advice before being directed to an LIT.
LIT — debt consultant relationships observed during this review were specific and often exclusive. For example, 57 % (5,500 of 9,660) of 2016 Division II filings for which prior financial advice was reported were received from LITs who had relationships with two large-volume debt consultants. These two firms accounted for 64 % of the total fees reported in 2016 filings for financial advice prior to insolvency.
Thirteen LIT firms, including one national-level firm, were found to have one or more LITs operating in a frequent and sustained relationship with the two large-volume firms. For approximately 50 LITs within these 13 firms, more than 40 % of their Division II filings were sourced from these debt consultants. For approximately 20 of those LITs, more than 90 % of their Division II proposals originated with these two firms.
With some exceptions, the remainder of the observations described in this report pertain to the practices of the 50 LITs and 13 firms noted above.
Overview of typical LIT administration and service provision involving debt consultants
As mentioned above, debtors sourced through debt consultants tended to pursue consumer proposals as opposed to bankruptcy. The OSB's review found that a debtor would typically meet with the LIT only once, at a time arranged by the debt consultant, to sign statutory documents. Prior to meeting with the LIT, consumer debtors communicated and had two to four meetings with the debt consultant. Typically, the LIT relied on the debt consultant to carry out the statutory obligations with respect to collecting, assessing and validating the debtor's information, and exploring and providing advice on insolvency options. In cases where the LIT had a frequent relationship with the debt consultant, all aspects of the insolvency process prior to filing were usually performed at third-party locations.
Information required for statutory documents was normally transmitted directly from the debt consultant's administrative staff to the LIT's administrative staff, often shortly before the meeting at which statutory insolvency documents were to be signed. Debtor meetings with the LIT (a number of which included the debt consultant) ranged in duration from 5 to 30 minutes. In some instances, due diligence by the LIT's administrative staff occurred only after the proposal was filed with the OSB. LITs usually met with the debtor to sign statutory documents at the debt consultant's service location. Signing of statutory documents also took place in various informal locations in towns and cities where the LIT did not have a registered office.
The LIT's inquiry into the affairs of the debtor and the LIT's opinion of the fairness and reasonability of the proposal were expressed at the time of the debtor meeting, through the LIT's signature on statutory documents. Communication with debtors regarding statutory responsibilities, meetings of creditors, examinations by an Official Receiver, proposal amendments and creditor voting results was almost exclusively conducted by the debt consultant's administrative staff, who interacted with the debtor.
In all instances, BIA counselling was provided by the debt consultant rather than the LIT or the LIT's staff. Debtors reported that subsequent communication during administration of their proposal was also with the debt consultant rather than with the LIT.
Costs of insolvency for consumer debtors
Debtors served by LITs who had ongoing relationships with debt consultants usually ended up paying thousands of dollars more for the administration of their insolvency than debtors who were not sourced through a debt consultant. Typically, debt consultants required a consumer debtor to sign a fee agreement for consulting services prior to being introduced to a "selected LIT." Debtors typically understood the role of the LIT as being limited to meeting with the debtor to "file" the proposal developed by the debt consultant.
In the cases reviewed the amount of the consulting fee portion of the agreement between the consumer debtor and the debt consultant averaged approximately $2,400 and reached as high as $4,200. For lower value proposals the consulting fee commonly ranged from 20 to nearly 40 % of the value of the proposal.
Debt consultant fees were represented to cover the cost of advisory meetings, advice and preparation of the consumer proposal. In all cases, the fees paid to the debt consultant for advice and preparation of the proposal were separate and additional to the regulated tariff amount paid to the LIT, pursuant to BIA regulations. Typically, $250 or $500 was charged to the debtor's bank account upon signing the fee agreement, with the balance of the fee structured as an obligation for future payments to the debt consultant to be drawn directly from the debtor's bank account in instalments after approval of the proposal. The advice provided to debtors in exchange for such fees, for example, was found to include a recommendation to switch banking institutions prior to filing the proposal if the debtor held an account with a bank that was also among the debtor's creditors.
Furthermore, the OSB's review found that debtors were often also sold supplemental services through the debt consultant and charged additional ongoing fees during the life of their consumer proposal, which further increased their costs. Through continued communications after approval of a proposal, often in conjunction with delivery of BIA counselling, debt consultants may market loans to pay out proposals at high interest rates, new credit instruments at high interest rates, proposal insurance, "credit rebuilding" loans and financial literacy services. Such expenses amounted to thousands of dollars in additional costs during the life of the consumer proposals reviewed.
A practice noted during the OSB's review, for example, involved marketing "proposal insurance," typically charged as a monthly expense at a cost of approximately 10 % of the value of the proposal, structured as a loan with ongoing payments to promote "credit repair." In one case, a debtor with a $31,900 proposal was sold proposal insurance, structured as a loan, for over $6,300. With the booking fee, the monthly administration fee and a 15 % rate of interest, in total the insurance cost $9,150. Added to the debt consultant's advisory services fee of more than $2,300, the total amount paid by the debtor in respect of this proposal was $43,350.
Another trend observed in proposals filed by LITs working with debt consultants was the introduction of "discount clauses," designed to facilitate third-party loans for the purpose of discharging debt, which encouraged continuance of unsustainable financial practices on the part of the debtor. Insofar as inclusion of a discount clause incites a debtor to enter into a new and costly loan, proposals that include discount clauses are not considered by the OSB to be fair to the consumer debtor or to creditors.
To take advantage of a 25 % discount clause in a $10,000 proposal, for example, a debtor would take a loan of $7,500, potentially paying $1,400 in mandatory fees, bringing the loan total to $8,900. At an advertised interest rate of 22.99 %, with a repayment schedule of $214 over 84 months, the debtor would pay $10,475 in fees and interest, for a total of $17,975. In some cases, the debtor's fees could increase even more due to inclusion of various other forms of insurance. In contrast, the same debtor could pay $10,000 at zero percent interest over 60 months under the terms of an undiscounted proposal.
In November 2016, steps were taken to ensure transparency around the use of such clauses, which were being included by about 35 of the 50 LITs who had working relationships with debt consultants. Since March 2017, use of such clauses has been discontinued. A full discussion of the impact of discount clauses can be found in the Superintendent's position statement "Reasonable and Fair Provisions in Consumer Proposals", (December 5, 2016).
Qualifications and experience
In cases where LITs were found to rely on debt consultants to comply with their BIA requirements and prepare statutory documents, there was no information available, publicly or in the insolvency files reviewed, that identified a consistent pattern of qualification or experience among the debt consultants. Some debt consultants with whom LITs have entered into a relationship publicly communicate some insolvency-related education, such as Insolvency Counsellor by the Canadian Association of Insolvency and Restructuring Professionals.
Debtor understanding of the insolvency process
Interviews with debtors served by LITs who had ongoing working relationships with debt consultants indicated that debtors had a very limited understanding of the role and obligations of the LIT in the insolvency process. Debtors were also usually not aware of the amounts of payments they made towards debt consultant fees versus creditors' fees versus the fees of the LIT. In one instance, the OSB identified arrangements where debtors made proposal payments through the debt consultant rather than directly to the LIT. Communication between the debtor and the LIT was often exclusively through the debt consultant. In some cases, debtors were unable to name their LIT.
The OSB's review, which included examining a sample of files, did not identify documentation provided by the LIT that might have explained the fee and payment parameters of the consumer proposal to the debtor. Through interviews, it was determined that debtors sourced through debt consultant relationships were usually unaware that it was not necessary to pay a debt consultant to prepare a consumer proposal. Interviews with debtors also revealed that the obligation to disclose debts and ongoing expenses for debt consultant services in the context of an insolvency filing was not raised in meetings with LITs.
Statutory and estate documentation
The OSB's review included analysis of statutory and estate documents for Division II proposals by debtors served by LITs who had ongoing relationships with debt consultants to assess the accuracy, transparency and completeness of the documentation filed; aggregate analysis was supplemented with individual file sampling and review. It was found that statutory documents filed by LITs who worked with debt consultants commonly contained material errors related to asset disclosure income sources, liabilities and assessment certificates.
Multi-year filing data from LITs who had ongoing relationships with debt consultants were compared with data from a control group of LITs whose BIA obligations were carried out in-house with employees under their direct supervision.
The OSB's comparison of the data identified a consistent difference in the frequency of files with very low proposed values. LITs working with debt consultants filed five-year consumer proposals with payments under $100 per month about 14 to 19 % of the time. This compares with only 4 % of such proposals filed by the control group of LITs. In addition, the OSB identified numerous instances in which LITs who had ongoing relationships with debt consultants filed proposals for which the reasonability of the proposal and the appropriateness of the advice provided to the debtor were questionable.
Disclosure of liabilities, assets, income and expenses
A common observation in the statutory consumer proposal documentation filed by LITs who had ongoing relationships with debt consultants was that the Statements of Affairs and Income and Expense statements filed were inaccurate with regard to the amount and duration of fees owing to the debt consultant. While the structure of debt consultant fees varies, the OSB found they were typically not included at all as a liability or as an expense, and were not identified by the LIT in the context of any investigation of the affairs of the debtor.
Fees paid were frequently reported as $250 or $500 on the assessment certificate the LIT completed with the debtor, often based upon amounts reported by the debt consultant to the LIT's staff in advance of the meeting to sign statutory documents. However, signed fee agreements obtained from some debtors identifying the full amount of debtor liabilities for debt consulting services were not located in LIT estate files. The duration and amount of the substantial outstanding and ongoing fees to be paid to debt consultants were not discernible to creditors.
Through its file reviews and interviews with debtors, the OSB did not identify circumstances in which a debtor reported that the LIT had inquired about debt consultant fee agreements or documented the outstanding liability of the debtor to the debt consultant (which was typically paid in monthly instalments drawn directly from the debtor's bank account after filing the proposal).
Real property valuations
Division II proposals, by definition, pertain to moderate-value estates. For debtors, real property (generally the family residence) is usually the single largest asset type by valuation. A minor variance in property valuation will have a relatively large impact on the ratio of the debtor's unsecured debt to net worth. While real property is not realized in the context of a consumer proposal, the ratio of the debtor's unsecured debt to net worth may be an important factor for unsecured creditors in assessing the financial circumstances of the debtor and in determining whether or not to accept the proposal.
Among the files reviewed, the OSB found that the LITs' valuation of property on the Statement of Affairs was never higher than that provided by the debt consultant. It was also found that due diligence to determine the property value was conducted and supplied by the debt consultant, frequently at a cost to the debtor of $150 and often without any subsequent validation by the LIT. The OSB compared data in hundreds of filings from LITs who had relationships with debt consultants with data in filings from LITs who did not work with debt consultants and found the real property equity in LIT files sourced from debt consultants was consistently and materially lower.
To further explore potential risks around property valuation, the OSB reviewed recent Division II filings from LITs who work with debt consultants in one major metropolitan area. Twelve low equity real property Division II estates were selected and the method of valuation in the estate file was reviewed. It was found that a common method of documenting a valuation was for the LIT to retain a copy of an email exchange between the debt consultant and a real estate agent in which a view on property value was offered. Among the 12 estates reviewed, the value reported by the LIT on the Statement of Affairs was, on average:
- 14 % less than the 2015 Tax Assessment value
- 29 % less than the 2016 Tax Assessment value
- 8 % less than the purchase price of the property as stated on the title search
- 21 % less than the value determined by a third-party appraiser contracted by the OSB
In the sample reviewed, appraised properties had been undervalued by between $23,000 and $116,000 (appraised value minus Statement of Affairs value). In these cases, the debtor's portion of the undervaluation (taking joint ownership into account) ranged from one quarter to nearly six times the value of unsecured liabilities discharged through the proposal.
In all but one of the files reviewed by the OSB, where the LIT had a working relationship with a debt consultant, LITs complied with their obligation to provide BIA counselling to the debtor by paying the debt consultant with whom they had a working relationship to provide the prescribed counselling. In all of those instances, the debt consultant chosen by the LIT to provide BIA counselling was the same debt consultant who had entered into a debt counselling service agreement with the debtor prior to the insolvency filing.
More often than not, when records were provided by the debtor, it was found that the debt consultant was also charging for additional "financial literacy" consulting services, in addition to, and separate from, counselling fees the debtor paid the LIT for counselling as per the Bankruptcy and Insolvency General Rules. During interviews, it was revealed that debtors were generally unable to distinguish between mandatory BIA counselling and other financial literacy services for which they were paying a debt consultant.
Conclusions and forward direction
Based upon the observations presented in this report, the OSB has determined that administrative practices of LITs who enter into relationships with debt consultants can place the integrity of the insolvency process at risk and can negatively impact the financial interests of both creditors and debtors in an insolvency filing.
Numerous practices observed were inconsistent with the intent and objectives of the BIA and OSB Directives vis-à-vis Division II proposals. The same practices also have the potential to diminish the perceived objectivity and professionalism of the LIT, whose credibility as an officer of the court is essential to maintaining trust in and efficient and effective operation of the insolvency process.
It is important to recognize that ongoing compliance monitoring by the OSB does not suggest that the business practices observed during this review and described in this report are applicable to the general LIT population of about 1,000 active professionals who consistently demonstrate high standards of rigour and professionalism in the administration of insolvency estates.
Observations and findings identified during this review do, however, indicate a need to strengthen elements of the existing regulatory framework to ensure that the intent and objectives of the BIA, its rules and OSB Directives (which currently address a number of subjects identified herein) are maintained.
Over the next year, the OSB will initiate a series of amendments to OSB Directives, BIA forms and compliance programs to address the risks and issues identified in this report. Areas of focus will include fulfillment of the LIT's responsibilities in all aspects of the insolvency process and rehabilitation of the debtor, including the assessment process, service delivery, and the process and requirement for providing prescribed BIA counselling.
A particular focus will be to ensure that LIT business practices are consistent with the professional standards of the Code of Ethics for Trustees as this will contribute to maintaining a level playing field within the insolvency system. The direction and emphasis of these changes will place priority on:
- Prevention — through advanced communication of updated OSB Directives, standards and changes in statutory document requirements, and by detecting and addressing any non-compliant activities at the outset and during administration of a filing
- Risk-based supervision — through increased monitoring and supervision of LITs who continue to demonstrate high-risk business practices to identify and address non-compliance
- Efficiency — by minimizing the burden for LITs whose business practices do not place the integrity of the insolvency process at risk
- Transparency — by ensuring insolvency system stakeholders have access to information that can contribute to informed decision making during approval of a consumer proposal and administration of an insolvency
January 16, 2018
The OSB wishes to thank those who submitted information and/or suggestions between April 28, 2017 and January 16, 2018. Input is taken into account as the OSB develops amendments to Directives, Forms and compliance programs to address the risks and issues identified in the report.
Contact OSB Regulatory Affairs for further information.