A process server’s letter arrives, or a lawyer forwards a one-page notice from a licensed insolvency trustee. The person you have been suing for two years has filed for bankruptcy. Your court date is in doubt, and the money you hoped to collect suddenly looks a long way off.
For the person on the other side of the file, the same notice may bring relief after months of collection calls and legal letters. Bankruptcy has real force in a lawsuit. But it does not make every claim vanish, and the effect depends on the kind of debt, whether there is security or insurance, and who else is on the hook.
Bankruptcy is governed by federal law, the Bankruptcy and Insolvency Act (BIA), so the basic rules are the same across Canada, including in Brampton. This article is general information and not legal advice. A licensed insolvency trustee can advise on the bankruptcy process itself, and a lawyer can advise on how it affects your claim.
The Automatic Stay
The central rule is section 69.3 of the BIA. On the bankruptcy of a debtor, no creditor has any remedy against the debtor or the debtor’s property, and no creditor may start or continue any action, execution, or other proceeding to recover a claim provable in bankruptcy.
That stay is automatic. Nobody needs to go to a judge first. From the moment of bankruptcy, a civil action to recover a debt from the bankrupt comes to a stop, and so do garnishments and enforcement of a writ against the bankrupt’s property, in most cases. A creditor who carries on anyway risks having the steps treated as ineffective, and it might attract a costs consequence.
It helps to break this down by the stage of the lawsuit:
- Before you sue. You generally cannot issue a claim against the bankrupt for a provable debt without getting the stay lifted.
- During the lawsuit. The action is paused against the bankrupt, although it may continue against other defendants.
- After judgment. Your judgment turns into a claim in the bankruptcy, and enforcing it against the bankrupt is usually stayed.
Section 69.3 only reaches claims provable in bankruptcy. Most debts and liabilities that existed at the date of bankruptcy qualify, including contract claims, negligence claims, and contingent or unliquidated claims, which the trustee can value. Some claims fall outside it, and a court order can change the picture.
Secured creditors stand in a different position. Subject to limited exceptions, subsection 69.3(2) says that a bankruptcy does not prevent a secured creditor from realizing on its security. A mortgage lender can generally still enforce its mortgage against the house, and a vehicle lender can still repossess. Whether a registered writ, a construction lien, or some other interest gives you security in this sense is a technical question, and it deserves legal review.
Proposals raise similar issues. A person or company filing a proposal, or a notice of intention to make one, also gets a stay under other sections of the BIA. The details differ, including how a consumer proposal affects things, and those stays can end if the proposal fails. Check which one you are dealing with, and what the notice actually says.
Lifting the Stay
A creditor can apply to the court under section 69.4 for a declaration that the stay no longer applies to it. The court may grant it, with any qualifications it considers proper, if it is satisfied that the creditor is likely to be materially prejudiced by the continued operation of the stay, or that it is equitable on other grounds.
Courts do not lift the stay automatically or just because a claim is sizable. The system exists to treat creditors fairly and in one process, and allowing one creditor to race ahead defeats that. Lifting the stay can be more realistic when:
- The claim is likely to survive discharge, such as one involving fraud (see below), and a court judgment is required to prove it.
- The creditor seeks only to recover from an insurer and not from the bankrupt’s estate.
- The lawsuit is nearly ready for trial and involves other defendants anyway.
- The claim cannot fairly be dealt with through the trustee’s process.
A creditor who wants to do this should show actual evidence, not just bare allegations. Even a successful application is usually followed by more steps in the original action.
Debts That Survive Discharge
A first-time individual bankrupt can be automatically discharged after 9 months, or after 21 months if required to make surplus income payments, unless someone opposes the discharge. Longer periods apply to those who have been bankrupt before. Discharge generally wipes out provable debts, but section 178(1) sets out exceptions. For civil litigants, the most relevant are:
- Damages awarded in civil proceedings for bodily harm intentionally inflicted, sexual assault, or a wrongful death resulting from them.
- Debts or liabilities for support, under a court decision or an agreement.
- Fraud, embezzlement, misappropriation, or defalcation while acting in a fiduciary capacity.
- Debts resulting from obtaining property or services by false pretences or fraudulent misrepresentation.
- Fines, penalties, and restitution orders imposed by a court in respect of an offence.
Consider a hypothetical: a contractor in Brampton takes a large deposit, promises that the money will go toward materials, knows that’s untrue, and spends it on other debts before going bankrupt. An ordinary breach of contract claim would probably be released on discharge. If a court finds the deposit was obtained by fraudulent misrepresentation, the debt may survive. That is exactly why how a claim was pleaded before the bankruptcy, and what any judgment says, can matter so much. A later court will look at the true nature of the claim, and a vague pleading or a default judgment on simple debt may not get you there.
Nothing here is automatic, and fraud has to be properly proved. Allegations of dishonesty should never be made casually.
If You Are a Creditor: What to Do Now
Do not ignore the notice. A few steps usually come first:
- Read the notice closely. Note the type of filing, the date of bankruptcy, the name of the trustee, and any meeting date.
- File a proof of claim. This is how you participate in any distribution. There is no cost-free assumption that the trustee already knows what you are owed.
- Tell the trustee about concerns. If assets seem to have been hidden or transferred, the trustee should know.
- Consider opposing the discharge. Creditors can oppose, and the court can impose conditions, including payment of a set amount.
- Check for payments and transfers. Sections 95 and 96 of the BIA allow certain preferential payments and transfers at undervalue before bankruptcy to be challenged, usually by the trustee. Under section 38, a creditor can ask for a court order allowing it to take the proceeding if the trustee won’t.
- Review limitation dates. Do not assume the stay has stopped the clock on a claim against any other party. Get advice before relying on that.
Realistically, unsecured creditors in many personal bankruptcies receive little or nothing. Before spending further on a claim, weigh the likely recovery honestly.
Other Defendants and Guarantors
The stay protects the bankrupt, not everyone standing nearby. Section 179 says an order of discharge does not release a person who was a partner or co-trustee with the bankrupt, or jointly bound, or who made a joint contract with the bankrupt, or a surety for the bankrupt.
So if you sued a contractor and its owner, or a borrower and a guarantor, the action can usually continue against those not bankrupt. Often this matters most in business lending, where the company files, and the owner remains on a personal guarantee. A co-signer on a loan can likewise expect the lender to turn to them.
The bankruptcy of a corporation raises slightly different questions. A bankrupt company generally does not get a discharge unless it pays its claims in full, but in practice it often just stops operating and has no remaining assets. Its directors may have separate personal exposure in some circumstances, for example for unpaid employee wages or some tax liabilities. That liability is not simply erased by the corporation’s bankruptcy, though it has its own requirements and defences.
Insurance Can Keep a Claim Alive
Where the bankrupt carried liability insurance, the lawsuit may still be worthwhile. A plaintiff in a car accident or slip-and-fall may be chasing the insurance policy far more than the individual. Section 132 of Ontario’s Insurance Act addresses situations where a person insured against liability fails to satisfy a judgment and execution is returned unsatisfied. In those circumstances, a judgment creditor may have a route to recover directly from the insurer, subject to the policy and the Act.
Getting there may still need a lifting of the stay so that liability can be determined. An early look at this can change the whole decision about whether to continue. An insurer may also have a role in the defence.
If the Bankrupt Person Was the Plaintiff
The story flips when the person suing goes bankrupt. Under section 71 of the BIA, the bankrupt’s property passes to the trustee, and that can include the right to sue. A person owed money by a former client, for example, can find that the claim now belongs to the trustee, who may pursue it, settle it, abandon it, or assign it.
There are limits. Courts have treated some claims of a personal nature differently from claims about property or money. A claim for pain and suffering, for example, may remain with the individual, while a claim for lost income may be more complicated. If you are a defendant and learn that your plaintiff has gone bankrupt, ask your lawyer whether that person still has the standing to continue, and whether the trustee must be added or substituted under the rules. If you are a plaintiff considering bankruptcy, get legal advice about your lawsuit before you file.
If You Are the One Going Bankrupt
A person facing a lawsuit often speaks to a trustee when a judgment or garnishment looks near. Filing can stop those collection steps, but it comes with real consequences, including how your assets, credit rating, and income are affected. Tell the trustee about every lawsuit, every creditor, and any past transfers.
Disclose all creditors. Section 178(1)(f) keeps alive a liability for the dividend that an undisclosed creditor would have received, unless that creditor had notice or knowledge of the bankruptcy and failed to act.
Do not move assets to a relative or pay back a favoured person just before filing. Those transactions can be challenged and can complicate your discharge. It’s also wise to send your lawyer and the court file the notice of stay, and to tell the plaintiff’s lawyer, so nobody moves ahead in ignorance. A lawyer can tell you whether a motion is needed.
Where to Go From Here
A notice of bankruptcy does not need a panicked response. It does need a quick and clear-eyed review: what kind of proceeding has been filed, what kind of claim you hold, whether it could survive discharge, and who else may be responsible.
Business owners owed money, including those enforcing a contract, should also review their security and paperwork going forward. A properly registered security interest and a clear personal guarantee are much easier to obtain before a dispute than after an insolvency. If you are in the middle of a lawsuit in Peel and the other side has filed, you can contact the firm with the notice, your pleadings, and any judgment, so a lawyer can assess your position.