Pitfalls of Negative Net Worth

Family debt and section 82

Pitfalls of Negative Net Worth

We frequently see headlines relating to record high levels of Canadian debt. Though these headlines can be somewhat alarmist – debt held by Canadian households equals approximately only one-third of assets – there is no doubt that a segment of Canadian families do owe more than they own.1 When these families separate, a rarely used provision the Family Law Act, SBC 2011, c 25 (“FLA”) becomes especially significant.

Section 81 of the FLA makes both spouses “equally responsible for family debt.” Simple enough. Section 82, though, stipulates that parties cannot arrange their affairs in such a way that “the rights and remedies of... creditors, guarantors or assignees in relation to family debt” are prejudiced. This, for the most part, probably reiterates creditor protections afforded under the Fraudulent Preference Act, RSBC 1966 c 164, and the Fraudulent Conveyance Act, RSBC 1996, c 163, but in conjunction with section 81 it may also have the effect of making spouses, to some extent, joint and severally liable for family debt. I say “probably” and “may,” because despite the prevalence of consumer debt, I did not find a case dealing substantively with prejudice to creditors under
section 82.

Aside from the novelty of section 82, one possible explanation for the dearth of case law is that spouses generally have enough liquidity to arrange their affairs without disturbing creditors’ claims. For example, spouses might selectively pay off their debts with family assets, leaving only the debt they want in each spouse’s name. When a family’s net worth is in the negative, or when spouses are jointly and severally liable to creditors, the issue becomes more thorny.

In this scenario there are no assets to use to pay down the debt, and creditors probably want to maintain any claim(s) against both spouses. Section 82 prevents the parties from arranging their affairs in a way that would prejudice a creditor, and more to the point, any agreement between the spouses wouldn’t bind a third-party creditor anyway. What’s dangerous is that clients might think they are creating finality by virtue of a final deal apportioning family debt, but which, in the same stroke, silently purports to prejudice creditors.

Lawyers have to be careful that they aren’t counselling their clients to breach legislation, including the FLA, the Fraudulent Preference Act, and the Fraudulent Conveyance Act. The implications of having to unwind an improper accord, especially if filed or entered with the court, are daunting. So, what does work when arranging high-debt separations? Getting to know your creditors.

In my experience, creditors are more than willing to forestall their collection efforts if there is a pot of gold at the end of the rainbow (and preferably a series of payments along the way). Whether the spouses are looking toward bankruptcy, debt consolidation, or simply regular payments, the situation is similar to when there are a number of charge-holders on a piece of real estate or personal property – creditors and debtors won’t make certain moves without talking to everyone else involved, and high-debt spouses in family law are wise to follow suit.

From an access-to-justice standpoint, it does seem rather repugnant that these technical and time-consuming issues occur not only in the context of parties who already have no money, but also because they have no money. Notwithstanding, parties and their lawyers need to speak to creditors before making arrangements that might prejudice creditors’ rights. That ostensibly brings both spouses and their banker to the family law bargaining table. And you thought the banks were already too involved.

  1. Canadian key household debt ratio hits record high | 

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