By Andrew Flynn

The Canadian economy has suffered many shocks in recent decades. The sky-high interest rates of the 1980’s and early 1990s. The dot-com bubble. The financial crisis of 2007-08. In total, there have been six recessions – two consecutive quarters of negative growth – since 1970.

Through it all, the economy has remained resilient and crisis after crisis has been followed by periods of recovery and growth. Canada’s insolvency system, renowned as a model the world over, has played an integral part in helping to keep the economy strong, ensuring that millions of Canadians and Canadian companies needing debt relief have been able to get help.

“We have components of an insolvency system that hits all of the check marks for a high-quality, gold standard system,” says Jean-Daniel Breton, CPA, FCIRP, LIT, senior vice-president at Ernst & Young Inc. in Montréal. “I think it's resilient, it's flexible.”

But we live in extraordinary times – many pillars of the financial sector are being tested as never before. The COVID-19 pandemic disrupted lives, work patterns, and the economy. Supply chains and workforces have yet to recover, leaving business scrambling for employees and parts. Russia’s invasion of the Ukraine, occurring when it did, rattled global stability and sent already skittish markets reeling. This all comes on top of an ongoing shift in industry and business to mitigate the evolving effects of climate change.

Given such a convergence of shocks to the system, what will the year – or years – ahead look like for the insolvency profession?

A ‘perfect storm’ of economic pressures

As 2022 wound down, it was clear that an entirely new economic paradigm was at play. “In contrast with earlier in the COVID-19 pandemic, households have recently faced a perfect storm of economic pressures, with asset values declining amidst turmoil in financial and housing markets, as well as increasing interest rates and persistently high inflation,” Statistics Canada said in October.

“On average, regardless of a household's demographic or economic characteristic, gains in household wealth acquired over the previous year have been erased.”

Canadians are feeling the impact of these factors in the form of inflation – which by the end of 2022 ballooned far above the Bank of Canada’s target rate of 2%. The Consumer Price Index (CPI) rose 6.9%, year-over-year, in October, with gas and mortgage interest costs leading the way. While that was down from June’s 8.1% year-over-year increase, it was still a crucial pain point for Canadians.

To help mitigate runaway price increases, the Bank of Canada used the principal tool in its arsenal to cool price inflation – the overnight rate. After decades of historically low rates, the central bank raised the overnight rate (the rate at which banks lend to each other) by 50 basis points to 4.25%. It was the seventh increase in nine months and the highest rates had been since January 2008.

“The bottom line is … that there’s no pain-free way to excise inflation out of the global economy in 2023,” Avery Shenfeld, Chief Economist of CIBC World Markets Inc., wrote in a late October forecast.

“Europe looks destined for an outright recession, and at best, the U.S. and Canada will hover on the precipice of one. If central banks are wise enough to recognize the lagged impacts of what they’ve already done, they won’t have that many more rate hikes to deliver, but in any scenario where they don’t overshoot the mark, they won’t have room to provide interest rate relief until 2024.”

Rising interest rates are felt in every industry across the county, says Pam Huff, a partner and National Chair of the Restructuring & Insolvency Group at Blake, Cassels & Graydon LLP.

“It applies across all businesses in Canada that are either overleveraged or just have high amounts of debt. All of a sudden, the cost of doing business for a widespread number of industries has increased significantly. We all understand the reason why this is happening – interest rate increases are a pretty blunt instrument to curb inflation, but it seems to be the only real tool that governments have to curb that.”

Household debt remains a big worry for consumers

Interest rates that have remained ultra-low since the credit crisis ended in 2008 – under 2% – have lit a fire under the housing market. With borrowing so cheap, consumers and businesses alike have spent more than a decade amassing relatively cheap debt. As 2022 came to an end, the ratio of household debt stood just above $1.80 for every dollar of household disposable income. The federal government, economists, and the central bank have been warning consumers for years that rising household debt is a real and looming threat to the financial wellbeing of many Canadians.

“The danger of that ratio is that it’s an average,” says André Bolduc, CPA, CA, CIRP, LIT, senior vice-president at BDO Debt Solutions in Ottawa. “In that average, you know, you have Canadians that are doing very well, they may have no mortgage and no debt. But then you've got the other segment of the population, who are much worse than that ratio, possibly double. There are always people who are on the verge of insolvency and with everything that's happening, it's going to push more people towards that edge.”

Bolduc also points out that more than half of Canadians are living paycheque to paycheque as they grapple with debt loads. The September BDO Affordability Index survey found that 54% of Canadians were living paycheque to paycheque, up three percentage points from the same period in 2021. According to the National Payroll Institute, 11% of Canadians are spending more than their paycheque, an all-time high since the institute started gathering statistics 14 years ago.

High household debt can be linked strongly to the red-hot housing market, according to CPA Canada chief economist David-Alexandre Brassard. With base interest rates likely to stay around 4.25 per cent or keep rising well into 2023, “that means Canadians will feel the pinch of higher interest rates, with the raise already totalling more than two per cent in the span of six months,” Brassard wrote in an October analysis.

“Unfortunately, further increases are likely in 2023, so consumers will feel the pressure.”

A rough road ahead for Canadian businesses

It’s no secret to insolvency professionals that the current crisis is much broader than COVID, Huff says, but that doesn’t mean pandemic-related troubles won’t remain at the heart of future insolvency matters.

“COVID was a very pinpointed crisis,” Huff says. “Many companies did very well in COVID because they provided services that were needed. As people had to start working from home, companies or businesses that relied on people being present, such as hospitality and retail, suffered.”

While government stimulus plans, especially for small- and medium-sized enterprises, helped to blunt the COVID shock for many businesses, that has ended. What followed was even more trouble as supply chains already pummeled by a global drop in outputs combined with tighter lending conditions and rising prices.

“Now where we are in this stage of our economic turmoil, is that rising interest rates across the board are going to affect Canadian businesses. And so it is the double-edged sword - you use those interest rates to bring down inflation by bringing down consumer spending. But how do you bring down inflation and provide stimulus at the same time? This is the conundrum for economists.”

“When I connect all those dots, I think that we've got a rough road ahead for Canadian businesses,” Huff says. “All indicators are that, in the absence of government stimulus in this high-rate environment where lenders are presumably not going to be in a mood to simply amend and extend their loan facilities, we're going to see a significant number of insolvency filings across industries in the coming year.”

Looking into the crystal ball

While it’s impossible to gauge with certainty just how big a surge there might be in insolvency filings in the years to come, many insolvency professionals are aware that there is a high probability it will happen.

“It’s always very, very difficult to look into the crystal ball and see how people will react,” Breton says.

“Anybody's guess would be as good as mine in that respect, but I see the potential for uncertainty about the future, which can then result in an increase in insolvency rates – I see that as a possibility.”

Risk and uncertainty translate into some level of economic difficulty, Breton says. But that uncertainty has been on the radar of the insolvency profession for many years, he adds, citing adaptations to climate change as one example. Businesses have long been attempting to alter their practices to meet demand for cleaner types of practices.

“Those are all things that may put more stress on pretty much every sector of the economy as we try, rightly so, to adjust to working towards a more sustainable way of doing things. A lot of insolvency has to do with people's perception of the future. Depending on how people see what tomorrow will be, they might be triggered to file an insolvency earlier or later or not at all.”

No seismic events on the insolvency horizon

Breton believes that while there will be increases in consumer insolvency filings in the years to come, “I don't think that we're going to see seismic events that will tip us over the edge,” such as the 45% spike in insolvencies between 2007 and 2009 following the financial crisis.

Huff believes that there won’t likely be any clarity on the size of a potential uptick on the corporate side until after first-quarter financial results are released.

“I've been through a few of these cycles, and I always find that we are not as busy as you would expect when the market has hit rock bottom,” Huff says.

“When the distress is at its most severe, there always seems to be a bit of a freeze. Nobody wants to act; nobody is sure by filing what their exit is going to be. Nobody is assured that there's going to be either a purchaser or that they're going to be able to get the debtor-in-possession financing that they might need for filing. Just like back in 2007-08, it was when we were coming out of the financial crisis that we were really busy.”

“I think right now we are approaching that connection of all the dots, that apex of international pressures, interest rate adjustments. That is when you drive companies into insolvency. And so, in terms of number of insolvencies, I wouldn't hazard a guess on that – I just feel that there's going to be a very significant uptick next year.”

The difference between what happened during the pandemic and what will happen in 2023 is that the pain will fall on businesses impacted by the amount of debt they carry. “There are many studies out there about the level of debt in Canada, at the consumer level, at the corporate level, and the government level,” Huff says. “If you put a strain on all debt at all those levels, yeah, you've got somewhat of a perfect storm.”

No threat to the system

One thing that insolvency professionals agree on is that there will be no shock to the system that the insolvency regime cannot handle, be it corporate or personal.

“We only have about 1,000 trustees that are handling files, but those trustees can handle a lot of files,” Breton says, noting that there were many gains in efficiency that sprang from the pandemic from video calls with debtors to electronic filing.

“We're changing the way that we're doing things, we're looking after the needs of the stakeholders in a responsible way, but by doing things more efficiently and spreading ourselves amongst a greater number of files by delegating and supervising as opposed to actually doing,” he says. “But we do have a critical mass of people who are capable of handling a lot of files.”

Change is a constant in the insolvency industry, Breton says, and that change occurs relatively slowly. “We do things differently than we used to, that's for sure. There are a lot fewer in-person meetings. There's a lot more that is done electronically and there's more efficiency from that perspective.”

Bolduc believes the system is working well and will continue to work well. “I don't see any major flaws. Yes, we can always be better and there are ongoing processes to make sure that the system stays up to date in terms of regulation or standards.”

“This business is cyclical,” Huff adds. “When it gets busy, we all work very hard. And when it's not so busy, we take a little bit less of a load. But I think we're all ready for – when I say we all, I mean the professional insolvency community generally, the trustees, the lawyers – we’re ready for a busy season.”

For LITs, whose business is to help people out of their distress, the worst that can happen is an increased number of problems to solve, Breton says. “For people who are problem solvers, that's not always a wrong thing or a bad thing. What I would say to, to my colleagues is, when you are looking at your practices do what you have always been doing – do not just look at your practice today but look at your practice tomorrow and the day after, and the day after that. Make sure that there is a sufficient amount of resiliency built into your practice, enough redundancy to be able to absorb the increased workload when it comes and to make sure that your staff is not burned out.”