Under the Bankruptcy and Insolvency Act (BIA) in Canada, paying back family members before filing for bankruptcy is considered a “preference payment.” A Licensed Insolvency Trustee (LIT) can legally reverse these payments up to 12 months prior to filing, forcing your relatives to return the money.
When financial troubles hit, it is a natural instinct to want to protect the people you love. Many Canadians choose to repay loans to parents, siblings, or friends before dealing with credit card companies or the Canada Revenue Agency (CRA). However, doing this right before filing for bankruptcy or a Consumer Proposal can create serious legal trouble for the very people you are trying to help. In Canada, bankruptcy laws are designed to treat all unsecured creditors equally.
If you pay back a family member while ignoring other debts, the law sees this as giving an unfair preference. This is heavily regulated across all provinces, from British Columbia to Nova Scotia, under federal insolvency laws. 🔍 If you are unsure how to handle debts owed to loved ones, reaching out to a Licensed Insolvency Trustee or a debt lawyer from our directory is a smart first step.
Understanding Preference Payments in Canada
The concept of a preference payment is straightforward but strict. Section 95 of the federal Bankruptcy and Insolvency Act (BIA) states that you cannot pick and choose who gets paid when you are insolvent. If you pay a creditor (including a family member) within a specific timeframe before declaring bankruptcy, it can be flagged by your LIT.
For regular creditors (like banks or credit card companies), the “look-back” period is typically three months. However, for people related to you by blood, marriage, or adoption-legally referred to as individuals “not at arm’s length”-the look-back period extends to a full 12 months. 📅 In cases where the payment was made with the clear intent to defraud other creditors, courts can investigate payments made up to five years prior.
Step-by-Step: How Trustees Handle Family Preference Payments
Whether you are filing in Toronto, Calgary, or Vancouver, the process your Licensed Insolvency Trustee must follow remains federally mandated. Here is what you and your family can expect if a preference payment is discovered.
Step 1: The Pre-Filing Debt Assessment
Before you officially file, you must complete an application and disclose all your financial transactions to your LIT. You will be asked directly if you have repaid, gifted, or transferred money or assets to any relatives in the past year. Honesty is crucial here, as hiding this information is a serious offence under the BIA.
Step 2: The Look-Back Investigation
Once your bankruptcy begins, the LIT reviews your bank statements, cancelled cheques, and e-transfers. 📊 If they spot a $5,000 e-transfer to your sister six months before filing, they are legally obligated to investigate it as a potential preference payment.
Step 3: The Demand Letter to Your Family Member
If the payment is deemed a preference, the LIT will send a formal demand letter to your family member. This letter will explain that the money received was part of an insolvent estate and must be returned to the Trustee so it can be divided fairly among all your creditors, including the CRA and credit card companies.
Step 4: Repayment or Legal Action
Your family member will be given a deadline to return the funds. If they refuse or cannot pay, the LIT has the authority to take them to court. 🀄 To avoid this stressful scenario for your relative, many bankrupts choose to pay the equivalent amount into their bankruptcy estate themselves, keeping their family out of the crossfire.
How Much Can This Cost You?
Failing to understand preference payments can be expensive for everyone involved. Here is a breakdown of potential costs in Canadian dollars (CAD) as of 2026:
- Returned Funds: Your relative must pay back 100% of the preference amount (e.g., if you paid them $10,000, they owe $10,000 to the Trustee).
- Extended Bankruptcy Penalty: If you try to hide the payment, your discharge could be opposed, meaning you remain in bankruptcy longer and must continue making surplus income payments.
- Legal Fees: If the LIT has to sue your family member, court costs and lawyer fees will reduce the overall pool of money, and your relative may need to hire their own defence lawyer.
How Long Does the Investigation Take?
The review of your financial history happens immediately when you file. A standard first-time bankruptcy in Canada takes 9 to 21 months, depending on your surplus income. However, if a preference payment is contested in court, the discharge of your bankruptcy could be delayed for several years until the matter is fully resolved.
Comparing Arm’s Length vs. Non-Arm’s Length
| Creditor Type | Examples | Standard Look-Back Period | Why It Matters |
|---|---|---|---|
| Arm’s Length | Banks, payday lenders, landlords | 3 Months | Regular commercial relationships with no personal bias. |
| Non-Arm’s Length | Parents, siblings, spouses, adult children | 12 Months | High risk of bias; laws assume you favoured them unfairly. |
To navigate these complex rules without risking your family’s financial security, consider consulting a local legal professional or LIT from our directory before making any major debt repayments.
Frequently Asked Questions (FAQ)
What happens if I don’t tell my Trustee about the payment?
Hiding a preference payment is a serious offence under the BIA. It can lead to your bankruptcy discharge being denied, or in severe cases, criminal charges for bankruptcy fraud.
Can I pay my family back after my bankruptcy is discharged?
Yes. Once you are officially discharged from bankruptcy and released from your legal debts, you can voluntarily choose to give money to your family members out of a moral obligation.
Does a Consumer Proposal stop preference payment investigations?
In a Consumer Proposal, you keep your assets. However, you must offer your creditors at least as much as they would receive in a bankruptcy. If there is a large preference payment, your Proposal must be increased to cover that amount, or the creditors will vote against it.
Can my family member simply refuse to pay the Trustee?
No. The Trustee has the legal right to sue them in provincial court (e.g., the Superior Court of Justice in Ontario) to recover the funds. It is a legally enforceable debt.
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