How Mehrdad's inherited bankruptcy file avoided a debt that survives discharge

The situation

The letter that mattered was not addressed to Mehrdad at all. It was addressed to the lawyer who had been handling his bankruptcy file for four months, a short note from CRA's collections division referencing trust amounts owing from a corporation Mehrdad had wound down the year before. That lawyer forwarded it to our office along with the rest of the file two weeks later, in an email that said only that he was closing his practice and Mehrdad's matter, among others, needed a new lawyer to finish it.

Mehrdad had run a small bakery in Cochrane for six years, incorporated, with two part-time staff during the busy season. Cristian, an administrative assistant who did the bakery's books on the side, had handled payroll for most of that time. When the bakery's lease ended and a planned relocation fell through, the business wound down owing money on several fronts: a supplier, a small equipment loan, and, it turned out, a portion of payroll source deductions withheld from staff paycheques but never remitted to CRA during the final difficult months.

Mehrdad had filed for personal bankruptcy to deal with the accumulated debt, on the advice of the previous lawyer, who had listed CRA as a creditor along with the supplier and the equipment lender, treating all of it as ordinary debt that a bankruptcy discharge would eliminate. The bankruptcy trustee had begun the process. Cristian continued helping Mehrdad sort through paperwork as the file moved forward, an administrative role that turned out to matter later, because Cristian still had the payroll records from the bakery's last year.

CRA's letter, the one forwarded from the outgoing lawyer, used a phrase the previous lawyer's file notes had not flagged clearly: amounts held in trust. Alina, the collections officer who signed the letter, was not threatening anything unusual by CRA's standards, simply confirming the amount owing and asking for a response. But the phrase mattered enormously, because trust amounts are treated differently from ordinary debt in a bankruptcy, and nothing in the file suggested the previous lawyer, or Mehrdad, understood that difference before the assignment into bankruptcy had already begun.

By the time the file reached us, the bankruptcy was underway but not yet complete, which meant there was still a window, a narrow one, to deal with the source deduction debt properly rather than let it ride through a process that would not actually discharge it, and then surface again, unresolved and accruing interest, on the other side of Mehrdad's fresh start.

What the law actually said

Money withheld from an employee's paycheque for income tax, Canada Pension Plan contributions and Employment Insurance premiums is not the employer's money at any point. The law treats it as held in trust for the Crown from the moment it is deducted, whether or not the employer ever actually remits it. That distinction, between money the corporation owes and money the corporation was only ever holding on someone else's behalf, is what separates an ordinary business debt from a source deduction debt, and it is the reason the two are not treated the same way when a business, or the person behind it, becomes insolvent.

A personal bankruptcy is built around the idea of a fresh start: most debts are wiped out once the process is complete, so a person overwhelmed by ordinary debt can move forward without carrying it indefinitely. The Bankruptcy and Insolvency Act carves out a narrow list of exceptions to that fresh start, though, and one of them covers debts arising from a breach of fiduciary duty, including misappropriating property held for someone else. Unremitted source deductions fit that description when the director actually used the withheld money rather than simply losing it to a failing business, and Mehrdad's own payroll records made that easy to establish: the deductions had been taken from staff paycheques and kept in the operating account through the bakery's final months rather than set aside. It is not an automatic feature of every unremitted-deductions debt; a director whose corporation failed before a remittance ever came due, without touching the money, could face a different answer. In Mehrdad's case, though, a bankruptcy that appeared to resolve everything on paper could leave this specific debt standing, untouched, the day after the discharge was granted, unless it was dealt with on its own terms first.

The previous lawyer's file had listed the CRA debt as a single line item among Mehrdad's creditors, without separating the portion attributable to unremitted trust amounts from any ordinary corporate debt CRA might also have been owed. That mattered, because Mehrdad going through with an assignment believing the entire CRA debt would be resolved was heading toward a discharge that would leave him with a real, uncleared debt he had every reason to believe was behind him.

It also mattered because director liability for unremitted source deductions is derivative rather than automatic: CRA has to assess the corporation first and come up empty, a writ of execution returned unsatisfied, or the company bankrupt, in liquidation or dissolved, before it can turn to a director personally, and it has only two years from the date a person stops being a director to do so. A director who took reasonable steps to prevent the failure has a due diligence defence against that assessment. None of those doors were open to Mehrdad. The corporation had already wound down, satisfying CRA's own precondition, the two-year window was still running, and the payroll records Cristian had kept showed Mehrdad signing cheques that drew on the withheld deductions rather than setting them aside, which left no room for a due diligence defence. That personal exposure existed whether or not the corporate bankruptcy, or his own personal one, ever touched it, and it was not going to be resolved by a process that was not built to resolve it.

Understanding this distinction early, before the bankruptcy proceeded further, was the entire difference between a debt that quietly outlives a fresh start and a debt that gets handled properly, on its own terms, before the rest of the file closes around it.

What we did

1. Reviewed the inherited file from the ground up rather than trusting the prior work. We did not assume the previous lawyer's characterization of the CRA debt was correct. We pulled the corporation's payroll records, with Cristian's help, and reconciled what had actually been withheld from staff paycheques against what had been remitted, which showed a clear trust-fund shortfall separate from other amounts CRA might have been owed.
2. Contacted CRA directly to confirm the nature of the debt. We requested a breakdown from Alina's office of exactly what portion of the amount owing was source deductions held in trust versus ordinary corporate tax debt, because the strategy that made sense depended entirely on getting that split right rather than treating the whole figure as one undifferentiated number, and that breakdown became the reference point for every step that followed.
3. Paused the next step in the bankruptcy process to reassess the plan. With the trustee's cooperation, we held off finalizing the assignment until Mehrdad understood that a portion of the CRA debt would not be discharged regardless of what happened, so he was not proceeding under the same mistaken assumption the previous lawyer's file had left him with, and so nothing moved forward on a plan built around an inaccurate picture of what the bankruptcy would actually clear.
4. Confirmed Mehrdad's personal director liability for the trust amount. We reviewed the payroll records and the timeline of the bakery's wind-down to establish precisely which pay periods the unremitted deductions related to, and confirmed Mehrdad, as the director who authorized payroll while the funds sat in the operating account rather than going to CRA, was personally exposed for that portion regardless of the corporation's own fate.
5. Negotiated a separate payment arrangement for the trust debt. Rather than let the source deduction debt sit as an open, interest-accruing liability waiting to resurface after discharge, we arranged a structured payment plan directly with CRA for that specific amount, sized to what Mehrdad could actually pay from ongoing income as a working baker, and kept entirely apart from the personal bankruptcy process so neither the trustee nor the discharge order needed to account for it.
6. Let the personal bankruptcy proceed for the debts it could actually resolve. With the trust-fund portion carved out and separately addressed, we allowed the assignment into bankruptcy to continue for the supplier debt, the equipment loan, and the ordinary, non-trust portion of what CRA was owed, which were the kinds of obligations a discharge was actually designed to eliminate rather than the kind that would simply reappear afterward.
7. Set up a written record for Mehrdad to keep after discharge. We gave Mehrdad a clear summary distinguishing what the bankruptcy discharge had resolved from what the separate payment arrangement was resolving, including the dates and amounts of every payment made, so that months or years later, if CRA correspondence arrived referencing the old corporation, he would have documentation showing the trust debt had already been addressed on its own terms rather than needing to reconstruct the history from memory.

The outcome

Mehrdad's personal bankruptcy proceeded and discharged the debts it was designed to discharge: the supplier balance, the equipment loan, and the ordinary portion of what he owed. The source deduction debt, a little over thirty thousand dollars once interest was included, was handled entirely outside that process, through the payment arrangement negotiated directly with CRA, and did not appear anywhere in the discharge. Because it was addressed before the bankruptcy concluded rather than left to surface afterward, Mehrdad went into his discharge with a full, accurate picture of what was actually behind him and what was not.

This is what prevention looks like in a file like this: not a debt eliminated, because trust-fund debt is not the kind of thing that can be made to disappear, but a debt correctly identified, sized and arranged for before it had the chance to blindside Mehrdad after he believed his financial slate was clean. Had the previous lawyer's characterization gone unchallenged, Mehrdad would likely have completed his bankruptcy believing the entire CRA balance was resolved, only to receive collections correspondence, with interest continuing to accrue, at a point when he had already rebuilt his finances around a fresh start that was not quite complete.

Mehrdad continued making payments on the trust debt under the arranged schedule after his discharge, working as a baker for another shop in Cochrane while Cristian moved into a full administrative role elsewhere. The arrangement did not erase what he owed, but it meant there was no surprise left in the file, and no gap between what he believed was resolved and what actually was. The written record we prepared meant that when a routine CRA notice referencing the old corporation arrived eighteen months later, a notice that would once have caused real alarm, Mehrdad was able to confirm within a day that it referred to an account already accounted for.

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