insolvency and bankruptcy act Archives - Ira SmithTrustee & Receiver Inc.

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Insolvency and bankruptcy act introduction

On October 2, 2020, the Supreme Court of Canada (SCC) rendered its decision in Chandos Construction Ltd. v. Deloitte Restructuring Inc., 2020 SCC 25 (Chandos decision). This decision upheld the idea that the anti-deprivation rule is completely valid when it pertains to both personal and business insolvency and bankruptcy act cases.

In this Brandon’s Blog, I describe the Chandos case and what it stands for.

**The definition of the word deprive and the insolvency and bankruptcy act context**

The Merriam-Webster dictionary states the definition of the word deprive is:

1: to take something away from; and
: to withhold something from.

In the Chandos Construction Ltd. (Chandos) insolvency and bankruptcy act case, the SCC was asked to rule on contract clauses that if upheld, would deprive the bankruptcy estate and therefore the unsecured creditors of money that would otherwise be available. This deprivation of funds, which may make total sense as between contracting parties, is not enforceable in bankruptcy.

**The anti-deprivation rule in the Canadian insolvency and bankruptcy act matters**

Neither the Bankruptcy and Insolvency Act (Canada) (BIA) nor the Companies’ Creditors Arrangement Act (CCAA) stops non-defaulting parties to a contract, from relying upon agreement provisions that create an inevitable result when a debtor declares bankruptcy. The common law becomes pertinent in these situations.

Canadian courts still refer to these anti-deprivation provisions as “ipso facto” provisions and also this idea as the fraud upon the bankruptcy law concept. In more current times, this has been described as the anti-deprivation rule.

The SCC has recognized the anti-deprivation rule since the 1890s. However, the contemporary application of this principle in Canadian law greatly originates from an Ontario court decision in 1995 – Canadian Imperial Bank of Commerce v. Bramalea Inc., 1995 CanLII 7262 (ON SC) (Bramalea decision).

This is a decision from the Ontario Court of Justice (General Division). Canadian courts have thought about and decided upon the anti-deprivation rule in many insolvency and bankruptcy act cases since then.

**The Bramalea case and its relevance of insolvency and bankruptcy act matters**

Luckily for me, Ira Smith was the receiver responsible for the file that involved the Bramalea decision. So, I have a bird’s-eye view of that case which started it all leading to the SCC Chandos decision.

In the Bramalea insolvency and bankruptcy act case, a group of companies, including Bramalea Inc. (Bramalea) was in a partnership agreement to develop and operate a shopping mall in Markham, Ontario called Shoppes on Steeles. In 1995, Bramalea was placed into receivership and bankruptcy. Bramalea’s partners included Sears Canada and a private real estate development company.

Amongst the different provisions of the partnership agreement was a specific provision in the contract which considers insolvency. It said that, in case of the insolvency of any of the partners, the non-insolvent partner(s) (given it does not waive the event of insolvency) can buy the interest of the financially troubled partner at the lesser of book value or fair market value.

The paradox of this case was that the large company partners at the time of the drafting of the partnership contract were concerned about what happens if the private property developer one day became insolvent? None of the partners ever believed that it would be that private company that would be the only one that was not insolvent. We all know what happened to Sears Canada!

The moving parties sought to exercise that right by serving a notification to buy the Bramalea passion at book value, approximated to be around $200,000. This was opposed by the receiver and also other stakeholders.

The receiver gave evidence that the fair market price surpassed book value by as much as $2 million to $3 million. The moving parties acknowledged that the fair market value of Bramalea’s stake in the partnership was more than book value. They did not agree with the receiver’s evidence regarding the amount of that difference. They additionally did not submit their own fair market valuation.

**The Bramalea insolvency and bankruptcy act decision**

Based on the evidence, the court took the view that the specific spread between book value and fair market value was not trivial. The court was satisfied that the distinction is greater than marginal, and enough to properly draw the interest of the receiver and the creditors.

The receiver’s position was that there is a higher principle in play and that the concern is not one of hindering the freedom of contract. Rather it was just one of whether or not that part of the partnership contract is void as being contrary to the public interest.

The receiver submitted that while the arrangement might quite possibly stand as between the contracting parties, it is void as against the receiver and also the bankruptcy trustee in the Bramalea insolvency and bankruptcy act proceedings.

The court agreed with the receiver’s position in this insolvency and bankruptcy act case. The court decided that it was clear from the provisions of the partnership agreement itself that the parties contemplated a transfer to one of the partners of the other partner’s partnership interest, only in case of insolvency, at a price less than what could be acquired for that interest on the open market.

The court specified that this stipulation made perfect sense, as between the contracting parties. It made total sense in regards to maintaining their partnership and their respective interests. Nevertheless, the court likewise specified that the clause cannot survive through the scrutiny of the “fraud on the bankruptcy law” principle.

The receiver ended up selling Bramalea’s partnership interest to the other partners for fair market value.

insolvency and bankruptcy act

**The Chandos Alberta court case and the anti-deprivation rule for insolvency and bankruptcy act matters**

Chandos was the general contractor for a condo project contracted with Capital Steel to give $1.3 million worth of steelwork. In the subcontract, Capital Steel agreed that if it became insolvent, Chandos was entitled to all costs arising from the suspension of the contract and it would forfeit 10% of the total subcontract price as an inconvenience fee. Capital Steel performed the majority of its commitments, nevertheless, it filed an assignment in bankruptcy before completing full performance.

As a result, Chandos was forced to finish the contract at an estimated expense of $22,800. Up until that point, Chandos owed Capital Steel $149,618 in outstanding invoices for the job it had performed.

Chandos relied upon the agreement and said that it was qualified to deduct its cost of finishing the job plus 10% of the total contract cost from the amount owing. Given the price of the subcontract, the 10% deduction eliminated Chandos’ balance owing plus an extra amount of $10,511. Chandos declared that gave them a provable claim in the Capital Steel insolvency and bankruptcy act case.

The Trustee’s application to the Alberta Court of Queen’s Bench

On March 6, 2017, the Trustee applied to the Alberta Court of Queen’s Bench seeking advice and directions on whether Chandos was entitled to rely on the provision in the contract or was it void pursuant to the anti-deprivation rule in common-law.

The chambers judge acknowledged that the common law anti-deprivation rule stops parties from contracting out of insolvency and bankruptcy act regulations. The judge stated that if that provision was a liquidating damages provision as opposed to a penalty, it would not violate the rule.

The chambers judge ruled that the condition was an authentic pre-estimate of costs, which imposed liquidated damages and not a penalty. He additionally held that the provision represented a bona fide commercial arrangement that did not have as its predominant objective the deprivation of Capital Steel’s property. Consequently, the chambers judge decided that Chandos can implement the clause against the Trustee.

**Trustee appeals the Chandos insolvency and bankruptcy act decision to the Court of Appeal for Alberta**

The Trustee appealed the Chandos decision to the Court of Appeal for Alberta. The appellate court reviewed the lower court decision in this insolvency and bankruptcy act case and decided that:

The chambers court properly determined the presence and application of the fraud on the bankruptcy law principle in Canada.
In describing the scope of the anti-deprivation rule, however, the chambers judge erred.
The lower court embraced the purpose-based technique set out by the Supreme Court of the United Kingdom
The appropriate technique is to check out the impact of the provision. Its purpose is a different analysis.
Chandos certainly had a genuine commercial interest it was looking to protect.
However, the clause conflicts with the BIA‘s scheme of distribution. The common law anti-deprivation rule revokes the clause and Chandos cannot count on it to defend its claim against the Trustee.

**Chandos appeals to the SCC in this insolvency and bankruptcy act anti-deprivation rule case**

One of the key goals of the insolvency and bankruptcy act law is to make certain there is a fair distribution among creditors. In order to fulfill the objective, the legislation restricts specific contractual stipulations that trigger when one of the parties goes into insolvency proceedings (ipso facto clauses).

As seen in the Bramalea situation, one of these limitations is the anti-deprivation rule. It holds that ipso facto conditions that rob the debtor’s creditors of assets they are qualified to receive in insolvency and bankruptcy act matters are void. This is likewise what the Court of Appeal for Alberta decided. Chandos appealed that decision to the SCC.

The Chandos appeal was heard on January 20, 2020. The SCC split decision was released on October 2, 2020. On the facts of Chandos, the SCC dismissed the Chandos appeal. The SCC refused to promote a contractual stipulation that the subcontractor Capital Steel waive 10 percent of the agreed price if Capital Steel became insolvent or bankrupt.

The SCC majority maintained that the test for application of the contractual provision is effects-based and not purpose-based. The SCC majority confirmed that the anti-deprivation rule stands under Canadian common law and it has not been eliminated in dismissing the appeal in this corporate insolvency and bankruptcy act case.

insolvency and bankruptcy act

Insolvency and bankruptcy act summary

I hope you have enjoyed this insolvency and bankruptcy act Brandon’s Blog. Hopefully, you have better insight now into the fact that a sick insolvent company’s business can be saved by doing a sale of its assets to a healthy organization.

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If you would prefer to listen to an audio version of this insolvency and bankruptcy act Brandon’s Blog, please scroll to the bottom and click on the podcast.

Introduction

The administration of the Canadian insolvency and bankruptcy system and the enforcement of the insolvency and bankruptcy act is delegated to the Office of The Superintendent of Bankruptcy (OSB). The Governor in Council appoints the Superintendent of Bankruptcy (Superintendent) “…to hold office during good behaviour for a term of not more than five years…”. The current Superintendent is Elisabeth Lang.

The OSB is a self-funding federal government agency. It must fund itself from the insolvency process and system in Canada. It earns its revenue mainly from:

The fees charged for the licensing of individual and corporate licensed insolvency trustees (formerly called trustees in bankruptcy) (Trustee).
Filing fees for the registration of all insolvency files in Canada.
The levy is payable out of dividends paid to creditors by a Trustee to help defray the Superintendent’s expenses of supervising the Canadian insolvency system. The levy is mandated by section 147 of the Bankruptcy and Insolvency Act, RSC 1985, c B-3 (BIA).

That is how the government business side of the Canadian insolvency and bankruptcy act system works. The rate of levy is a sliding scale according to Rule 123 of the BIA as follows:

Full administration bankruptcy

Five percent, if the amount of payments is $1,000,000 or less.
5% of the first $1,000,000, plus one and one-quarter per cent of the amount in excess of $1,000,000, if the amount of payments exceeds $1,000,000 but is not more than $2,000,000.
Five percent of the first $1,000,000, one and one-quarter percent of the second $1,000,000, plus one-quarter of one percent of the amount in excess of $2,000,000, if the amount of payments exceeds $2,000,000.

In a proposal, the levy is the same as above, except for distributions over $2 million, there is no further levy collected on the excess.

The rate of levy payable for a streamlined personal bankruptcy, called a summary administration, is:

100 percent, if the amount of payments is $200 or less; or
100 percent of the first $200 plus zero percent of the amount in excess of $200, if the amount of payments exceeds $200.

The challenge to the levy

I want to describe to you the case of Superintendent of Bankruptcy v Business Development Bank of Canada, 2019 MBCA 72 (CanLII). This is an appeal to the Court of Appeal of Manitoba from the ruling of the lower court.

Topsyn Flexible Packaging Ltd. (the insolvent) is a bankrupt company. The Trustee made a payment from the sale of assets to the secured creditor, Business Development Bank of Canada (BDC) on account of its secured debt. The lower court judge on hearing the evidence ruled that the levy was not payable to the Superintendent by the Trustee for the payment made to BDC. The Superintendent appealed that decision.

The Superintendent’s position was that the lower court erred in deciding that the Trustee was not required to hold back the levy payable to the Superintendent from the funds paid to BDC.

History

The insolvent first filed a Notice of Intention To Make a Proposal. During those proceedings, the Court issued various vesting orders approving the insolvent selling its assets. The cash received from the sales was paid over to the Trustee as mandated by the Court Orders. The cash stood in place of the assets and the Trustee held the cash pending the determination as to who was entitled to the money and in what priority.

Ultimately the insolvent could not make a viable Proposal and was deemed to have filed an assignment in bankruptcy.

After falling into bankruptcy, the Trustee paid over the net proceeds from the deals to BDC (as well as Royal Bank of Canada, another secured creditor) (RBC). The Trustee also kept back the levy that should be paid.

The BDC motion

Ultimately, BDC filed motion materials on its application to the Court that the levy in favour of the Superintendent is not payable relative to funds paid to BDC as well as RBC as secured creditors of the insolvent.

The approval and vesting orders likewise ordered the insolvent to pay over the net sale proceeds to the Trustee, to be held pending a decision regarding priority.

The lower court made the following findings in deciding that the levy was not payable:

When it made the repayments to BDC and RBC, the Trustee was acting neither as a representative for BDC or RBC nor as trustee in bankruptcy of the insolvent.
The secured creditors and the Trustee believed that the funds held from the sale of assets from the approval and vesting orders were being kept in escrow for the secured creditors, subject only to determine who had priority for payment as between BDC and RBC.

The appeal court analysis

This lower court decision is just plain wrong. From my perspective, the issue was decided many years ago. The OSB’s position through its Directive No. 10, which has been updated over the years, is quite clear. The OSB directive on this point is its Directive No. 10R.

Although directives are not law, they do outline the OSB’s interpretation and position on BIA issues. This directive states that the levy is payable on all distributions made, with only two exceptions. The exemptions are:

When the Trustee has actually functioned as the agent pr receiver in a separate but related engagement for a secured creditor in selling the assets.
When the Trustee actually redeems, or buys out the security, within the definition of section 128(3) of the BIA.

Neither of those exceptions took place in this case.

The appellate court looked at section 147 of the BIA and Directive No. 10R. The appellate court said that Parliament’s objective is for all secured creditors that get payments from an insolvency proceeding under the BIA pays the levy. The appeallate court said that had Parliament planned that such payments to secured creditors were to be excluded from the application of s. 147, such a provision would have been included in the statute. No such exception exists in the BIA.

The appeal court also went through a very thorough analysis or previous case law. That level of detail is beyond the scope of my Brandon’s Blog. You can read the appeal court decision by clicking here if you like.

The appeal court decision

The appeal court said that the lower court judge made 2 mistakes which led him to discover that the levy is not payable in this situation.

The first mistake was in finding that the net sale proceeds were being held by the Trustee in escrow as opposed to in its role as trustee in bankruptcy.
The second mistake is highlighted by the fact that he made no findings concerning the existence of an escrow contract, its terms, the nature of the relationship produced by it, or exactly how that arrangement might bypass the requirements for the Trustee to deduct the levy and remit it to the OSB.

The appeal court, therefore, allowed the OSB’s appeal and the Trustee will have to remit the levy to the OSB on payments made to BDC and RBC.

There was always a simple fix

The simple fix is really easy. A bankruptcy trustee needs to obtain an independent legal opinion on the validity and enforceability of the security held by creditors claiming to be secured. The Trustee should get that opinion as early on in the bankruptcy administration as possible.

Once the Trustee has the opinion that the security is good, the Trustee can then approach the secured creditor(s) to see if they wish to retain that firm to act on the secured creditor’s behalf either as its agent or as a receiver. That is a separate appointment under the insolvency and bankruptcy act system.

Once appointed separately by the secured creditor, the payment made to the secured creditor by its agent or receiver, does not attract the levy. The secured creditor did not rely on the bankruptcy process to produce the payment to it, so no levy is payable. This has been our standard well-established way of dealing with such a situation forever.

Summary for insolvency and bankruptcy act

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