Liquidation Proceedings in Canada

This article outlines the legislative framework behind and briefly describes the process of a bankruptcy proceeding,[1] the Canadian equivalent of a chapter 7 filing in the U.S. Proposals under the BIA and the Companies’ Creditors Arrangement Act, the Canadian equivalents to a chapter 11 filing in the U.S., will be dealt with in a subsequent article.

In Canada, the principal federal insolvency statute that governs bankruptcy (liquidation) proceedings is the Bankruptcy and Insolvency Act[2] (BIA).[3] Bankruptcy proceedings may be commenced voluntarily or involuntarily. An insolvent company may make a voluntary assignment in bankruptcy if (1) it has unsecured debts of at least CAD$1000; (2) is resident, carries on business or has property in Canada; and (3) satisfies either a cash-flow or balance-sheet test for insolvency. A creditor may apply for a bankruptcy order against a debtor if it can demonstrate that (1) it is owed at least CAD$1000 on an unsecured basis, (2) the debtor satisfies the residency requirements (noted above) and (3) the debtor has committed a specified “act of bankruptcy” within the six-month period before the application. Under the BIA, “acts of bankruptcy” include conduct that demonstrates attempts to defraud, defeat or delay creditors or conduct that demonstrates insolvency such as the debtor ceasing to meet its obligations as they become due. A secured creditor may apply for a bankruptcy order against its debtor, provided that at least CAD$1000 of its claim is unsecured.

If the application is not opposed by the debtor, a bankruptcy order may be obtained 10 days after the service on the debtor of the application. If the application is opposed by the debtor, a bankruptcy order will be made only after a trial at which the allegations set out in the application have been proven by the petitioning creditor on a balance of probabilities. A debtor who has made a voluntary assignment is in the same position as a debtor who has been involuntarily assigned into bankruptcy.

Upon a debtor becoming bankrupt, there is an automatic stay of proceedings against the debtor and its property. Secured creditors are exempt from the stay and, subject to limited exceptions, may exercise their security as they see fit. Furthermore, the debtor ceases to have rights to deal with and dispose of its property. A trustee in bankruptcy is appointed, either by the debtor (voluntary) or by the court (involuntary), and all of the debtor’s assets vest in the trustee (subject to the rights of secured creditors and trust beneficiaries). The trustee is an officer of the court and is required to administer the debtor’s estate, liquidate the debtor’s assets and distribute the proceeds to creditors according to the priority scheme outlined in the BIA. Under the BIA and provincial legislation, the trustee may also attack preferential payments and treatments, as well as undervalue transactions made by the debtor within certain specified periods prior to the bankruptcy.

The trustee’s appointment is confirmed, or the trustee is replaced, by the creditors at the first meeting of creditors. The creditors may also appoint up to five inspectors who instruct the trustee in its administration of the estate.

As a part of its administration of the estate, a trustee may elect to affirm, terminate (disclaim) or assign executory contracts of the debtor (subject to certain exceptions)[4]. If the trustee elects to terminate the contract, the counterparty has a provable claim in bankruptcy for damages. The trustee may assign a contract with court approval. However, certain contracts cannot be assigned, such as post-bankruptcy contracts, certain financial contracts, collective agreements and personal service contracts. The assignment of real property leases is governed by provincial law.

Creditors establish their claims against the bankrupt by filing a proof of claim with the trustee. In general, all debts and liabilities to which the debtor was subject on the date of bankruptcy are “provable claims” and should be included in a proof of claim. Provable claims as of the date of bankruptcy can include debts that are currently due, debts that are due in the future, unliquidated claims and contingent claims. The trustee is required to review the proofs of claim and determine whether to approve the claims in whole or in part. The trustee must value contingent or unliquidated claims. All claims are determined as of the date of bankruptcy.

The proceeds of realization are distributed by the trustee according to the following priority scheme[5] outlined in the BIA, which differs from the distribution scheme applicable in civil matters. Each category of claims must be fully satisfied for proceeds to be available for the next category:

  1. statutory priority claims;
  2. secured claims;
  3. preferred claims;
  4. unsecured claims; and
  5. postponed claims.

1. Statutory Priority Claims

The BIA provides for the following statutory priority claims (in order):

a)     An unpaid supplier has a limited right of repossession over goods delivered by the supplier in the 30 days preceding the bankruptcy;

b)     An unpaid farmer, fisher or aquaculturalist who supplied the debtor with farm products, fish, seafood or aquatic plants has a security interest over all of the inventory of the debtor for claims relating to such products, delivered 15 days prior to the bankruptcy;

c)     The environmental authorities have a security in any environmentally damaged real property (and contiguous property) that requires remediation;

d)     Employees have a limited priority over the current assets of the debtor (as of the date of bankruptcy) for unpaid wages and accrued vacation pay (for the period beginning six months prior to the initial bankruptcy event and ending on the date of bankruptcy) up to a maximum of $2,000 per employee[6] (the “wage claim”); and

e)     Claims relating to unpaid pension contributions in respect of prescribed pension plans are secured by a charge over all of the assets of the debtor (the “pension claim”).

2. Secured Claims

Secured creditors are generally free to enforce their claims outside of the bankruptcy process to the extent of the realizable value of their security (subject to the rights of creditors with a statutory priority). In cases where the realizable value of the secured creditor’s collateral is less than the debt owed, the deficiency is an unsecured claim in bankruptcy. The priority amongst secured creditors is determined by federal and provincial law.

3. Preferred Claims

Preferred claims include costs of administration, limited landlord claims for unpaid or accelerated rent, certain municipal taxes and others in the amounts specified under the BIA.

4. Unsecured Claims

Any remaining balance is distributed to the unsecured creditors on a pro rata basis.

5. Postponed Claims

Postponed creditors include non-arm’s-length creditors, profit-sharing lenders and holders of equity claims.

Following distribution of the proceeds of realization, the trustee applies to the court for its discharge.

 

The bankrupt corporation itself cannot obtain a discharge unless all of its creditors are paid in full. In practice, this means that most corporations are effectively wound up after a bankruptcy proceeding. The timeline of a bankruptcy proceeding will depend on the complexity of the bankruptcy and whether cross-border issues are involved. On average, a corporate bankruptcy takes from a year to 18 months to complete.

 

[1] For the purposes of this article, the BIA does not distinguish between individual and corporate debtors. The discharge regime applicable to individuals, the debts that survive discharge, and certain other matters specific to the administration of an individual estate are beyond the scope of this article.

[2] Bankruptcy and Insolvency Act, RSC 1985, c B-3.

[3] The liquidation of certain excluded entities such as banks, trust companies, railways and insurance companies is governed by the Winding-up and Restructuring Act and other specialized statutes.

[4] Note that, at least in the province of Quebec, clauses that provide for the automatic termination of a contract upon a party’s bankruptcy are enforceable.

[5] Trust property, including property that is deemed to be held in trust under specific legislation, is not available for distribution.

[6] Travelling salespersons have an additional claim of CAD$1,000 for disbursements.

 

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