Canadian bankruptcy law reform: A selective research agenda · applies if the debtor is a company and there are claims of at least Can$5 million outstanding against it. The CCAA overlaps

Canadian bankruptcy law reform: A selective research agenda Anthony Duggan·

This article was written for an Insolvency Law Teaching and Research Workshop run by the University of Southern Queensland in Brisbane earlier this year. It gives an account of the commercial bankruptcy law reform process in Canada with particular reference to three issues: (1) the disclaimer, assignment and assumption of executory contracts (including collective bargaining agreements) i.n insolvency proceedings; (2) the review of pre-bankruptcy transactions (transfers at under value and preferences); and (3) the subordination of claims (subordination agreements, subordination of equity claims and equitable subordination). The discussion of each issue starts with a short account of the current Canadian law, before moving on to deal with the reform proposals and the debate surrounding them. In line with the nature of the workshop, the article incorporates questions for further research, some of which are already under active consideration In Canada. Insolvency Jaw reform is also on the agenda in Australia and New Zealand. Local law reformers may find there are lessons to learn from the Canadian experience. Likewise, there are lessons Canada may learn from Jaw reform experiences in Australia and New Zealand and elsewhere.

INTRODUCTION The two main bankruptcy statutes in Canada are the Bankruptcy and Insolvency Act RSC 1985 c B-3 (BIA) and the Companies' Creditors Arrangements Act RSC 1985 c C-36 (CCAA). The BIA governs consumer and commercial bankruptcies and reorganisations. The CCAA is a reorganisation statute. It applies if the debtor is a company and there are claims of at least Can$5 million outstanding against it. The CCAA overlaps with the BlA commercial reorganisation provisions and, where both statutes apply, the debtor has a choice of regime. The d ifference between the two regimes is that the debtor initiates the BIA reorganisation procedure by making a proposal to creditors. Creditors meet and vote on the proposal subject to rules that are spelled out in the statute itself. The main function of the court is to approve the proposal once creditors have voted on it. By contrast, the debtor initiates the CCAA reorganisation procedure by making an application to the court. The debtor puts together a plan for submission to creditors subject to deadlines the court imposes on a case-by-case basis. Creditors meet and vote on the plan subject to the court's direction and the court at the end of the process decides whether or not to approve the plan. In short, the BIA commercial reorganisations regime is a statutedriven one, while the CCAA regime is a court-driven one. In practice, most large corporate reorganisations take place under the CCAA. Large companies prefer the greater flexibility the CCAA allows. Smaller companies prefer the BIA regime because it is cheaper and more predictable in its operation.

The last substantial round of bankruptcy law amendments was in 1997. The 1997 amending statute required the federal government to report to Parliament on the operation of the BIA and CCAA within five years. To meet this requirement, the government in October 2002 gave the Standing Senate Committee on Banking, Trade and Commerce a reference 'to examine and report on the two statutes. The committee submitted its report in November 2003.1 The Report of the Senate Standing Committee (SSC) makes 53 recommendations for reform. Nineteen of its recommendations

• Iacobucci Chair, Faculty of Law, University of Toronto. 1 Standing Senate Committee on Banking, Trade and Commerce, Debtors and Creditors Sharing the Burden: A Review of the Bankruptcy and htsolvency Act and the Companies' Creditors Arrangements Act (November 2003) (the SSC Report).

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relate to consumer insolvency. The other 34 recommendations relate to conunercial insolvency. The commercial insolvency recommendations deal with the following matters, among others: the creation of a super priority for wage-earners up to $2,000; the enactment of provisions to facilitate debtor-inpossession financing in the context of BIA and CCAA reorganisations; adoption of the UNCITRAL Model Law on cross-border insolvency; an overhaul of the current law governing transfers at undervalue and preferences; the enactment of comprehensive provisions governing executory contracts in bankruptcy and reorganisation proceedings; and the extension of the priority rules that apply in formal bankruptcy proceedings to BIA and CCAA reorganisations.

The two main insolvency professional organizations in Canada are the Insolvency Institute of Canada (IIC) and the Canadian Association of Insolvency and Restructuring Professionals (CAIRP). In March 2002, an IIC and CAIRP Joint Task Force made a submission in the form of a refort to the federal government detailing 86 reconunendations for commercial insolvency Jaw refonn. The SSC took account of the JTF Report in formulating its own reconunendations but it did not adopt all the JTF's recommendations. There are differences of both substance and detail between the JTF Report and the SSC Report on certain issues.

Some SSC and JTF recommendations, if adopted, would move Canadian law closer to the United States Bankruptcy Code (US Code).3 Others would maintain, or even accentuate, current differences. Given Canada's physical proximity to the United States, the economic ties between the two countries and the increasing number of cross-border insolvencies, harmonisation of laws is an important consideration.

The SSC Report and the JTF Report demonstrate qualified support for greater harmonisation, but not at the expense of Canadian autonomy in relation to matters of policy, drafting and the like. The Canadian Government has not yet announced the reforms it plans to implement. In the meantime, there are a raft of research issues arising out of: ( 1) the SSC and JTF recommendations and the differences between them; and (2) the differences between the SSC and JTF recommendations and the US Code. The following discussion picks three topics by way of illustration: executory contracts; review of pre-bankruptcy transactions; and subordination of claims.

Insolvency law reform is also on the agenda in Australia and New Zealand. In Australia, the Parliamentary Secretary to the Treasurer announced on 22 March 2005 that the government would be developing an integrated set of proposals to improve the operation of the insolvency laws.4 In New Zealand, the Mini stry of Economic Development has been conducting a review of the insolvency laws since May 1999. This resulted in the April 2004 release of a draft Insolvency Law Reform Bill (NZ). The Bill is expected to be introduced into Parliament during 2005.5 Given these local initiatives, an account of what is happening in Canada seems particularly appropriate.

EXECUTORY CONTRACTS Introduction These days, executory contracts issues arise most frequently in the context of business reorganisations. However, the governing principles were developed in the context of formal bankruptcy proceedings. On entering into office, the debtor's trustee in bankruptcy has to decide how to handle the estate's assets and whether to try selling the business as a going concern. A debtor putting together a reorganisation plan will face similar decisions. The debtor's assets will often include executory contracts, for example: contracts for the completion of orders; real or personal property lease agreements; and intellectual property licence agreements. If a contract is beneficial to the estate, the trustee (bankruptcy) or debtor in possession (reorganisation) may want to keep it on

2 Insolvency Institute of Can11da and Canadian Association of Insolvency and Restructuring Professionals, Report (March 2002) (the JTF Report). 1 II USC (United States Code, Ch II). 4 Media Release: "Pearce Announces Integrated Approach to Insolvency Law Refonn": see http://parlsec.treasurer.gov.au/cjp/ content/pressreleases/2005/009.asp viewed 24 May 2005. ' Ministry of Economic Development, Update: Insolvency Law Review (28 October 2004): see http://www.med.govt.nz/ri/ insolvency/revjew/update/index.html viewed 24 May 2005.

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Canadian bankruptcy law reform: A selective research agenda

foot or assign it for value to a third party. Questions arise as to the availability of these options if the contract contains a bankruptcy termination provision which the counterparty wants to enforce or if the contract prohibits assignment. If a contract is not beneficial to the estate, the trustee or debtor in possession may want to disclaim it, remitting the counterparty to a proof of claim for damages in the deh.tor's bankruptcy or reorganisation. Questions arise as to the availability of this option if the counterparty is ready and willing to keep the contract on foot. Canada lacks a comprehensive set of provisions dealing with executory contracts issues. There are provisions covering the adoption, assignment and repudiation of commercial landlord and tenant agreements, but these are limited to the case where the debtor is tenant and they onJy apply in formal bankruptcy proceedings.6 The law governing other types of contract is an amalgam of common law and isolated statutory provisions.

United States Code, s 365 contains a comprehensive set of rules governing executory contracts and leases. It is not limited to particular kinds of contracts, though it does lay down special rules for certain cases. Nor is it limited to fo rmal bankruptcies (Ch 7 proceedings). It applies to all kinds of bankruptcy proceedings including Ch 11 proceedings (commercial reorganisations). The main elements of s 365 are as follows:

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a trustee may assume, assign or reject any executory contract or lease subject to the court's approval;

if the debtor is in default, the trustee may not assume the contract unless the trustee cures the default, compensates the counterparty for any loss resulting from the debtor's default and provides adequate assurance of future performance;

a trustee may assign an executory contract notwithstanding any provision that prohibits or restricts assignment;

the trustee may assign an executory contract only if the trustee assumes the contract in accordance with the rules governing assumption and adequate assurance of futu re performance by the assignee is provided;

the trustee may not assume or assign an executory contract if applicable State law excuses the counterparty from dealing with a person other than the debtor and the counterparty does not consent to the assumption or assignment;

the counterparty has no right to terminate an executory contract solely on the ground of the debtor's insolvency or financial condition, notwithstanding any provision in the agreement to the contrary but subject to any applicable State law that excuses the counterparty from deali ng with the trustee;

as a general rule, a court-approved rejection by the trustee becomes a breach of contract and the counterparty can claim in the debtor's bankruptcy for contract damages. However, the counterparty cannot normally sue for specific perlormance or the like; and

• the trustee must make an all or nothing choice between assumption and rejection. The trustee cannot assume part of a non-severable contract and reject the rest. Nor does the trustee have any unilateral right of variation.

Disclaimer United States Code, s 365 does not specify the standard the court is to apply in deciding whether or not to approve the trustee's decision to reject a contract. This means the courts have had to develop their own rules. There are three different tests: the "burdensome to the estate" test; the "balancing the equities" test; and the "business judgment" test. Under the burdensome to the estate test, the court will allow a trustee to reject a contract only if the trustee can show that performance of the contract would be burdensome to the estate. Under the balancing the equities test, the courts weigh the benefits to the estate if the contract is rejected against the costs to the counterparty. Under the

6 See eg Commercial Tenancies Act RSO c L7, ss 38 and 39, applicable in bankruptcy proceedings by virtue of BIA, s 146. See also BIA, ss 65.1 and 65.2, dealing with the assumption and disclaimer of commercial lease agreements in BIA reorganisation proceedings.

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business judgment test, the courts defer to the trustee's business judgment as to whether rejection would be beneficial to the estate. Most courts apply the business judgment test.

Assume that the debtor has a contract to sell potatoes to the counterparty for $100. The debtor goes into bankruptcy before completion. In the meantime, the price of potatoes has risen. The trustee could sell the potatoes to a third party for $150. Can the trustee reject the contract with the counterparty on the ground that it would be more profitable for the estate to sell the potatoes to the third party? Under the burdensome to the estate test, the answer is probably no - since it is no more burdensome to sell the potatoes to the counterparty than it is to sell them to the third party. Under the balancing the equities test, the answer is maybe. More information is needed to quantify the benefit to the estate and the cost to the third party. Under the business judgment test, the answer is probably yes. Reneging on the counterparty in favour of the third party nets the estate an additional $50. What kinds of case will the business judgment test weed out? According to Tabb,7 in most cases, the only reason the trustee's decision to reject would not be approved is if the trustee made a mistake, for example about the legal effects of rejection. The trustee may believe that rejection will bring certain benefits to the estate. If that is not the case, the reason for rejection disappears and the court will not give its approval.

The SSC's Recommendation 30 proposes amendments to the BIA and CCAA to permit disclaimer of executory contracts provided a number of conditions are met, including a requirement that the debtor establish serious hardship without the disclaimer. Adoption of this recommendation would move Canadian Jaw closer to US Code, s 365. An important point of departure is that, in the United States, most courts apply the business j udgment test in determining whether to approve the rejection (disclaimer) of an executory contract. Under the business judgment test, the court defers to the trustee's (debtor-in-possession's) business judgment as to whether rejection would be beneficial to the estate. The business judgment test would normally allow the trustee (debtor) to reject a contract wjth a view to substituting a more profitable contract with a third party. The "serious hardship" test the SSC proposes probably would not. The SSC's test is closer to the United States burdensome to the estate test than it is to the business judgment test.

The JTF's Recommendation 26 proposes that jn CCAA proceedings, BIA proposals and BIA liquidation proceedings (formal bankruptcy), the debtor (with the prior written consent of the monitor or trustee in the case of reorganisation proceedings) or the bankruptcy trustee (in the case of formal bankruptcy proceedings) should have the power to disclaim executory contracts. In contrast to the SSC and US Code, s 365, the JTF's recommendation does not stipulate for court approval in every case. In the JTF's view, the SSC's serious hardship test is unworkable because, "at its core, the decision to disclaim involves the exercise of business judgment concerninf a business plan and futu re prospects that are not by their nature subject to meaningful legal proof'. A better solution, the JTF goes on to say, would be to give the counterparty a right to require an explanation of the business reasons for the decision to disclaim. That way, "in an egregious case there would be some scope for a review".9 The JTF's position implies a view that it is not cost-effective to have the courts secondguess the business judgment behind every decision to disclaim. Instead, the courts should become involved only in exceptional cases where the counterparty can show grounds for calling the decision into question.

United States Code, s 365 represents a trade-off between the jnterests of the debtor's estate in having the contract set aside and the counterparty's interest in having the contract petformed. Speaking more generally, if contracts could be set aside in bankruptcy as a matter of course, contract policy (pacta sunt servanda) might be unacceptably compromised. On the other hand, jf contracts could not be set aside in bankruptcy at all, bankruptcy policy (maximisation of the estate's value) might be undermjned. The trade-off the JTF recommendations make between these competing

7 Tabb CJ. The Law of Bankruptcy (Foundation Press, Westbury, 1997) p 588. See generally Westbroolc JL. " A Functional Analysis of Executory Contracts" (1989) 74 Minnesota Law Review 227. • Joint Task Force, Draft Supplemental Reform Proposals (16 September 2004) p 7 (ITF Draft Supplemental Reform Proposals). 9 Seen 8.

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interests is not necessarily the same as the trade-off the United States courts make in the application of US Code, s 365. Questions for research include the following:

1. What are the relative costs and benefits of the various tests the United States courts apply in relation to rejection approvals?

2, In light of the answer to (1 ), is the JTF's preference for the business judgment test warranted?

3. How corrunonly do United States courts applying the business judgment test disapprove disclaimers and what are the typical grounds?

4. In light of the answer to (3), is the US Code, s 365 court approval requirement cost-effective in the United States itself and would it be cost-effective if translated to Canada?

5. Does the JTF's proposed alternative rule (giving the counterparty a right to demand an explanation for the disclaimer) sufficiently protect the counterparty having regard to the competing interests outlined above?

Assignment The SSC's Recorrunendation 31 recommends amendment of the BIA and CCAA to permit the assignment of executory contracts, subject to court approval and provided that: (a) the proposed assignee is at least as creditworthy as the debtor was at the time the contract was entered into; and (b) the proposed assignee agrees to compensate the counterparty to the contract for any loss resulting from the debtor's default. The JTF recommends a right of assignment, subject to prohibition by the court if the proposed assignee does not meet lawful criteria reasonably applied by the counterparty before entering into similar agreements (for example, franchise agreements) or the proposed assignee is less creditworthy than the debtor was at the time the contract was entered into. 10

Under the SSC's recorrunendation, all assignments would require court approval and the onus would be on the trustee or debtor to apply. This is similar to US Code, s 365. By contrast, under the JTF's recorrunendations, an assignment would be valid without court approval and the onus would be on the contract counterparty to apply for a prohibition order. The difference between the two approaches may have costs implications. There may be other implications as well. Questions for research include the following:

l. What are the relative costs and benefits of the competing rules?

2. Are there any material differences between Canada and the United States which might affect the cost-benefit assessment for Canada?

Assumption United States Code, s 365 gives the trustee or debtor the right to assume an executory contract, subject to court approval and the various other conditions outlined above. The right to assume is relevant in the case where the trustee or debtor wants to keep a valuable contract on foot, but the contract contains a termination clause which the counterparty is threatening to enforce. The SSC Report does not specifically recommend a right to assume, but a right to assume must be implicit in its recommendations governing assignment, because otherwise the right to assign would be illusory. 11

According to the JTF, there should be a provision specifying that an executory contract is not subject to termination by reason of the debtor's insolvency (certain financial contracts excepted). 12 Questions for research include the following:

1. Is the JTF's recorrunendation sufficient from the trustee/debtor's perspective, or should the legislation provide for a full-blown right to assume, along the lines of US Code, s 365?

2. Is the JTF's recorrunendation sufficient from the counterparty's perspective, or should the right to assume be subject to the kinds of conditions US Code, s 365 imposes (cure, compensation and adequate assurance of future performance)?

10 See Senate Standing Committee on Banking, Trade and Commerce, n I, Recommendations 29-32. 11 Joint Task Force, n 8, Commenlary on Recommendation 30. 12 See n II; see also Senate Standing Committee on Banking, Trade and Commerce, n I , Recommendation 33.


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3. Should the right to assume be subject to court approval (on application by the trustee/debtor) or disapproval (on application by the counterparty) and what are the relative costs and benefits of the two approaches?

Collective bargaining agreements The SSC Report recommends special rules for the disclaimer of collective bargaining agreements. It says that where a collective bargaining agreement is being disclaimed, the debtor should have the burden of establishing that post-filing negotiations have been carried on in good faith for relief of too· onerous aspects of the agreement and should establish in court that disclaimer is necessary for a viable restructuring. The JTF has proposed that, in order to implement the SSC's recommendation, a provision along the lines of US Code, s 1113 should be enacted in Canada. 13

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The main features of US Code, s 11 13 are as follows:

After filing a petition, and before filing an application seeking rejection of a collective bargaining agreement, the debtor in possession or trustee must make a proposal to union representatives based on the "the most complete and reliable information available at the tjme of such proposal" which provides for such modifications as are "necessary to permit the reorganisation of the debtor" and assures that all creditors and affected parties are treated "fairly and equitably". The debtor in possession or trustee must also provide the union representatives with "such relevant information as is necessary to evaluate the proposal".

The debtor in possession or trustee must meet with the union representatives "to confer in good faith" in attempting to reach mutually satisfactory modifications of the agreement.

The court may approve an application for rejection only if it finds that the debtor in possession or trustee has dealt with the union representatives as the section requires, the union representatives have refused to accept the proposal "without good cause" and the "balance of the equities" "clearly" favours rejection.

Upon the filing of an application for rejection, the court must schedule a hearing to be held no later than 14 days afterwards. All interested parties may appear and be heard. Adequate notice of the hearing must be provided. The court may extend the time for commencement of the hearing for up to seven days where the circumstances of the case and the interests of justice require or for additional periods to which the parties agree. The court must rule on the application within 30 days after the date of commencement of the hearing. In the interests of justice, the court may extend this time for such additional period as the parties agree to. If the court does not rule on the application within the required time, the debtor in possession or trustee may terminate or alter the agreement pending the ruling.

• The court may make protective orders to prevent disclosure of information provided to the union representatives "where such disclosure could compromise the position of the debtor with respect to its competitors".

• The debtor in possession or trustee cannot unilaterally terminate or alter a collective bargaining agreement other than in accordance with s 1113. The court may make an order authorising interim changes to a collective bargaining agreement pending determination of the rejection application. A hearing is required and the court must be satisfied that the order is "essential to the continuation of the debtor's business" or necessary "to avoid irreparable damage to the estate". Key unions oppose the SSC and JTF recommendations. For example, a United Steelworkers

Union policy document recommends amending the CCAA to make it clear that:

11 Joint Task Force, n 8, Recommendation S l l. See also Syndical national de l'amiante d'Asbestos Inc v Jeffrey Mine Inc (2003) 40 CBR (4th) 95, where the Quebec Court of Appeal held that the monitor in CCAA proceedings had no power toreengage workers on terms other than those provided for in the governing collective bargaining agreements or in amendments to the agreements negotiated with the appropriate union. The court also doubted the constitutionality of judicial powers under the CCAA to override provincial labour relations law. For criticism of the decision, see Ziegel JS, Duggan AJ and Telfer TGW. Canadian Bankruptcy and Insolvency Law: Cases, Text and Materials (Emond Montgomery Publications Ltd, Toronto, 2003) pp 505-506.

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• "courts do not have the right to :\mend collective agreements; • courts do not have the right to permit employers to suspend pension contributions". 14

The union's position is that "employee and union interests in connection with CCAA situations are disti nct from the interests of other creditors and stakeholders in the process". 15 The Quebec Court of Appeal's decision in the Jeffrey Mine case endorses this viewpoint. 16 Questions for research include the following: l. How well does US Code, s 1113 work in practice and are all stakeholders satisfied with its

operation? 2. Does US Code, s 1113 strike the right balance between bankruptcy policy and labour policy so

far as Canada is concerned? 17

3. What provision, if any, do other countries make for the disclaimer of collective bargaining agreements in bankruptcy and how do these provisions compare with US Code, s 1113?18

United States Code, s 1114 is a related provision. It sets out special rules for the modification of retirees' benefits payable under a plan maintained or established by the debtor. Neither the SSC nor the JTF makes any specific recommendation in relation to retiree benefits. Commentators have critic ised United States Code, s I 114, arguing that the protection it gives retirees is largely ill usory'9

Questions for research include the following: I. Are these criticisms valid and how well does US Code, s I J 14 actually work? 2. Should Canada adopt a provision along the lines of US Code, s 111 4? 3. If not, what alternative rule might Canada adopt?20

REVIEW OF PRE-BANKRUPTCY TRANSACTIONS Introduction There are currently two separate but related sets of provisions in Canada dealing with the review of pre-bankruptcy transactions: • The provisions governing gifts and transfers at undervalue: BIA, s 91 (settlements), s JOO

(reviewable transactions) and s 10 I (share redemptions and the like) supplemented by provincial laws governing fraudulent conveyances.

• The provisions governing fraudulent preferences: BJA, ss 95 and 96 supplemented by provincial laws governing assignments and preferences.

1' Unfair, Unc/~ar and Umvorkable: Why Working People Need Changes in Canada 'J Bankmp1cy Laws (Policy Documenl)

(October 1994) p 6. The policy document can be viewed on the union's website at www.uswa.ca/program/content/1708.php. uSee n 14. 16 Sec n 13. 17 Compare with n 14. 18 These questions are comprehensively addressed in a recent report commissioned by Industry Canada: Sarra J. Proposed Model of a F~derallnsolvency Co/lecrive Bargaining Process: Final Report 10 /ndus1ry Canada (5 March 2005. unpublished). The report's main recommendations are as follows: ( 1) the BIA and CCAA should expressly state that a collective bargaining agreement remains in force following the commencement of reorganisation proceedings unless the court d1rects otherwise; (2) disclaimer or amendment of a collective bargaining agreement should be allowed only if it is essential for a successful reorganisation and subject to the outcome of negotiations between the parties; (3) the legislation should provide for voluntary and mandatory insolvency collective bargaining processes; (4) the aim of the voluntary process would be 10 facilitllte a voluntary agreement between the pa11ies and there would be provision for 1he appointment of a judicial mediator/arbitrator al I he parties' request; (5) the mandatory process would come into play, if the voluntary process broke down. upon application by either party for the appointment of a judicial mediator/arbitrator. 1q See eg Tabb, n 7, pp 598-602 and references there cited. ~ Ontario provides limited protection via the Ontario Pension Benefits Guarantee Fund to pension plan members in cases where a pension is under-funded on closure: see Pe11sio11 Benefits Acl RSO c P8, ss 82-86. There is no corresponding provision in the other Provmces. See Davis RB. "Doomed to Repeat History? Retiree Benefits and the Refonn of Canada's Insolvency Laws" in A11nual Review of Insolvency Law- 2004 (Cars well-Thompson. Toronto, 2005) p 197, arguing for the adoption in Canada of as 1114·type provision.

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Gifts and transfers at undervalue Sections 91, 100 and 101 of the BIA are all aspects of fraudulent conveyances law. The origins of fraudulent conveyances law lie in the Statute of Elizabeth (the Statute of Fraudulent Conveyances 1571). The Statute of Elizabeth was received into Canadian provincial law at the time of settlement and it still applies in most parts of Canada. Four Provinces (British Columbia, Manitoba, Newfoundland and Ontario) have enacted fraudulent conveyances laws. It is not settled whether the Statute of Elizabeth still applies in these provinces.21 However, the question may not matter because the fraudulent conveyances statutes are in substance the same as the Statute of Elizabeth. The provincial assignments and preferences laws (in all Provinces except Manitoba, Newfoundland and the Northwest Territories) also contain fraudulent conveyances provisions, but these apply only if the debtor is insolvent or near insolvency at the date of the transaction. Neither the Statute of Elizabeth nor the fraudulent conveyances laws are limited to cases of insolvency.

Section 91 of the BIA deals with settlements. It says that a settlement of property made within one year, or in some cases five years, before the settlor became bankrupt is void against the trustee. A settlement is a kind of gift. Courts have held that the term "settlement" implies an intention on the part of the debtor that the transferred property be retained for the benefit of the recipient in a fo rm that it can be identified. Section 100 of the BIA deals with reviewable transactions. A reviewable transaction is a transfer at undervalue by the debtor to a counterparty where the debtor and the counterparty are not at arm's length (for example, where they are related to one another).22

Section 100 provides that where the debtor enters into a reviewable transaction within one year before bankruptcy, the trustee may apply to the court for an order requiring the counterparty to pay the value shortfall. Section 101 of the BIA deals with the purchase or redemption by a corporation of its own shares in a banlcruptcy context. T hese transactions are the functional equivalent of a gift because they do not return value to the corporation and so they have the potential to defeat creditors. Section I 0 1 supplements federal and provincial corporations statutes which, generally speaking, prevent a corporation from purchasing or redeeming its shares if it is insolvent. Section 101 also catches the declaration of a dividend at a time when the corporation is insolvent on the theory that this, too, is the functional equivalent of a gift by the corporation to its shareholders.

As this brief account indicates, the current Canadian Jaws governing transfers at undervalue and the like are piecemeal, fragmented and out of date. In particular:

1. the BIA provisions catch some types of transfer at undervalue but not others and there is no rational basis for the selection;

2. the review periods vary arbitrarily from one provision to another;

3. there is no consistent remedy structure;

4. the BIA provisions are limited to formal bankruptcy proceedings and they do not apply in BIA or CCAA reorganisation proceedings; and

5. the continued application of provincial Jaws raises the possibility of different case outcomes from Province to Province.

In relation to (5), the SSC Report said:

[T]here should be a uniform system nationwide for the examination of fraudulent and reviewable transactions in situations of insolvency. At present, there is a lack of fairness, uniformity and predictability by virtue of both federal and provincial/territorial legislation addressing fraudulent and reviewable transactions ... a national standard is needed for reviewable transactions that diminish the value of the insolvent debtor's estate?3

The SSC Report recommends amendment of the BIA and CCAA to "ensure consistent and simplified rules ... A trustee/monitor under a proposal should have the same powers as a trustee in bankruptcy. The Acts should provide a standard for challenging transactions that may affect the value of creditors'

21 Royal Bank of Canada v North American Life Assurance Co. [ 1996] I SCR 325. n Bankruptcy and Insolvency Act, s 3.1 (defining "reviewable transaction") and s 4(2) (defining "related persons"). 23 See Standing Senate Commiuee on Banking. Trade and Commerce, n 1, p 122.

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realisable claims."24 The SSC Report does not go into details about what the new provisions should look like. However, a JTF Worldng Group has proposed a model which has the following main features: 25

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Sections 9 I and I 00 of the BJ A would be replaced by a single, comprehensive provision governing the transfer of goods and services at undervalue. There would be a con·esponding provision in the CCAA.

The new provisions would be a complete code under both the BIA and the CCAA and they would apply to the exclusion of provincial laws. They would apply in formal bankruptcy proceedings and also in BIA and CCAA reorganisation proceedings unless excluded by the terms of the reorganisation proposal.

The provjsion would give standing to the bankruptcy trustee in the case of formal bankruptcy proceedings, the proposal trustee in the case of BIA reorganisation proceedings and the plan monitor in the case of CCAA reorganisation proceedi ngs subject to the right of creditors to take over a claim if the trustee or moni tor failed to act.

There would be a limitation period of three years from the date of the initial bankruptcy event or the initial application for reorganisation.

In the case of a non-arm's length transaction, the review period would run back five years from the date of the initial bankruptcy event or the in itial application, while in the case of an arm's length transaction , the review period would be one year.

In the case of a non-arm's length transaction occurring within one year before the date of the initial bankruptcy event or the initial application, the trustee or moni tor would need to prove only that there was a conspicuous difference in fair market value.

In the case of a non-arm's length transaction occurring between one and five years before the date of the initial bankruptcy event or the initial application, the trustee or monitor would also need to prove that: (a) the debtor was insolvent at the time of the transaction or the transaction rendered the debtor insolvent; or (b) the debtor in tended to defeat, hinder or delay creditors.

In the case of an arm's length transaction the trustee or monitor would need to prove: (a) a conspicuous difference in fair market value; (b) the debtor's insolvency; and (c) the debtor's intention to defeat, hinder or delay creditors.

• The court would have power to set aside the transaction and to award additional or alternative remedies (including compensation), subject to certain defences (including a defence in favour o f a bona fide transferee for value).

There would be specific safe harbour provisions for certain transactions involving financiers unrelated to and dealing at arm's length with the debtor and transfers made to comply with a family court order or the like.26

These recommendations build on current Canadian law. They aim to take the best elements from the federal and provincial s tatutes outlined above. An alternative and more radical approach would be to scrap the current laws altogether and enact a new set of provisions from scratch. United States Code, s 548 provides a possible model. The main features of s 548 are as follows:

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the provision applies to the transfer of an interest of the debtor in property and any obligation incurred by the debtor within one year before the date of filing the petition;

the trustee must prove either that: (a) the debtor's intention was to hinder, delay or defraud creditors; or (b) the debtor received less than a reasonably equivalent value in exchange for the

,. See Standing Senate Committee on Banking, Trade and Commerce, n I, Recommendation 26. H IIC and CA!RP Joint Task Force on Business Insolvency Law Refonn, Working Group 011 Preferences (D1scuss10n Paper, 12 September 2004) (JTF Preferences Working Group Paper). The JTF Working Group's model was endorsed in substance by the JTF in Joint Task Force, Further Supplemental Reform Proposals (28 September 2004), Recommendations l and 4-13. 26 The model also envisages: (I) separate but parallel provisions governing (a) dividend payments and share redemptions or buy-backs and (b) the payment of excessive finance fees (default interest and the like); and (2) an oppression remedy modelled on the oppression provisions in the corporations statutes.

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transfer or obligation and the debtor was insolvent on the transaction date or became insolvent as a result of the transaction; and

• the remedy is avoidance of the transfer or obligation subject to a defence in favour of a bona fide transferee or obligee for value.

The main differences between the JTF Working Group's proposed transfer at undervalue provision and US Code, s 548 are as follows.

•

•

•

•

United States Code, s 548 does not distinguish between arm's length and non-arm's length transactions.

Section 548 sets a review period of one year across the board, whereas under the JTF Working Group's model the review period is one year for arm's length transactions and five years for nonarm's length transactions.

Both models make fraudulent intention, value shortfall and the debtor's insolvency on the transaction date badges of fraud. However, the applications are different. For example, under the JTF Working Group model, value shortfall alone (but not fraudulent intention alone) may be sufficient in some cases to justify setting the transaction aside, while under US Code, s 548, fraudu lent intention alone (but not value shortfall alone) may be enough.

United States Code, s 548 provides for avoidance of an offending transaction, whereas the JTF Working Group model provides for other remedies as well or instead.

Questions for research include the following:

l . How significant are these differences as a matter of both policy and practice?

2. What are the benefits of the JTF Working Group Model relative to US Code, s 548 and, particularly having regard to the value of greater harmonisation, should Canada adopt the United States provision?

3. Are there other models Canada might consider and how do these compare with the models discussed above?27

Preferences Section 95(1) of the BIA provides that every payment made by an insolvent person in favour of any creditor with a view to giving that creditor a preference over the other creditors shall, if the person making it becomes bankrupt within three months after the date of making it, be deemed fraudulent and void as against the trustee in bankruptcy. Section 95(2) provides that where any payment mentioned in s 95( 1) has the effect of giving a creditor a preference over other creditors, or over any one or more of them, it shall be presumed, in the absence of evidence to the contrary, to have been made with a view to giving the creditor a preference over other creditors. Section 96 of the BIA extends the review period to 12 months in the case of non-arm's length transactions. The prov incial assignments and preferences statutes also contain anti-preference provisions. These are similar to the BIA provisions, but there are a number of differences including the following:

• The courts have read the provincial statutes as requiring proof of concurrent intention (in other words, there must be proof of both the debtor's intention to give a preference and the counterparty's intention to receive it). Section 95 requires proof of the debtor's intention only.18

• Under both s 95 of the BIA and the provincial statutes, if a transaction has the effect of giving the counterparty a preference, the debtor's intention is presumed. However, under the provincial statutes, the presumption only applies if an action to set aside the transaction is brought within 60 days after the date of the transaction or the date of the debtor's bankruptcy.

27 The uncommercial transactions provisions in ss 588FB and following of the Corporations Act 2001 (Cth) provide a possible alternative model: see Note, "Canadian Bankruptcy Law Refonn" (2004) 78 AU 704 at 706-707. See also the model Professor Cuming proposes: Cuming RCC, "Transfers at Undervalue and Preferences under the Bankruptcy and Insolvency Act: Rethinking Outdated Approaches" (2002) 37 Canadian Business Law Journal 5 at 10-20. 18 Blaine L Hudson, Trustee v Benallack [1976] 2 SCR 168.

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•

•


Sections 95 and 96 of the BlA set a three-month review period extended to one year if the transaction is not an arm's length one. The provincial statutes do not specify a review period. The payment of money by the debtor to the counterparty cannot be attacked under the provincial statutes. The preference provisions are subject to much the same criticisms as the transfer at undervalue

provisions. In particular, the SSC's concerns about "lack of fairness, uniformi ty and predictability•· apply equally to both .29 So does its call for a single set of nationwide rules.30 The JTF Preferences Working Group has recommended a set of provisions which would give effect to the SSC's recommendation. 31 The main featu res of the JTF Working Group model are as follows:

The current laws would be replaced by a new provision in the BIA and also in the CCAA. The new provision would be a complete code and the provincial starutes would no longer apply. The provision would apply in reorganisation proceedings unless excluded by the terms of the proposal. The provision would give standing to the bankruptcy trustee in the case of formal bankruptcy proceedings, the proposal trustee in the case of BIA reorganisation proceedings and the plan monitor in the case of CCAA reorganisation proceedings, subject to the right of credi tors to take over a claim if the trustee or monitor failed to act.

• There would be a limitation period of three years mnning from the date of the initial bankruptcy event or the date of the initial reorganisation application.

• In the case of a non-arm's length transaction, the review period would run back five years from the date of the original bankruptcy event or the init ial application, while in the case of an arm· s length transaction, the review period wou ld be one year.

• In the case of a non-arm's length transaction occurring within one year before the date of the initial bankruptcy event or the initial application, the trustee or monitor would need to prove only that the transaction amou nted to a preference in fact. In the case of a non-arm's length transaction occurring between one and five years before the date of the initial bankruptcy event or the initial application, the trustee or monitor would need to prove that: (a) the transaction amounted to a preference in fact; and (b) the debtor was insolvent at the time of the transact ion or the transaction rendered the debtor insolvent.

• In the case of an arm's length transaction, the trustee or monitor would need to prove that: (a) the transaction amounted to a preference in fact; and (b) the debtor intended to prefer the counterparty. There would be a rebuttable presumption of intention to prefer in the three months preceding the date of the initial bankruptcy event or the date of the initial application.

• It would be a defence for the counterparty to prove that: (a) the debtor was solvent on the transaction date and not rendered insolvent by the transaction; or (b) the counterparty was entitled to receive the transfer in priority to other creditors.

• The court would have power to set aside the transaction and to award addi tional or alternative remedies, including compensation.

• There would be specific safe harbour provisions for certain transactions involving financiers unrelated to and dealing at arm's length with the debtor, including eligible financial contracts and sales pursuant to securitisations. The JTF Report recommends that the new preference provisions should provide for the

continuation of the English subjective test for preferences. 32 The JTF Working Group's model adopts an effects-based, or preference in fact, test for non-arm's length transactions, but it retains the

~Seen 23. -'0 Seen 24.

·'1 JTF Preferences Working Group Discussion Paper, pp 2-3 and Terms Sheet. The JTF Working Group's model was endorsed

in substance by the JTF in Joint Task Force. Fur1her Supplemema! Reform Proposals (28 September 2004). Recommendations 1-3 and 11 · 13. 11 See Joint Task Force, n J I. Recommendation 66.


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subjective test for arm's length transactions. The subjective test is open to criticism on the ground that it is out of touch with modern bankruptcy policy. For example, Cuming says of the test that it is33

not only difficult to apply, but, to a great extent, it misses the point. The point is that the transfer, if left intact, frustrates implementation of the policy of bankruptcy legislation, equitable treatment of all creditors. The fact that the debtor intended or did not intend this result should not be relevant. The actual or presumed intentions of the debtor when making a preferential transfer are not important. What is important is the effect that such a transfer has on the position of creditors with claims in bankruptcy. What matters to them is that a central policy of bankruptcy law is not frustrated by a preferential payment or transfer which, by definition, results in material loss to them.

The policy Cuming describes is reflected in US Code, s 547, which adopts an effects-based test across the board. Broadly speaking, a transfer constitutes a preference if it enables the counterparty creditor to recover more than it would have received in a formal bankruptcy distribution if the transfer had not been made. The debtor's state of mind is immaterial. The JTF's concern was that "transactions in good faith are not necessarily protected from an effects-based standard, as all preferences in the review period would be caught". The JTF's objective was to "strike a balance between the ability of the debtor to conduct its affairs in the period prior to the commencement of insolvency proceedings and the ability of trustees, receivers and creditors to recover value where a transaction has given a preference contrary to the statute".34

United States Code, s 547 addresses this concern by enacting a detailed set of safe harbour provisions which exempt specific transactions from the reach of the provision. The downside of this approach is that it increases the law's complexity. Furthermore, it runs the risk of overlooking particular exemptions. Piecemeal reforms may be necessary to fill the gaps and this makes the law more complex still.

The preference provisions in ss 588FA and following of the Corporations Act 2001 (Cth) take a different tack. -In common with the United States, the Austral ian provisions use an effects-based test. However, in place of detailed safe harbour provisions to protect legitimate commercial dealings, the Australian model relies on a shortly stated good faith defence. It is a defence if:

(a) the counterparty creditor acted in good faith;

(b) the creditor had no grounds for suspecting that the debtor was insolvent or close to insolvency on the transaction date and a reasonable person in the creditor's circumstances would have no reasonable grounds for so suspecting; and

(c) the creditor provided valuable consideration or changed its position in reliance on the transaction. 35

In summary, US Code, s 547, in carving out a detailed set of specific exceptions, adopts a rulesbased approach. The Australian model, with its reliance on the shortly stated good faith defence, adopts a standards-based approach.

The advantage of the rules-based approach is greater certainty. The disadvantages are more complex drafting and the risk of both over- and under-inclusiveness. The advantages of the standards-based approach are drafting simplicity and flexibility of application. The main disadvantage is reduced certainty.


l. How significant in practice is the difference between the subjective test and the effects-based test likely to be?

2. What are the benefits of the JTF Working Group model relative to US Code, s 547 and, particularly having regard to the value of harmonisation, should Canada adopt the United States provision?

n Cuming, n 27, p 23. ~ See JTF Report, n 2, Commentary on Recommendation 66. 35 Corporations Act2001 (Cth), s 588FG(2).



3. In particular, is the distinction the JTF Working Group model draws between arm's length and non-arm's length transactions sustainable as a matter of policy?36

4. What are the benefits of the JTF Working Group model and US Code, s 547 relative to the AustraJian provisions and other possible models for reform?37

5. In particular, does the Australian good faith defence sufficiently protect bona fide transactions, given an effects-based preference test, and how does it compare with the JTF Working Group's proposed defence (that the creditor wns entitled to receive the transfer in priority to other creditors)?

SUBORDINATION OF CLAIMS Subordination agreements The JTF recommended amendment of the BIA and CCAA to "expressly recognise voluntary contractual subordination" and to make it clear that "subordination agreements are enforceable during the course of inso lvency proceedings by the debtor, applicable insolvency administrators or other creditors notwithstanding third party beneficiary/privity of contract rules". 311 The JTF suggested modelling the amendment on US Code. s 51 O(a), which provides that "a subordination agreement is enforceable in a case under this title to the same extent that such agreement is enforceable under applicable non-bankru ptcy law".39 The SSC Report failed to pick up these recommendations.

The JTF Report argued that a statutory rule is needed to remove uncertainty in Canada concerning the circumstances when subordination agreements can be recognised and who can enforce them.40 The fo llowing discussion focuses on subordination agreements which affect priority between unsecured creditors. Subordination agreements which affect priorities between secured creditors are already provided fo r in the provincial personal groperty security statutes and these provisions apply both inside and outside the debtor's bankruptcy.

A subordination agreement is "a transaction whereby one creditor (the subordinated or junior creditor) agrees not to be paid by a borrower or other debtor until another creditor of the common debtor (the senior creditor) has been paid".42 Under one form of subordination agreement, "the junior creditor agrees with the debtor that, so long as the senior debt is outstanding, the junior debt is not payable unless and until the senior debt has been paid in fu11". 43 The agreement will contain a provision along the following lines:44

[I]f the debtor becomes subject to any liquidation. dissolution. rehabilitation or insolvency proceeding or to any assignment for the benefit of its creditors or any other distribution of its assets. or any nnalogous event occurs, the junior debt will rank in right of payment subordinate to and after the pnor payment of the senior debt.

Does this form of agreement infringe the pari passu rule?45 The question arises because there is some au thority to suggest that the bankruptcy distribution rules are mandatory and that parties cannot contract ou t of the Act.46 Re Maxwell Communications Corp pic [ 1993] BCC 369 (ChD) is the leading Engl ish case in point. There Yinelott J held that a bilateral subordination agreemen t between

.16 Cf Cuming. n 27. pp 26-27, arguing that. in terms of extending the review period for certain classes of transaction, the

relevant distinction is not whether the debtor and creditor counterparty were related to one Dnother but, r:uher, whether the creditor was aware or ought to have been aware of the debtor's insolvency nnd therefore knew, or ought to have known, that it was receiving an unfair preference. n See eg the model Professor Cuming proposes: Cuming, n 27, pp 23-29. >a See JTF Report, n 2, Recommendation 76. 'q Joint Task Force. n 8, Commentary on Recommendation 76. "0 See JTF Report. Commentary on Recommendation 76. 41 See eg Personal Property Security Act RSO 1990 c P- 10, s 3&. '2 Wood PR, The lAw ojS11b(lldinated Debt (Sweet & Maxwell. London. 1990). para I. I.

4) Seen 42 , para 2.5 .

... Also seen 42, para 2.5. •s In Canada, see BIA, s 141: "subject to this Act, all claims proved in a bankruptcy shall be paid rateably " •~ Nationnl Westnrm~ter Bnnk Lid,. Halesowen Prc.~s11-ork & Assemblies Ltd I 19721 AC 785: Rolls Ra~nr Ltd'' Cox I I 9671 I QB 552.


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the debtor and a junior creditor was valid so long as it did not give one creditor an advantage denied to other creditors. In the Maxwell case itself, Vinelott J treated the junior creditor as having in substance waived its claim in favour of the other unsecured creditors. It is clear that after bankruptcy, a creditor is free to waive its debt or to decline to submit a proof. In principle, Vinelott J reasoned, a creditor should equally be entitled to agree with the debtor in advance that, if the debtor becomes bankrupt, the creditor's claim will no longer be payable or will be postponed or subordinated to other creditors (at 376). An alternative method of subordination is for the junior creditor and senior creditor to agree that, on the debtor's insolvency, the junior creditor will turn over to the senior creditor all recoveries the junior creditor receives in respect of the junior debt.47 The turnover method of subordination does not infringe the pari passu rule and it would be a "triumph of form over substance" to recognise subordination by the turnover method and not by a direct contract between the debtor and the junior creditor (at 380-381).48

[n the Maxwell case, the subordination agreement was in favour of all the other unsecured creditors and so it was plain that the agreement did not give any creditor an advantage over others. By contrast, Re Air Canada Ltd [2004] CanLII 34416 (On SC) concerned a subordination agreement in favour of some unsecured creditors only. The agreement was for the benefit of unsecured creditors to whom the debtor was indebted for "borrowed money". "Borrowed money" was not defined. Trade creditors argued that the Maxwell case was distinguishable because in the present case the subordination agreement gave the senior creditors an advantage denied to the other unsecured creditors. The remedy the trade creditors requested was an order declaring that the junior creditors were subordi nated to all the unsecured creditors. Farley J rejected the claim, saying that it would give the trade creditors a windfall: the trade creditors "did not bargain or pay for any benefit or advantage in respect of the (junior debt] nor are they parties to any agreements in respect thereto" (at [9]). He treated the agreements between the debtor and the junior creditors as being in substance the same as a turnover agreement between the junior creditors and the senior creditors. T he substance of the agreement was that each junior creditor would receive its rateable share of the proceeds under the reorganisation plan but would transfer (or turn over) the agreed proportion of their entitlement to the senior creditors (at [11 )). The decision puts a gloss on the Maxwell case: a subordination agreement is effective provided it does not adversely affect other creditors and other creditors will not be adversely affected if they receive no less as a consequence of the agreement than they would have received if the distribution had been made on a pari passu basis. In the context of CCAA reorganisation proceedings the governing principle is that all unsecured creditors must be treated equitably, "but equitably does not necessarily mean equal" (at [6]). The Air Canada case was decided after the date of the JTF Report. Adoption of the JTF's recommendation would amount to a codification of the decision.

Supplementary amendments are needed to deal with junior creditors' voting rights in BIA or CCAA reorganisation proceedings: ( l ) should junior creditors be placed in a separate class for voting purposes? (2) either way, should junior creditors be allowed to vote on the plan? Farley J did not have to address these questions in the Air Canada case because the parties had entered into a settlement agreement stipulating that the junior creditors were not to be placed in a separate class but were to be included in the general class of unsecured creditors and that they were to be entitled to vote the face value of their claims in the same manner as all the other unsecured creditors. Nevertheless, Farley J did say that, "with respect to the right to vote, I do not see that the fact that there is a subordination takes away or detracts from [the j unior creditor's) right to vote" (at [15)). For a CCAA reorganisation plan to succeed, the debtor must secure the approval of all classes of its creditors, even those who have subordinated their claims.49 By contrast, the implication of the Maxwell case is that the junior creditor waives its voting rights, along with other aspects of the claim, by e ntering into the

47 See Wood, n 42, para 2.4. •a The turnover method of subordination does not infringe the pari passu rule because "the junior creditor claims the full amount of the junior debt o n the insolvency of the debtor pari passu with all other general creditors, including the senior creditor. The turnover obligation, which achieves the subordination, is purely a relationship between the junior creditor and the senior creditor": see Wood, n 42, para 3.1 . 49 Quoting Uniforet Inc ( Re the Arrangement oj) [2003] QJ No 9328 (SCJ) at [21) per Tingley J.

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subordination agreement. The trouble with Farley J's position is that if the junior creditor has unrestricted voting rights, it might use its vote to veto the reorga nisation plan and negate the substance of the subordination agreement. The trouble with denying the junior creditor voting rights altogether is that it would be inconsistent with the turnover theory on which, according to the Air Canada case. partial subordinations are based: the turnover theory contemplates the junior creditor's participation in the bankruptcy or insolvency proceedings as if the subordination agreement had not been entered into. Furthermore. denying the junior creditor's voting rights altogether may prejudice its interests insofar as its claim is not subordinated to other creditors. The JTF's recommended so lution is a rule allowing the court to approve a proposal or sanction a plan of arrangemen t, "notwithstanding that any class of creditors, ranking either by statute law or by agreement, subordinate to all or part of the body of general unsecured creditors, may have voted against the proposal". 5° This is similar to the cramdown provision in US Code, s 1129(b). Questions for research include the following: I. Should a subordinated creditor have voting rights in BIA or CCAA reorganisation proceedings

and, if so. in what circumstances? 2. Should Canada adopt a cramdown provis ion along the lines of US Code, s l l29(b)? 3. If so, should the provision be limited to the case of subordinated debt, as the JTF

recommendation contemplates, or should it apply generally. as in the case of US Code, s 1129(b)?

Subordination of equity claims ln Re Blue Range Resource Corp (2000j AJ No 14 (Alta QB). Big Bear acquired all the Blue Range shares in a hostile takeover. It purchased some of the shares for cash and acquired the balance in a share swap. The Blue Range shares turned out to be worthless. Big Bear, having assu med control of Blue Range, caused Blue Range to initiate CCAA reorganisation proceedings. Big Bear filed a claim in the reorganisation fo r damages, alleging that it had suffered loss due to misrepresentations by Blue Range about the value of its shares. The court held that Big Bear's claim was not an ordi nary tort claim. It was in substance a claim by a shareholder for the return of its equity investment. On this basis, it said that Big Bear's claim should rank in the reorganisation behind the claims of the ordinary unsecured cred itors. The main policy justification (at [33]) was that51

defrauded stockholder claimants in the purchase of stock are presumed to have been bargaining for equity type profits and assumed equity type risks. Conventional creditors are presumed to have dealt with the corporation with the reasonable expectation that they would have a senior position against its assets to that of the alleged stockholder claims based on fraud.

A secondary consideration, the court said (at [45]), was that if Big Bear's claim ranked equally with the unsecured creditors, the door would be opened in many insolvency scenarios for aggrieved shareholders to claim misrepresentation or fraud. Claims like this might complicate adjudications in the context of CCAA proceedings.

The SCC's Recommendation 40 was for a new provision stating that, "the claim of a seller or purchaser of equity securities, seeking damages or rescission in connection with the transaction, should be subordinated to the claims of ordinary creditors". The JTF made a similar recommendation. except that the JTF recommendation would have extended to all in substance equity claims, includ ing claims for payment of dividends, redemption or retraction or repurchase of shares and damages (including securities fraud claims). 52 Adoption of these proposals would, in effect, codify the decision in the Blue Range case.

As in the case of subordination agreements. supplementary amendments would be needed to deal with the question of voti ng rights in reorganisation proceedings. As the law presently stands, for a reorganisation plan to succeed, all credi tors must be "given the right to vote, in the appropriate class.

<o Joint Task Forece. n 8. Recommend;uion S28. ~~ Quoting from Re Surling Homex Corp 579 F 2d 206 at 2tl ( 1978 ). ~2 See JFT Repon. n 2. Recommendat ion 62.

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on the proposed compromise". 53 The court will refuse to approve the plan if the plan denies a subordinated equity claimant the right to vote, as happened in Menegon v Philip Services Corp (2000) 11 CBR (4th) 262. The problem is that if a subordinated equity claimant has unrestricted voting rights, it may use its vote to veto the reorganisation plan and negate the subordination. The JTF has recommended a cramdown rule to deal with the problem.54 Questions for research include the following:

l. Is a cramdown rule the best solution?

2. What are the alternatives?

Equitable subordination The doctrine of equitable subordination applies where a non-arm's length creditor has exploited its controlling position by taking unfair advantage of the debtor or securing a benefit over the debtor 's other creditors that it would not otherwise have obtained.55 In the leading United States case of Pepper v Litton 308 US 295 (1939), for example, the wrongdoer was the debtor's controlling shareholder and he caused the debtor to confess to a judgment in his favour in respect of a long dormant wage claim. In Taylor v Standard Gas and Electric Co 306 US 307 (1939), the wrongdoer was the debtor's parent company and it caused the debtor to declare large dividends in its favour which could not be economically justified. The remedy the American courts apply is to subordinate the wrongdoer's claim, in whole or part, until the other creditor's claims have been satisfied. United States Code, s 510(c) provides statutory confirmation that the doctrine of equitable subordination applies in United States bankruptcy proceedings.

It is not yet settled whether the doctrine of equitable subordjnation applies in Canada. 56 The JTF, with the objective of creating "some certainty for parties in their financing transactions", has recommended a provision declaring that the doctrine does not apply.57 On the other hand, JTF Recommendation 65 proposed the enactment of an oppression remedy, modelled on the corporations statutes, which would be available for the benefit of creditors in a case where the debtor's directors or officers acted in a manner that was oppressive, unfairly prejudicial to or unfairly disregarded creditors' interests.


l . How is the oppression remedy different from the doctrine of equitable subordination? 2. What are the relative costs and benefits of the two approaches, having regard in particular to the

need for certainty in commercial transactions?

3. Is either an oppression remedy or equitable subordination necessary, given the revamped provisions the JTF has recommended for the review of pre-bankruptcy transactions?58

CONCLUSION This article has canvassed three selected topics in Canadian bankruptcy law reform and identi ficd a set of research questions in relation to each topic. Bankruptcy law reform has not been high on the Canadian political agenda and in some important respects the Canadian bankruptcy and insolvency laws lag behind the laws of other countries. In these respects, there are lessons for Canada to learn from law reform experiences elsewhere. On the other hand, the Canadian bankruptcy and insolvency laws do have some innovative features and, moreover, the debate over law reform in Canada is lively, informed and current. In these respects, there are lessons for other countries to learn from the Canadian experience. In short, comparative legal scholarship may result in reciprocal benefits for

53 Menegon v Philip Services Corp (2000) 11 CBR (4th) 262 at 278 per Blair J. See also Re Air Canada Ltd (2004] CanLII 34416 at [15] per Farley J. 54 Seen 50. 55 Ziegel, Duggan and Telfer, n 13, p 410. 56 See Telfer TGW, "Transplanting Equitable Subordination: The New Free-wheeling Equitable Discretion in Canadian Insolvency Law?'' (200 I) 36 Canadian Business lAw Journal 36. 57 See JTF Report, n 2, Recommendation 69. S3 See JTF Report, n 2, Pt 3.



research and law reform. This is the spirit in whic h the foregoing account of Canadian developments has been offered.


Reproduced from Anthony Duggan, "Canadian Bankruptcy Law Reform: A Selective Research Agenda" (2005) 13 Insolvency Law Journal 1. By permission of Thomson Reuters Canada Limited.

Documents

Canadian bankruptcy law reform: A selective research agenda · applies if the debtor is a company and there are claims of at least Can$5 million outstanding against it. The CCAA overlaps