Overview (March 2000) - International Law Office

Receiverships
Bankruptcy
Reorganization

Historically, Canadian insolvency law has been significantly more creditor-oriented than that of the United States. However, through the evolution of the law relating to the Companies' Creditors Arrangement Act (CCAA) over the last few years and the implementation of significant amendments to the Bankruptcy and Insolvency Act (BIA) in 1992, Canadian insolvency law has moved closer to the US model.

Receiverships

Where reorganization of a company in financial difficulty is not attempted or fails, the company will usually be liquidated in a receivership initiated by one of the company's secured creditors. The receiver may be appointed privately on a non-judicial basis, under the terms of a debenture or general security agreement that grants the secured creditor a charge over all of the company's assets, or by the court as an adjunct to enforcement proceedings by a secured creditor. In recent years, there has been an increasing trend toward court-supervised receiverships. Once the debtor is notified of the appointment of the receiver, the officers and directors of the debtor cease to have control over the debtor's assets that are subject to the charge.

Although obligated to act in a commercially-reasonable fashion, the duties of the privately appointed receiver are primarily owed to the secured creditor. A court-appointed receiver is an officer of the court and therefore is not an agent of the secured creditor or the debtor and, as such, has duties with respect to all parties who have interests in the property of the debtor.

The receiver has a duty to take possession of the property of the debtor to recover the debt and to account to the debtor and other interested parties for the assets and their realization. The receiver is usually a corporation which employs chartered accountants, who are also licensed trustees in bankruptcy and members of the insolvency practice of an accounting firm. The receiver may sell assets either as an operating business, or on a piece-meal basis, so long as every aspect of the sale is done in a commercially-reasonable fashion. Prior notice of the sale must usually be given to other secured creditors and the debtor. Any interested party may apply to the court to seek resolution of a dispute that arises in the administration of the receivership.

Before appointing a receiver, the BIA requires that the debtor be given at least 10 days' notice in a prescribed form. Once the receiver is appointed, it is required to give notice of its appointment to creditors and to the superintendent of bankruptcy, and will ultimately be obliged to give an accounting with respect to the sale of the assets of the debtor and disposition of the proceeds thereof.

Bankruptcy

The debtor may become bankrupt either in conjunction with, or separate from, a receivership. There are three ways an insolvent party can become bankrupt under the BIA.

First, an insolvent party may do so voluntarily by making an assignment in bankruptcy and assigning its property to a trustee for the general benefit of creditors. Assignment is effective immediately upon filing the assignment with the Office of the Official Receiver and is done with the assistance of a trustee in bankruptcy.

Second, the insolvent party may become bankrupt at the demand of creditors. In such a situation, the insolvent party is said to have been 'petitioned' into bankruptcy. In that instance, one or more creditors to whom the insolvent party owes at least C$1,000 may file a petition with the court. When an insolvent party becomes bankrupt, its property vests in the trustee. The trustee's obligation is to administer the bankrupt's estate for the general benefit of creditors.

Last, a debtor may be deemed bankrupt upon the failure of a proposal under the BIA.

The trustee verifies creditors claims, values the bankrupt's property, realizes on that value and eventually pays out the property as a dividend to the creditors. The BIA only deals with unsecured creditors. Secured creditors can realize on their security despite the stay of proceedings and may prove a claim for any deficiency that might exist after so doing. Unsecured creditors, on the other hand, must prove their claim for the full amount of their indebtedness in order to receive a dividend from the trustee's administration of the bankrupt's estate.

The BIA provides rights to suppliers to obtain the return of their goods in the event of either a receivership or bankruptcy, provided that the supplier files a claim in a prescribed form with the receiver or trustee within 30 days of the delivery of the goods, and the goods remain identifiable and have not been resold. However, recent jurisprudence has made this remedy problematic.

An individual bankrupt is automatically discharged from bankruptcy nine months after making an assignment or being petitioned, unless he or she has been bankrupt before or a creditor opposes the discharge. Where discharge is not automatic, a hearing will be held before the Bankruptcy Court. Whether a bankrupt is a first-time bankrupt or not, the discharge may be absolute, conditional, or suspended for a period of time.

Reorganization

The law with respect to commercial reorganizations has been subject to dramatic change over the last few years.

Apart from negotiated reorganizations or 'work-outs' (which are very common, particularly in major insolvencies), more formal court-sanctioned reorganizations can be accomplished, either under the CCAA or the BIA. The CCAA is intended for larger insolvency cases and is only available where the total claims of a debtor company exceed C$5 million. The provisions of the CCAA allow a debtor company more flexibility in reorganizing itself than the provisions of the BIA.

Both the CCAA and the BIA go part way toward implementing the US Chapter 11 model. Nevertheless, the Canadian rules continue to give the debtor fewer rights than in the United States, impose elements of court and professional supervision on the debtor in possession, and give substantially less time to propose and seek approval of the reorganization.

While both the CCAA and the BIA provide a broad automatic stay of proceedings against all potentially adverse parties, the stay period is substantially shorter in Canada than in the United States. Under the BIA, the initial stay period is only 30 days, but may be extended in 45 day increments with court approval but shall not exceed a total stay of six months. The CCAA stay is usually more generous as it is assumed that larger commercial entities take longer to reorganize. The debtor, while remaining in possession, is almost always subjected to some form of outside professional supervision in the form of a court-appointed monitor or trustee. This monitor or trustee reports on the debtor's affairs to the court and creditor body, guards against dissipation of assets and sometimes becomes engaged in the negotiation of the reorganization.

An example of this outside supervision is the requirement under the BIA that, within 10 days of the commencement of the reorganization, the trustee is required to sign a cash-flow statement produced by the debtor, indicating that the trustee believes such statement to be reasonable.

The ability of debtors in Canada to repudiate executory obligations such as leases or supply contracts is much more limited than under Chapter 11 in the United States. Currently, the extent of this right under the CCAA proceedings is uncertain. Under the BIA, the only executory contracts that can be repudiated are real property leases, and this may be done only if it is essential to the reorganization, and upon the payment of six months' rent.

Reorganization plans must be accepted by the creditors and confirmed by the court. The level of approval required under both the CCAA and the BIA is a majority in the number of creditors and 66% of the value of the claims in each class of creditors present and voting at a meeting. Dissenting creditors are bound by the proposed compromise, provided that the required majority is attained and the court approves the plan. Under the BIA, if the reorganization is not approved, the debtor is immediately deemed bankrupt.

Finally, there are no clear rules allowing priority to those granting credit after the commencement of a reorganization. Accordingly, despite the stay of proceedings, a reorganization will often collapse because of insufficient cash flow to sustain operations where a debtor is unable (i) to obtain the consent of the secured creditors to allow funding secured by a charge ahead of existing secured creditors, or (ii) to make arrangements with key creditors for the grant of additional credit.

For further information on this topic please contact Martin Rabinovitch, Kevin von Bargen or Keith Clark at Lang Michener by telephone (+1 416 360 8600) or by fax (+1 416 365 1719) or by e-mail (mrabinovitch@toronto.langmichener.ca, kvonbargen@toronto.langmichener.ca, or kclark@LMLS.com).

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