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Bankruptcy, Insolvency and Restructuring

Canada’s bankruptcy and insolvency regime draws upon both British and American insolvency concepts to create an insolvency regime that reflects Canada’s history and geography but has significant practical differences from its British and American conceptual roots.

Canada does not have a unitary bankruptcy code like the United States. Canada also does not have a separate bankruptcy court, with the Superior Courts of each province playing that role. Constitutionally, bankruptcy and insolvency are federal powers, but the determination of priorities and ownership of property of the bankrupt is determined under the laws of the province in which that property is situated.

Accordingly, provincial law has a great deal of importance in Canadian insolvency proceedings as provincial laws differ substantially across Canada with respect to property issues. This is particularly true of the Province of Quebec which, like Louisiana, has a civil code-based system, while Ontario and the rest of the Canadian provinces are based on the British Common Law system.

Stays of proceedings granted in foreign insolvency proceedings, including under the U.S. Bankruptcy Code, can be recognized and enforced in Canada.

Corporate Restructuring

The various Canadian insolvency statutes described below should be thought of conceptually as a “toolbox” where the provisions of different statutes are used for different situations.

A corporate restructuring can occur under either the provisions of the Companies’ Creditors Arrangement Act (CCAA) or the Bankruptcy and Insolvency Act (BIA). Each statute imposes a comprehensive stay of proceedings on creditors.

The CCAA has a minimum debt threshold of C$5 million and is intended to be a more flexible tool to be used in larger corporate restructurings. The BIA has “proposal” provisions that are intended to be used in corporate restructuring where the debt outstanding is less than C$5 million and provide a more structured, stricter regime, with a maximum proceeding length of six months that is intended for the restructuring of smaller entities, hopefully at lower cost.

CCAA and BIA insolvency law features similar to U.S. practices
  • The granting of priority charges for debtor-in-possession (DIP) financing.
  • Provisions to set aside certain preferential and reviewable transactions.
  • The granting of priority charges to professionals, officers and directors for post filing fees and director claims by creditors.
  • The ability to approve out of the ordinary course sales of assets prior to a plan or proposal being made to creditors.
  • The ability to disclaim certain executory contracts.
Differences between Canadian insolvency law and U.S. practice
  • In Canada there is no “adequate protection” concept and the debtor is free to use cash collateral after filing for protection under the CCAA of BIA. Secured creditors can move to lift the stay the of proceedings imposed under the CCAA or BIA, if they can prove that they are unduly prejudiced by the effects of the stay of proceedings.
  • In Canada, there is no separate “Chapter 11 Debtor” that comes into existence upon the filing for protection under the CCAA or the BIA, and existing contracts and security documents are not impaired merely due to the filing. Instead, the debtor continues as the same entity it was prior to the filing, except it is under the supervision of a court officer, typically an accountant, appointed by the court to supervise the restructuring of the debtor and who reports to the court and the creditors.
  • There is no formal requirement for the appointment of a creditors’ committee, although the court may appoint a committee and grant a priority charge on the debtor’s assets to pay for legal and financial representation for the committee.
  • Critical vendors are not entitled to be paid their pre-filing obligations by the debtor, and instead, a critical vendor supply order enforces continued supply by the critical vendors and in exchange grants a critical vendor charge on the debtor’s assets for post-filing supply in priority to existing creditors.
  • Certain executory contracts can be disclaimed in the proceeding, but not loan and security documents or union collective agreements.
  • Contracts may be assigned by the debtor with court approval if consent to assignment is not obtained from the other contracting party.
  • Termination on insolvency clauses in contracts are deemed ineffective.
  • Rights under “eligible financial contracts” (e.g. derivatives agreements, swaps, futures contracts) may not be stayed.
  • Suppliers cannot terminate or amend contracts merely because of pre-filing non-payment but can demand C.O.D. terms during the proceedings.
  • There is no statutory “cram-down” mechanism as would exist under U.S. bankruptcy law.
  • There is no “absolute priority” rule.
Plan of Arrangement or Proposal

A Plan of Arrangement under the CCAA or a Proposal under the BIA is effectively a contract between the debtor corporation and its creditors. In each case, the Plan or Proposal may be made to individual classes of creditors. The claims of any class of creditors that is specifically dealt with in the Plan or Proposal may be treated as unaffected obligations with the effect that the claims of these creditors cannot be compromised.

Upon the filing of the Plan or Proposal, meetings are called of the classes of affected. Under either the CCAA or the BIA, 50% in number of creditors, and two-thirds in value of creditors, of each class voting on the Plan or Proposal, must vote in its favour.

If the creditors vote against a Plan under the CCAA, there are no automatic legal consequences. Under the BIA, failure of the creditor to approve a Proposal results in the debtor being ported into a liquidation proceeding similar to a Chapter 7 bankruptcy, where a trustee in bankruptcy is appointed over the assets of the debtor to be liquidated. If the creditors of the voting classes approve the Plan or Proposal the matter proceeds to the court for an approval hearing.

In the Canadian system, the Monitor appointed by the court in the CCAA, or the Proposal Trustee appointed under the BIA, plays a critical role in monitoring the debtor prior to the filing of the Plan or Proposal and in making recommendations to the court as to the general fairness and features of the Plan or Proposal. The court is protective of its officers and generally gives great deference to their recommendations.

In Canada and Ontario, insolvency proceedings crystallize certain liabilities of directors for unpaid source deductions, HST, unpaid employee wages and benefits and vacation pay, and other liabilities imposed by statute. Certain pre-filing director liabilities can be compromised by a Plan or Proposal.

Receivership

The chief vehicle for secured creditors and lenders to recover secured indebtedness in Ontario is the appointment of a court appointed receiver. Secured creditors may apply to appoint a receiver after giving notice to the debtor of their intention to enforce their security and waiting the 10-day statutory notice period. There is also a requirement to give “reasonable” notice arising from jurisprudence, however, practically, the 10-day statutory notice period has been accepted as a “reasonable” notice period.

The application for the appointment of a receiver is typically made under the BIA because a receiver appointed under the BIA has authority in all of Canada’s provinces due to the paramountcy of the federal bankruptcy regime. Receivers can generally also be appointed under provincial judicature statutes, but typically their authority is limited to the province of the court in which they are appointed.

Functions of the receiver

Court appointed receivers are officers of the court that report to the court. Their functions:

  • Take possession of the assets and safeguard them.
  • Obtain valuations of the assets.
  • Formulate a plan for sale of the assets that receives approval from the court.
  • Implement the sale plan through sales on an en bloc basis or of individual assets depending on the circumstances.
  • Distribute the proceeds to creditors in accordance with the priorities of the secured and unsecured claims.

Typically, the receiver obtains a first charge on the assets to secure its fees and that of its counsel.

Secured creditors and deemed trusts

Among the unique features of Canadian secured creditor practise is the existence of government “deemed trusts” and liens. The amounts withheld by the employer from its employees’ paychecks for taxes and other employee withholdings (source deductions) are deemed to be the property of the Crown and do not form part of the estate of the debtor in receivership or bankruptcy. This “deemed trust” for source deductions has priority over all secured creditors, with certain limited exceptions for those creditors with security over real estate. A similar “deemed trust” exists for goods and services or harmonized sales tax collected by the debtor corporation but not remitted to the Crown (GST/HST).

The Wage Earner Protection Program Act (WEPPA) creates a charge on the “current assets” (typically inventory and accounts receivable) for unpaid employee wages and vacation pay (depending on the province) up to a maximum of approximately C$6,000 per employee. This charge is a first charge on this collateral.

Many tactical decisions made in Canadian insolvency proceedings, particularly in smaller estates under the C$5 million Companies’ Creditors Arrangement Act debt threshold, involve the practicality of incurring professional costs to realize on assets in an environment where there may be significant arrears of source deductions secured, GST/HST and WEPPA liabilities by “deemed trusts” ahead of the claims of secured and unsecured creditors.

Bankruptcy Liquidation

A trustee in bankruptcy can also be appointed by the debtor upon the debtor signing an “Assignment into Bankruptcy”. Creditors can force a bankruptcy by filing a “Bankruptcy Application” with the court and obtaining a bankruptcy order against a debtor who can oppose this application.

Although superficially this bankruptcy proceeding is similar to U.S. Chapter 7 bankruptcy, a trustee in bankruptcy does not have the ability to stay validly perfected secured creditors and they may realize their security under the powers granted under the security agreement or move to appoint a receiver.

Typically, bankruptcy in Canada is often used to compromise unsecured creditor claims and as a tool to “reverse priorities” for certain provincial “deemed trust” claims and to overturn the priority of the deemed trust for GST/HST discussed earlier. As a result, for corporate restructuring and realizations, bankruptcy is mostly used as a tool to reverse priorities, rather than as a restructuring proceeding and is often combined with a court appointed receivership.

As noted above, Ontario has a personal property security regime modelled in some ways on various versions of Article 9 of the Uniform Commercial Code (UCC). Conceptually, perfection, registration, and priorities in Ontario are similar to the UCC with important differences.

In the bankruptcy and insolvency context, a secured creditor with a properly perfected security interest has priority over subsequent registered security interests and over unperfected security interests. An unperfected security interest is inferior in priority to the interest of a trustee in bankruptcy and these secured creditors become ordinary unsecured creditors in bankruptcy.

The Canadian insolvency process is meant to be transparent with respect to provincial personal property security regimes and accordingly, if the security interest of a secured creditor is properly perfected in Ontario than it should not be affected simply because some form of insolvency proceeding has occurred.

Generally, courts will tend to grant the debtor corporation an opportunity to restructure, as one of the purposes of the BIA and CCAA is to avoid social harm of having corporations close their doors and employees lose their jobs.

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