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Bankruptcy in Canada, as in the United States, is basically a federal law, applicable to all provinces and territories. Unlike the United States, however, Canada does not have a specialized bankruptcy court, though it does have judges who have become expert in these proceedings.
In order to understand Canadian law, it is important to make a distinction between three terms sometimes used interchangeably: insolvency, bankruptcy, and receivership.
Insolvency describes the inability of a debtor to pay its obligations. It can also describe the situation of a debtor’s assets being insufficient to satisfy its obligations. There are several remedies to insolvency under Canadian law. They are:
- Bankruptcy – a formal proceeding whereby an insolvent company’s assets are liquidated to pay off its unsecured creditors. (Secured creditors can participate in bankruptcy to the extent of any deficiency claims.);
- Reorganization Proposal – an offer made by the debtor to the creditors to settle the debt;
- Receivership – primarily a remedy of secured creditors (like banks), who take control of the assets of an insolvent company.
Three federal statutes govern bankruptcy in Canada:
- Bankruptcy and Insolvency Act (BIA) – This is the basic statute for both personal and commercial bankruptcies and will be discussed in detail below.
- Companies’ Creditors Arrangement Act (CCAA) – This is a corporate reorganization-oriented statute that was enacted in 1933. The Act gives judges latitude to make broad compromises, and was not much used until the 1980s when attorneys discovered it could be useful in large, complex corporate bankruptcies. The CCAA was amended in 1997 to make it more consistent with the BIA.
- Winding-up and Restructuring Act (WUA) – This statute provides for the liquidation of major financial institutions, including banks, insurance companies, and trust and loan companies. None of these can be liquidated under the BIA.
Under Canadian law, the major remedy for secured creditors – receivership – is outside the bankruptcy law. Upon the debtor’s default, a receiver may be appointed to immediately take possession of the collateral and either operate or liquidate the business for the benefit of the security holder. A receivership may be unrelated to bankruptcy, may precede bankruptcy, or may become an incident within bankruptcy. Receivers are private professionals, hired by the creditor. They are usually also qualified as trustees under the bankruptcy laws.
Bankruptcy and Insolvency Act (BIA)
The BIA was first enacted in 1919 and amended in 1949, 1992, 1997 and 2005. It initially focused solely on liquidation, providing a legislative framework for the liquidation of the assets of an insolvent individual, corporation or partnership, and the distribution of the proceeds among the creditors. In the amendments of 1992, it was broadened to provide ways for insolvent debtors to avoid bankruptcy by negotiating reorganizations.
There are two methods by which bankruptcy proceedings can be initiated:
- The insolvent debtor can voluntarily go bankrupt. In this case, the debtor either assigns all its property to an Official Receiver, or makes a proposal to its creditors for restructuring the debt.
- Creditors can petition the court for a receiving order, providing the debts owed to the petitioning creditor exceed $1000 and the debtor is proved to have committed an act of bankruptcy in the six-month period prior to the filing of the petition.
The BIA specifies 10 acts of bankruptcy. The most common is when the debtor “ceases to meet its liabilities generally as they become due.” The second most common bankruptcy act is when a writ is returned nulla bona (no assets located), or if the debtor permits a writ of execution or writ of enforcement to remain unsatisfied 14 days after a seizure under the writ.
The overall supervision of bankruptcy under the Bankruptcy and Insolvency Act is vested in a federal civil servant, the Superintendent of Bankruptcy, who is a senior officer in the Industry Department. Each Canadian province has one or two designated bankruptcy divisions, and each division has four or five Official Receivers.
The Official Receiver, who is an officer of the court, receives and files assignments, appoints trustees on assignments, and examines all debtor conduct and the disposition of debtor property.
First Meeting of the Creditors
The Official Receiver chairs the first meeting of the creditors, which is scheduled within three weeks of the date of bankruptcy. At this meeting, the appointment of the trustee is affirmed or another is substituted. The creditors also appoint one to five inspectors, who act as the representatives of the creditors throughout the process, similar to the Unsecured Creditors’ Committee under United States bankruptcy law.
Under Canadian law, the key player in the bankruptcy is the third party trustee. He is responsible for the management and/or liquidation of the estate and any distributions to creditors. If the debtor has made a proposal to creditors for restructuring its debt, the debtor engages a trustee to perform the day-to-day administration of the estate. In the case of a creditor bankruptcy petition, the creditors select the trustee.
Only licensed individuals may be appointed trustees. These are generally private professionals, often chartered accountants, who are licensed and regulated by the federal government through the Superintendent of Bankruptcy. They must pass rigorous examinations and keep up to date with changes in law and practice. High standards of training, experience, supervision and public reporting are important.
The trustee is responsible for making a list of all creditors, taking control of the business and its books and assets, deciding (with the approval of the inspectors) whether liquidation or sale will yield the best value, realizing that value, and paying the proceeds to the creditors. While the company’s directors cooperate with the Trustee and might assist him in his duties, they are relieved of all responsibility for operating the company and dealing with customers and creditors.
Unpaid suppliers have limited rights to repossess goods under the BIA and receiverships. The supplier must present a written demand for repossession to the purchaser, receiver or trustee within 30 days of delivery of the goods. The goods must be identifiable and in the same state as when delivered. This right to repossess must be exercised not later than 10 days after the written notice is given, unless the time is extended under mutual agreement. This right to repossess ranks above any other claim or right against the purchaser, other than the right of a bona fide subsequent purchaser for value and without notice.
Proof of Claim
Any creditor who wants to participate in the distribution of a bankruptcy estate must provide the trustee a proof of claim. The proof of claim is a prescribed form that is sent with the notice of bankruptcy or notice of proposal. If a meeting of creditors is called, those creditors wishing to vote at the meeting must file their proof of claim with the trustee before the time set for the opening of the meeting.
A bankruptcy (liquidation) operates as an automatic stay of proceedings on the enforcement measures of unsecured creditors. The resulting assignment or receiving order takes precedence over all judgment enforcement measures. Secured creditors are not subject to this automatic stay of proceedings. Secured creditors are permitted to realize on their collateral, with the exception that a trustee may apply to the court for an order staying enforcement for up to six months.
Under the BIA rules for a reorganization proposal, a 30-day stay on all creditors' claims is automatic. Thereafter, if the court is satisfied that the debtor is working toward a viable proposal, three further stays of 45 days each may be granted.
The BIA contains several provisions that allow the trustee to set aside specific transactions, thus increasing the assets available to creditors. Certain types of gifts may be set aside. The court may review non-arm’s length transactions entered into within one year prior to the bankruptcy. Fraudulent preferences may be set aside. The trustee is also allowed to invoke provincial law concerning fraudulent conveyances and preferences.
Note: An arm’s length transaction is a sale involving a willing seller and a willing buyer without any undue pressure or special incentives. An example of a non-arm’s length transaction might be a sale between two relatives.
An insolvent company wishing to reorganize may make a proposal to its creditors under both the Bankruptcy and Insolvency Act and, if liabilities exceed Can $5 million, under the Companies’ Creditors Arrangement Act. A stay of proceedings by unsecured creditors (see Automatic Stay above) is normally in effect while the restructuring takes place. At the end of the process, it is expected that the company will continue under different ownership and probably different management.
Under the BIA, the debtor generally files a notice of intention to file a proposal with the provincial court. The notice of intention includes the name of the selected trustee, the names of all creditors owed more than Can $250, and the amounts owed. Copies of the filing must be delivered to all known creditors within 5 days. Within the next 10 days, a cash flow statement, attested to by the trustee, must be filed.
Once a proposal is filed, the trustee calls a meeting of creditors within 21 days. The automatic stay remains in force during this period. Each class of creditor votes separately, and it requires two-thirds in value and half in number of the creditors in a class for the proposal to bind that class. If the proposal passes the creditors, the court is asked to approve. If a proposal is rejected by the creditors, the debtor is found bankrupt and liquidation follows.
A basic difference between a proposal under the BIA and a Chapter 11 reorganization under U.S. bankruptcy law, is that there is no provision for a debtor-in-possession. In Canada, it is the assigned trustee who is responsible for administering the proposal.
Distribution of Proceeds
The trustee is responsible for the sale of the bankrupt’s estate. As mentioned above property that is subject to a security interest will be realized by the secured creditor outside the bankruptcy system. The remaining proceeds are then distributed to other creditors in priority order.
Various classes of claims are given a preference over general creditors on distribution. Each class must be fully paid out before the next class receives anything. Preferred claims include costs of administration of the bankruptcy, claims of employees, claims for municipal taxes, claims of landlords for arrears of rent, etc.
After the claims of all preferred creditors are fully satisfied, the balance is distributed among the general creditors.
Companies’ Creditors Arrangements Act (CCAA)
Unlike the BIA, the CCAA is quite open-ended. Action commences with a court application by the debtor company. Relief, as well as control of the proceedings, is within the discretion of the judge. The Act provides relatively little in terms of procedural guidance, though case law is firming this up. The business community and its professional advisors consider its flexibility to be particularly helpful in large and complex bankruptcies. Since 1997, only insolvencies where the assets involved exceed $5 million have access to the CCAA.
As with the BIA, two-thirds of value and half in number of creditors must approve the debtor’s plan of arrangement. However, unlike the BIA, failure of the plan does not result in automatic bankruptcy.
As all proceedings are directed by the Court, they are generally more costly than a reorganization under the BIA.
A somewhat contentious amendment to the BIA and CCAA was passed by Canadian parliament and given “Royal Assent” on November 25, 2005. Bill C-55, An Act to establish the Wage Earner Protection Program Act, to amend the Bankruptcy and Insolvency Act and the Companies’ Creditors Arrangement Act and to make consequential amendments to other Acts, remains on track to be proclaimed into force this summer, but not before June 30, 2006.
If proclaimed into force as currently drafted, Bill C-55 will give rise to new priority claims for unpaid wages and unpaid pension plan contributions that will rank ahead of all other secured creditors including those with purchase-money security interests. Bill C-55 will also provide statutory authority for the courts to grant priority charges over existing secured creditors for certain director and officer indemnities, debtor-in-possession financing, critical supplier payables and administrative expenses.
Web Sites Providing Information on Canadian Bankruptcy Law
Canadian corporate bankruptcy: law and public policy (2003): A PDF of an extensive document outlining the history of corporate bankruptcy law in Canada along with detailed explanation of the three statutes making up the bankruptcy law in Canada and various reforms to these acts.
Bankruptcy Canada: Much that you need to know about Canadian bankruptcies including an article on six insolvency prediction formulae and a dictionary of Canadian bankruptcy terms.
Office of the Superintendent of Bankruptcy: Site includes FAQs for creditors and debtors, publications, list of bankruptcy trustees, Canadian bankruptcy statistics, etc.
Bankruptcy and Insolvency Act: Full text of Act provided by the Canadian Legal Information Institute.
Companies' Creditors Arrangement Act: Full text of Act provided by the Canadian Legal Information Institute.
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