Liquidations

The two most common ways to liquidate an insolvent company in Canada are either through a bankruptcy proceeding under the BIA, or by way of an appointment of a receiver or interim receiver. In recent years, the CCAA has also been used as a process for the self-liquidation of a debtor, without a plan being filed and, in most cases, with the support and co-operation of the debtor’s main secured creditor(s).

3.1 Bankruptcy

3.1.1 How are bankruptcy proceedings commenced?

The legal process of bankruptcy (generally analogous in effect to Chapter 7 of the U.S. Code) can be commenced in one of three ways:

Involuntarily, by the filing of a bankruptcy application by one or more of the debtor's creditors; or

Voluntarily, by the debtor making an assignment in bankruptcy for the general benefit of its creditors; or

On the failure of a BIA proposal by the debtor to its creditors, as a result of the rejection of the proposal by creditors or the court, or default under the proposal.

3.1.2 What is the effect of the commencement of the bankruptcy proceeding?

When a corporate debtor becomes bankrupt, the debtor ceases to have legal capacity to dispose of its assets or otherwise deal with its property, which vests in a trustee in bankruptcy (other than property held in trust). Such appointment is expressly subject to the rights of secured creditors. Trustees in bankruptcy are licensed insolvency professionals who, in almost all cases, are chartered accountants. They are not government officials but they are licensed and regulated by a federal government office known as the Office of the Superintendent of Bankruptcy. In a voluntary proceeding, the debtor itself selects the trustee, however, the selection is subject to confirmation by unsecured creditors at the first meeting of creditors. In an involuntary proceeding, the applying creditor selects the trustee, also subject to confirmation at the first meeting. Unsecured creditors are to be provided with notice of the first meeting of creditors promptly after the trustee’s appointment.

3.1.3 What are the trustee's duties?

A trustee is an officer of the court and, accordingly, must represent the interests of creditors impartially. It is the trustee’s duty to collect the debtor’s property, realize upon it and distribute the proceeds of realization according to a priority scheme set out in the BIA (discussed below). The trustee is required to give notice of the bankruptcy to all known creditors of the bankrupt. The trustee must also convene a first meeting of the creditors of the bankrupt within 30 days of appointment, unless extended by the court.

At the first meeting of creditors, creditors with proven claims must confirm the trustee’s appointment. Proven creditors may also elect “inspectors” from their ranks who will then act in a supervisory role and instruct the trustee. There are certain actions that a trustee cannot engage in without inspector approval, such as carrying on the business of the bankrupt or the sale or other disposition of any property of the bankrupt. A trustee must obtain court approval if it wishes to undertake these actions prior to the appointment of inspectors. At the first meeting, the creditors can vote to dispense with inspectors.

3.1.4 How does a creditor prove its claim?

Upon the commencement of bankruptcy proceedings, unsecured creditors are stayed from exercising any remedy against the bankrupt or the bankrupt’s property and may not commence or continue any action or proceeding for the recovery of a claim (unless the creditor is granted special permission by the court). Secured creditors are not subject to this stay of proceedings (discussed below).

A creditor can assert its claim against the debtor by completing a statutorily prescribed proof of claim and submitting it to the trustee in bankruptcy. A proof of claim form is attached to the notice of bankruptcy sent by the trustee to all known creditors. The creditor must submit the completed form before the first meeting of creditors if it wishes to vote on the motion to affirm the appointment of the trustee or vote for and/or act as an inspector in the bankruptcy. Otherwise, the creditor need only submit its proof of claim before the distribution of proceeds by the trustee (known creditors will be provided notice before distribution).

A trustee can challenge the quantum of the amount set out in a proof of claim or the entire claim itself. Disputed claims may be resolved through a judicial process if the parties are not able to reach an agreement.

3.1.5 How does bankruptcy affect the rights of secured creditors?

The rights of a trustee in bankruptcy are expressly subject to the rights of secured creditors. Accordingly, bankruptcy does not affect the rights of secured creditors to enforce their security, however, the secured creditor may be delayed for a short period of time as the trustee reviews the security and determines if there is equity for the estate in the collateral subject to the security. A trustee will obtain an independent opinion of the security to confirm the validity and enforceability of the secured creditor’s security as against the trustee and the bankrupt’s property. To the extent that the amount of a secured creditor’s debt exceeds the value of the collateral subject to its security, a secured creditor may participate in the bankruptcy process and file a proof of claim in respect of the unsecured deficiency portion of its claim.

3.1.6 Can the trustee void certain pre-bankruptcy transactions?

Provided the assets available to the trustee are sufficient to support the costs, the trustee is responsible for scrutinizing the actions of the bankrupt before the bankruptcy and for reporting to creditors on transactions that may be impugned as preferences, fraudulent conveyances, transfers at undervalue or on other grounds and, where appropriate, commencing proceedings to challenge such transactions. If a challenge is successful, depending on the remedy, the transaction is either voided and property transferred by the debtor before the bankruptcy must be returned to the bankrupt estate or, in the case of a “transfer at undervalue” (described below), the difference in value between the actual consideration given by the debtor (if any) and the fair market value as determined by the court must be paid to the bankrupt estate. To the extent assets are not available to the trustee to pursue such remedies, creditors can apply to the court for an order to pursue the trustee’s remedies, for the benefit of those creditors that fund the proceedings.

The 2009 amendments to the BIA introduced the concept of “transfer at undervalue”, which is defined as a transfer of property made by the bankrupt for little or no consideration within one year of the initial bankruptcy event, when the bankrupt is insolvent and where the bankrupt intends to defeat or defraud creditors. The “initial bankruptcy event” is the earliest of the filing of the following: an assignment, a proposal, a notice of intention to file a proposal, a CCAA filing or the first application for a bankruptcy order against a person. Moreover, where the bankrupt disposes of property for little or no consideration to a party that is not at arm’s length, the relevant period of review is five years.

Another change introduced by the 2009 amendments is that in respect of transactions with non-arm’s-length parties, it is no longer a defence for debtors to prove that they did not intend to make a preferential payment. The fact of a non-arm’s-length creditor having received a preference is sufficient to void the transaction, irrespective of whether or not the debtor actually intended to give such preference.

Generally, Canadian trustees are much less aggressive in attacking pre-bankruptcy transactions than their U.S. counterparts and the technical requirements to void such transactions are more onerous than they are in the United States.

3.1.7 What rights do unpaid suppliers have?

Suppliers have a limited right to recover inventory supplied to a bankrupt debtor. Prior to the amendments, unpaid suppliers could repossess goods delivered 30 days before the issuance of the demand for the return of such goods following a bankruptcy or receivership of the customer. The amendments provide a modest change, allowing unpaid suppliers the right to repossess goods shipped 30 days before the date of bankruptcy or receivership, rather than having the time-frame tied to the date the demand was issued. In addition, the written demand must be sent within 15 days of the purchaser becoming bankrupt or subject to a receivership. The goods must be identifiable, in the same state as on delivery, still in the possession of the trustee or receiver, and not subject to an arm’s-length sale. In practice, suppliers often find it difficult to satisfy these tracing requirements.

3.2 Receiverships

3.2.1 What is a receiver?

A receiver or receiver and manager, which must be a licensed trustee in bankruptcy, may be given the authority to deal with the debtor company’s assets, including authority to operate and manage the business in place of the existing management, and to shut down the business if the receiver concludes the continued operations will likely erode the recoveries for creditors or there is insufficient funding to continue operations. The receiver does not become the owner of the debtor company’s assets; however, the receiver may have the right (but not the obligation) in the order appointing it to take possession and custody of the assets and to sell them.

3.2.2 How is a receiver appointed?

A receiver may be appointed (i) privately by a secured creditor pursuant to the terms of a security agreement or (ii) by court order.

(a) Privately Appointed Receiver. A secured creditor may have the right to appoint a receiver under its security agreement. The receiver’s duties are primarily to the secured creditor that appointed it. It also has a general duty to act honestly, in good faith and in a commercially reasonable manner, including the duty to attempt to maximize recoveries, and to obtain the best price for the debtor’s assets in the circumstances.

(b) Court-Appointed Receiver. In the case of a court-appointed receiver, the receiver is appointed by a court order, typically on application by a secured creditor under the Rules of Court of the province where the debtor’s business is based. Generally, the courts in the common law provinces (i.e., all provinces other than Quebec) have the authority to appoint a receiver when the court is satisfied that it is “just or convenient” to do so. As a result of the 2009 amendments, courts also have the authority to appoint receivers under the BIA, with authority across Canada (the BIA being a federal statute) as opposed to in a particular province, as is the case with receivers appointed under provincial Rules of Court. Court appointments usually occur in more complex cases, especially where there are significant disputes among creditors or between the creditor and the debtor or in cases where it appears likely from the outset that the assistance of the court will be required on an ongoing basis.

A receiver appointed by the court derives its powers from the court order and any specific legislation governing its powers. The receiver is an officer of the court and has duties to all creditors of the debtor. It takes directions and instructions from the court, not the creditor that first sought its appointment. In most cases, the court order appointing the receiver gives the receiver broad powers similar to those normally granted to a privately appointed receiver under a security agreement, although certain actions, such as major asset sales, usually require specific court approval.

(c) Interim Receiver. Prior to the 2009 amendments to the BIA, it was quite common in cases where a debtor had assets in several provinces for an “interim receiver” to be appointed by the court pursuant to the provisions of the federal BIA. The advantage of the federal interim receiver was that its jurisdiction extended nationally by virtue of the federal scope of the BIA, while the jurisdiction of a receiver appointed under the Rules of Court is limited to the province in which it is appointed. While the title suggested a temporary role, interim receivers were often given a mandate similar to an ordinary court-appointed receiver, and were often appointed as both interim receiver under the BIA and as receiver under the applicable Rules of Court, in order to exercise authority across Canada.

The 2009 amendments now restrict “interim receivers” to having a more temporary mandate. The appointment of the interim receiver expires on the earlier of: (a) the taking of possession by it or a trustee in bankruptcy of the debtor’s property, and (b) the expiry of 30 days following the day on which the interim receiver was appointed or any period specified by the court, or in the case that an interim receivership coincides with a proposal, upon court approval of the proposal. This restriction on the duration of an interim receivership and the advent of the national receiver has triggered a decline in the use of interim receiverships.

3.2.3 What reporting requirements does a receiver have?

On its appointment, the receiver must provide notice of its appointment to all known creditors and, at various stages of administration of the receivership, prepare and distribute interim and final reports concerning the receivership. These reports are filed with the Office of the Superintendent of Bankruptcy and may be made available to all creditors. Court-appointed receivers must also report to the court itself.

3.2.4 How do creditors assert their claims in a receivership?

Where a receiver is court-appointed, the court will typically issue a stay of proceedings restricting creditors from exercising any rights or remedies without first obtaining permission from the court. This stay will be much broader than the statutory stay of proceedings that occurs when a company simply becomes bankrupt and is generally analogous to the comprehensive stay of proceedings found in CCAA proceedings.

Typically, once a receiver has realized on the assets of the debtor, it will seek to distribute proceeds to creditors in accordance with their entitlements and priority, following court approval. If the only recovery is to secured creditors, there may be no need for a claims process. If there are any surplus funds after satisfying all secured claims, the receiver may run a court-sanctioned claims process or seek the court’s approval to assign the debtor into bankruptcy and have unsecured claims dealt with through bankruptcy proceedings (described above).

3.3 Priorities in Liquidation

3.3.1 Are there super-priority claims?

Secured creditors rank in priority to unsecured creditors in a liquidation; however, there are certain statutorily prescribed super-priority claims that will rank ahead of secured creditors.

The 2009 amendments to the BIA establish a priority for certain workers (the priority does not apply to wage claims of officers or directors of the debtor company), to a maximum of C$2,000 per employee, for unpaid wages (including vacation pay) earned up to six months before the appointment of a receiver or initial bankruptcy event. The priority is secured by a charge over the debtor company’s current assets, which are essentially inventory and receivables. To the extent that a receiver or trustee pays the aggrieved worker, the secured claim is reduced accordingly.

The Wage Earner Protection Program Act establishes a program run by the federal government through which employees entitled to claim a priority for unpaid wages are compensated directly by the government, to a maximum of the greater of C$3,000 in actual unpaid wages or an amount equal to four times the maximum weekly insurable earnings under the Employment Insurance Act (which currently equals approximately C$3,323). The government is subrogated to the rights of the unpaid employee for amounts paid under this program, and receives a priority claim against the current assets of the debtor company in the amount of the compensation actually paid out, to a maximum amount of C$2,000 per employee. Any balance over such C$2,000 priority claim does not have priority over secured creditors.

The 2009 amendments to the BIA also establish a priority for amounts deducted and not remitted and for unpaid regularly scheduled contributions (i.e., not special contributions or the underfunded liability itself) to a pension plan by creating a priority charge, equal to the amount owing, over all of the debtor company’s assets.

The recent amendments to the CCAA effectively provide the same priorities for unpaid wages and unpaid pension contributions against proceeds realized in a CCAA sale, and also require that any plan of arrangement provide that such priority claims be satisfied.

Before distributions are made to unsecured creditors in an insolvency proceeding, certain statutorily mandated priority claims, such as employee deductions (i.e., income tax withholdings, unemployment insurance premiums and Canada Pension Plan premiums) must also be paid.

In addition to those listed above, there are a number of other federal and provincial statutory liens and deemed trusts that have priority over secured creditors outside of bankruptcy, but which are treated as ordinary unsecured claims following bankruptcy (e.g., liens for unremitted federal and provincial sales tax). CCAA liquidations and receivership proceedings are often converted into bankruptcy proceedings once the statutory super-priority claims and secured creditor claims are satisfied, in part to achieve a reversal of priorities.

A recent decision of the Ontario Court of Appeal departed from earlier case law, however, and held that it was not appropriate for a company that also acted as the pension plan administrator to seek to bankrupt itself in order to defeat the deemed trust provided for under the Pension Benefits Act (Ontario) (PBA). Moreover, the Court of Appeal held that a deemed trust created under the PBA extends to the entire wind-up deficiency of a defined benefit pension plan, and not just to unpaid regular contributions and special payments (the relevant personal property security legislation in Ontario grants priority to the PBA deemed trust over secured creditors’ security interests in inventory and receivables). A wind-up deficiency is the amount that needs to be funded to fully satisfy obligations owing to beneficiaries upon wind-up or termination of a defined benefit plan, and is therefore potentially many orders of magnitude greater than any unpaid scheduled contributions, and a liability that is significantly more difficult to calculate in advance of a winding-up of a pension plan. On the facts of the particular case, the deemed trust for the wind-up deficiency took priority even over the charge securing DIP financing, however, the Court of Appeal was clear that under the right circumstances, a DIP charge could have priority over the PBA deemed trust. As of September 2011, leave to appeal to the Supreme Court of Canada has been sought but not yet granted.

3.3.2 What is the priority scheme after the super-priorities and secured creditors are satisfied?

The BIA sets out the priority scheme for distribution to unsecured creditors, primarily as follows:

The costs of administration of the bankruptcy;

A Superintendent of Bankruptcy’s levy on all payments made by the trustee to creditors (which is currently approximately 5%);

Preferred claims, which include wage claims in excess of the statutory C$2,000 charge, secured creditors’ claims in the amount equal to the difference between what they received and what they would have received but for the operation of the wage and pension super-priorities, and landlords’ claims up to the maximum amounts prescribed by statute; and

Ordinary unsecured claims on a pro rata basis.