Restructuring and insolvency in Canada: overview

A Q&A guide to restructuring and insolvency law in Canada.

The Q&A gives a high level overview of the most common forms of security granted over immovable and movable property; creditors' and shareholders' ranking on a company's insolvency; mechanisms to secure unpaid debts; mandatory set-off of mutual debts on insolvency; state support for distressed businesses; rescue and insolvency procedures; stakeholders' roles; liability for an insolvent company's debts; setting aside an insolvent company's pre-insolvency transactions; carrying on business during insolvency; additional finance; multinational cases; and proposals for reform.

To compare answers across multiple jurisdictions, visit the Restructuring and insolvency Country Q&A tool.

This Q&A is part of the global guide to restructuring and insolvency law. For a full list of jurisdictional Q&As visit www.practicallaw.com/restructure-guide.

David Cohen and Alex MacFarlane, Gowling Lafleur Henderson LLP
Contents

Forms of security

1. What are the most common forms of security granted over immovable and movable property? What formalities must the security documents, the secured creditor or the debtor comply with? What is the effect of non-compliance with these formalities?

Canada is a federal jurisdiction with two distinct legal systems. All provinces and territories are common law jurisdictions except the Province of Québec, which is a civil law jurisdiction. The common forms and requirements for the creation and perfection of security granted over immovable and movable property depend on the provincial jurisdiction.

Immovable property

Since the scope of immovable property is a matter of provincial law, reference should be made to the applicable provincial laws in the jurisdiction where the property is situated. Generally, real estate is classified as immovable property, while fixtures attached to real property may or may not be considered immovable property.

Common law jurisdictions

Common forms of security and formalities. Security over immovable property can be granted by way of a:

  • Mortgage. This is generally used where there is a single piece of real property that is financed by a single lender.

  • Debenture. This is commonly used in commercial lending transactions to cover multiple pieces of real property, as well as movable property. Like a mortgage, there is often only one lender.

  • Trust deed. This is commonly used in sophisticated bond financings and syndicated loan transactions where many lenders are involved.

In addition to the above, in very rare circumstances a person without a registered mortgage may be able to assert an equitable mortgage or interest in immovable property. This can occur where the original mortgage documentation is defective in some way and the court is asked to deem the mortgage as an equitable mortgage.

For a security interest granted over immovable property to be enforceable, the mortgage, debenture or trust deed must be:

  • In writing.

  • Registered on the title to the property subject to the charge. Each Canadian province and territory has its own real property registry system. Registration of a charge in the applicable real property registry system constitutes notice of a security interest.

The various provincial Personal Property Security Acts (PPSA) may apply to fixtures that have become immovable property, provided the security interest was created when the fixture was movable property (see below, Movable property).

Effects of non-compliance. If the registration requirements are not complied with:

  • The creditor's security interest will be ineffective over the debtor's immovable property in a bankruptcy.

  • Any secured creditors in relation to such property will rank alongside other unsecured creditors in priority in a bankruptcy (see Question 2).

Québec

Common forms of security and formalities. Security over immovable property is generally obtained through a hypothec, which is similar in function to a mortgage. To be enforceable, a hypothec must be:

  • Created by deed.

  • Signed in the presence of a Québec notary.

  • Registered in the land registry office for the jurisdiction where the property is located. Registration of a hypothec serves as notice of the security.

Effects of non-compliance. If the registration requirements are not complied with:

  • The creditor's security will be ineffective over the debtor's immovable property in a bankruptcy.

  • Any secured creditors in relation to such property will rank alongside other unsecured creditors in priority in a bankruptcy (see Question 2).

Movable property

The treatment of movable property differs depending on whether the movable property is located in a common law or civil law jurisdiction.

Common law jurisdictions

Common forms of security and formalities. In the common law jurisdictions, creditors can take security over movable property pursuant to a properly executed and registered security agreement. Types of security agreements include:

  • General security agreement. An agreement whereby the debtor grants the secured party a security interest over all of the debtor's present and after-acquired property.

  • Chattel mortgage or equipment lease. An agreement whereby the debtor grants a security interest over specific assets.

Security agreements can also grant a security interest over third party receivables that are owed to the debtor pursuant to a receivable financing agreement.

For movable property, most Canadian provinces have adopted provincial PPSA legislation, which is loosely modelled on Article 9 of the Uniform Commercial Code (UCC). The UCC is not a US federal law, but rather a set of laws governing commercial transactions between US states and territories in relation to borrowing money, leases, contracts and the sale of goods (for details see www.sba.gov/category/navigation-structure/starting-managing-business/starting-business/understand-business-law-7).

PPSA legislation is structured to apply to every transaction which creates (in substance) a security interest in personal property without regard to the particular type of security involved.

To be enforceable against third parties, a security interest in the debtor's personal property must be both:

  • Attached. Attachment of a security interest occurs when all of the following are performed:

    • value is given;

    • the debtor has acquired rights in the secured asset over which the security is being granted;

    • a written security agreement is signed by the debtor; and

    • the written security agreement provides a clear description of the secured asset over which the security interest has been granted.

  • Perfected. Perfection of a security interest can be achieved through:

    • Registration under the PPSA in the applicable electronic registration system; or

    • Possession by the secured party, if the secured asset is chattel paper, a tangible good, an instrument, a negotiable document of title or money.

    Investment property can be perfected by control. Control is obtained when a secured party can sell the property without any further action by the debtor. Depending on the type of investment property, this can be achieved by either:

    • becoming the entitlement holder; or

    • entering into a control agreement.

    Investment property includes:

    • certificated or uncertificated security;

    • security entitlement;

    • securities account;

    • futures contract;

    • futures account.

    A security interest in a secured asset that is perfected as at the date a debtor commences insolvency proceedings will be effective against all the other creditors of the debtor. On the other hand, an unperfected security interest will have the following consequences:

    • the security interest will not be effective in an insolvency; and

    • in terms of priority, the creditor will rank as an unsecured creditor (except in relation to certain specific types of secured assets that can be perfected by possession or control).

Effects of non- compliance. A security interest in the personal property of a debtor that has not attached and/or been perfected will be ineffective as against a trustee in bankruptcy. This means the creditor will rank with any other unsecured creditors for any recovery of debt.

Québec

Common forms of security and formalities. Security over movable property in Québec is granted under a hypothec, as with immovable property (see above, Immovable property, Québec: Common forms of security and formalities). However, the requirements for the deed of hypothec are different for movable property in Québec:

  • A notary is not required for the creation of a hypothec.

  • To be published (perfected), either:

    • the security must be recorded electronically in the Register of Personal and Movable Rights Registry ("RPMRR");

    • the property subject to the security interest must be delivered to the creditor or third party (pledge); or

    • the creditor must have obtained control of the property subject to the security.

Title retention. Although not a form of security per se, a reservation of ownership (title retention) may be published at the RPMRR by the owner of movable property subject to a contract of sale by instalment, a lease, or a leasing agreement (crédit-bail) to render his or her ownership opposable to third parties.

Effects of non-compliance. A security in the movable property of a debtor that has not been published will be ineffective against a trustee in bankruptcy. This means the creditor will rank with any other unsecured creditors for any recovery of debt.

 

Creditor and contributory ranking

2. Where do creditors and contributories rank on a debtor's insolvency?

Creditor claims on a debtor's insolvency rank in the following order:

  • Super-priority claims. These include:

    • valid trust claims;

    • realty property taxes;

    • certain deemed trusts and super-priority pension and wage claims;

    • claims under the Wage Earner Protection Act;

    • qualified unpaid supplier claims, commonly referred to as "30-day good claims" or "revendication claims" (these are similar to reclamation rights under the US Bankruptcy Code);

    • unremitted payroll deductions; and

    • court-ordered charges in CCAA proceedings (see Question 6) and bankruptcy proceedings (see Question 7).

  • Secured claims.

  • Preferred unsecured claims. These include:

    • landlord claims for up to three months' accelerated rent;

    • amounts that would been paid to a secured creditor but for the payment of wage and pension claims; and

    • certain workers' compensation claims.

  • General unsecured claims.

Creditor claims have priority over shareholder claims. Secured creditors rank ahead of preferred and unsecured creditors other than for certain claims that are given priority under statute. In some instances, the priorities can differ depending on the type of insolvency proceeding.

In CCAA proceedings, or BIA proposaI proceedings, administrative expenses (i.e. the costs of the insolvency proceedings) are typically paid first ahead of all priority claims, including the claims of employees and any deemed trust claims, or super priority pension and wage claims.

The claims of secured creditors will be paid from the proceeds of any sales that occur during the insolvency proceedings in accordance with their priority status as existed as of the date of the sale. To the extent that there remains surplus proceeds after satisfaction of the claims of secured creditors from the assets subject to their security, those surplus proceeds will be shared rateably among all general unsecured creditors.

 

Unpaid debts and recovery

3. Can trade creditors use any mechanisms to secure unpaid debts? Are there any legal or practical limits on the operation of these mechanisms?

Trade creditors can secure unpaid debts by registering a purchase money security interest (PMSI). A PMSI permits trade creditors to claim a prior ranking security interest over the inventory or equipment they have sold or financed, which ranks ahead of all other PPSA claims in relation to the same collateral, provided the technical registration and notice requirements are strictly observed. This is beneficial where other PPSA registrants have previously taken a general security interest in all present and after-acquired property.

A PMSI can be created in the following situations:

  • A security interest taken or reserved in collateral, to secure payment of all or part of the price of the collateral, other than investment property.

  • A security interest taken in collateral, other than investment property, by a person who gives value for the purpose of enabling the debtor to acquire rights in or to the collateral, to the extent that the value is applied to acquire the rights.

  • The interest of a lessor of goods, under a lease term that exceeds one year (including leases for less than one year but which contain renewal options exceeding one year).

Trade creditors have other mechanisms to secure unpaid debts, including:

  • A general or specific security agreement in relation to the collateral being sold or financed.

  • A cash deposit.

  • A letter of credit in respect of the debtor issued by a financial institution.

  • A personal guarantee from a principal of the debtor.

In addition to the above, trade creditors can ship consignment goods under a consignment agreement. By entering into a consignment agreement, the goods subject to consignment do not become the property of the debtor, even though the debtor takes delivery of the goods. Care should be taken to conform to the technical consignment law requirements, including the requirement for the goods to be segregated or clearly marked. This means that if the debtor becomes insolvent, the trade creditor can require the return of its property. If the consignment agreement is for less than a year (including renewal periods) it does not need to be registered under the PPSA. However, Ontario differs from other Canadian provinces, in that its PPSA has no requirement to register consignment agreements, even if they are for longer than one year.

 
4. Can creditors invoke any procedures (other than the formal rescue or insolvency procedures described in Questions 6 and 7) to recover their debt? Is there a mandatory set-off of mutual debts on insolvency?

Unsecured creditors

An unsecured creditor can initiate legal proceedings against a debtor to recover debt. A judgment obtained in favour of the unsecured creditor:

  • Is enforceable against the debtor.

  • Permits the unsecured party to rank higher in priority than other unsecured creditors.

However, once formal insolvency procedures are commenced an unsecured creditor's claim will rank pari passu with other unsecured claims, regardless of whether the judgment was obtained against the debtor.

In addition to initiating legal proceedings, trade creditors can also enforce their debts against the debtor by:

  • Ceasing to supply goods and services to the debtor.

  • Demanding cash on delivery.

Secured creditors

Secured creditors have the same remedies available to them to recover debt as unsecured creditors. However, secured creditors can also enforce their security interest against the debtor's collateral.

Under section 244 of the Bankruptcy and Insolvency Act (BIA), a secured creditor must provide the debtor with ten days notice if it intends to enforce its security interest against "all or substantially all" of the debtor's assets. This is known as a "244 Notice". Following delivery of the enforcement notice to the debtor, the debtor can elect to waive the ten-day notice period. The objective of the ten-day notice period is to provide the debtor with an opportunity to decide if it should initiate formal rescue or other insolvency procedures.

A secured creditor can seek to enforce its security interest against the debtor by taking direct possession of the collateral. However, the secured creditor must deliver a 244 Notice prior to taking possession or enforcing on its security. A secured creditor can also:

  • Sell the collateral and apply the sale proceeds against the debt.

  • Retain the collateral in satisfaction of the debt.

  • Appoint a receiver to realise the assets (see Question 6).

Set-off

During insolvency, a right of set-off can arise by law, in equity or by contract.

Legal set-off. There are two requirements that must be met for the claim of legal set-off to be made:

  • The cross claims must be liquidated, enforceable and mature.

  • The claims must have arisen between the same parties acting in the same capacity (the claims must be mutual).

Equitable set-off. Unlike a set-off arising by law, an equitable set-off does not require the claims to be liquidated, enforceable and mature, or that they be mutual. However, when determining if equitable set-off is available, the courts will inquire into the connection between the claims. Equitable set-off is available if it would be inequitable to allow one claim to be enforced without taking the other claim into account.

Contractual set-off. Contractual set-off occurs when, under certain claims, the parties agree that neither legal nor equitable set-off would necessarily apply, but that each party to the contract in question has the right of set off in respect of any amounts that may be owed against any amounts that may be owing to such party by the counterparty.

There is no distinction between creditors located inside and outside of Canada.

 

State support

5. Is state support for distressed businesses available?

Canadian governments generally do not provide financial support for distressed businesses. However, government intervention has occurred on rare occasions where the matter is deemed to be of public interest.

 

Rescue and insolvency procedures

6. What are the main rescue/reorganisation procedures in your jurisdiction?

CCAA proceedings

Objective. Large capital companies can seek protection from their creditors under the provisions of the Companies' Creditors Arrangement Act (CCAA). The principal objective of the CCAA is to enable the debtor company to formulate a plan of compromise in respect of the debtor's obligations owing to its creditors, to be voted on by such creditors, and if approved by the requisite majority in each class of creditors, sanctioned by the court overseeing the debtor company's CCAA proceedings. However, in most CCAA proceedings the debtor never actually formulates or files a plan of reorganisation, but typically uses the CCAA proceedings as a mechanism to effect a sale of all, or part of its business, property and/or assets.

Initiation. CCAA proceedings can be initiated by either a creditor or the debtor. The court will generally exercise its discretion to grant protection if:

  • A reorganisation would be favourable to the debtor company's creditors.

  • The debtor company has a reasonable likelihood of continuing as a going concern and can develop an acceptable reorganisation plan.

  • The debtor company does not have an improper motive for making the application.

Provided the debtor company can establish that it meets the requirements of the CCAA, the burden will be on any opposing creditors to show why the court should not grant the debtor the opportunity to reorganise.

Substantive tests. To proceed under the CCAA, the debtor must:

  • Be insolvent, meaning that either:

    • the debtor is unable to meet its liabilities as they fall due (cash flow test);

    • the debtor's assets are less than its liabilities (balance sheet test).

  • Have debts in excess of Can$5 million (including any affiliate companies),

There is no obligation imposed on the directors of the debtor company to initiate insolvency proceedings on behalf of the debtor company, although the directors may consider it prudent to initiate such proceedings in order to avoid, or minimise any statutory liabilities of the debtor company for which they may be personally liable by reason of being a director of an insolvent company. Directors may also consider that an insolvency filing is required in order to avoid any potential claims that the debtor company traded while “knowingly insolvent”.

Consent and approvals. For a reorganisation plan to be accepted by its creditors, a meeting must be held for the purpose of voting on the reorganisation plan, and a majority in number of each class of creditors holding two-thirds in value of the total debt represented by that class, must vote in favour of the plan. Once the reorganisation plan is accepted by the requisite majority in each class of creditor, the plan must then be approved by the court before it becomes binding on those classes of creditors which voted in favour of the plan.

Supervision and control. Under the CCAA, a monitor (that is, a person licensed to act as a trustee, (typically an accounting firm) who has not been the company's auditor within the two year period preceding the CCAA application) is appointed to supervise the debtor company and to assist the debtor company with the formulation of its plan of reorganisation. The debtor remains in control of its business and its property and assets, but is subject to the monitor's scrutiny. If a transaction is outside the ordinary course of business, or does not comply with any court imposed restrictions, the monitor will report such activities to the court.

Protection from creditors. Once an application under the CCAA has commenced and the court has granted the debtor CCAA protection, the court will issue an order (Initial Order) prohibiting all creditors (both secured and unsecured) from taking any further steps to pursue any existing or future claims against the debtor and its directors and officers, without either the:

  • Prior consent of the debtor and the monitor.

  • Leave of the court.

The Initial Order is usually granted for no more than 30 days although this can be extended (see below, Length of procedure).

In relation to intellectual property licences, a debtor company that initiates CCAA proceedings cannot deprive a licensee of its right to use intellectual property for as long as the licensee continues to perform its obligations under the governing licence agreement. Furthermore, a debtor company will not be deprived of its ability to continue to use intellectual property licensed to it as a result of obligations owing by the debtor company to the licensor for the period preceding the CCAA proceedings.

Suppliers to the debtor company are required to continue to supply goods and services during CCAA proceedings on the same terms that existed prior to the commencement of the CCAA proceedings, but suppliers are not obligated to extend credit to the debtor company during such period.

Length of procedure. There is no prescribed time limit for CCAA proceedings. However, proceedings typically can be completed in less than a year. After the making of the Initial Order, the debtor is granted up to 30 days of protection from its creditors. Within the initial 30-day stay period the debtor must return to court in order to request an extension. After the initial 30-day protection period there is no limit on the length of any extension or on the number of extensions that a debtor may seek from the court.

Conclusion. Once the CCAA reorganisation plan is approved by the requisite majority of the debtor's creditors in each class and is thereafter sanctioned by the court, the debtor will have successfully negotiated a compromise with its creditors with regard to the debts owed to such creditors prior to the commencement of CCAA proceedings, provided that the payments required under the CCAA and the plan are made when required. After the implementation of the plan and at the conclusion of the CCAA proceedings, the debtor can resume its normal business operations.

BIA Proposal

Objective. This is a proposal proceeding under the BIA. The principal objective of a BIA proposal is to enable the debtor to reach a compromise with its creditors through a restructuring of its obligations pursuant to a proposal. BIA proposal proceedings are also used as a mechanism by the debtor to effect a sale of all, or part of its business, property and/or assets.

Initiation. The creditor initiates a BIA proposal by either filing a proposal, or filing a notice of intention to make a proposal (Notice of Intention). On the filing of the Notice of Intention, all creditors are stayed for an initial period of 30 days (unless a secured creditor has filed a 244 Notice and the statutory ten day period has expired) (see below, Protection from creditors).

If the creditors who are subject to the proposal or the court refuse to approve the proposal, the debtor is automatically deemed to have made an assignment into bankruptcy (see Question 7).

Substantive tests. To proceed with a proposal under the BIA, the debtor must:

Consent and approvals. A proposal under the BIA must be approved by at least two-thirds in value and a majority in number of the creditors, including the secured creditors to whom the proposal was made.

Following the creditors' approval, the court must approve the proposal on the basis that it is for the general benefit of the creditors. For the court to approve a BIA proposal, evidence must be provided that the creditors will be better off under the proposal than if the debtor was liquidated pursuant to a bankruptcy.

Supervision and control. After the debtor files a proposal or a Notice of Intention, a trustee is appointed by the court to supervise the process. The role of the trustee is to:

  • Monitor the debtor's actions.

  • Assist the debtor to develop a proposal and work with the debtor to reach a compromise with its creditors.

  • Alert the court if there are any adverse material changes.

However, the trustee does not have any direct control over the debtor's affairs and the debtor remains in control of its property and assets.

If the BIA proposal proceedings transition into a bankruptcy, the debtor will cease to carry on business and the trustee in bankruptcy will take possession and control of the debtor's property and assets (see Question 7).

Protection from creditors. Once a proposal or Notice of Intention has been filed, no creditors (whether secured or unsecured) can bring or continue any proceedings against the debtor. The stay prohibits any creditor, including a secured creditor, from exercising any remedy against the debtor or its property, or commencing or continuing any action, execution or other proceeding for the recovery of a claim provable in bankruptcy. Secured parties can only enforce their security interest if they have served a 244 Notice on the debtor and the statutory ten day notice period has expired or the debtor company consented to an earlier enforcement by the secured creditor at the time that the 244 Notice was delivered by the secured creditor, or thereafter.

With respect to intellectual property licences, a debtor/licensor who initiates a BIA proposal proceeding cannot deprive a licensee of its right to use the intellectual property under a licence agreement as long as the licensee continues to perform its obligations under the governing licence agreement. Furthermore, a debtor/licensee cannot be deprived of its ability to continue to use intellectual property licensed to it as a result of obligations owing by the debtor licensee company to the licensor for the period preceding the initiation of the BIA proposal proceedings.

Suppliers to the debtor company are required to continue to supply goods and services during BIA proposal proceedings on the same terms that existed prior to the commencement of the BIA proceedings, but suppliers are not obligated to extend credit to the debtor company during such period.

Length of procedure. Unlike CCAA proceedings, a BIA proposal has defined time limits. On the filing of a Notice of Intention, all creditors are stayed for an initial period of 30 days. The time for filing a proposal (and the stay period) can be extended by the court for a maximum period of six months (including the initial 30 day stay), in 45-day intervals. On an application to extend, the burden is on the debtor to establish all of the following:

  • It has acted in good faith.

  • A viable proposal is likely to be developed if the extension is granted.

  • No creditor will be materially prejudiced by the extension of the stay.

Conclusion. Under a BIA proposal, the debtor continues to deal with its property and assets. If the requisite majority of the debtor's creditors in each class of creditors and the court ultimately approve the BIA proposal, provided the debtor complies with its obligations under the proposal, the debtor will have successfully negotiated a compromise for its pre-filing indebtedness with its creditors. However, if the debtor defaults on its obligations to its creditors under the proposal, as approved, the debtor will be deemed to have made an assignment into bankruptcy (see Question 7).

Once the debtor has fulfilled its obligations (as set out in the BIA proposal), the trustee will issue a certificate confirming that the debtor's obligations under the proposal have been fully complied with. At that point, the debtor is considered to have completed its restructuring and will be able to resume its normal business operations.

Receivership

The BIA also provides for the enforcement of security and the appointment of a receiver on a national basis. A secured creditor who plans to enforce its security on all or substantially all property and assets of an insolvent debtor must give prior notice of its intention to do so by way of a 244 Notice and then must wait ten days after sending the 244 Notice before taking further steps, unless the debtor consents to an earlier enforcement at the time of the delivery of the 244 Notice.

Once the receiver is appointed, the receiver must:

  • Give notice of its appointment to all creditors.

  • Issue reports on a regular basis outlining the status of the receivership.

  • Prepare a final report and statement of receipts and disbursements when the appointment is terminated.

A receiver or receiver/manager is appointed either:

  • Privately, by a secured creditor. Where a security agreement provides for the private appointment of a receiver, the powers of the receiver must also be set out in the agreement. Unlike a court-appointed receiver (see below), a private receiver's loyalties reside with the appointing creditor, and the receiver will work to maximise recoveries for the creditor. Privately appointed receivers usually have broad powers, including the power to:

    • carry on the business; and

    • sell the debtor's assets by auction, tender or private sale.

Although private appointments can reduce costs and delays and provide the secured creditor with greater control over the realisation process, it is often advisable to obtain a court appointment. This is especially the case if:

  • there are major disputes among creditors or with the debtor; and/or

  • it is clear that the assistance of the court will be required throughout the receivership.

It is also often important to potential purchasers of the assets of the debtor from the receiver to have the protection of a court order approving the sale of assets.

  • By court order. The jurisdiction for a court appointment of a receiver is found in the applicable provincial judicature acts and rules for court proceedings and pursuant to section 243 of the BIA. A receiver can be appointed under the rules for court proceedings and applicable provincial judicature acts alone, but it is more common for the appointment to be made under both the BIA, if by a secured creditor, and the rules for court proceedings/judicature acts.

    The court's appointment of a receiver usually begins with a secured creditor commencing an action or application against the debtor. The receiver is then appointed in a summary proceeding within the action or application. The order appointing the receiver typically:

    • stays proceedings against the receiver and debtor;

    • provides the receiver with control over the property and assets of the debtor;

    • authorises the receiver to carry on the debtor's business and to borrow money on the security of the assets; and

    • ultimately authorises the receiver to sell the debtor's property and assets with the approval of the court.

    The court order also typically authorises the receiver to commence and defend litigation in the debtor's name.

    While the duty of a privately appointed receiver is primarily to the appointing secured creditor (subject to a general duty to act in a commercially reasonable manner) (see above), the court-appointed receiver is an officer of the court and has a duty to protect the interests of all of the debtor's creditors. By the nature of its appointment, a court-appointed receiver may not be entitled to obtain an indemnity from the secured creditor who sought the appointment.

    A court appointment may be necessary if the debtor opposes the appointment of the receiver and will not let the receiver into possession. In certain provincial jurisdictions, the courts will grant possession orders and affirm the appointment of a private receiver with powers as set out in the security documents, thereby avoiding the requirement for a formal court appointment.

 
7. What are the main insolvency procedures in your jurisdiction?

Bankruptcy

Objective. An insolvent liquidation is commonly carried out as a bankruptcy under the BIA. In the context of liquidation, the BIA is intended to provide for the fair distribution of the debtor's unencumbered assets among its unsecured creditors.

The right to file a claim and receive a dividend in the distribution of the proceeds derived from the liquidation of the bankrupt's unencumbered assets replaces all of the pre-bankruptcy remedies of the debtor's unsecured creditors. However, the bankrupt's secured creditors can also enforce their security outside of the administration of bankruptcy (see Question 4).

Initiation. When a debtor is insolvent, a bankruptcy can be initiated in three ways:

  • The debtor voluntarily assigns itself into bankruptcy.

  • The debtor is involuntarily placed into bankruptcy by its creditors.

  • The debtor becomes bankrupt as a result of the failure of a BIA proposal (see Question 6, BIA proposal).

If the debtor assigns itself into bankruptcy voluntarily, he can choose a trustee.

However, if the debtor is involuntarily placed into bankruptcy, he will have one appointed for him.

For a corporate debtor, initiation also requires the company's board of directors to pass a resolution prior to the court approving the assignment into bankruptcy. There is no obligation imposed on the directors of the debtor company to initiate bankruptcy proceedings on behalf of the debtor company, although the directors may consider it prudent to commence a bankruptcy proceeding in order to avoid, or minimise any statutory liabilities of the debtor company for which they may be personally liable by reason of being a director of an insolvent company. Directors may also consider that a bankruptcy filing is required in order to avoid any potential claims that the debtor company traded while “knowingly insolvent”.

Substantive tests. The debtor is considered bankrupt when he:

  • Has debts of at least Can$1,000 owing to its creditors.

  • Has committed an act of bankruptcy within the six months prior to the application for a bankruptcy order (which may include having become insolvent and unable to meet its financial obligations generally as they become due).

Consent and approvals. An involuntary bankruptcy is made by order of the court upon application by one or more creditors of the debtor. A voluntary bankruptcy is commenced by the trustee in bankruptcy selected by the debtor filing an assignment in bankruptcy with the Superintendent of Bankruptcy.

Supervision and control. Once the bankruptcy is effective, all of the debtor's property and assets vest in the trustee, subject to the rights of secured creditors, and the debtor ceases to have any control over its affairs. The trustee must be licensed by the Superintendent of Bankruptcy (that is, an independent government agency responsible for the supervision and integrity of the Canadian bankruptcy system). In a corporate bankruptcy the trustee:

  • Replaces the management of the corporation.

  • Assumes full control over all of the debtor's property and assets.

Secured creditors retain their right to enforce on their security provided they do so in a commercially reasonable manner.

Protection from creditors. Once a debtor has become bankrupt, all of the debtor's property, wherever located, vests in the trustee subject to the rights of secured creditors. The trustee then proceeds to administer the estate for the benefit of the bankrupt's unsecured creditors. The BIA provides for an automatic stay of proceedings once the bankruptcy has commenced. The debtor's unsecured creditors are prevented from:

  • Exercising any remedy against the debtor or its property.

  • Commencing or continuing any action, execution or other proceeding for the recovery of a claim provable in bankruptcy.

However, the bankruptcy stay does not affect secured creditors, who are generally free to enforce their security outside of the liquidation process.

The law governing intellectual property licences in a bankruptcy proceeding is unclear and licensees may lose their rights to use the intellectual property upon the bankruptcy of the licensor. The trustee-in-bankruptcy has the authority to disclaim executory contracts. Accordingly, the licensee may wish to have the licence agreement deemed to be a non-executory contract in the drafting of the licence agreement in order to prevent a subsequent trustee-in-bankruptcy from being able to disclaim the licence agreement in the bankruptcy proceedings of the licensor.

Suppliers are prevented from terminating contracts with the debtor company by reason of the stay of proceedings which is effective upon the commencement of bankruptcy proceedings. However, suppliers are not obliged to provide goods, or services to the bankrupt company unless they receive assurances from the trustee that the trustee will ensure that they will be paid for such goods, or services provided. Such assurances become a personal obligation and liability of the trustee.

Length of procedure. Unlike a BIA proposal, there is no specified timeline for bankruptcy proceedings.

Conclusion. The debtor's assets (after secured creditors have realised their security and after the payment of super-priority creditors) are distributed on a pro rata basis among the unsecured creditors in accordance with their proven claims. The bankruptcy concludes once the trustee has distributed all the proceeds realised from the sale of the property and assets of the debtor to the debtor's creditors and the trustee has been discharged by the court.

 

Stakeholders' roles

8. Which stakeholders have the most significant role in the outcome of a restructuring or insolvency procedure? Can stakeholders or commercial/policy issues influence the outcome of the procedure?

Stakeholders

The debtor plays a critical role with respect to the outcome of any restructuring proceedings.

In addition, the following parties also play significant roles:

  • Any significant secured creditor or class of secured creditors.

  • Bondholders or noteholders, or a class of bondholders or noteholders.

  • The relevant insolvency professional (see Question 6).

  • A unionised work force.

  • Federal, provincial and municipal governments.

  • Federal and provincial pension administrators.

  • Environmental protection agencies.

  • Any critical suppliers to the debtor.

  • Lien claimants.

  • Investors.

Influence on outcome of procedure

Stakeholders generally will have influence on the outcome of restructuring proceedings. Creditors who either individually or collectively hold a "blocking" amount, meaning the amount of the indebtedness owed by the debtor to that particular creditor or class of creditors (33 1/3% of the debt), effectively have a "block" on the approval of any restructuring plan or proposal brought forward by the debtor.

Unions, pensioners, retirees and other employee groups will also have a significant impact on a restructuring on account of the size of their numbers, public perceptions and the sensitivity that the courts generally have to their economic interests.

Courts across Canada have consistently demonstrated a proclivity to support corporate restructuring on the basis of the greater economic good that results to the economic stakeholders and community at large from a restructured company rather than a liquidation. The most recent legislative amendments that were adopted by Parliament in the 2009 amendments to the CCAA and the BIA have further codified this receptiveness to support corporate restructurings.

The particular economic interests that are given a high level of protection are listed under the super-priority claims in Question 2.

 

Liability

9. Can a director, partner, parent entity (domestic or foreign) or other party be held liable for an insolvent debtor's debts?

A director, corporate parent, or any other party will not be held liable for the debts of an insolvent company, subject to the exceptions described below.

Director

Certain statutes impose personal liability on corporate directors. All Canadian provinces and territories (which have jurisdiction over matters concerning labour relations) and the federal government (in relation to federally regulated industries) impose personal liability on directors for:

  • Unpaid wages.

  • Accrued vacation pay.

  • Termination and severance pay (in certain cases).

Directors are personally liable for payroll remittances for amounts deducted from employee's wages on account of:

  • Income taxes.

  • Canada Pension Plan (or Québec Pension Plan, as applicable) contributions.

  • Employment insurance premiums.

The above amounts are deducted from the pay cheques of the company's employees. They are considered to be similar in nature to trust funds.

However, directors have a defence against liability if they can prove:

  • They were duly diligent.

  • The failure to remit any required amounts in a timely manner was beyond their control.

Directors can be held personally liable in situations where a company defaults in payment of its goods and services tax or harmonised sales tax (HST) obligations. Canadian provinces which retain a separate retail sales tax (instead of HST) also impose personal liability on directors for failure to remit the required provincial sales tax.

Directors can also be personally liable for failure to remit certain pension contributions, particularly for amounts which were deducted from the employees' pay.

In addition to specific statutory liabilities, corporate directors can also be personally liable if the director acted improperly so as to cause loss to the company's creditors.

Finally, if a director provides a personal guarantee in favour of a lender as a condition of advancing credit, there is the possibility of the director being subject to contractual liability.

Partner

To determine the effect of a bankruptcy on a partner in a partnership the type of partnership must first be determined. The bankruptcy of a partnership will automatically result in the bankruptcy of all its partners. However, this outcome can be avoided by forming limited partnerships whereby the partners are only liable up to their individual contributions to the partnership. In limited liability partnerships, if the general partner becomes bankrupt the limited liability partners are not automatically bankrupt.

Parent entity (domestic or foreign)

Unless there is a contractual commitment stating otherwise, a parent company is not liable for an insolvent subsidiary's debts.

However, there is an exception to this rule for certain employee claims. At common law, it is possible for a court to determine that the employees of the insolvent subsidiary were also employees of the parent company, meaning the parent is jointly liable for the debts of the insolvent subsidiary to the employees. This may arise if the parent company has exercised common control over the subsidiary. In addition, in certain circumstances employment legislation in most Canadian provinces and territories permits liability to be imposed on a related company (such as parent company, subsidiary or company within the same group).

Under tax legislation it is also possible for the parent to become liable for the insolvent subsidiary's tax liabilities if the parent company has received assets from the subsidiary for less than the fair market value.

Other party

Other parties that may be held liable for the debts of an insolvent debtor include guarantors. Where the debt has been guaranteed an act of default by the primary obligor will trigger the guarantor’s obligations and the guarantor will be liable for the debts of the primary obligor in accordance with the terms of the guarantee.

In law, a corporation has a distinct legal personality. Therefore, shareholders will rarely be held personally liable for debts incurred by the corporation. Under extraordinary circumstances, however, courts will disregard the distinct legal personality of a corporation and hold the shareholders directly responsible for the corporation’s liability. Courts have demonstrated a willingness to pierce the corporate veil in situations where a shareholder has used the corporate structure as a cloak, sham, or alter-ego in a way that is fraudulent. In other words, the law will respect the separate existence of a corporation except for occasions when the owners of a corporation are hiding behind the corporate protection after having misled or deceived creditors.

 

Setting aside transactions

10. Can an insolvent debtor's pre-insolvency transactions be set aside? If so, who can challenge these transactions, when and in what circumstances? Are third parties' rights affected?

The BIA and the CCAA allow for pre-insolvency transactions to be set aside in two situations:

  • Preference.

  • Transaction at undervalue.

Provincial legislation permits the setting aside of preferences and transactions to defeat, delay or defraud creditors and can be used where the applicable BIA time periods have passed.

A trustee, or a monitor, under the CCAA, can initiate proceedings to challenge a transaction as a preference or transfer at undervalue. In situations where the trustee refuses to act, a creditor can initiate proceedings.

Preference

In a preferential transaction, one creditor receives payment over another creditor before the initial bankruptcy event, or the date proceedings were commenced under the CCAA, with the effect of the debtor preferring one creditor over another.

For a transaction to be considered a preference:

  • If the debtor and creditor are not related, it must have been made within three months of the initial bankruptcy event (or the date proceedings were commenced under the CCAA).

  • If the parties are related (such as a family member), it must have been made within twelve months of the initial bankruptcy event (or the date proceedings were commenced under the CCAA).

A transaction deemed preferential is void and will be set aside by the court. The money is then distributed to the bankrupt's estate in the manner set out in Question 2.

Transaction at undervalue

In a transaction at undervalue the debtor was insolvent at the time the transaction occurred, or became insolvent as a result of the transaction, and the intent of the debtor was to defeat, delay or defraud its creditors. The transaction must have occurred:

  • If the parties are not related, within one year of the commencement of the bankruptcy proceedings.

  • If the parties are related, within five years of the commencement of the bankruptcy proceedings.

Where a transaction at undervalue occurs, a court can:

  • Set aside the transaction.

  • Order the recipient to pay the difference between what they paid for the property and the actual fair market value of the property.

A third party who acquires property that is subject to a determination by the court that it is a transfer at undervalue, as between the debtor company and the vendor to the third party, the third party purchaser will be subject to the remedies available under the BIA if they are found to be a “person who is privy” (as that term is defined in the BIA) to the initial transaction which has been found to be a transfer at undervalue. That is, the transaction could be set aside, or the persons privy to the transaction could be required to pay the difference in the consideration received by the debtor company and the value of the consideration given by the debtor company in respect of the property.

 

Carrying on business during insolvency

11. In what circumstances can a debtor continue to carry on business during rescue or insolvency proceedings? In particular, who has the authority to supervise or carry on the debtor's business during the process and what restrictions apply?

In order for the debtor company to continue to carry on its business in a CCAA proceeding or under a BIA proposal proceeding certain conditions must be met. While a company can continue to operate under its own authority, the monitor (under the CCAA) or a trustee (under the BIA) will be appointed to oversee the business. The court-appointed monitor or trustee typically has no decision-making authority (see Question 6, CCAA proceedings: Supervision and control and Question 6, BIA proposal: Supervision and control).

 

Additional finance

12. Can a debtor that is subject to insolvency proceedings obtain additional finance both as a legal and as a practical matter (for example, debtor-in-possession financing or equivalent)? Is special priority given to the repayment of this finance?

Additional financing can be obtained by the debtor subject to insolvency proceedings. This financing is called interim financing or debtor-in-possession (DIP) financing and is available in CCAA proceedings and BIA proposals.

If the court makes an order approving DIP financing to the debtor, the DIP lender is then granted a corresponding priority charge over the debtor's property and assets, including over existing secured claims (however, the DIP lender may be subject to other court-ordered charges in the proceeding). Existing secured creditors will be notified prior to the court granting an order for DIP financing.

 

Multinational cases

13. What are the rules that govern a local court's recognition of concurrent foreign restructuring or insolvency procedures for a local debtor? Are there any international treaties or EU legislation governing this situation? What are the procedures for foreign creditors to submit claims in a local restructuring or insolvency process?

Recognition

The CCAA and the BIA both have provisions that allow for the recognition of and co-ordination with foreign proceedings as either a:

  • Foreign main proceeding.

  • Foreign non-main proceeding.

The Canadian courts will recognise a foreign proceeding as a foreign main proceeding where the debtor's centre of main interest is located in the jurisdiction of the foreign proceeding. To determine the debtor's centre of main interest, the courts look to the location of the debtor's management and its headquarters, as well as the location that significant creditors recognise as being the centre of the debtor's operations (among other things).

The Canadian definition of a foreign non-main proceeding deviates from the UNCITRAL Model Law on Cross-Border Insolvency 1997. Under Canadian law, a foreign non-main proceeding is any foreign proceeding other than a foreign main proceeding.

When recognising a foreign proceeding, the Canadian court must specify as to whether the foreign proceeding is a main or non-main proceeding. The determination by the Canadian court as to whether the proceeding is a foreign main or non-main proceeding has important implications on the treatment of that proceeding and the debtor in Canada. If the proceeding is determined by the Canadian court to be a foreign main proceeding, the debtor is entitled to certain automatic relief by the Canadian court.

Concurrent proceedings

Canadian courts encourage comity and frequently recognise foreign insolvency proceedings. Where appropriate, joint hearings can be held with the foreign court.

International treaties

The recognition provisions of the BIA and the CCAA are largely modelled on the UNCITRAL Model Law on Cross-Border Insolvency 1997. Canada passed legislation adopting the treaty in 2005. The CCAA and the BIA were amended in 2009 to incorporate the UNCITRAL concepts, but in the context of Canadian insolvency and restructuring proceedings.

Procedures for foreign creditors

Foreign creditors can submit claims in the same manner as Canadian creditors. There are no special procedures that must be followed by foreign creditors in order to submit claims.

 

Reform

14. Are there any proposals for reform?

Both the CCAA and the BIA were substantially revised in September 2009. There is an ongoing five-year review process but specific reform proposals are not yet available for review or discussion.

*The authors gratefully acknowledge the contribution of Lisa A MacDonnell, a partner, and Christine Marchetti, an associate, both practicing in the area of financial services and corporate law, with Gowling Lafleur Henderson LLP in Toronto, for their background research and assistance with the drafting and updating of this article.

 

Online resources

Justice Laws

W http://laws.justice.gc.ca/eng/

Description. Official versions of the Bankruptcy and Insolvency Act and the Companies' Creditors Arrangements Act can be found on this website, which is maintained by the Government of Canada.



Contributor profiles

David Cohen, Partner

Gowling Lafleur Henderson LLP

T + 1 416 369 6667
F + 1 416 862 7661
E david.cohen@gowlings.com
W www.gowlings.com

Professional qualifications. Ontario, barrister and solicitor

Areas of practice. Senior practitioner in Gowlings' Toronto office, practising financing, restructuring and insolvency law in a domestic and cross-border context.

Professional associations/memberships. Executive member of the National Financial Services Industry Group; practice co-ordinator for the Distressed M&A Practice, Private Equity and Venture Capital National Practice Group.

Alex MacFarlane, Partner

Gowling Lafleur Henderson LLP

T + 1 416 369 4631
F + 1 416 862 7661
E alex.macfarlane@gowlings.com
W www.gowlings.com

Professional qualifications. Ontario, barrister and solicitor

Areas of practice. Specialises in complex cross-border restructuring and insolvencies. Routinely provides restructuring, insolvency and litigation advice to a wide array of clients including Chapter 11 debtors, directors and officers, financial institutions, court-appointed monitors and receivers, and many other stakeholders including creditor committees and interested purchasers in respect of formal restructuring/insolvency proceedings.


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