Insolvency and directors' duties in Canada: overview

A Q&A guide to group insolvency and directors' duties in Canada.

The Q&A global guide provides an overview of insolvency from the perspective of companies that are operating within a domestic and/or international group of companies, and considers the various complexities that this can introduce into insolvency procedures. It also has a significant concentration on duties, liabilities, insurance, litigation, and subsequent restrictions imposed on directors and officers of an insolvent company.

To compare answers across multiple jurisdictions, visit the International Insolvency: Group Insolvency and Directors’ Duties Country Q&A tool.

This Q&A is part of the International Insolvency: Group Insolvency and Directors’ Duties Global Guide. For a full list of contents, please visit www.practicallaw.com/internationalinsolvency-guide.

Justin R Fogarty, Pavle Masic and Jason Dutrizac, Regent Law Professional Corporation
Contents

Corporate insolvency proceedings

1. What are the main out-of-court and court-sanctioned insolvency proceedings involving a liquidation of the company's assets?

BIA proceedings

The Bankruptcy and Insolvency Act (BIA) provides for both restructurings (through BIA proposals) and liquidations (through bankruptcy proceedings) of insolvent businesses. The BIA provides for an administrative process based on specific rules that must be strictly complied with.

The BIA also provides a detailed statutory scheme for liquidations and the distribution of proceeds.

CCAA proceedings

The Companies' Creditors Arrangement Act (CCAA) is used primarily for the restructuring of more complex corporate businesses (although it can also be used to conduct a sale or liquidation).

The CCAA provides for a more flexible process than the BIA, and is driven by court orders and directions. In CCAA proceedings, the court has wide discretionary powers to make any order it sees fit under the circumstances to resolve the insolvency (section 11, CCAA).

While the CCAA does not include liquidation provisions, Canadian courts have held that the BIA provisions on liquidation and distribution necessarily apply if a CCAA restructuring is unsuccessful.

See also Question 2.

 
2. Are there statutory proceedings allowing for a rescue/restructuring of the debtor company's operations and debts?

The two primary statutory regimes for the rescuing/restructuring of Canadian companies are commencement of proceedings under the:

  • Bankruptcy and Insolvency Act, RSC 1985, c B-3 (BIA).

  • Companies' Creditors Arrangement Act, RSC 1985, c C-36 (CCAA).

The objective of both the BIA and the CCAA is to provide for an orderly rescuing/restructuring of companies under court supervision.

Canada's statutory insolvency regime has undergone significant reform over the last 20 years. The first major changes were adopted in 1992. Further amendments were made in 1997 which required the Canadian parliament to review additional proposed changes within five years. This review resulted in Bill C 55, which came into force in November 2005. Further changes were made in 2007 through Bill C 62. These last amendments were an effort to harmonise the "patchwork" that was Canadian insolvency legislation.

The current state of Canadian insolvency legislation evolved through case law, with courts using their inherent jurisdiction to fill in gaps in legislation. These gaps have been, for the most part, filled by recent amendments (see above). Canadian insolvency law continues to evolve in response to complex domestic and international insolvency proceedings. While Canada's insolvency legislation resembles provisions of the US Bankruptcy Code, it is arguably more flexible than the US Code and practice.

This Q&A deals with specific questions and is not exhaustive. It provides an overview of the Canadian insolvency legislation and practice. For a more detailed analysis, it is essential to consult with a Canadian insolvency practitioner.

 
3. What are the general requirements for commencing insolvency proceedings?

A company is insolvent, and insolvency proceedings will generally be commenced, if either:

  • It is unable to meet its obligations generally as they become due; or

  • Its liabilities exceed the value of its assets.

To commence proceedings under either the Bankruptcy and Insolvency Act (BIA) or the Companies' Creditors Arrangement Act (CCAA) (see Question 2), a special resolution of directors is required, authorising a member of management to either:

  • Sign the necessary documents to file under the BIA; or

  • Commence court proceedings under the CCAA.

BIA proceedings

The debtor initiates BIA proceedings by either filing a:

  • Proposal (that is, its restructuring plan); or

  • Notice of Intention to File a Proposal (NOI) with the Office of the Superintendent of Bankruptcy (OSB), which is more common.

A list of all creditors owed Can$250 or more must be included in support of the NOI (section 50.4(1), BIA).

The NOI provides for an automatic stay of proceedings for an initial period of 30 days, which, on findings that the debtor is acting in good faith and with due diligence, can be extended for additional periods of up to 45 days each (for an aggregate total of up to six months). 

Once the proposal is filed, the stay continues until the creditors meet to vote on the proposal.

CCAA proceedings

Under the CCAA, an application must be made to the court of the relevant province with supporting affidavit material to demonstrate that both the:

  • Company meets the threshold test to invoke the provisions of the CCAA; and

  • Restructuring would be for the benefit of the company and the creditors.

If the debtor company is seeking a judicial stay of proceedings, it must satisfy the court that it is acting in good faith (section 11.02(3), CCAA).

The application must include (section 10(2), CCAA):

  • A cash flow statement;

  • A report containing representations of the debtor company regarding the cash flow statement; and

  • Copies of all financial statements prepared during the year before the application.

 

Insolvency of corporate groups

4. Are there joint insolvency proceedings available that can apply to a whole group of companies? Do all members of a corporate group have to proceed under the same type of insolvency proceeding?

BIA proceedings

In a bankruptcy or a proposal proceeding initiated under the Bankruptcy and Insolvency Act (BIA), each company must file individually in the "locality of the debtor" (section 43(5), BIA). The locality of the debtor is defined as the principal place where either (section 2(1), BIA):

  • The debtor has carried on business or resided during the year immediately preceding the bankruptcy; or

  • The greater part of the property of the bankrupt is located, if the above condition does not apply.

The onus is on the petitioner to show that the place where the petition is presented is located within the locality of the debtor.

Consolidation of BIA proceedings requires the authorisation of the court. If two or more applications are filed against the same debtor, or against joint debtors, the court can consolidate the proceedings on any terms that it deems fit (section 54(4), BIA).

If a bankruptcy order has been made against one member of a partnership, any other application against a member of such partnership must be filed in, or transferred to, the same court, and this court can give directions for consolidating the proceeding as it thinks just (section 43(16), BIA).

CCAA proceedings

The Companies' Creditors Arrangement Act (CCAA) is used in more complex cases because of its flexibility, and when it is anticipated that the restructuring may take longer than the timeframe allowed for a BIA proposal (six months from the filing of a proposal (Part III, BIA)).

Joint proceedings are available for affiliated companies (section 3(1), CCAA). Affiliated companies are defined as either subsidiaries of the debtor or companies affiliated at law with the debtor company (section 3(2), CCAA).

Proceedings for a family of companies must be commenced in either (section 9(1), CCAA):

  • The competent court of the province where the head office or chief place of business of the company is located; or

  • Any province within which any assets of the company are located, if the company has no place of business in Canada.

There is no requirement for each corporate entity in the family to either proceed under the same type of proceedings or to file proceedings at all. For example, in the restructuring of AbitibitBowater Inc., Re, (2009), certain members of the corporate entity did not file for protection under the Companies' Creditors Arrangement Act (CCAA).

The proceedings under the Bankruptcy and Insolvency Act (BIA) are available for all companies, whereas the use of the CCAA is restricted to corporations that have aggregate liabilities in excess of Can$5 million (section 3(1), CCAA).

 
5. Can the same insolvency office holder(s) administer the assets and the liabilities of the entire corporate group? Is a court hearing required to determine whether administration by the same individual(s) is appropriate and, if yes, does notice have to be given to creditors?

A single administrator can administrate the assets and liabilities of the corporate family under both the Bankruptcy and Insolvency Act (BIA) and the Companies' Creditors Arrangement Act (CCAA).

BIA proceedings

The administrators appointed under the BIA are trustees (either bankruptcy or proposal trustees). The trustees are court officers.

Each member of the family must file an individual Notice of Intention to Make a Proposal (NOI). The NOI must identify a trustee selected by the debtor (section 50(2), BIA).

The duties of the proposal trustee under the BIA are to assist the company to make a viable proposal to creditors (if possible) and to report to the court. The proposal trustee must:

  • Investigate the affairs of the company.

  • Prepare a report as to the accuracy of financial information (section 50(5)).

  • File a cash flow report with the Official Receiver's (OR's) office within ten days of the initial filing. This report must include a statement on who prepared it and the reasonableness of the assumptions that are made in it (section 50(6)); and

  • Monitor and report to the court and the creditors regarding:

    • the progress of the restructuring; and

    • any material adverse change (section 50(1)).

In addition, the proposal trustee is responsible for administering the voting process for any compromise that requires the approval of 66.66% in value of unsecured creditors, and 51% in number of each voting class.

The appointment of the trustee must be affirmed by the creditors at the first meeting of creditors (section 102(5)).

In the case of a voluntary assignment in bankruptcy, the bankrupt files the assignment with the Official Receiver (OR) in the locality of the debtor (section 49( 1) and 49(4), BIA). While the BIA provides that the OR appoints the trustee, the OR will usually appoint the firm that assisted the bankrupt with the assignment.

The creditors can object to the appointment of a proposal trustee at the first meeting of creditors, which is not a court hearing. The creditors can also choose a different trustee at a subsequent meeting of creditors (section 14, BIA).

A person can be prevented from being a trustee if his interests conflict with those of the company, or where another party is better qualified.

CCAA proceedings

The administrators appointed under the CCAA are monitors and are also court officers.

A CCAA proceeding is commenced by a debtor seeking an Initial Order. This Order declares that the debtor, or affiliated debtor companies, qualifies for relief under the CCAA. The court must appoint a Monitor, Interim Receiver or Receiver in the Initial Order for the purpose of monitoring or administering the debtor's business and financial affairs during the restructuring. The company's auditors cannot be appointed as monitors.

Both the filing of a Notice of Intention to Make a Proposal (NOI) under the BIA and an Initial Order granted by a court under the CCAA necessarily involve the appointment of a court administrator. The Initial Order contains a "comeback" provision which allows all creditors with an interest in the proceedings who did not receive notice of the original application to come back to court and present arguments against parts of the Initial Order.

A creditor can make an application to replace the court appointed administrator after the "comeback hearing" (or at a later date on notice during the CCAA proceedings) (section 11.7(3), CCAA).

The suitability of the administrator can also be challenged by any creditors who did not receive notice of the initial proceedings.

A person can be prevented from being a monitor if his interests conflict with those of the company, or where another party is better qualified.

 
6. If the law does not permit a single insolvency office holder, are there provisions allowing different office holders to co-ordinate with each other so that the value of the group's assets can be maximised?

The Bankruptcy and Insolvency Act (BIA) and the Companies' Creditors Arrangement Act (CCAA) do not prohibit administration by a single party (see Question 5). However, this is very rare in practice.

 
7. Can professional advisers work for the entire corporate group?

There are no restrictions against joint representation by either accounting or law firms in either a Bankruptcy and Insolvency Act (BIA) or Companies' Creditors Arrangement Act (CCAA) proceeding, although this is not common. In addition, the monitor or proposal trustee is often represented separately from the debtor company to avoid the appearance of a potential conflict of interest.

 
8. Are the rules regarding members of a corporate group transferring assets to one another different when one or more members are insolvent?

BIA proceedings

After the debtor is bankrupt, the following transactions can be challenged, if they take place within a specified period (Bankruptcy and Insolvency Act (BIA)):

  • Preferences. These are transactions made with the intent to benefit one creditor over others (section 95).

  • Transactions at undervalue (section 96).

The specified period is extended for transactions between "related persons" (as defined in section 4(2) of the BIA which covers relationships between individuals, two entities and an entity and individual). A preference is voidable as against the Trustee if it was made either:

  • Three months within the initial bankruptcy event, where the parties are not related.

  • One year within the initial bankruptcy event, where the parties are related.

CCAA proceedings

The position is the same as for BIA proceedings (see section 36.1(1), Companies' Creditors Arrangement Act (CCAA)) (see above, BIA proceedings).

 
9. How are claims of one member of a corporate group against other members of the group treated in a formal insolvency processes for those members?

Claims of one member of a corporate family against other members of the corporate family are valid and enforceable and such claims are on equal footing with those of third party creditors.

In the event that such claims constitute preferences (see Question 8), they can be subordinated unless the transaction was considered a proper transaction (in the opinion of the trustee or the court) (section 137, Bankruptcy and Insolvency Act ( BIA)).

Substantive consolidation

10. Is pooling of assets and liabilities of some or all members of a corporate group allowed, so that a creditor of one member becomes, in essence, a creditor of all members?

There are no specific provisions concerning substantive consolidation in the Bankruptcy and Insolvency Act (BIA) or the Companies' Creditors Arrangement Act (CCAA). In both types of proceeding, the courts have exercised their inherent authority to permit consolidation where the benefits of consolidation outweigh the prejudice. There are very few reported cases on substantive consolidation, and there is no definitive case outlining which criteria must be considered.

The authority for substantive consolidation of bankrupt estates in Canada lies under the equitable jurisdiction of the court granted by section 183(1) of the BIA. Pooling is not automatic and the Canadian courts will take a contextual approach and consider all relevant factors (see Re Redstone Investment Corporation and Bacic v Millennium Educational & Research Charitable Foundation). In particular the court will focus on the following factors:

  • Difficulty in segregating and identifying ownership of individual assets and liabilities.

  • Actual level of commingling of assets and business functions.

  • Existence of consolidated financial statements; and

  • Similarity of interests and ownership between the various corporate entities.

The courts will also consider the:

  • Level of integration and interdependence of the affiliated entities' financing arrangements; and

  • Behaviour of the debtor before filing (for example, whether there has been a transfer of assets without corporate formalities, under unreasonable commercial terms or with intent to prejudice creditors).

Canadian courts generally tend not to interfere with stakeholder rights (with some exceptions).

 
11. What proceedings are required for the court to order the pooling of assets and liabilities?

Consolidation can be sought as part of the initial proceedings, or by way of application or motion during the course of a proceeding under the Bankruptcy and Insolvency Act (BIA) or the Companies' Creditors Arrangement Act (CCAA). The motion or application can be brought by any interested party.

 
12. Is the partial pooling of assets and liabilities allowed? What conditions apply?

There are no specific provisions concerning consolidation (see Question 10). The court can, in theory, allow partial consolidation if circumstances are such that it is demonstrably just and equitable for the stakeholders in general. The factors that the court considers typically do not focus on the creditworthiness of the debtors nor on the allocation of assets between debtor companies within a family of companies. In addition to its factual analysis (see Question 10) the court will weigh up the overall benefit to creditors of one group member against the detriment to creditors of another group member. While there are few reported cases on partial consolidation and there is no definitive case outlining which criteria must be considered, the factors are generally similar to those outlined in Question 10.

 
13. If the pooling of assets and liabilities is permitted, are there any protections for certain types of creditors?

In determining whether to permit consolidation, courts take into account all relevant factors, including the interests of secured creditors and lien holders. Although a court has jurisdiction in a consolidation case to order specific protections for certain types of creditors in the appropriate circumstances, no such protections have been ordered to date. Courts have either ordered or rejected substantive consolidation.

Secured creditors

14. How are secured creditors treated in relation to a group of companies?

The treatment of secured creditors of a family of companies is not different than that of secured creditors of unrelated companies. However, a creditor cannot recover more than it is owed.

A creditor can maintain claims against both the principal debtor and any guarantor or surety, unless it is restricted from doing so under the terms of the relevant agreement.

 

Insolvency proceedings for international corporate groups

15. What extra considerations are necessary if one or more members of the corporate group is incorporated under or governed by the laws of another jurisdiction?

The fact that a company is incorporated under or governed by the laws of another jurisdiction does not in itself affect the application of the Canadian insolvency legislation. A family of companies with non-Canadian members can file proceedings under both regimes.

However, the court will consider whether the companies' centre of main interest (COMI) is Canadian. Factors that Canadian courts consider when determining a company's COMI include, among others, the (see Re Nortel Networks Corp.):

  • Location where corporate decisions are made.

  • Location of employee administrations.

  • Location of the company's marketing and communication functions; and

  • Extent of integration of an enterprise's international operations.

If the company's COMI is not in Canada, the court may decline jurisdiction and only allow the "truly" Canadian entities to file under either the Bankruptcy and Insolvency Act (BIA) or the Companies' Creditors Arrangement Act (CCAA).

 
16. If insolvency/restructuring proceedings are started for corporate group members in different countries, do international treaties or EU legislation apply?

Canada incorporated the provisions of the UNCITRAL Model Law on Cross-Border Insolvency 1997 into the Bankruptcy and Insolvency Act (BIA) and the Companies' Creditors Arrangement Act (CCAA), with modifications (see Question 17).

 
17. Do domestic courts typically attempt to exercise jurisdiction over all the assets of a company filing locally (regardless of where the assets are located) or do they limit their jurisdiction to local assets?

Part XIII of the Bankruptcy and Insolvency Act (BIA) and Part IV of the Companies' Creditors Arrangement Act (CCAA) have recently been adopted and constitute a departure from the provisions of the UNCITRAL Model Law on Cross-border Insolvency 1997. Consequently, Canadian courts exercise jurisdiction over non-Canadian entities and assets to the extent that the centre of main interest (COMI) of the entity is Canadian, which is mainly question of fact. This area of the law is evolving both domestically and internationally.

 
18. Do local courts enforce court orders from foreign jurisdictions that attempt to exercise jurisdiction over assets located in your jurisdiction that are owned by a company subject to foreign insolvency proceedings?

Canadian courts enforce court orders from foreign courts that attempt to exercise jurisdiction over assets located in Canada in accordance with the principles of the UNCITRAL Model Law on Cross-border Insolvency 1997, which are incorporated into Canadian law.

In the last five years, there has been a number of important decisions where Canadian courts have recognised foreign orders, and vice versa. In addition, cross-border protocols have been used to ensure fair dealing and avoid unnecessary conflicts.

 
19. Can the courts co-operate with foreign courts to co-ordinate the administration of group assets?

Canadian courts have signed the Transnational Insolvency Project of the American Law Institute (ALI) among the NAFTA countries (that is, Canada, Mexico and the US). These states have also widely adopted the UNCITRAL Model Law on Cross-border Insolvency 1997.

The UNCITRAL Model Law assists signatory states in situations where the insolvent debtor has assets in more than one state or where some of the creditors of the debtor are not from the state where the insolvency proceeding is taking place. The Model Law contains access provisions that give representatives of foreign insolvency proceedings and creditors a right of access to the courts of an enacting state to seek assistance and authorise representatives of proceedings conducted in the enacting State to seek assistance elsewhere. In addition, the Model Law expressly empowers courts in signatory states to co-operate in the areas governed by the Model Law and to communicate directly with their foreign counterparts. Co-operation between courts and foreign representatives, and between representatives (both foreign and local) is also authorised.

The advantages of cross-border communications are illustrated by the Regulation (EC) 1346/2000 on insolvency proceedings (Insolvency Regulation), which became effective for member states of the EU in 2002. Co-operation with EU courts has been achieved through the adoption of a cross-border protocol.

 

Directors' duties

20. Does your jurisdiction encourage or discourage overlapping boards or management teams for separate members of a corporate group?

There are no express prohibitions on overlapping boards or management teams for separate members of a family, nor are there any legal advantages to it.

Overlapping boards or management of entities that are intending to merge (which are common) may give rise competition law issues.

 
21. What legal consequences are there for the directors of a parent company where they are not directors of the subsidiary but do manage the subsidiary's affairs?

A person who occupies the position of director can be deemed to be a "de facto" director regardless of its title (if any) (section 2, Bankruptcy and Insolvency Act (BIA)). Such a person will therefore be treated in the same way as a formally appointed director. Whether a person is a "de facto" director is a question of fact. The courts usually look at the person's actions and whether he operated as a director or executive officer.

 
22. What are the main duties and responsibilities of directors and officers to the company, shareholders and third parties? Do they change when the company becomes insolvent?

Directors owe duties to all stakeholders in the corporation, depending on the circumstances and the interests of the relevant stakeholder (whether creditor, shareholder, government or employees). The Supreme Court of Canada held that, when acting in the best interests of the corporation, it may be legitimate for the directors and officers to consider "the interests of shareholders, employees, suppliers, creditors, consumers, governments, and the environment", depending on the particular circumstances of the case (BCE Inc v 1976 Debentureholders, 2008 SCC 69(BCE Inc)).

While directors and officers should seek to ensure that individual stakeholders are affected by corporate actions equitably and fairly, duties to individual stakeholders are subsidiary to the directors' overriding duty to act in the best interests of the corporation. In addition, directors have statutory duties that apply in specific circumstances.

Directors do not have a specific obligation to shareholders; their obligation is to consider the best interests of the corporation.

The Supreme Court of Canada made it clear that the duty of directors and officers to act in the best interest of the corporation no longer means acting only in a way that will maximise profits for shareholders (see above, BCE Inc case). This is an important distinction from US law. However, dissatisfied shareholders often bring oppression remedy claims where the directors and officers are perceived as not having acted to maximise profits.

In addition, the Canada Business Corporations Act (CBCA) contains provisions designed to protect shareholders from the unfair dilution of their shares through the prevention of acts that favour certain shareholders or insiders over others. In the case of publicly traded companies, there are additional provisions protecting shareholders under provincial securities laws, such as periodic and continuous disclosure requirements.

While the company is solvent, directors do not generally owe any specific duties to creditors. However, they have an obligation to consider the interests of creditors in fulfilling their statutory duties to the corporation. A failure to do so can lead to oppression claims, or, more rarely, to a derivative action initiated by creditors on behalf of the corporation.

Various federal laws provide that directors may be liable for the failure of a corporation to remit tax and other payments to the government. This includes failure to remit:

  • Income tax, employment insurance premiums and Canada Pension Plan premiums from payments such as wages or benefits; and

  • Goods and Services Tax (GST) (where the company charges GST).

In addition, directors may owe duties to government bodies under environmental legislation.

The CBCA provides that directors may be liable to employees for up to six months' unpaid wages, although this varies in each province.

As a corporation approaches insolvency, directors and officers continue to be under the duty to act in the best interests of the corporation. However, the importance of the various stakeholders' interests will change on insolvency.

As the corporation becomes financially distressed, the interests of creditors become more important and the interests of shareholders become correspondingly less important (as the creditors become claimants to the residual value of the corporation).

Similarly, once a corporation becomes insolvent and it is clear that there will be little or no return on the shareholders' equity, the directors' and officers' obligation to act in the interests of the shareholders is less important.

Where a company becomes financially distressed, the duties owed by directors and officers under employment and tax legislation become a greater concern. When a company enters the "zone" of insolvency, it is therefore critical for directors and officers to ensure that employees' wages have been paid and taxes have been properly withheld and remitted.

However, the ability of various stakeholders to take action against directors or officers for breach of their duties is more limited on insolvency. Once a corporation files a notice of intention to make a proposal under the Bankruptcy and Insolvency Act (BIA), or obtains a stay from the court under the Companies' Creditors Arrangement Act (CCAA), claims against directors and officers are automatically stayed and can only be brought with the leave of the court. The position is the same where only one company of a family of companies becomes insolvent.

 
23. How are competing duties addressed where directors and officers of different group company members overlap and there are conflicts of interest between the group members?

Section 122 of the Canada Business Corporations Act (CBCA) and equivalent provisions in provincial business corporation statues establish two principal duties to be discharged by directors and officers in managing a corporation. The first is the statutory fiduciary duty (or duty of loyalty) to the corporation, which requires directors to "act honestly and in good faith with a view to the best interests of the corporation". This requires directors to:

  • Avoid conflicts of interest and self-dealing; and

  • Only exercise their discretional powers for a proper purpose.

A director of officer of a company who is also a director or officer of another company that is a party to a material contract with the first company must disclose his interest in writing to the company (section 120CBCA). If disclosure of the interest is made in accordance with section 120(1) to (6), a material contract between the two companies is not invalid by reason of the presence of that director at the meeting of directors that authorised the contract, as long as the contract was approved by the directors and was reasonable and fair to the company when it was approved (section 120(7)CBCA). If a director or an officer of a corporation fails to comply with his disclosure obligation, a court may, on application of the corporation or any of its shareholders, set aside the contract or transaction on any terms that it thinks fit, or require the director or officer to account to the corporation for any profit or gain realised on it, or both (section 120(8), CBCA).

 
24. What specific types of conduct are in breach of the duties and responsibilities of directors and officers?

Failure to take reasonable steps to minimise losses to creditors

Directors and officers have a duty to act in the best interests of the corporation, which requires balancing the interests of all stakeholders, including creditors. In certain situations (for example, where insolvency is inevitable), failing to take reasonable steps to minimise losses to creditors will constitute a breach of duty. In other circumstances (for example, where other stakeholders have divergent interests), such failure will not be a breach of directors' duties.

Misappropriation of corporate assets

The misappropriation of corporate assets is a clear breach of directors' and officers' fiduciary duty which may also attract criminal liability.

Undervaluation of corporate assets in a preference or other transaction to the detriment of creditors

On insolvency, directors and officers can be liable for preferences and transfers at an undervalue (section 96Bankruptcy and Insolvency Act (BIA)) (see Question 8). Directors may be liable for the difference between the value of the consideration received by the insolvent company and the fair market value of the assets.

Failure to inform creditors of insolvency

Directors and officers have no specific duty under Canadian law to inform creditors of insolvency. However, if the directors or officers of a company know that the company is insolvent and do not take steps to mitigate losses suffered by creditors, they are likely to face an oppression claim. Officers or directors can be found to be a party to a bankruptcy offence where a bankrupt company (after, or within one year before a bankruptcy event) obtains any credit or property by false representations, and the director or officer authorised, directed, or acquiesced in the commission of the offence (Part VII, BIA).

Preferring payment to one creditor as opposed to another when insufficient monies are available to pay both

Where an insolvent company makes a preferential payment, such payment is not valid as against the trustee in bankruptcy if it took place within three months (if made to an arm's-length creditor) or a year of bankruptcy (if made to a "related person") (section 95, BIA) (see Question 8).

Although the BIA does not specifically provide that directors or officers can be liable for preferential payments, such conduct could form the basis of an oppression claim.

Continuing to trade when there is little prospect of being able to pay when due

See above, Failure to inform creditors on insolvency.

Other types of conduct

Directors may be found liable for many other acts prohibited by Canadian federal and provincial law. For example, directors may be liable for declaring dividends where the corporation is insolvent or approaching insolvency. Directors and officers may also be liable for failing to keep appropriate records in certain circumstances surrounding insolvency.

In addition, certain conduct can also be in breach of directors' and officers' duties and responsibilities under securities, employment, tax and environmental law.

 
25. What civil and criminal liability exists for directors and officers if they breach their duties and responsibilities?

Directors or officers may be found civilly liable for breaches of their duties. Findings of criminal liability against directors and officers of insolvent corporations are rare. However, directors or officers can be convicted of a bankruptcy offence where the corporation commits such an offence and they authorised, directed, or acquiesced in the offence, regardless of whether the company is convicted (section 204, BIA). A director or officer may then face either:

  • Imprisonment for up to one year or a fine of up to Can$5,000, or both (on summary conviction); and

  • Imprisonment for up to three years, a fine of up to Can$10,000, or both (on indictment).

The court can also order a director or officer to make restitution. However, in practice, criminal prosecutions of directors or officers under the BIA are rare, and prison sentences even rarer.

Directors or officers may also be civilly and/or criminally liable under tax, employment, environmental and securities legislation. Directors may be fined and/or imprisoned for specific violations of federal tax and employment insurance law.

 
26. Is potential personal civil or criminal liability a factor in officers and directors deciding if and when to put the company into a formal insolvency/reorganisation procedure?

The existence of potential personal civil or criminal liability will generally encourage directors and officers to act prudently and file for insolvency/reorganisation procedure once it becomes clear that the company will not be able to meet its obligations as they become due, and that no "white knight" is likely to rescue the company.

Waiting until the last minute to file proceedings can expose directors and officers to an oppression claim from creditors. In addition, in the case of a public company, failure to file for proceedings when an insolvency event occurs can lead to directors' liability under securities legislation.

 
27. Is insurance available to protect directors and officers from claims arising while operating a financially distressed company?

In most cases, director and officer insurance policies (D&O insurance) will continue to protect directors and officers during insolvency. The risks of claims arising from operating a financially distressed company will be incorporated into the premiums paid under the policy.

D&O insurance is also available after filing for insolvency/reorganisation proceedings, although premiums are much higher, and the scope of the liabilities covered is more limited. For example, premiums will generally not cover liability to tax authorities for failure to remit deductions at source. A priority charge is often created to cover the potential risk of directors or officers being held financially liable after filing insolvency/reorganisation proceedings.

The availability of insurance is generally not a factor in deciding when and if to file insolvency/reorganisation proceedings. In the past, directors and officers used to resign before filing to avoid potential liability and/or high insurance costs. However, a priority charge is now usually created to indemnify directors and officers and avoid such an outcome. Canadian law has evolved in a way that usually allows the board to make the decision to file for insolvency/reorganisation without being concerned about the availability of insurance.

 
28. Can directors and officers resign from their positions if the company becomes financially distressed and what difference will this make to their potential liability?

There is no legal requirement for officers and directors to resign once the company becomes financially distressed. However, officers and directors who do so expose themselves to oppression claims. Directors and officers can generally only be liable for the events occurring during their term in office, not after they resign.

 
29. How common is litigation against directors and officers for violation of their duties after commencement of insolvency/reorganisation proceedings? Is the litigation typically successful?

Lawsuits against officers and directors after the commencement of an insolvency/reorganisation procedure are rare. Generally, such lawsuits are brought in instances where either:

  • The company did not file in a timely manner; or

  • There has been fraud.

A resolution or settlement of claims and/or lawsuits against directors and officers will usually be included into the Plan of Arrangement or Proposal. Most Proposals under the Companies' Creditors Arrangement Act (CCAA) or the Bankruptcy and Insolvency Act (BIA) will include a release of claims against officers and directors, although these releases may exclude claims for fraud. These suits will therefore usually only proceed if the proposal or plan of arrangement is unsuccessful, or in cases involving fraud.

Litigation is usually not successful as claimants typically accept a discount on the value of their claims as part of the negotiated plan (see above). In addition, fraud claims against directors and officers are typically difficult to establish.

 
30. What defences against civil and/or criminal sanctions are available to directors and officers?

Business judgment rule

The business judgment rule is the broadest defence available to officers and directors. The Supreme Court of Canada held that courts should defer to the business decisions of directors that are made in good faith and in the performance of their duty to determine what is in the best interests of the corporation (see BCE Inc v 1976 Debentureholders, 2008, SCC 69). Canadian courts will generally not substitute their decision for that of directors, provided that the decision was fully informed and within a range of reasonable alternatives, even where subsequent events may have cast doubt on the directors' decision.

Although the Canadian and American versions of the business judgment rule are similar, American courts tend to allow more deference to directors. The American rule is based on the presumption that corporate decisions are informed, honest, and made in good faith, whereas Canadian courts will generally not accord deference until after they examine the process under which the decision was made.

Good faith

Good faith alone is insufficient to act as a full defence against civil or criminal sanctions, although it is a necessary element of other defences.

Due diligence

Under the Canada Business Corporations Act (CBCA), a director has a due diligence defence for certain offences if the director exercised the care, diligence and skill that a reasonably prudent person would have exercised in comparable circumstances, and if he relied in good faith on the financial statements of the corporation or the report of a professional (for example, an asset valuation professional) (section 124).

Reliance on outside consultants or professionals

Directors have a defence to breach of their fiduciary duties and duty of care if they have relied in good faith on either the:

  • Financial statements of the corporation; or

  • Report of a professional (for example, a lawyer, accountant or financial adviser).

Exercise of reasonable judgment

The business judgment rule (see above, Business judgment rule) applies so long as the business decision was reasonable, made in good faith and in the best interests of the corporation. Canadian courts have broadly interpreted the terms "best interests of the corporation" as including the interests of all stakeholders, and are generally sympathetic to the efforts made to preserve the "ongoing value'" of the enterprise.

 
31. If it appears that "going concern values" will result in a higher return to creditors than a liquidation of the assets, can directors and officers be protected if they decide to continue operations to protect the values for the benefit of all creditors?

Officers and directors can be protected under the business judgment rule (see Question 30, Business judgment rule). Although nothing will protect an officer or director from liability for incurring credit or continuing a business they know is insolvent, courts will generally be supportive of efforts to maintain the company as a going concern once formal proceedings are started.

 
32. If a company becomes insolvent, is a director or officer of the insolvent company legally restricted from acting as a director or officer in another company, or from obtaining credit as a promoter of another company?

An officer or director of the insolvent company is not legally restricted from acting as an officer in another company.

 
33. If a director or officer becomes personally insolvent, is he legally restricted from continuing to act as a director or officer of his current company or another company?

Current company

A bankrupt person cannot be a director of a corporation (section 105(1), Canada Business Corporations Act (CBCA)). The CBCA does not contain similar restrictions on a bankrupt person acting as an officer.

Another company

See above, Current company.

 

Online resources

CanLII

W www.canlii.org/en/

Description. CanLII is a non-profit organisation managed by the Federation of Law Societies of Canada. This website provides access to court judgments, tribunal decisions, statutes and regulations from all Canadian jurisdictions.



Contributor profiles

Justin R Fogarty, Founding Partner

Regent Law Professional Corporation

T +416 840 8992
F +416 943 6270
E justin.fogarty@regentlaw.ca

Professional qualifications. Ontario, Barrister and Solicitor

Areas of practice. Corporate governance and board issues; commercial litigation; insolvency, bankruptcy and restructuring; banking and corporate finance.

Non-professional qualifications. BA, Ottawa University; LLB, University of Windsor; LLM (Banking and Finance), Osgoode Hall Law School; Certificate in International Negotiations, Harvard Law School

Languages. English, French

Professional associations/memberships

  • Executive Board of Directors, Canadian Defence College (May 2012 – present).
  • Vice Chair, Advisory Board, The Prince's Operation Entrepreneur (May 2012 – present).
  • Director, 33 Signals Foundation (January 2011 – present).
  • Member of the Board of Directors, the Conference of Defence Associations Institute (June 2010 – present).
  • Chairman of the Board, Marengo Capital Partners Ltd. (May 2009 – present).
  • Co-Chair and Co-Founder, the Lawyers Polo Association (August 2008 – present).
  • Counsel, Heenan Blaikie LLP (March 2011 – October 2012).
  • Co-Chair of the Insolvency and Restructuring Subcommittee, International Bar Association (October 2010 – October 2012).
  • General Editor, National Insolvency Review, LexisNexis (January 2001 – July 2012).
  • Director, Alpine Canada Alpin (September 2009 – January 2012).
  • Member of the Canadian Advisory Board, Commercial Finance Association (January 2002 – January 2005).
  • Director, Turnaround Management Association (January 1999 – June 2002).
  • Law Society of Upper Canada.

Publications. Past editor of the National Insolvency Review.

Pavle Masic, Partner

Regent Law Professional Corporation

T +416 840 8992
F +416 943 6270
E pavle.masic@regentlaw.ca

Professional qualifications. Ontario, Barrister and Solicitor

Areas of practice. Bankruptcy, insolvency and restructuring; commercial litigation; regulatory litigation.

Non-professional qualifications. Juris Doctor, University of Toronto Faculty of Law; Bachelor of Commerce, McMaster University's DeGroote School of Business

Languages. English

Professional associations/memberships. Law Society of Upper Canada.

Jason Dutrizac, Partner

Regent Law Professional Corporation

T +416 840 8992
F +416 943 6270
E jason.dutrizac@regentlaw.ca

Professional qualifications. Ontario, Barrister and Solicitor

Areas of practice. Bankruptcy, insolvency and restructuring; commercial litigation; regulatory litigation.

Non-professional qualifications. JD, University of Windsor, 2003, Certificates in Advanced Negotiations and Mediation; Harvard Law School, 2007; Mediation Centre of Southeastern Ontario, 2011; BA (Hons), Mount Allison University, 1999

Professional associations/memberships. Law Society of Upper Canada, Canadian Bar Association.

Publications. Debt Restructuring: An Alternative to Insolvency Proceedings.


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