The number of bankruptcies and creditor protection proceedings has increased over the past few months as indicated by the Office of the Superintendent of Bankruptcy Canada http://www.ic.gc.ca/eic/site/bsf-osb.nsf/eng/h_br01011.html.

If you are a creditor of a company who may be having financial difficulty, here are some things you should be aware of in formal bankruptcy and insolvency proceedings.

Bankruptcies and Receiverships – Liquidating Assets

In both bankruptcies and receiverships, the property of the debtor company is collected by the trustee in bankruptcy or the receiver, as the case may be. The assets are then liquidated and the proceeds distributed to creditors in accordance with certain priorities. In a bankruptcy, secured assets are excluded from liquidation and are dealt with separately by the secured creditor. Practically speaking, that leaves little to nothing left over to be shared among the unsecured creditors. In a receivership, it is the secured creditor who appoints the receiver, and they liquidate assets to pay themselves first.

If you receive a notice that a debtor of yours is bankrupt or has gone into receivership, you should file a proof of claim. A proof of claim allows you to share in any proceeds for the unsecured creditors, and, if filed before the first meeting of creditors, allows you to attend and vote at that meeting. However, attending a meeting or reviewing the reports prepared by the trustee or receiver, as the case may be, will likely be unnecessary unless you are aware of special circumstances that may impact the proceedings, for example, settlements made by the debtor, recent transfers of property to family members or any property concealed by the debtor.

Proposals and Plans – Alternatives to Bankruptcy

A debtor company may also make a proposal to creditors under the Bankruptcy and Insolvency Act (“BIA”) or prepare a plan of arrangement under the Companies’ Creditors Arrangement Act (“CCAA”). These procedures allow the company to reorganize itself and continue operating in a manner that is, hopefully, financially viable. They also include a method for payment of creditors, in whole or in part.

To fall within the scope of the CCAA, the debtor company must have debts over $5 million owing to creditors. A BIA proposal has no minimum threshold, and it is a relatively simple and inexpensive procedure. In a BIA proposal situation creditors are divided into classes and all creditors in each class must be treated equally. The CCAA gives the debtor more flexibility in creating its plan as there are fewer rules surrounding how creditors must be treated. If a BIA proposal is not approved, the debtor company goes immediately into bankruptcy. When a CCAA plan is not approved, the debtor company does not become bankrupt, however the protection afforded to the debtor company from creditors while preparing the plan is then removed and often the same pressures that existed before the plan was filed still exist and the debtor company may be forced into bankruptcy or receivership before long.

Since the purpose of a plan or proposal is for the company to continue operating there are certain guidelines for their relationships with suppliers. Normally being insolvent means a party is in default of most supply and licencing agreements. However, the respective statutes prohibit the termination or amendment of these agreements by reason only that the debtor company is insolvent or that a proposal or plan has been filed. Persons who are required to continue performing their obligations under supply and licencing agreements are entitled to demand payment in cash for goods, services and the use of leased or licenced property. If payment is not received immediately, the agreement may then be terminated.

The BIA and CCAA are set to be amended in the near future, although the exact date is not known, and these amendments create new consequences for those dealing with the debtor company. One such consequence in a CCAA plan situation is the concept of the critical supplier. The court will be able to declare a supplier a “critical supplier” and they must continue supplying goods or services even if they cannot be paid at the time. However, the critical supplier is given a super priority over the property of the debtor company for the value of the goods or services supplied. This same concept is not extended to proposals under the BIA.

Another amendment to be aware of is the right of debtors involved in a reorganization to terminate any agreement to which the debtor is a party, with a few exceptions. This ability will allow the debtor company to cancel any agreement simply because it may not be profitable for their reorganization. The affected parties may apply to court for relief or they may have a provable claim in the reorganization. But essentially, this leaves them without a contract that may be their only source of income or a key component to their whole operation.

Sarah MacDonald
Business Law Group
Tel: 905.276.0416
E-mail: smacdonald@kmblaw.com

The comments in this newsletter are of a general nature and are not designed to replace professional advice in specific situations. If you would like extra copies of this newsletter, or you know of anyone who would be interested in joining our mailing list, please contact Cheryl Woolcott at (905) 276-9111.