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Insolvency - Anti-Deprivation Rule. Chandos Construction Ltd. v. Deloitte Restructuring Inc.
In Chandos Construction Ltd. v. Deloitte Restructuring Inc. (SCC, 2020) the Supreme Court of Canada notes that the principle of set-off is imported into bankruptcy law:[42] This brings us to Chandos’ final argument concerning the effect of set-off on the application of the anti-deprivation rule in this case. Set-off is given statutory approval in s. 97(3) of the BIA:(3) The law of set-off or compensation applies to all claims made against the estate of the bankrupt and also to all actions instituted by the trustee for the recovery of debts due to the bankrupt in the same manner and to the same extent as if the bankrupt were plaintiff or defendant, as the case may be, except in so far as any claim for set-off or compensation is affected by the provisions of this Act respecting frauds or fraudulent preferences. As this Court described in Husky Oil, at para. 3, s. 97(3) incorporates the provincial law of set-off (and the related civil law concept of compensation) into the federal bankruptcy regime. Set-off is a defence to the payment of a debt. The effect of set-off is to allow a creditor who happens to be also a debtor to recover ahead of their priority.
[43] The BIA’s affirmation of set-off and the anti-deprivation rule are not incompatible. While set-off reduces the value of assets that are transferred to the Trustee for redistribution, it is applicable only to enforceable debts or claims (see, e.g., Holt v. Telford, 1987 CanLII 18 (SCC), [1987] 2 S.C.R. 193, at pp. 204-6). The anti-deprivation rule makes deprivations triggered by insolvency unenforceable. The combination means that set-off applies to debts owed by the bankrupt that were not triggered by the bankruptcy. . Chandos Construction Ltd. v. Deloitte Restructuring Inc.
In Chandos Construction Ltd. v. Deloitte Restructuring Inc. (SCC, 2020) the Supreme Court of Canada re-affirmed the bankruptcy anti-deprivation rule, which voids any effort to diminish the value of an insolvent's estate available to the creditors:IV. The Existence of the Common Law Anti-Deprivation Rule
[25] As to the existence of the anti-deprivation rule, I see no error in Rowbotham J.A.’s consideration of this issue, in that the rule has existed in Canadian common law and has not been eliminated by either this Court or Parliament.
[26] Justice Rowbotham correctly found that there has been support for the anti-deprivation rule in the decisions to which she referred; I would add Watson v. Mason (1876), 22 Gr. 574 (U.C. Ch.) and Hobbs v. The Ontario Loan and Debenture Company (1890), 1890 CanLII 10 (SCC), 18 S.C.R. 483, at p. 502 (per Strong J.), even if Hobbs is from a period in Canadian history where no federal bankruptcy legislation existed (R. J. Wood, Bankruptcy and Insolvency Law (2nd ed. 2015), at pp. 33-35).
[27] No decision of this Court has eliminated the anti-deprivation rule. Coopérants, as Rowbotham J.A. stated, was not an anti-deprivation case as there was no deprivation (Coopérants, at paras. 43-44).
[28] Nor has Parliament eliminated the anti-deprivation rule. As Rowbotham J.A. observed, Parliament did not implement ss. 65.1, 66.34, or 84.2 of the BIA so as to eliminate the anti-deprivation rule: the anti-deprivation rule protects third party creditors, whereas Parliament’s changes were directed toward protecting debtors (see Bill C-22: Clause by clause Analysis, cl. 87, s. 65.1 and cl. 89, s. 66.34, reproduced in the Attorney General of Canada’s book of authorities, at Tab 4; Standing Senate Committee on Banking, Trade and Commerce, Debtors and Creditors Sharing the Burden: A Review of the Bankruptcy and Insolvency Act and the Companies’ Creditors Arrangement Act (2003), at pp. 74-75). This goal of protecting the debtor is relevant only where the debtor persists after the proceedings conclude. It is common for the debtor to persist after a restructuring or after the bankruptcy of a natural person. It is uncommon for the debtor to persist after a corporate bankruptcy as, typically, no assets remain for the corporation after all creditors are paid.
[29] Moreover, as the intervenor Attorney General of Canada submitted, Parliament’s actions are better understood as gradually codifying limited parts of the common law rather than seeking to oust all related common law. As this Court has repeatedly observed, Parliament is presumed to intend not to change the existing common law unless it does so clearly and unambiguously (Parry Sound (District) Social Services Administration Board v. O.P.S.E.U., Local 324, 2003 SCC 42, [2003] 2 S.C.R. 157, at para. 39; Heritage Capital Corp. v. Equitable Trust Co., 2016 SCC 19, [2016] 1 S.C.R. 306, at paras. 29-30).
[30] Indeed, the most relevant statutory provision in the BIA is not s. 65.1, s. 66.34, or s. 84.2, but rather s. 71. As this Court recognized in Royal Bank of Canada v. North American Life Assurance Co., 1996 CanLII 219 (SCC), [1996] 1 S.C.R. 325, s. 71 provides that the property of a bankrupt to “passes to and vests in the trustee” (para. 44). This helps maximize the “global recovery for all creditors” in accordance with the priorities set out in the BIA (Alberta (Attorney General) v. Moloney, 2015 SCC 51, [2015] 3 S.C.R. 327, at para. 33; see also Husky Oil Operations Ltd. v. Minister of National Revenue, 1995 CanLII 69 (SCC), [1995] 3 S.C.R. 453, at paras. 7-9). The anti-deprivation rule renders void contractual provisions that would prevent property from passing to the trustee and thus frustrate s. 71 and the scheme of the BIA. This maximizes the assets that are available for the trustee to pass to creditors.
V. The Content of the Anti-Deprivation Rule
[31] As Bramalea described, the anti-deprivation rule renders void contractual provisions that, upon insolvency, remove value that would otherwise have been available to an insolvent person’s creditors from their reach. This test has two parts: first, the relevant clause must be triggered by an event of insolvency or bankruptcy; and second, the effect of the clause must be to remove value from the insolvent’s estate. This has been rightly called an effects-based test.
[32] Chandos submits that this Court should change the anti-deprivation rule to follow Belmont and adopt a purpose-based test. As noted above, Belmont held that the English anti-deprivation rule does not invalidate provisions of “bona fide commercial transactions which do not have as their predominant purpose, or one of their main purposes, the deprivation of the property of one of the parties on bankruptcy”. Chandos says we should follow this reasoning because upholding bona fide commercial agreements would strike the best balance of public policy considerations and contribute to commercial certainty. It also submits that the side-effects of such a rule would not be so deleterious, as unsecured creditors tend to receive little in bankruptcy; as well, courts would be able to tell who had inserted provisions that remove value from the debtor’s estate for bona fide commercial reasons. None of these reasons holds water.
[33] The goal of public policy, in this instance, is not decided by the common law; rather, that policy has been established in the legislation. What is left to the common law is the choice of means that best gives effect to the statutory scheme adopted by Parliament. Thus, once a court ascertains that Parliament intended, by virtue of s. 71, that all of the bankrupt’s property is to be collected in the trustee, it is not for the court to substitute a competing goal that would give rise to a different result. In this, I agree with Professor Worthington that “[a]ny avoidance, whether intentional or inevitable, is surely a fraud on the statute” (“Good Faith, Flawed Assets and the Emasculation of the UK Anti-Deprivation Rule” (2012), 75 M.L.R. 112, at p. 121).
[34] In addition, I would disagree that adopting a purpose-based test would create commercial certainty. To the contrary, applying such a test would require courts to determine the intention of contracting parties long after the fact and it would detract from the efficient administration of corporate bankruptcies. Parties cannot know at the time of contracting whether a court, possibly years later, will find their contract had been entered into for bona fide commercial reasons. This will give rise to uncertainty at the time of contracting.
[35] The effects-based rule, as it stands, is clear. Courts (and commercial parties) do not need to look to anything other than the trigger for the clause and its effect. The effect of a clause can be far more readily determined in the event of bankruptcy than the intention of contracting parties. An effects-based approach also provides parties with the confidence that contractual agreements, absent a provision providing for the withdrawal of assets upon bankruptcy or insolvency, will generally be upheld. Maintaining an effects-based test is also consistent with the existing effects-based test recognized in Gingras, at p. 487, for the pari passu rule founded on s. 141 of the BIA (previously s. 112 of the Bankruptcy Act, R.S.C. 1970, c. B-3), as well as the effects-based test set out in ss. 65.1, 66.34 and 84.2 of the BIA. These tests should remain consistent to prevent duplicative proceedings and avoid arcane disputes over whether the pari passu rule or the anti-deprivation rule is engaged by a particular provision. Although it is often easy to tell that a provision would affect the amount a creditor will receive, determining whether this is because it deprives the estate of value (thus violating the anti-deprivation rule) or because it reallocates the estate among creditors (thus violating the pari passu rule) depends on the precise machinery of law, disputes over such intricacies can be avoided if both rules apply an effects-based test.
[36] Moreover, an intention-based test would encourage parties who can plausibly pretend to have bona fide intentions to create a preference over other creditors by inserting such clauses. Parties will often be able to state some commercial rationale for provisions altering contractual rights in the event of a counterparty’s insolvency, such as guarding against the risk of the counterparty’s non-performance. An intention-based test would render the rule ineffectual, save in the most flagrant cases of deliberate circumvention of insolvency law. This would threaten to undermine the statutory scheme of the BIA.
[37] Reliance on general principles of contractual freedom to support an intention-based test is no less misplaced. As noted in Bhasin v. Hrynew, 2014 SCC 71, [2014] 3 S.C.R. 494, at para. 70, the common law of contract “generally places great weight on the freedom of contracting parties to pursue their individual self-interest” but, by definition, an assignment in bankruptcy strips the insolvent party of their interest. As Rowbotham J.A. observed, a party who might become insolvent has no incentive to resist a clause that deprives their estate of value upon bankruptcy. Parties do not negotiate with a view to protecting the interests of their creditors in the event of their bankruptcy. The costs of accepting the clause are borne solely by the unsecured creditors of the insolvent company (who are without a seat at the bargaining table) while the benefits are enjoyed only by the company while it is solvent.
[38] Finally, while it may be true that unsecured creditors tend to receive relatively little now, the effect of a purpose-based rule is that they would receive less.
[39] Overall, Chandos has not shown us good reason to adopt a purpose-based test. In my view, adopting the purpose-based test would create “new and greater difficulties” of the sort cautioned against in Watkins v. Olafson, 1989 CanLII 36 (SCC), [1989] 2 S.C.R. 750, at p. 762. As recognized in Bhasin, at para. 40, although a change to the Canadian common law may be appropriate when it creates greater certainty and coherence, it is not when the change would foster uncertainty and incoherence.
[40] All that said, we should recognize that there are nuances with the anti-deprivation rule as it stands. For example, contractual provisions that eliminate property from the estate, but do not eliminate value, may not offend the anti-deprivation rule (see Belmont, at para. 160, per Lord Mance; Borland’s Trustee v. Steel Brothers & Co. Limited, [1901] 1 Ch. 279; see also Coopérants). Nor do provisions whose effect is triggered by an event other than insolvency or bankruptcy. Moreover, the anti-deprivation rule is not offended when commercial parties protect themselves against a contracting counterparty’s insolvency by taking security, acquiring insurance, or requiring a third-party guarantee.
[41] In sum, the Court of Appeal was correct to consider whether the effect of the contractual provision was to deprive the estate of assets upon bankruptcy rather than whether the intention of the contracting parties was commercially reasonable. . Hutchingame Growth Capital Corporation v. Independent Electricity System Operator
In Hutchingame Growth Capital Corporation v. Independent Electricity System Operator (Ont CA, 2020) the Court of Appeal considered contractual and bankruptcy disputes between an intended electricity generator and the Independent Electricity System Operator (“IESO”), which is the successor to the Ontario Power Authority. One issue was whether the standard contract between the generator and the IESO terminated on the generator's bankruptcy (as the contract held), or whether that was prevented by the common law bankruptcy 'anti-deprivation' rule:(c) The termination provision in the RESOP Contract did not violate the common law “anti-deprivation rule”
[40] HGC submits that contractual provisions, like ss. 7.2(2) and 7.1(20), which terminated the RESOP Contract automatically on the bankruptcy of Greenview Power, are void as being contrary to public policy under the common law doctrine of “fraud on the bankruptcy law,” particularly the component of the doctrine known as the “anti-deprivation rule”. HGC argues that the automatic termination had the effect of removing value from Greenview Power’s insolvent estate and prevented secured creditors from exercising their rights over the secured assets.
[41] Professor Wood explains that the anti-deprivation rule invalidates contractual provisions that remove assets otherwise available to creditors in the event of insolvency. He discusses the fraud on the bankruptcy law doctrine in Bankruptcy and Insolvency Law at p. 88:Canadian courts have recognized that a contractual provision that is designed to remove value from the reach of an insolvent person’s creditors is void on the basis that it violates the public policy of equitable and fair distribution on bankruptcy. This is referred to as the “fraud on the bankruptcy law principle.” The principle can be usefully broken down into two distinct components: the anti-deprivation rule and the pari passu rule. The anti-deprivation rule operates by invalidating provisions that withdraw an asset that would otherwise be available to satisfy the claims of creditors upon the insolvency of the party or the commencement of insolvency proceedings. [Internal citations omitted.] [42] The common law anti-deprivation rule applies in commercial bankruptcies, including Greenview Power’s bankruptcy: Aircell Communications Inc. (Trustee of) v. Bell Mobility Cellular Inc., 2013 ONCA 95, at para. 12, citing Canadian Imperial Bank of Commerce v. Bramalea Inc. (1995), 33 O.R. (3d) 692, 1995 CanLII 7420 (C.J.); Capital Steel Inc. v. Chandos Construction Ltd., 2019 ABCA 32, 438 D.L.R. (4th) 195, at paras. 21 and 32, leave to appeal granted, [2019] S.C.C.A. No. 109.
[43] In each of these cases, the bankruptcy had the effect of depriving creditors of a valuable asset. In Aircell, a dealer of telecommunications products deprived the estate of earned commissions on sales: at paras. 1-2. In Bramalea, a clause in a partnership agreement permitted a partner to acquire an insolvent partner’s interest in a shopping mall venture at book value rather than at the substantially higher fair market value: at paras. 3, 10. In Capital Steel, the contract reduced the amount owing to the bankrupt by ten percent: at paras. 1, 16 and 32.
[44] By contrast, in this case, the IESO received no financial benefit from the automatic termination of the RESOP Contract and removed no value from the reach of Greenview Power’s creditors to its benefit. As Mr. Fogul testified at trial, his client had no “skin in the game” or an economic interest in the project; its interest as a regulator was ensuring “the rules, regulations and the contracts are covered.”
[45] The trial judge rejected HGC’s argument that the termination clause in the RESOP Contract violated the “anti-deprivation rule,” noting that the termination clause in this case “does not offend the public policy expressed in [Bramalea and Aircell],” because the contractual provision did not cause an inequity among creditors: at para. 109.
[46] I would reject HGC’s argument that its rights as a secured creditor under the Bankruptcy and Insolvency Act were prejudiced by the automatic termination of the RESOP Contract on bankruptcy. The trial judge noted that the Contract as a whole preserves the rights of secured creditors, like HGC: at paras. 119, 124. Section 9.2(3) of the RESOP Contract was designed to protect a secured creditor, such as HGC, against automatic termination resulting from the generator’s bankruptcy; HGC had the right to revive the terminated agreement within 90 days of the bankruptcy if it paid outstanding amounts owing to the IESO and cured existing defaults. Had HGC availed itself of the revival right, it could have exercised its rights as a secured creditor against the Greenview assets.
[47] I see no legal error in the trial judge’s determination. I also note that the RESOP Contract is an executory contract. As the IESO points out, “[the] IESO’s obligation to buy electricity [did] not arise until Greenview began supplying electricity in accordance with the contract’s terms.” In Capital Steel, the majority noted that clauses that “operate to terminate executory agreements … [and therefore] eliminat[e] a debtor’s opportunity to perform a contract [do] not necessarily result in a deprivation of value that would prejudice creditors” (citations omitted): at para. 34; see also Belmont Park Investments Pty Ltd. v. BNY Corporate Trustee Services Ltd. & Anor, [2011] UKSC 38, [2012] 1 A.C. 383. . Chandos Construction Ltd. v. Deloitte Restructuring Inc.
In Chandos Construction Ltd. v. Deloitte Restructuring Inc. (SCC, 2020) the Supreme Court of Canada notes that the principle of set-off is imported into bankruptcy law:[42] This brings us to Chandos’ final argument concerning the effect of set-off on the application of the anti-deprivation rule in this case. Set-off is given statutory approval in s. 97(3) of the BIA:(3) The law of set-off or compensation applies to all claims made against the estate of the bankrupt and also to all actions instituted by the trustee for the recovery of debts due to the bankrupt in the same manner and to the same extent as if the bankrupt were plaintiff or defendant, as the case may be, except in so far as any claim for set-off or compensation is affected by the provisions of this Act respecting frauds or fraudulent preferences. As this Court described in Husky Oil, at para. 3, s. 97(3) incorporates the provincial law of set-off (and the related civil law concept of compensation) into the federal bankruptcy regime. Set-off is a defence to the payment of a debt. The effect of set-off is to allow a creditor who happens to be also a debtor to recover ahead of their priority.
[43] The BIA’s affirmation of set-off and the anti-deprivation rule are not incompatible. While set-off reduces the value of assets that are transferred to the Trustee for redistribution, it is applicable only to enforceable debts or claims (see, e.g., Holt v. Telford, 1987 CanLII 18 (SCC), [1987] 2 S.C.R. 193, at pp. 204-6). The anti-deprivation rule makes deprivations triggered by insolvency unenforceable. The combination means that set-off applies to debts owed by the bankrupt that were not triggered by the bankruptcy. . Urbancorp Toronto Management Inc. (Re)
In Urbancorp Toronto Management Inc. (Re) (Ont CA, 2022) the Court of Appeal considered the anti-deprivation rule:[36] As to the first proposed ground of appeal, we do not accept the moving party’s submission that the Supervising Judge erred in his application of Chandos. It bears noting, as the Supreme Court did, that the anti-deprivation rule has relatively ancient roots in Canadian law, dating to Watson v. Mason (1876), 22 Gr. 574 (Ont. C.A.) and Hobbs v. The Ontario Loan and Debenture Co., (1890) 1890 CanLII 10 (SCC), 18 S.C.R. 483. The rule was referred to by Blair J., as he then was, in Canadian Imperial Bank of Commerce v. Bramalea Inc. (1995), 1995 CanLII 7262 (ON SC), 33 O.R. (3d) 692 (Gen. Div.), in which he adopted the following summary of the rule, at p. 694:A provision in an agreement which provides that upon an insolvency, value is removed from the reach of the insolvent person’s creditors to which would otherwise have been available to them, and places that value in the hands of others – presumably in a contract other than a valid secured transaction – is void on the basis that it violates the public policy of equitable and fair distribution amongst unsecured creditors in insolvency situations. [37] He added, at p. 695:… I am satisfied that the principle which underlies the notion is the deprivation of the creditors’ interests in a bankruptcy as a result of a contractual provision that is triggered only in the event of bankruptcy or insolvency and which results in property that would otherwise be available to the bankrupt and the creditors, or its value, being diverted to which is in effect, a preferred unsecured creditor. [Citations omitted.] [38] In Chandos, the majority confirmed that the anti-deprivation rule exists in Canadian law and has not been judicially or statutorily eliminated. Referring to Bramalea, it described the rule as follows, at para. 31:As Bramalea described, the anti-deprivation rule renders void contractual provisions that, upon insolvency, remove value that would otherwise have been available to an insolvent person's creditors from their reach. This test has two parts: first, the relevant clause must be triggered by an event of insolvency or bankruptcy; and second, the effect of the clause must be to remove value from the insolvent's estate. This has been rightly called an effects-based test. [Emphasis added.] [39] After stating that the focus of inquiry is on the effects of the provision rather than the intention of the parties in drafting it, the majority in the Supreme Court stated, at para. 35:The effects-based rule, as it stands, is clear. Courts (and commercial parties) do not need to look to anything other than the trigger for the clause and its effect. The effect of a clause can be far more readily determined in the event of bankruptcy than the intention of contracting parties. An effects-based approach also provides parties with the confidence that contractual agreements, absent a provision providing for the withdrawal of assets upon bankruptcy or insolvency, will generally be upheld. [Emphasis added.] [40] The Court added, at para. 40:All that said, we should recognize that there are nuances with the anti-deprivation rule as it stands. For example, contractual provisions that eliminate property from the estate, but do not eliminate value, may not offend the anti-deprivation rule (see Belmont, at para. 160, per Lord Mance; Borland’s Trustee v. Steel Brothers & Co. Limited, [1901] 1 Ch. 279; see also Coopérants). Nor do provisions whose effect is triggered by an event other than insolvency or bankruptcy. Moreover, the anti-deprivation rule is not offended when commercial parties protect themselves against a contracting counterparty's insolvency by taking security, acquiring insurance, or requiring a third-party guarantee. [Emphasis added.] [41] The emphasized portions of the above extracts make it clear that the focus of the concern is (a) whether the provision in question is “triggered” by an event of bankruptcy or insolvency and (b) whether the effect of the contractual provision is to deprive the estate of assets upon bankruptcy: see Lloyd W. Houlden, Geoffrey B. Morawetz & Janis P. Sarra, The 2021 Annotated Bankruptcy and Insolvency Act (Toronto: Thomson Reuters, 2021), at F§108. The Supreme Court in Chandos was clearly aware of the commercial importance of the issue when it stated that “contractual agreements, absent a provision providing for the withdrawal of assets upon bankruptcy or insolvency, will generally be upheld.”
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