Bankruptcy and Insolvency: Recent Amendments

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Originally presented to the Canadian Association of Insolvency and Restructuring Professionals Insolvency and Restructuring Forum
May 2010

These materials contain summaries of complex matters, omitting details which may be important in a particular case.
DO NOT RELY ON THESE MATERIALS without separate advice on your specific situation.

Background

Insolvency reform in Canada has typically been a slow, incremental affair. As a subject for legislative action, it suffers from two disabilities. First, it’s insolvency: no one cares, because no one plans on going bankrupt. There is no natural stakeholder group lobbying for change in this area, or the existing stakeholders are not regarded as high-priority. This lack of a constituency makes it difficult to get insolvency reform on the government’s agenda and keep it there long enough to actually bring about real change.

Secondly, this area of law is bedevilled by conflicting interests. Insolvency is a zero-sum game: since there is not enough value to go around, anything you give to one stakeholder group tends to come out of the mouth of some other stakeholder group or groups. By and large, whatever change you might consider to benefit one group, some other group is going to feel their ox is being gored. This is not a guaranteed way for politicians to increase their popularity.

So, in 2005, although a lot of work had been done in various parliamentary committees and work groups on a large omnibus package of insolvency reforms, there was little indication that any of this package was going to actually get on the government’s legislative agenda anytime soon.

Then, in the fall of 2005, insolvency reform found itself in the right place at the right time. More accurately, insolvency reform found itself with the right name. One of the high profile aspects of the reform package was a new “Wage Earner Protection Program” regime. This consisted of a separate statute, the Wage Earner Protection Program Act, and related changes to the main insolvency statutes, the Bankruptcy and Insolvency Act (BIA) and Companies’ Creditors Arrangement Act (CCAA). This regime sought to improve the situation for wage earners where their employer became insolvent.

In the lead-up to a federal election, politicians did not want to be on the wrong side of anything containing the words “wage earner protection”. In a show of worker solidarity, or political opportunism, Parliament rammed this legislation through in record time, enacting it just before breaking for the election that followed in 2006.

In addition to wage earner protection, the reform package also contained a number of other amendments as well, dealing with entirely different insolvency issues. These were wide-ranging reforms, not just cleanup and technical improvements, involving whole new provisions driven by policy goals. The amending statute totalled 141 sections.

Although the legislation was enacted, it was not actually proclaimed in force. In essence, it sat on the books of the government, needing only a pen stroke to bring it to life. This was a good thing, since the hurried enactment resulted in a deeply flawed piece of legislation going on the books which everyone knew was not yet ready for prime time. The package was flawed by numerous inconsistent provisions, grammatical errors, undefined terms, etc. In fact, the government agreed not to bring it into force until further changes and corrections had been made.

Following the federal election, the newly elected Harper government did continue fixing the problems with the amendments which had been identified. By December 2007, they were able to introduce a further legislative package, essentially amending the amendments. This was also a substantial piece of legislation, 113 sections long.

Again, the new statute was enacted, but not proclaimed in force, since there was still lots of work to be done on system changes and consequential regulations.

And there things sat until 2008. On July 7, 2008, certain provisions of the new statutes were proclaimed in force. Three noteworthy changes:

  1. The wage earner protection regime
  2. Exemptions for RRSPs and similar financial instruments
  3. Changes to the treatment of student loans

The balance of the amendments were proclaimed in force September 18, 2009 ( with a few further minor amendments since that time).

2008 Amendments

Wage Earner Protection Program

The new wage earner protection regime consists of two parts, set out in the new Wage Earner Protection Program Act (WEPPA) and in related changes to the BIA and CCAA.

The first part is the creation of a fund to pay up to $3,000.00 to each worker for wages owing where the employer becomes insolvent. (To be precise, the amount paid is actually the greater of $3,000.00 or four times the worker’s maximum EI insurable earnings.) These amounts are paid out of the government’s general account, the Consolidated Revenue Fund.

The second part is the creation of a corresponding charge on the assets of insolvent employers to secure these payments. The amounts included in this charge more or less mirror the above payments to workers, except that the charge only covers up to $2,000.00 for each worker.

The insolvent employer need not be bankrupt for these new provisions to kick in. The WEPPA regime applies in both bankruptcy and receivership situations.

The protection provided under the WEPPA regime has a number of limitations:

  1. To qualify, the unpaid pages must have been earned no more than six months previously. Older wages are not covered.
  2. There is no coverage for wages owing to directors or officers. Nor is there coverage for non-arm’s-length employees, unless the trustee in bankruptcy (or receiver) is satisfied that the arrangements are equivalent to an arm’s-length arrangement.
  3. The amounts are limited, as mentioned.
  4. The charge on the employer’s assets covers only current assets, defined as cash, cash equivalents, inventory, accounts receivable, and the proceeds derived from any of them.

Where there is already a charge on the employer’s assets, for example a prior charge in favour of a bank or other secured creditor, does it have priority over the WEPPA charge? Short answer: the WEPPA charge has priority. It is in effect another government super-priority, which comes ahead of (almost all) prior secured charges.

Canada’s lenders are obviously not too happy about this aspect of the new WEPPA scheme. Lenders used to occasionally use bankruptcy as a way to rearrange priorities to ensure that their secured debt had priority ahead of wages. That is no longer possible.

This in turn means that lenders have to further discount any security they hold over current assets to the extent of unpaid wages. This also likely means increased monitoring by lenders, with attendant increased costs.

The WEPPA regime also applies to unpaid pension contributions for both the employee’s withheld portion and the employer’s unpaid contribution. These are also protected by a charge over the insolvent employer’s assets. And, this charge covers all assets of the company, not just current assets.

The charge for unpaid pension contributions enjoys the same super-priority, except that this charge is itself behind the charge for wages.

RRSPs

RRSPs will now be exempt from creditors under another change proclaimed in force in July, 2008.

First, the old law. Generally-speaking, RRSPs were not exempt from creditors, but instead could be attached and liquidated by creditors. Whatever other special status RRSPs enjoyed, which were primarily tax-related, they were not special when it came to availability to creditors.

Under the old law, it could be difficult to get at RRSPs, because they are often in the nature of a trust arrangement, or because the situs of the RRSP is outside the province, but they were not exempt. Often the practical solution was to bankrupt the debtor. His or her trustee in bankruptcy could get at any RRSPs in short order.

This is all now changed as a result of the BIA amendments. The Act now specifically provides that RRSPs are not available to creditors, but remain the property of the bankrupt.

Some features of this new exemption are noteworthy. There is no maximum amount. As a result, courts are going to be facing bankrupts who are seeking their discharge having little or no assets for their creditors, but who sit on substantial wealth in their RRSPs. This may prove challenging.

There is only one restriction to the exemption. Not covered is “property contributed to any such plan or fund in the 12 months before the date of bankruptcy”. The wording of this is not great, since it implies that the trustee in bankruptcy needs to identify the very dollars contributed in the last year. However, in most cases contributions will be added to an existing pool of investments and will not be traceable in this way. In practice the provision will likely be interpreted to mean, “an amount equal to the value of all property contributed in the 12 months before the date of bankruptcy.”

The exemption applies to three classes of investments: RRSPs and RRIFs, both as defined in the Income Tax Act, and “any prescribed plan”. In fact, the government has already added a type of prescribed plan: “deferred profit sharing plans”, again as defined under the Income Tax Act.

This new exemption for RRSPs raises some interesting questions. If all contributions to a RRSP within the last year are not exempt from creditors, does that mean that all contributions outside the one year mark are allowed? Is the one year limitation a shield as well as a sword? Would such a transfer, which would otherwise be attackable under the Fraudulent Conveyance Act, now be bullet-proof?

If you over-contribute (before the one-year window), is the over-contribution still sheltered? You will not get the tax benefit, but it’s still an RRSP contribution, and could still be covered by the exemption.

Provincial RRSP Changes

As an aside, the BC provincial government has also been busy addressing RRSPs and creditors.

As part of the Economic Incentive And Stabilization Statutes Amendment Act (which generated news coverage dealing with changes to the property tax assessment regime), the BC legislature also passed a new exemption for RRSPs that largely mirrors the changes under the BIA.

Like the federal exemption, this one applies to RRSPs, RRIFs and to deferred profit sharing plans, again all as defined in the Income Tax Act. Unlike the federal exemption, this provincial exemption also applies outside of bankruptcy.

The provincial exemption also has a one-year window on plan contributions, but since there is no bankruptcy, the statute uses the date when “the debt being enforced arose”. Any contribution within one year prior to that date is not exempt.

Student Loans

The Canada Student Loan Program was set up to provide credit to students trying to get a higher education, who otherwise would not be able to obtain credit on their own. Because they are young, have no assets and little or no employment history, these students were regarded by bankers and other lenders as poor credit risks. As a result, lenders had generally been reluctant to lend to this group. The government stepped in and in essence guaranteed these loans to students.

Later on, when it came time to repay, perhaps not surprisingly, many of these students defaulted. The government reacted to this shocking development by passing new laws making student loans different from other kinds of debt. Following this change, debtors who went bankrupt owing money under the Program were treated somewhat as criminals, rather than as debtors. If such a debtor went bankrupt within ten years of being a student, then their debt to the Program survived bankruptcy. This lumped student loans into a category of the most reprehensible debts, such as damages for sexual assault, claims for fraud and embezzlement, etc., given especially harsh treatment under the BIA.

The amendments have softened this treatment somewhat. Now, debtors with student loans will find those loans surviving bankruptcy only if they were incurred within seven years of bankruptcy, rather than ten. Also, bankrupts can now apply to be relieved of their student loans, even after discharge, on the basis of hardship, at any time after 5 years from the date of the loans.

This is an improvement for student loan debtors, although arguably still wrong-headed.

2009 Amendments

Bankruptcy

Discharges Generally

In general, bankruptcy discharges will now take longer. In the past, all first-time bankrupts were entitled to an automatic discharge after nine months. “Automatic discharge” means that there is no need to attend in court, and the discharge is granted once the required time period passes. Automatic discharges are not available where the trustee or a creditor objects to the discharge.

With the recent changes, most bankrupts are no longer entitled to an automatic discharge until twenty-one months have passed. Only bankrupts without surplus income continue to be entitled to an automatic discharge after nine months.

“Surplus income” is a threshold set by the Superintendent of Bankruptcy for income earned during a bankruptcy. Any income above that threshold must be paid over in part to the trustee for distribution to creditors. As an example, under the current guidelines for Metro Vancouver, surplus income starts at $1,836 per month for an individual, and at $3,413 for a family of four. (These figures are net of income taxes.)

So, it does not take much income for a bankrupt to be pushed into surplus income territory, at which point the coming changes force them to wait another twelve months for their automatic discharge.

Note: It is possible for bankrupts to apply to court for their discharge prior to the above time periods.

For bankrupts who are in bankruptcy for a second time, it gets worse. They now have to wait twenty-four months for their automatic discharge, and where they have surplus income, the wait for an automatic discharge increases to thirty-six months.

Personal Tax Debtors

Debtors who go bankrupt owing significant amounts for income taxes are singled out for rougher treatment under another change. If:

  1. You become bankrupt with $200,000 or more in personal income tax debt; and
  2. That debt is equal to 75% or more of your total debt

then you’re a “tax debtor”.

“Personal income tax debt” does not include liability as a director for a company’s tax liability.

The changes make things worse for tax debtors in a number of ways. First, tax debtors are not entitled to an automatic discharge at all, at any time. They must apply to court for their discharge.

Secondly, tax debtors cannot apply for early discharge. They must wait out the same time periods mentioned above for automatic discharges, before they apply for their discharge.

Thirdly, the new provisions set out specific criteria, relating to the bankrupt’s income tax debt, which the court must consider in setting discharge conditions. These criteria are:

  1. The circumstances of the bankrupt when the income tax debt was incurred;
  2. Any efforts the bankrupt made to pay the income tax debt;
  3. Whether or not the bankrupt paid others while failing to pay the income tax debt; and
  4. The bankrupt’s financial prospects for the future.

Clearly, the drafters of these changes want income tax debt to be treated like some higher quality of indebtedness. It remains to be seen how courts will treat these criteria.

Transfers at undervalue

The BIA contains a number of provisions for the attack of transactions that the law regards as unfair to creditors. Under another change, a new provision has been introduced, the “transfer at undervalue”.

If:

  1. A transaction involving the bankrupt was for no consideration or for consideration which was conspicuously less than fair market value;
  2. The transfer took place within one year before bankruptcy; and
  3. The bankrupt by entering into this transaction intended to defraud, defeat or delay a creditor;

then the court can unwind the transaction, or grant judgment against the other party for the difference between the actual consideration and fair market value.

Or, if the bankrupt and the other party were not acting at arm’s-length, then two further provisions apply:

  1. The review time period is extended from one year to five years; and
  2. Within the first year before bankruptcy, the bankrupt’s intention is not relevant.

This new provision will replace two existing means to attack transactions: settlements and reviewable transactions.

Like the old reviewable transactions provisions, this now provision can apply to a purchase as well as to a sale. So, if a bankrupt purchases a $50,000 asset for $100,000, or sells a $100,000 asset for $50,000, then the transfer at undervalue provisions may apply to set it aside.

National Receivers

The court will be able to appoint a receiver over a company’s assets in any province, under further changes to the BIA. There will no longer be a need to get complementary orders in each province separately.

Cross-Border Insolvencies

An entirely new regime for the administration of cross-border insolvencies has also come into force. This has required changes to the CCAA as well as to the BIA.

The new provisions are based on the model put forth by the United Nations Commission for International Trade Law.

BIA Proposals and CCAA Plans

Pension Plans

Previously, any proposals and plans had to provide for immediate payment in full of outstanding wage claims. Under the amendments, any proposals and plans must still provide for payment in full of outstanding pension plan contributions, but not necessarily immediately.

Sales

Sales during restructuring proceedings which are out of the ordinary course of business of the debtor now require court approval, on notice to secured creditors.

Executory contracts

There is now a general right to disclaim executory contracts (contracts to be performed in the future) as part of a BIA proposal or CCAA plan. Previously, these Acts only gave the right to disclaim commercial leases of real estate.

There are some exceptions: eligible financial contracts (derivatives and swaps), financing agreements where the debtor is the borrower, leases where the debtor is the lessor, and, most importantly, collective bargaining agreements.

DIP Financing

Restructuring proceedings under the CCAA regularly feature “debtor-in-possession” (DIP) financing: court-ordered financing that is a charge on the debtor company’s assets, ranking ahead of existing secured creditors. The ability of the court to do so in BIA proposal proceedings had been less clear.

The amendments now clarify that the court can order DIP financing in BIA proposal proceeding, and give a charge on the debtor company’s assets as security for the DIP financing, that ranks ahead of existing secured creditors. The provisions set out specific criteria for courts to consider in deciding whether to grant DIP financing, and how much. These also now appear in the CCAA.

Oddly, the debtor company needs only give notice to secured creditors of such an application. What about the scenario where there’s enough value in the assets to pay for existing secured debt, plus the new DIP debt? In that case, the stakeholders affected by the new DIP security are the unsecured creditors, not the secured creditor.

Director and Officer Charge

There are also new provisions which allow the court in appropriate circumstances to order a charge in favour of a company’s directors and officers, in both BIA and CCAA insolvency proceedings. Again, these charges can rank in priority ahead of existing secured charges.

Conclusion

Whatever the motivation for their original enactment, these changes in general improve Canada’s insolvency laws in a number of ways, adding certainty and fairness and accomplishing worthwhile policy objectives.

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