When bankruptcy reshuffles the priority of creditors

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Under ordinary circumstances, certain creditors enjoy a favoured standing in the realization pecking order. For example, federal and provincial legislation may create preferred rights in respect of debts such as collected but unremitted taxes and unpaid wages. However, once a debtor is bankrupt, a new hierarchy for creditors will govern.

This reshuffling of priorities, as set out in the Bankruptcy and Insolvency Act (BIA), may create new opportunities for certain creditors to maximize their chances at recovering owed amounts or minimizing losses. In fact, some creditors may strategically invoke a debtor’s bankruptcy to achieve a more advantageous footing. Consider two of the possible scenarios 

Government claims reduced to unsecured claims

Prior to bankruptcy, a debtor may carry significant obligations to the federal or provincial governments which, in the normal course of events, may have priority over other creditor claims, including secured creditors. However, once a debtor is bankrupt, unless the government has taken steps to protect its interests, many governmental claims join the ranks of other unsecured creditors pursuant to section 86 of the BIA. Bankrupting a debtor in such a case can be a consideration for secured creditors to protect its interests.

A bankruptcy can also give a one class of unsecured creditor, unpaid suppliers, the opportunity to recover their unpaid goods before the debtor’s assets can be sold and distributed to benefit other creditors in priority over all creditors, including government creditors.

Landlords may lose priority over distrained goods

Another example in which creditors bump one another in priority involves rent distress. Under provincial law, a landlord may exercise the right to seize a tenant’s good to satisfy arrears before most other secured creditors can collect. But once there is a bankruptcy, the BIA rules apply and the landlord’s right to priority under a rent distress is lost.

When owed amounts fall into a bankrupt estate, creditors are wise to consult with an insolvency lawyer about their readjusted level of priority and possible strategies to maximize their recovery.

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