When bankruptcy benefits secured creditors

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Secured creditors generally operate outside of bankruptcy proceedings. Not only may they continue to realize upon their security while unsecured creditors seek payment of their debts in bankruptcy, but secured creditors can actually benefit from a debtor’s bankruptcy in at least three different ways.

Favourable change in priorities

Bankruptcy can be advantageous to secured creditors because the priority scheme under the Bankruptcy and Insolvency Act (BIA), a federal statute, overrides provincial laws granting priorities to certain creditors.

For example, under provincial law, a landlord who distrains a tenant’s goods in order to collect rental arrears normally ranks above a secured creditor. But once a bankruptcy order is made against the debtor, the landlord loses its priority, and ranks behind secured creditors.

As another example, provincial laws accord precedence to certain claims, such as for government remittances and employee wages. Following a bankruptcy order, priorities change, and the priority scheme under the BIA takes precedence.

It is not improper for a secured creditor to seek a bankruptcy order against a debtor for the purpose of rearranging priorities, seeking to put themselves in a position to maximize their recovery.

Debtor examination

Bankruptcy also provides a process to formally investigate a debtor’s affairs. The trustee overseeing the bankruptcy has the right to acquire financial documentation and conduct examinations of the debtor under oath.

This careful scrutiny can be useful in situations where creditors suspect that the debtor may be concealing assets or has conveyed them fraudulently in an effort to shelter them from seizure in repayment of the debt. Secured creditors may want to resort to bankruptcy proceedings against a debtor where the creditor has reason to believe their security is being improperly dissipated.

Reversal of unfavourable transactions

A final benefit of bankruptcy for secured creditors lies in the ability of the trustee to reverse certain transactions that might otherwise be disadvantageous to creditors. These may include preferential payments to certain creditors or a sale of the debtor’s assets to a non-arm’s length buyer.

Secured creditors would do well to seek professional legal counsel in order to determine the most effective route to protect their interests when their debtors are financially precarious.

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