Bankruptcy and creditors’ rights

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Subject to the provisions of the Bankruptcy and Insolvency Act (BIA), one or more unsecured creditors of a debtor may apply to the court for a bankruptcy order in respect of the debtor if:

  • The debt or debts owing to the creditor or creditors by the debtor is $1,000 or more; and,
  • If debtor has committed an act or bankruptcy in the six month period prior to the filing of the application with the court.

Secured creditors are generally outside the distribution scheme of the BIA. They are entitled to realize on the property of the debtor charged by the security, and thus may have no interest in the bankruptcy of the debtor.

However, in some instances, it may serve the purposes of the secured creditor to have a bankruptcy, for example, to reorder certain priorities between the secured creditor and other creditors. In such case, a secured creditor may value the security at $1,000 less than the amount the secured creditor is owed in order to qualify as an unsecured creditor of the debtor for $1,000, and can then make an application for a bankruptcy order.

Bankruptcy can also be initiated by a debtor who is an “insolvent person” as defined by the BIA by the debtor making an assignment in bankruptcy.

Appointing the trustee in bankruptcy

If an unsecured creditor applies for a bankruptcy order, such creditor will initially select the person to act as the trustee in bankruptcy. Where the debtor makes an assignment in bankruptcy, the debtor will initially select the person to act as trustee in bankruptcy.

However, the selection of an initial trustee in bankruptcy by the creditor who obtains the bankruptcy order or the debtor on the assignment in bankruptcy might only be until the first meeting of unsecured creditors. At that meeting, the creditors who are entitled to vote at the meeting will be asked to either affirm the appointment of the initial trustee or to vote for the substitution of the trustee. Creditors seeking to appoint a new trustee should be mindful that in doing so they may have to take on financial obligations in relation to the new trustee’s fees and expenses if there are insufficient assets in the in the estate.

Administration of the bankruptcy estate

The trustee in bankruptcy is an officer of the court and is answerable to the creditors and other stakeholders with claims or interests related to the bankrupt. In administering the bankruptcy estate, the trustee must act in the best interest of all creditors.

As of the date of bankruptcy, subject to the rights of secured creditors, the trustee will take control of the bankrupt’s property for the benefit of the unsecured creditors. The trustee will notify all of the known creditors of the first meeting of creditors and invite them to file proofs of claim in relation to the bankrupt. It is the trustee’s responsibility to assess the proofs of claim and either accept, reject or accept in a lesser amount, the filed proofs of claim.

Unsecured creditors at the first meeting of creditors are entitled to appoint persons called inspectors to oversee the administration of the bankruptcy estate. An inspector will be a creditor or the representative or nominee of a creditor.

In the process of administering the estate, the trustee will exercise the powers set out in section 30 of the BIA with the permission of the inspectors. If there are no inspectors appointed by the creditors, then the trustee may exercise those powers on its own, which include:

  • Realizing on the property of the bankrupt;
  • Initiating or defending actions related to the bankrupt’s property; and,
  • Compromising claims by or against the estate.

How much a trustee is realistically able to do to recover money for the estate may depend on the value of the estate. For example, while there may be a basis for a claim by the trustee against a third party, the trustee might not have the funds in the estate to pursue such claim unless one or more of the creditors are prepared to fund the litigation or a lawyer is prepared to take the claim on a contingency basis.

Some creditors have unique rights or priorities that will need to be recognized by the trustee. For example, certain governmental claims have a super-priority in respect of the bankrupt’s property and unpaid suppliers may have a right to recover goods delivered in the period prior to the bankruptcy.

There are several BIA provisions dealing with secured creditors. Secured creditors can be compelled to deliver a proof of claim and to value their security so that the trustee can determine whether to redeem the security. If the secured creditor will have a shortfall on its claim, it is entitled to file a proof of claim as an unsecured creditor in respect of such shortfall.

Secured creditors will, in a bankruptcy, generally have the right to take independent action to recover on the security. Unsecured creditors have no independent rights in respect of the property of the bankrupt or claims that could be pursued by the trustee. The exception, however, is when an unsecured creditor takes an assignment of a claim for value from the trustee or obtains an order under section 38 of the BIA. In such circumstances, an unsecured creditor may be able to recover all or substantially more in relation to its claim than it would under the distribution scheme of the BIA.

If an unsecured creditor does not take such an initiative, it must wait on the trustee to realize on the bankrupt’s uncharged property or to pursue other claims. Unless there is an interim distribution, it is only when the trustee is near completion of the administration of the estate that the trustee will distribute the proceeds in accordance with the priorities set out in section 136 of the BIA.

Depending on the circumstances, both secured and unsecured creditors may benefit from timely legal advice before and during the course of a bankruptcy in order to understand their rights.

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