Creditors beware. Creditor must payout settlement amount to bankruptcy estate as condition of granting s. 38 application

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Section 38(1) of the Bankruptcy and Insolvency Act (“BIA”) allows a creditor to apply for an assignment of the trustee’s right to pursue a claim that the trustee has failed to or is unwilling to pursue. It also provides the court granting such an order, discretion to impose “such other terms and conditions as the court may direct.”

Normally under section 38(3), any benefit derived from such a proceeding belongs exclusively to the creditor who is assigned the rights to pursue the action under subsection (1), and only the surplus, if any, belongs to the bankruptcy estate. 

However, what if there was a settlement agreement in place, or the trustee was offered a settlement amount to settle the proceeding prior to the section 38 application? Wouldn’t it be unfair for a sole creditor to now exclusively benefit from the proceeding just because it made an application under s. 38 to be assigned all rights of the trustee in the proceeding? 

In such a case, the British Columbia Court of Appeal in W. Hanson Holdings Ltd. v. Wolrige Mahon Ltd., Trustee in Bankrupcty of Intercoast Lumber Inc., 1995 CanLII 2479 (BCCA) ordered that such a creditor be assigned the proceeding, on the condition that the creditor pay the proposed settlement amount to the Estate, so as to not prejudice other creditors from receiving a share of the settlement amount that they ought to have received. This guarantees that, regardless of the outcome of the proceeding, the Estate and any other creditors that may have benefitted from the settlement, will not be prejudiced by the granting of a section 38 order, and will still be guaranteed to receive, at the minimum, a pro rata distribution of the proposed settlement amount. 

In considering whether to pursue an assignment of a claim in bankruptcy, experienced advice can help avoid unexpected results.

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