A Quick Lesson on Bankruptcy and Insolvency Law

Before getting into the facts of this case, a short introduction to insolvency law is required. This area of law involves two major regimes which are embodied in separate statutes: the Bankruptcy and Insolvency Act (BIA) and the CCAA. Whereas the BIA applies to an “insolvent person”, which may include individuals and corporations of any size, the CCAA applies only the companies with more than $5 million in debt. Both regimes allow debtors make proposals. If a proposal under the BIA fails, then the debtor can use the bankruptcy provisions in the BIA. Generally speaking, bankruptcy proceedings under the BIA involve selling off a debtor’s assets and distributing the proceeds to creditors according to a distribution scheme set out in the BIA.  In comparison, the CCAA does not have any provisions that allow for the liquidation of a debtor’s assets where reorganization fails. The debtor or creditor(s) must rely upon the provisions in the BIA to assign into bankruptcy or apply for a bankruptcy order, respectively.

The traditional view is that the CCAA seeks to avoid liquidation by allowing the debtor to restructure its business. During reorganization a stay is granted by the supervising court so that none of the creditors can enforce their debts. The purpose of the stay is to allow the struggling company to focus on its rehabilitation and reach a compromise with its creditors. Rehabilitation is facilitated by the relatively flexible regime that is facilitated by the CCAA’s skeletal legislative framework. The CCAA is described as skeletal because there are, or rather, there used to be, a lot of gaps in the legislation. The gaps in the legislation enabled the courts to exercise a wide degree of discretion so to facilitate rehabilitation, the ultimate goal of the CCAA.

The Crown Wages War Against Century 21 Inc. Over GST Funds

In Century 21 Inc. a debtor had initiated proceedings under the CCAA. Its creditors included the Crown and Century 21 Inc. The former was owed $305,202.30 in GST funds that were collected but not yet remitted to the Crown. While the reorganization was in progress, the funds were held in a separate trust held by the monitor of the reorganization pursuant to a court order. When the debtor’s reorganization failed the Supreme Court of British Columbia (BCSC) partially lifted the stay of proceedings that was imposed pursuant to the CCAA to allow the debtor to voluntarily assign into bankruptcy under the BIA. The CCAA stay was continued partially so to allow for the orderly disposition of the debtor’s assets in order to maximize the recoveries for the interested parties. In response to the debtor’s application, the Crown petitioned for the GST funds to be paid out to it. The legal dispute at hand arises out of the fact that this case involves the simultaneous use of two pieces of conflicting legislation.

According to s. 222(1) of the ETA, the GST funds were held in a deemed trust in favour of the Crown. Part of the complication arises from s. 222(3) which states that the trust operates notwithstanding any other enactment of Canada except the BIA. The other part of the complication is that s. 18.3 of the CCAA states that subject to certain exceptions, none of which mentions GST funds, deemed trusts in favour of the Crown do not operate under the CCAA. Thus, the SCC had to determine which provision took precedence.

At the BCSC, Brenner C.J. held that the Crown lost its preference under the BIA and thus it was not entitled to the GST funds. The money was only to be paid out in the event that a viable plan was formed at the end of the CCAA process. Since there was going to be a sale of assets under the BIA as well as under the continued CCAA stay the Crown lost its preference under the BIA.

The Court of Appeal (BCCA) overturned the BCSC by holding that there were two independent bases upon which to find in favour of the Crown. For the first ground of appeal, Tysoe J.A. for the unanimous Court of Appeal relied upon his Ontario counterpart’s decision in Re Ottawa Senators Hockey Club Corp. (2005), 73 O.R. (3d) 737 to overturn the lower court decision. In that decision, the Ontario Court of Appeal held that s. 222(3) of the ETA had precedence over s. 18.3(1) of the CCAA because the latter was enacted earlier and was more specific than the former. The result of this decision was that the deemed trust for GST funds in question survived in a CCAA proceeding and the Crown was entitled to its unremitted GST funds. Accordingly, Tysoe J.A. applied Ottawa Senators in favour of the Crown. For the second ground of appeal, Tysoe J.A. held that an express trust was created when Brenner C.J. ordered that GST funds be segregated in the monitor’s trust account.

Ottawa Senators Loses in Overtime

In the final round of appeal the precedent in Ottawa Senators was crushed by a 8:1 SCC majority led by Deschamps J. The SCC overturned the BCCA’s decision because it disagreed with the result and reasoning in Ottawa Senators. At paragraph 44, Deschamps J. states,

While a conflict may exist at the level of the statutes wording, a purposive and contextual analysis to determine Parliament’s true intent yields the conclusion that Parliament could not have intended to restore the Crown’s deemed trust priority in GST claims under the CCAA when it amended the ETA in 2000 with the Sparrow Electric amendment.

The “Sparrow Electric amendment” mentioned by Deschamps refers to the amendment to the BIA that strengthened the deemed trust in favour of the Crown created by s. 227(4.1) of the Income Tax Act. Parliament could have expressly legislated that s. 222(3) had precedence but it did not. Further, she adds that Parliament has “shown its willingness to move away from asserting priority for Crown claims in insolvency law.”

In dissent, Abella J. employs a different method of interpretation to hold that the Crown did have priority over the GST funds. Firstly, she upholds the precedent in Ottawa Senators. The interpretation issue before her was uncomplicated: since s. 222(3) unambiguously states that the deemed trust therein operates notwithstanding any law except the BIA, it is clear that there is no legislative intent to exempt the CCAA from the operation of the ETA. Secondly, Abella J. shores up her argument by stating that there is no policy reasons for interfering with what she views as clear legislative intention. While her approach to interpretation is well-reasoned and logically sound, I find myself persuaded by the majority’s decision based on its homage to the different policies that drive the BIA and CCAA. The majority points out that adopting Abella J.’s approach could lead to statute shopping because the BIA, unlike the CCAA, would shield the debtor from the Crown’s interest in GST funds. Another persuasive argument rooted in policy is the majority’s observation that:

If Ottawa Senators were to be followed, Crown priority would differ depending on whether restructuring took place under the CCAA or the BIA. The anomaly of this result is made manifest by the fact that it would deprive companies of the option to restructure under the more flexible and responsive CCAA regime, which has been the statute of choice of complex reorganizations.

Notwithstanding the increasing parallels between the two regimes, the distinguishing characteristic of the CCAA is that it  provides the flexibility for debtors to achieve the ultimate goal of rehabilitation. The minority’s position has the potential to make the CCAA impotent, which in turn, necessitates that it not be adopted.

Discretion

This case also provided the SCC with the opportunity to develop the exercise of discretion under the CCAA. First, the exercise of discretion must be in furtherance of the CCAA’s purposes. As an example it cites the following excerpt from Elan Corp. v. Comiskey (1990), 41 O.A.C. 282, at para. 57, per Doherty J.A., dissenting:

The legislation is remedial in the purest sense in that it provides a means whereby the devastating social and economic effects of bankruptcy or creditor initiated termination of ongoing business operations can be avoided while a court-supervised attempt to reorganize the financial affairs of the debtor company is made.

Second, courts must “rely first on an interpretation of the provisions of the CCAA text before turning to inherent or equitable jurisdiction to anchor measures taken in a CCAA proceeding.” Third, “the requirements of appropriateness, good faith, and due diligence are baseline considerations that a court should always bear in mind when exercising CCAA authority.  Appropriateness under the CCAA is assessed by inquiring whether the order sought advances the policy objectives underlying the CCAA.”

Living in Harmony

I find this decision particularly interesting because of the detailed history of the law’s development and certain comments made by Deschamps J. which somewhat touches on a key debate in insolvency law.  At paragraph 24 she discusses the harmonization of the BIA and CCAA:

With parallel CCAA and BIA restructuring schemes now an accepted feature of the insolvency law landscape, the contemporary thrust of legislative reform has been towards harmonizing aspects of insolvency law common to the two statutory schemes to the extent possible and encouraging reorganization over liquidation [.]

What is noteworthy about the majority’s observation of harmonization is that it undermines the criticism that the increasing parallels between the two regimes make the CCAA redundant. One key debate in insolvency law involves the argument that that as the CCAA’s skeletal framework is fleshed out via judicial decisions that parallel the framework of the BIA, the latter’s existence as a separate statue comes into question. Harmonization seems to imply that the each statute plays a separate function: whereas the CCAA provides for flexible reorganization that can lead to rehabilitation, the BIA provides a structured route for liquidation. Concerns about parallelism are valid insofar that they reinforce the need to distinguish the CCAA as a flexible and creative tool for the courts to exercise discretion. The majority does not explicitly touch on parallelism, though its decision does manage to preserve the distinctiveness of the CCAA, thus allaying concerns that the former is increasingly becoming redundant.

Bank Engages in Tug-of-War with Credit Union

Unlike the applicable legislative framework, the facts of this case are quite straightforward. In October 1991, a debtor granted a security interest in his present and after-acquired personal property to Innovation Credit Union (“ICU”) pursuant to the PPSA, in exchange for a loan. The debtor subsequently obtained a loan from the Bank of Montreal (“BMO”), which was secured by granting a security interest in favour of BMO pursuant to the Bank Act. Since ICU had not registered its security interest until after BMO had obtained its security interest and the debtor did not inform BMO of the prior security interest, BMO was unaware of the extent of its financial risk. When the debtor defaulted on his bank loan, BMO seized some of the property subject to the Bank Act security. In turn, ICU brought an application pursuant to s. 66 of the PPSA seeking a declaration that it had priority over BMO.

At first blush, one familiar with the PPSA would speculate that BMO would win out over ICU because the latter did not perfect its security interest. As will be discussed later, the applications judge, Zarzeczny J., made the error of adopting that approach. According to Zarzeczny J., the priority rule specified in s. 428 of the Bank Act gave BMO priority over subsequently acquired priority rights.  The rule is that a Bank Act security interest has “priority over all rights subsequently acquired in, on or in respect of that property, and also over the claim of any unpaid vendor.” This approach was rejected by the Saskatchewan Court of Appeal and the SCC.

Legal Acrobatics: Using Provincial Property Law to Interpret Federal Law

Charron J., writing for the unanimous SCC, agreed with the Court of Appeal that the proper approach involved focusing on ss. 427(2) and 435(2) of the Bank Act. The relevant provisions are listed below:

s. 427(2)(c) Delivery of a document giving security on property to a bank under the authority of this section vests in the bank in respect of the property therein described…the following rights and powers, namely…the same rights and powers as if the bank had acquired a warehouse receipt or bill of lading in which that property was described”.

s.435(2) Any warehouse receipt or bill of lading acquired by a bank under subsection (1) vests in the bank, from the date of the acquisition thereof,

(a) all the right and title to the warehouse receipt or bill of lading and to the goods, wares and merchandise covered thereby of the previous holder or owner thereof; and

(b) all the right and title to the goods, wares and merchandise mentioned therein of the person from whom the goods, wares and merchandise were received or acquired by the bank, if the warehouse receipt or bill of lading is made directly in favour of the bank, instead of to the previous holder or owner of the goods, wares and merchandise.

The combined effect of these two provisions is that the “bank can acquire no greater interest in the collateral than the debtor himself has at the relevant time.” To determine the interest that BMO acquired from the debtor, the SCC turned to provincial property law.

Since s. 428 of the Bank Act provides that a security interest granted under it has “priority over all rights subsequently acquired in, on or in respect of that property, and also over the claim of any unpaid vendor” [emphasis added], the SCC stated that the Bank Act is a “property-based” security regime. This regime is to be distinguished from that of the PPSA, which is a “priority-based approach”. Unlike a property-based approach, the regime under the PPSA “does not rely upon either the common law notion of title or the equitable concepts of beneficial interest or equity of redemption to resolve priority disputes.”

To determine what interest the debtor conveyed to BMO, the SCC resorted to provincial property law. This approach is consistent with constitutional principles because the provinces have jurisdiction to legislate on property and civil rights in the provinces. The rule established in Bank of Montreal v. Hall, [1990] 1 S.C.R. 121 that “Bank Act security provisions are valid federal legislation which cannot be subject to the operation of provincially enacted priority provisions” was not contravened because the PPSA’s priority rules were not invoked to resolve this dispute. Instead, it was the Bank Act’s provisions which governed, notwithstanding its silence on the issue of a priority dispute between a prior unregistered security interest taken under the PPSA and a subsequent registered security interest under the Bank Act

Application of provincial property law yielded the holding that the ICU security interest had priority. The relevant property law applied was the maxim of nemo dat quod non habet – no one can give what he does not have. A useful example was provided by the SCC:

Simply put, under this rule where A conveys legal title to property first to B and subsequent to C, legal title vests in B. Since A no longer has legal title to give to C, A cannot transfer title to C. Thus as between two competing legal interests in property, the nemo dat rule gives priority to the first party to take a legal interest in the property.

Under the circumstances, “A” would be the debtor, “B” would be ICU, and “C” would be BMO. When the debtor granted a security interest to BMO, ICU already had a proprietary interest in the collateral.

The Unsatisfactory Status Quo

The SCC acknowledged that its reasoning in this case may be unsatisfactory, particularly in regards to the fact that BMO did not know about the extent of its financial risk because ICU had not registered its interest. However, the SCC was unwilling to accept a first-to-register rule because of the difficulties that such a rule would create and the intrusion into the federal legislature’s powers. At paragraphs 53 and 61, Charron J. stated that it is exclusively within Parliament’s realm of powers to enact such a rule. Whether Parliament will and/or should exercise that power and remedy the mess that this archaic legislation has created is a matter that will have to be discussed in the future.

This November, the Supreme Court of Canada (“SCC”) will weave in and around federal and provincial legislation that has generated consternation over divorce and property division equity in Canadian provinces. The judges will hear party submissions from the Manitoba Court of Appeal (“MCA”) decision of Schreyer v. Schreyer, 2009 MBCA 84, a judgment that ultimately released Mr. Schreyer from any obligation to make an equalization payment to his former wife, Mrs. Schreyer, even though he had been discharged from bankruptcy and was no longer required to pay his debts.

I ask my readers to bear with the wave of legislation and facts to follow which are required to explain this remarkable result. It will be most straightforward to begin with a chronology of events.

Ten years of divorce proceedings

1980: Mr. and Mrs. Schreyer marry.

1991: Mr. and Mrs. Schreyer move in to a farm then occupied by Mr. Schreyer’s parents.

March 27, 1997: Manitoba Agricultural Credit Corporation approves $65,000 loan to Mr. Schreyer to purchase farm.

September 15, 1997: Mr. Schreyer purchases and is registered as owner of the farm.

December 4, 1999: Mr. and Mrs. Schreyer separate. Mrs. Schreyer moves out.

March 15, 2000: Mrs. Schreyer files for a petition of divorce from Mr. Schreyer, in part seeking an equal division of marital property.

December 20, 2001: Mr. Schreyer makes an assignment into bankruptcy. He makes no disclosure of his wife’s pending equalization claim and Mrs. Schreyer has no knowledge of his bankruptcy.

November 29, 2002: Mr. Schreyer receives discharge from bankruptcy.

October 24, 2005: Hearing and valuation of assets take place.

October 25, 2007: Master deducts Mr. Schreyer’s debts from his assets (the farm) and concludes that he owes Mrs. Schreyer an equalization payment of $41,063.48.

April 30, 2008: Family Division judge confirms master’s report.

Mr. Schreyer: Any equalization payment is extinguished by my discharge from bankruptcy

Foremost among the claims made by both Mr. and Mrs. Schreyer before the Court of Appeal was Mr. Schreyer’s argument that, according to the federal Bankruptcy and Insolvency Act (the “BIA“), his order of discharge from bankruptcy released him from all debts, including the equalization payment to his wife. Section 178 of the BIA sets out exceptions to a person’s discharge:

Debts not released by order of discharge

178. (1) An order of discharge does not release the bankrupt from

…

(b) any debt or liability for alimony or alimentary pension;

(c) any debt or liability arising under a judicial decision establishing affiliation or respecting support or maintenance, or under an agreement for maintenance and support of a spouse, former spouse, former common-law partner or child living apart from the bankrupt;

…

Claims released

(2) Subject to subsection (1), an order of discharge releases the bankrupt from all claims provable in bankruptcy.

Mrs. Schreyer argued that, according to s. 67(1) of the BIA, property of a bankrupt divisible among his creditors did not include property “within which the bankrupt resides.” Thus, she was still entitled to an equal division of their matrimonial home.

Property of bankrupt

67. (1) The property of a bankrupt divisible among his creditors shall not comprise

(a) property held by the bankrupt in trust for any other person;

(b) any property that as against the bankrupt is exempt from execution or seizure under any laws applicable in the province within which the property is situated and within which the bankrupt resides;

MCA: Mr. Schreyer is, sadly, correct

In reviewing the judge’s decision, the MCA first noted that Mrs. Schreyer’s petition for divorce occurred before Mr. Schreyer’s bankruptcy. She had no knowledge of it before her husband’s discharge and filed no claim with respect to it. If she had, she might have been able to obtain leave to proceed with her claim against the husband outside of the bankruptcy.

The Court then ruled that an equalization payment was a debt like any other. Mrs. Schreyer could not rely on s. 67(1) of the BIA because, according to Maroukis v. Maroukis, [1984] 2 S.C.R. 137 (“Maroukis“), claims of spouses for valuation and accounting were not claims attached to specific assets (in this case, the farm) unless subsequently ordered by the court. Therefore, subject to the s. 178(1) exceptions, the equalization payment to which Mrs. Schreyer was entitled would be extinguished.

The MCA then decided that equalization payments did not fit into one of the s. 178(1) exceptions. Although the section directed that bankrupts would not be released from alimony or spousal support obligations, it did not so provide for equalization payments. Thus, the Court, pursuant to s. 178(2) of the BIA, released Mr. Schreyer from the equalization payment he owed Mrs. Schreyer.

The SCC in tight position to grant Mrs. Schreyer equity

The situation of Mr. and Mrs. Schreyer harks back to the case of Murdoch v. Murdoch, [1975] 1 S.C.R. 423, in which Mrs. Murdoch was denied a half interest to the ranch she had lived and worked on with Mr. Murdoch. Public reaction to the outcome incited significant law reform, including what is now Ontario’s Family Law Act, in the areas of divorce and property division. The irony is that today, similar legislation in Manitoba may well end up overriding Mrs. Schreyer’s struggle for equalization.

The circumstances here are a prime example of the infamous clash between the “letter of the law” and the “spirit of the law.” The exceptions laid out in s. 178(1) of the BIA imply that Parliament did not intend discharges from bankruptcy to release individuals from responsibilities to support spouses and children. Yet, the MCA was also correct in reading that the letter of the law does not enumerate equalization payments as one of those exceptions.

The SCC will without doubt be in a tight position to find an interpretation of the BIA that reflects the broader spirit of fairness contained in the Act. One possible alternative may be to re-examine its decision in Maroukis so as to root a spouse’s interest first in the property before the financial equalization payment. One might also fancy returning to the landmark 1980s separation cases to construe an equitable trust without overruling legislation. In both situations, s. 67(1) of the BIA could potentially apply.

Still, it will be a test for the SCC to craft an equitable solution for Mrs. Schreyer. Even if the Court manages to reinstate her equalization payment, she will likely receive less than half of the fair market value of the farm. As the MCA pointed out, according to s. 16 of The Family Property Act in Manitoba, the closing date for the inclusion of assets and liabilities in valuation is the date when the spouses last cohabited with each other. Both Mr. and Mrs. Schreyer had agreed that the closing date was December 4, 1999. Therefore, while Mr. Schreyer’s debts would be accounted for in the valuation, his bankruptcy claim in 2001 and subsequent discharge in 2002 would not. His debts would still, therefore, be deducted from the equalization payment he owed Mrs. Schreyer.

A call for… more legislative reform

The MCA decision essentially allows indebted spouses to strategically file claims for bankruptcy so as to minimize, or even eliminate, equalization payments owed to non-bankrupt spouses. The disposition of this case holds implications for couples far beyond Manitoba. It will affect all provinces, including Ontario, which are similarly based on equalization rather than property division schemes. Regardless of the SCC’s decision, one hopes this case will be a sign to Parliament and to provincial legislatures to review family legislation. As Justice Wright wrote in a similar judgment in Balyk v. Balyk, 1994 CanLII 7498, “I cannot torture the law to fit the hard case.”

The MCA also expressed some frustration in rendering its decision. Justice MacInnes opined,

From the wife’s perspective, the unfortunate and unfair circumstances here are that the husband’s assets were exempt assets and therefore were not shareable amongst his creditors, whereas his debts, including the wife’s equalization claim, were extinguished upon his discharge from bankruptcy. In the result, he is left with the farm property and no unsecured debt and her entitlement to an equalization payment is extinguished by reason of his bankruptcy. This, however, is the result mandated by the clear wording and intent of the relevant legislation.

It is grimly ironic that the facts of this case should almost resemble a comedy of errors, in which every minute detail generates yet another gambit to frustrate the responsibilities denoted by statute. I only hope it might end as a true comedy of errors should.

Update: On July 14, 2011, the SCC released a unanimous decision dismissing Mrs. Schreyer’s appeal. Justice LeBel, writing for the Court, wrote that Mrs. Schreyer’s equalization payment qualified as a provable claim under the BIA and that Mr. Schreyer was therefore released from it by his discharge from bankruptcy. The only option available to Mrs. Schreyer would have been to apply to the bankruptcy judge for an exemption of the family farm under s. 69.4 of the BIA. In closing, the Court noted the failures of the BIA to adequately provide remedies for spouses such as Mrs. Schreyer and to differentiate between equalization schemes and division of property schemes. It recommended the amendment of the BIA “to address the potentially inequitable impact of bankruptcy law on the division of family assets.” The appeal was dismissed without costs. Readers can access the SCC’s full judgment here.

In a move to address systemic inconsistencies in Canadian securities regulation, the federal government recently drafted a federal Securities Act, intended to coordinate and harmonize securities regulation. The draft Act was referred to the SCC for a reference on the Act’s constitutionality. The first post of this series addresses this matter in depth. The proposed federal Securities Act (“Act”) is expected to revolutionize the securities trade in Canada. In anticipation of the SCC’s decision on the constitutionality of the Act, it is worthwhile in the meanwhile to examine the new rules and regulations outlined in the Act, and the potential effects these provisions may have on Canadian capital markets.

What’s the Difference?  The New Provisions

While drafting the Act, the federal government used an approach whereby the fundamental provisions are included in the legislation, while specific and technical requirements are included in accompanying rules and regulations. Like existing provincial securities legislation, the Act contains all of the foundational principles. The rules and regulations are separate from the Act so that they can be easily changed and adapted to the dynamics of the markets over time.

The Act was highly influenced by provincial legislation, particularly the Alberta and Ontario statutes. Many provisions of the federal legislation are identical or quite similar to the provincial statutes. In the following areas, the draft Act has not made substantial changes.

1. Prospectus and registration requirements
2. Continuous and timely disclosure requirements
3. Regulation of take-over
4. Civil liability

Significant changes have been incorporated in other areas that will have a crucial impact on the Canadian securities market.

The Establishment of the Canadian Securities Regulatory Authority (“CSRA”)

Administration of the scheme will be the responsibility of the CSRA, a crown corporation responsible for its own funding. A CSRA Board of Governors will be appointed on recommendation of the federal Minister of Finance after a “Council of Ministers” has been consulted. The Council of Ministers will comprise of the federal Minister of Finance and representatives appointed by the provincial commissions. The CSRA will contain two branches: a regulatory division and an adjudicatory division.

The regulatory division will fall under the control of the Board of Governors, headed by a Chief Regulator. The Chief Regulator will be responsible for all operations relating to securities regulation.

A federal securities tribunal will exist as the adjudicatory division.  Responsible for conducting enforcement hearings, the tribunal will be controlled by the Chief Adjudicator. The Tribunal will have the authority to review and/or even strike down decisions made by the Chief Regulator. Decisions of the Tribunal can be appealed to a provincial court of appeal. The Tribunal will also be vested with the power to make orders in the public interest and the ability to impose administrative penalties (to a maximum of $1 million, or any amount obtained or lost as a result of violating the Act).

Self-Regulatory Organizations

The Chief Regulator will have the power to recognize a self-regulatory organization (such as an exchange, a clearing agency, or an auditor oversight organization). Approval by the Chief Regulatory will be mandatory for all self-regulated organizations. The power of the Chief Regulator is a significant difference from the existing scheme. The Chief Regulator will also be given the power to designate certain business entities with prescribed services. More information on this power will likely be outlined in the regulations.

Registration

Registration (under provincial regulation) is required for any person who trades in an exchange or security contract.  In comparison, the Act adopts the Ontario business trigger test by requiring registration of those “in the business” of trading in securities and exchange contracts.

The Act requires registrants to deal in good faith with clients. Positive requirements are imposed with respect to the identification, disclosure and management of conflicts of interests. Section 110 of the Act states “A registrant must deal fairly, honestly and in good faith with their clients.” Requiring this behaviour of registrants specifically is new to the draft Act.

Notably, provincial statutes do not consistently provide a requirement that “front-running” be prohibited. Front-running involves a broker taking advantage of their knowledge of pending orders from customers and trading securities for their own account(s).  This is referred to “material order information” in the Act. In addition, unfair practices with respect to investor relations are prohibited under the proposed Act.

Additionally, the Act includes provisions that will give the Minister of Finance the power to designate a federal dispute resolution body to deal with complaints respecting registrants.

New Treatments for Derivatives

Significant changes have been proposed in derivatives regulation. Without yet having access to the specific regulations concerning derivatives, the Act suggests that a national and consistent framework for derivatives classification and treatment will lead to harmonization. New definitions have been created and other definitions have been altered, such as:

1. Prescribed derivatives: Those derivatives with securities-like features will be treated as securities.
2. Exchange-traded derivatives: These derivatives will only be permitted to be traded on recognized exchanges.
3. Designated derivatives: Risk disclosure statements will be required to be filed and delivered.
4. Excluded derivatives: The Act gives power to exclude derivatives from the above categories.

The prescribed derivative category is new and  will most likely capture those securities seen as “hybrids” under the existing provincial schemes. Typically, these products were treated as derivatives despite a predominant security-like nature. A clear and concise classification for derivatives addresses the inconsistencies in both definitions and treatments found when comparing all thirteen provincial  and territorial statutes.

A “Voluntary” Regime

As mentioned in the first post of this series, the proposed Act will operate on a voluntary basis, applicable only in those provinces and territories that elect to be bound by the legislation. Despite the advantages of a voluntary system, there is still potential for the federal system to be rendered less effective.

If the purpose of the Act is to harmonize and coordinate securities regulation across the country, a province’s decision to opt out may result in inconsistencies in the Canadian securities trade. Consider the hypothetical situation where a designated derivative is to be traded between investors in two provinces, one of which has not opted in. Since this type of security would be classified by the federal regulator, it is unclear how a non-participating province would react if they disagreed with the federal classification. There are many instances where problems could arise on semantics alone.  Perhaps when the regulations are released we will have better idea of how the challenges associated with non-cooperating provinces will be addressed. Until then, we must raise these concerns in order to facilitate comprehensive analysis of the proposed Act.

Specific provisions, however, will apply throughout Canada irrespective of whether a province has opted in or not. These provisions are those relating to criminal offences and punishment, and will replicate the related existing offences in the Criminal Code.

More Dealer Protection Leads to a More Predictable Regime for Investors

The Act will benefit investors through increasing dealer protection and giving regulators more power to crackdown on securities fraud.

In an article by David Baines, Baines argues that the proposed Act favours dealers and issuers at the expense of investors and consumers. He lists the advantages to dealers by outlining the administrative and bureaucratic shortcuts that the Act permits, such as registration with only one national body (as opposed to thirteen). I respectfully question Baines’ assertion that companies currently must deal with all thirteen provincial and territorial regulators. The existing system uses the “passport” system, where issuers only deal with the securities regulator of their home province. The passport system is a strength of the current scheme.  Other operational inefficiencies for dealers do exist, many of which are addressed by the Act. For example, the Act clarifies definitions of derivatives, expanding registration requirements and allowance of self-regulatory agencies. I also question Baines’ statement that the Act favours dealers at the expense of investors. In my opinion, creating clear rules and eliminating bureaucratic red tape for dealers is a benefit that certainly has the potential to be passed on to the investor through cost savings.

Dealer protection is not enough to create investor-friendly capital markets. The existing passport system does not strenuously enforce securities fraud. Two methods currently exist to address securities fraud: (1) through a provincial regulator calling a hearing; and (2) prosecution of offenders at the request of provincial commissions under the applicable Securities Act. Both of these methods require provincial commissions actively watching and identifying dishonest behaviour. Finance Minister Jim Flaherty has suggested that a federal regulator would be “tougher.” Baines argues that while the U.S. Securities and Exchange Commission is known as the world’s toughest regulator, scandals such as Enron and Bernie Madoff have occurred. A country with approximately 275 million more people than Canada is bound to experience more fraud given the size of the market.

A federal regulator has the potential to be more effective in identifying and prosecuting securities fraud through examining Canada-wide patterns and coordinating enforcement action across the provinces.

First, the proposed monetary penalties are greater and may have a stronger deterrent effect.  For a general offence, the penalty is now a fine up to $5 million or imprisonment up to five years.  New criminal provisions relating to fraud and market manipulation were also been proposed, carrying maximum imprisonment terms of up to fourteen years. Moreover, new offences and penalties relating to insider trading and tipping have also been included.

Secondly, offenders will find it more difficult to escape the scrutinizing eye of the federal regulator. The “evidence gathering” rules set out in the draft Act will allow investigators to compel third-party entities (companies not the target of the investigation) to give written evidence and will force brokerage firms to disclose stock-trading information. This proposal mirrors the U.S. method of grand jury questioning. Although individuals cannot be compelled under these rules, these rules are a good start towards moving Canada closer to a more effective enforcement model (like the one used in the U.S.). Ultimately, stronger methods of both deterring and identifying fraud would benefit investors.

The Act is not perfect. Its voluntary nature will pose challenges, and its proposed enforcement provisions may not go far enough. However, it represents the first step of the process to regulate securities at the national level, a long overdue move in Canadian capital markets.

Background and Facts

AbitibiBowater Inc., a US incorporated pulp and paper manufacturer, operated throughout the province of Newfoundland for over a century. In 2008 Abitibi announced that its last operating mill, located in Grand Falls-Windsor, would close in March of 2009. This marked the end of the company’s active operations in the province. However, Abitibi still retained numerous property rights, assets, and undertakings within Newfoundland amounting to well over $300 million. This included interests in hydroelectric facilities, surface rights, and paper mills.

Twelve days after the final closure was announced the province rushed through the Abitibi-Consolidated Rights and Assets Act, S.N.L. 2008, c. A-1.01 (“Abitibi Act”), expropriating the majority of the company’s provincial assets. This included the cancellation of “water and hydroelectric contracts and agreements” between the province and Abitibi, the cancellation of ongoing legal proceedings Abitibi had against the province, and the blocking of access to Newfoundland’s courts by Abitibi. In response, the company filed a Notice of Arbitration under NAFTA Chapter 11 seeking redress for the expropriation in the amount of $500 million.  The NAFTA claim is ongoing and will not be discussed in detail here.

In November of 2009 the province issued Environmental Protection Act, SNL2002 Chapter E-14.2 (“EPA”) orders per s. 99 of the EPA, compelling Abitibi to clean up various sites, many of them expropriated under the Abitibi Act. Abitibi had to submit a remediation plan by January 15, 2010 and the cleanup or “remediation actions” were to be completed by January 15, 2011. The estimated cost of the cleanup was significant–“from the mid-to-high eight figures.” Abitibi claimed that the EPA orders were a part of a “campaign of retribution and harassment against it, with the apparent goal of dissuading [the company] from pursuing its claims for compensation” under NAFTA.

Before the EPA orders were issued, Abitibi filed for protection from its creditors under the Companies’ Creditors Arrangement Act, R.S.C. 1985, c. C-36 (“CCAA”). Through the CCAA a company that owes in excess of $5 million can apply for an initial order for protection from creditors for a period of 30 days (extensions can be had upon court approval). During this period a company is expected to prepare a plan of compromise or arrangement. In the present case, an initial stay order and subsequent extension order were both granted by the court. The extension order included an amendment to the initial stay order (at s. 10.1) essentially stating that the stay order would not apply to government regulatory orders. The stay imposed would not affect a government’s exercise of powers in relation to matters of “public health…or the environment…”

Accordingly, Newfoundland argued that the EPA orders were non-monetary, subject to the exception in s. 10.1, and thus were not within the scope of the creditor claims process under the CCAA. Abitibi requested that the court find that the EPA orders did not meet the exception in s. 10.1 and were claims “stayed by the stay of proceedings issued in the initial order.” Consequently, the province would be barred from filing any claims during the reorganization process, including the EPA orders, as the deadline to do so had passed.

The Quebec Superior Court Decision

The primary issue before the Superior Court was whether or not the EPA orders compelling Abitibi to clean up the expropriated sites were “statutory non-monetary obligations” or “financial or monetary in nature.” If found to be the latter then they would “fall within the meaning of claim under the CCAA…” Abitibi rejected the characterization of the orders as non-monetary in the hope they would be brought within the creditor protection process. If that happened, the enforcement of the orders would be subject to the court’s discretion and would most likely remain unfulfilled, leaving Newfoundland with the bill for the cleanup. Also, if a claim was not submitted within the process timeline it would be “extinguished for good,” unless an extension was granted to the province.

The EPA Orders Are Claims within the Scope of the CCAA

The Superior Court found the orders to be “in substance financial or monetary in nature” and within the definition of a claim under CCAA protection. The following factors were considered:

- The provisions of the CCAA;
- The true nature and impact of the EPA Orders;
- The factual context of their issuance and their content;
- The Province’s behavior prior and after their issuance;
- The EPA and the applicable case law; and
- The end result of the Province’s position.

A “claim” as defined in s. 12(1) of the CCAA is, in part, “any indebtedness, liability or obligation of any kind that, if unsecured, would be a [claim] provable in bankruptcy…” The Bankruptcy and Insolvency Act (“BIA”) has a similar definition in s. 121(1).

According to the Superior Court “[t]he true regulatory character or otherwise financial and monetary nature of a given order is influenced by who issues the order, who stands to benefit from it, what remains its genuine objective and what means of enforcement truly exist in reality.” If you have been following the Abitibi-Newfoundland dispute you will immediately identify the problem for Newfoundland with the application of these criteria. In fact, it is common conjecture that the orders were given to offset the potential cost of a NAFTA claim. According to the Superior Court:

[i]n all likelihood, the pith and substance of the EPA Orders is an attempt by the Province to lay the groundwork for monetary claims against Abitibi, to be used most probably as an offset in connection with Abitibi’s own NAFTA claims for compensation… [Furthermore] [t]he evidence suggests that the target was not the enforcement of statutory duties or obligations. The target was Abitibi.

The majority of the property subject to the orders was in the hands of the province. The lower court found that as a result “money is clearly the only remedy”—Abitibi does not have access to the property it has been ordered to cleanup. Hence, the province would derive the financial benefit from the cleanup, not Abitibi. Also, according to ss. 102(3) and 102(4)of the EPA any unfulfilled order becomes a debt to the province. In that sense, Newfoundland is a creditor with a claim as defined in s. 12(1) of the CCAA .

Finally, the province attempted a constitutionally based argument asserting that Quebec lacked the jurisdiction to interfere with a statutory power of the Newfoundland government. This argument was dismissed by the Superior Court with a reference to the characterization of the orders as monetary in nature and within the claims process.

The Quebec Court of Appeal Denies Leave to Appeal

The Superior Court convincingly characterized the EPA orders as monetary or financial in nature. The Court of Appeal agreed and noted that the EPA orders were not immunized by the lower courts decision but merely drawn into the claims process. In other words, the Superior Court did not go beyond its jurisdiction because it did not impair the orders in a manner that suggested interference with provincial powers. The Court of Appeal also noted that, taking into account the restorative purpose of the CCAA, the impact of the EPA orders may have caused undue harm on the creditor claims process and Abitibi’s reorganization.

Furthermore, the Appeal court held that the purpose of the CCAA mandates deference to judicial decisions in the CCAA process. Newfoundland could not assume a right to appeal a CCAA decision, and one would only be granted if certain criteria were considered:

[T]here must be serious and arguable grounds that are of real and significant interest to the parties:  (…) Subsumed in the general criterion are four applicable elements:  (1) whether the point on appeal is of significance to the practice; (2) whether the point raised is of significance to the action itself; (3) whether the appeal is prima facie meritorious or, on the other hand, whether it is frivolous; and (4) whether the appeal will unduly hinder the progress of the action.

The criteria were not met in this case.

Leave to Appeal to the SCC?

Newfoundland Premier Danny Williams claims that the province will pursue Abitibi to the SCC if necessary. The only issue that might warrant leave to appeal to the SCC is the argument that it was not within the Quebec’s jurisdiction to interfere with a law enacted by the Newfoundland legislature. The Superior Court declined to address this argument in detail and instead focused on differentiating the EPA orders as monetary or non-monetary.

There is a fine line between immunizing the EPA orders (possibly contrary to the principle of federalism) and relegating them to the status of a claim under the CCAA. But, as mentioned earlier, the EPA contains provisions (s. 102(3) & (4)) deeming unfulfilled orders as outstanding debts to Newfoundland. The legislation recognizes the possibility that its orders may not be abided by. If that happens the target of the orders becomes indebted to the province for the unfulfilled amount. This is precisely what has happened in this case. Abitibi, for various reasons, is not able to fulfill the orders. Therefore, the debt owed to Newfoundland falls within the claims process under the CCAA. The province, per its own legislation, assumed the status of creditor.

Factual Background

Innocent Party 1: I-Trade Finance
Roy Ablacksingh et al, through their company Webworx, induced I-Trade to advance more than $11 million to finance contracts for computer services with a non-existent U.S. company. At the time the matter went to court, more than $5 million had yet to be recovered.

Innocent Party 2: BMO
Mr. Ablacksingh and Ms. Ramsackal were joint cardholders of a BMO Mastercard account. They pledged their investment account to BMO as security to increase their credit limit to $75,000. Unbeknownst to BMO, the funds that the pair used to purchase shares in the Investment Account originated from the aforementioned fraudulent scheme. No security agreement was signed or registered under the Personal Property Security Act, R.S.O. 1990, c. P.10(the “PPSA”). Notwithstanding the $75,000 credit limit, the outstanding balance on the BMO Mastercard Account is $138,747.66.

The Disputed Funds
The shares in the Investment Account were eventually sold for $130,771.11.  Since the shares were bought using funds provided by I-Trade, I-Trade claimed priority as the loan can be traced to the Investment Account. If the funds can be traced to anyone other than a bona fide purchaser for value without notice, then I-Trade would be entitled to the money.  I-trade would lose priority, however, if BMO had a valid security interest or was a bona fide purchaser for value without notice.

The Decisions

The motions judge, Kiteley J., ruled in favor of I-trade. In her view:

(1) BMO did not have a security interest in the shares in the Investment account.
(2) BMO was not a bona fide purchaser for value without notice. I-Trade had priority because they could trace their investment to the shares in the account.
(3) I-Trade was entitled to the funds based on unjust enrichment and constructive trust principles.

The ONCA disagreed.  Setting aside the order of the motion judge, Blair J.A. held:

(i) BMO had a valid, perfected security interest that was recognized under PPSA
The ONCA found this case was “not a priority contest between I-Trade and BMO under the PPSA”.  Blair J.A. questioned whether the PPSA was even applicable, as section 4(1) states the PPSA does not apply to a lien given by statute or rule of law. The Court of Appeal contended that a constructive trust would be a lien given… by rule of law.

Nonetheless, Blair J.A. went on to apply the PPSA.  BMO was a “purchaser” (i.e. a person who takes by purchase, including “taking by pledge”), which had taken a security interest in the Investment Account because it secured payment or performance of an obligation, as per section 1(1) PPSA. BMO’s interest in the Investment Account met the three requirements of attachment in section 11(2): BMO had possession of the collateral by virtue of an agency agreement; BMO obtained its right to the Investment Account in exchange for appropriate consideration; and, Mr Ablacksingh had sufficient rights in the collateral at the time it was pledged to BMP. This security interest was perfected by possession, pursuant to section 22(1) PPSA.  Accordingly, the Court of Appeal concluded that BMO had an enforceable security interest in the shares in the Investment Account.

(ii) A Bona Fide Purchaser for Value Without Notice is not affected by fraud 
Having determined that BMO was a perfected secured creditor, Blair J.A.  then confirmed BMO’s claim as a bona fide purchase for value without notice of the fraud interrupted I-Trade’s ability to trace the funds.  While a transferee’s interest in collateral is voidable before the property is transferred to a third party, the transferee’s interest in collateral is no longer voidable once property has been transferred to a bona fide purchaser for value without notice.  The Court of Appeal further held it was irrelevant whether or not the contract between BMO and Mr. Ablacksingh constituted a valid security agreement pursuant to the PPSA, because this is was not a case involving a priority dispute.

(iii) Principles of unjust enrichment and constructive trust do not apply
Finally, Blair J.A. held that I-Trade was not entitled to the proceeds of the sale of shares based on unjust enrichment and constructive trust principles. In order to impose a constructive trust, three requirements need to be met:

(a) A benefit or enrichment of one party,
(b) A corresponding detriment to or deprivation suffered by other party
(c) The absence of any juristic reason for the benefit or enrichment

I-Trade’s argument foundered on this third point. The Court of Appeal assumed BMO was enriched at the expense of I-Trade.  In this case, however, there was a valid juristic reason for such enrichment: the legitimate contractual relationship between Mr. Ablacksingh and BMO.  Accordingly, Blair J.A. declined to find a constructive trust based on principles of unjust enrichment.

Implications

Given precedent-based approach to the ONCA’s decision, why the Court chose to hear this appeal is something of a puzzle.  It will be interesting to see what further gloss the Supreme Court of Canada will add to this decision: perhaps a rebalancing of innocents’ interests is in the offing.  Until the final decision is handed down, the Court of Appeal’s decision affirms the legal protection of bona fide purchasers for value of without notice of prior fraud related to that property.  The practical steps a lender should take to protect its interests remain the same: register security interests in assets under the PPSA, and ensure valid personal guarantees are executed by debtors.  Unfortunately for creditors in the position of I-Trade, while subsequent lenders can be put on notice after a third-party’s fraud has been uncovered, by the time the third party’s malfeasence has been revealed the initial lender’s interest might well already be subordinated to another lender’s claim.

The issue in C.P. Desjardins de Montmagny was determining the status of collected but unremitted GST and QST amounts where a business later filed for bankruptcy, and determining the priority as between the government, the trustee in bankruptcy, and secured creditors in claiming the amounts in question. Since the 1992 amendments to the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B‑3, it is established law that any statutory deemed trust creating a superpriority for the Crown for amounts related to excise tax is extinguished as soon as the debtor files for bankruptcy. Tax authorities must be treated as an ordinary creditor. Thus the fact that the Quebec Superior Court found in favour of the Crown was surprising; all three judgments were overturned by the Quebec Court of Appeal and the appellate judgments were upheld by the Supreme Court in short order.

The appeal arose from three cases involving bankruptcies of a number of companies and problems related to unremitted GST and QST amounts. In all three cases, businesses filed for bankruptcy under the BIA while they had GST and QST amounts that had been collected but not yet remitted or collectible by the Crown. In two of the claims—Deputy Minister of Revenue of Quebec and Her Majesty the Queen in Right of Canada v. Caisse populaire Desjardins de Montmagny and Raymond Chabot Inc., in its Capacity as Trustee for the Bankruptcy of 9083‑4185 Québec inc., 2006 QCCS 2108, and Deputy Minister of Revenue of Quebec and Her Majesty the Queen in Right of Canada v. Raymond Chabot Inc. in its Capacity as Trustee for the Estate of the Debtor Consortium Promecan inc., 2006 QCCS 6370—the Quebec Deputy Minister of Revenue gave notice to the respective businesses’ trustee in bankruptcy of the Minister’s stance that the Crown “owned” the GST and QST amounts collected by the bankrupt business. In Deputy Minister of Revenue of Quebec and Her Majesty the Queen in Right of Canada v. National Bank of Canada, 2006 QCCS 2656, the National Bank of Canada had a security interest in the accounts of the bankrupt debtors, pursuant to the Bank Act, S.C. 1991, c. 46. However, the Deputy Minister of Revenue of Quebec claimed these amounts as GST and QST amounts collected by the bankrupt businesses on behalf of the Crown.

In all three cases, the Quebec Superior Court sided with the Crown, holding that the Crown owned the disputed GST and QST amounts. “In essence, the Superior Court judges held that the GST and QST amounts were not part of the bankrupt’s patrimony” (at para. 6).

The Quebec Court of Appeal overturned all three decisions, holding that the Deputy Minister of Quebec is an unsecured creditor under the BIA and must be treated as an ordinary creditor (« que le sous-ministre du Revenu du Québec, pour fins de réclamation sur TPS et TVQ s’il y a lieu, est un créancier ordinaire au sens de la Loi sur la faillite et l’insolvabilité et, qu’en conséquence, il n’a aucun droit sur les comptes à recevoir ou autres actifs de la débitrice », 9083-4185 Québec inc. (Syndic de), 2007 QCCA 1837 at para. 7).

Writing for a unanimous panel of seven justices, Justice LeBel dismissed the Crown’s appeal in a summary fashion (the judgment consists of 30 short paragraphs).

He clarified that under the BIA, any statutory deemed trust created in favour of the Crown is extinguished when the debtor files for bankruptcy (with the exception of the three employee source deductions expressly enumerated in subsection 67(3) of the BIA: income tax deductions under subsection 227(4) or (4.1) of the Income Tax Act; CPP contributions under subsection 23(3) of the Canada Pension Plan; and EI contributions under subsection 86(2) or (2.1) of the Employment Insurance Act. See Caisse populaire Desjardins de l’Est de Drummond v. Canada, 2009 SCC 2, and its analysis by TheCourt.ca).

Justice LeBel then addressed the Deputy Minister’s submission that the Crown “owns” the GST and QST amounts collected by a business. Essentially, the argument was that the GST and QST amounts collected by a business are never the property of the business itself but immediately become the property of the Crown upon collection. As such, upon bankruptcy, these sums do not form part of the bankrupt business’s patrimony to be apportioned amongst secured and unsecured creditors. Rather, the trustee is to hold these funds separately, and turn them over to the Crown as its mandatary.

This line of argumentation basically ends up with the same result that the government was aiming to overcome with the 1992 amendments to the BIA overriding of Crown statutory trusts under the BIA regime. At that time, subsection 67(2) was introduced, which reads:

(2) Subject to subsection (3), notwithstanding any provision in federal or provincial legislation that has the effect of deeming property to be held in trust for Her Majesty, property of a bankrupt shall not be regarded as held in trust for Her Majesty for the purpose of paragraph (1)(a) unless it would be so regarded in the absence of that statutory provision. [emphasis added]

As discussed in Justice LeBel’s decision, the aim of this and other amendments was to limit the priority given to the Crown in bankruptcy proceedings. The aim was to avoid a situation where the federal and provincial Crowns would clean up the bankrupt’s estate due to unremitted taxes, leaving nothing behind for the unsecured creditors. Rather, the Crown was to be considered an unsecured creditor on par with other unsecured creditors and compete for its claim. Conceding that the Crown does not have a superpriority trust in respect of excise tax amounts but then claiming that the Crown outright owns these amounts from the outset has the effect of a “super-superpriority.”

Justice LeBel rightly rejected this argument, finding that such a proposition would be contrary to a purposive and contextual reading of the BIA as well as the federal Excise Tax Act and Quebec Act respecting the Ministère du Revenu.

Michael Z. Galambos, et al. v. Estela Perez (32586) presents a fact scenario in which the relationship between the parties suffers from a rather uncommon blurring of lines, between solicitor and client, employer and employee, as well as debtor and creditor. The case will therefore be of limited precedential value.

Facts:
In May of 2001, the respondent’s B.C. law firm hired Estela Perez to work as a part-time bookkeeper. Owing to a lucrative contract with Department of Justice, the firm began growing and Ms. Perez was asked to assume the role of full time office manager. Additional employees were hired and the firm also moved into a new office space.

In January of 2002, however, it became obvious that due to the increased overhead, the firm would be unable to financially cover its impending payroll, and the respondent requested that Perez “take care of it.” This request was interpreted by Perez to mean that she should loan $40,000 from her personal account to the law firm. Upon learning of the loan, the respondent instructed Perez to reimburse herself. In response, Perez partially repaid herself a total of $15,000. Perez was also instructed by the respondent that she should not disclose the transactions to the firm’s other employees.

As the law firm’s financial situation continued to deteriorate, Perez continued to transfer funds from her personal account into that of the law firm. By March of 2004, the total amount loaned was close to $200,000. Many of the deposits were made without the advance knowledge of the respondent.

During the law firm’s period of financial decline, Perez had also asked one of the firm’s lawyers to assist her in preparing a will and completing mortgage transactions. While the respondent was not personally involved in this legal work, he was clearly aware of it. Further, the respondent never suggested to Perez that she ought to have independent legal advice with regard to either the unsecured loan or with regard to the effect of the loan on the will and mortgage.

In March 2004, the respondent assigned himself into bankruptcy and the firm went into receivership. Although the respondent acknowledged that his firm owed Perez, the firm’s secured creditors left nothing for her to recover.

The automatic stay of proceedings in relation to bankruptcy was lifted by leave of the court, and Ms. Perez was allowed to bring an action for breach of contract, negligence and breach of fiduciary duty.

Trial Decision:
Ms. Perez’s action was dismissed on the ground that she had not established the causes of action pleaded. In particular, the trial judge found that Perez was not a client at any of the times that she made loans to the firm. Whereas she had engaged the services of the firm, each of the retainers was for a limited and discrete task, not entitling Perez to the “full panopoly of protective duties.”

The trial judge further determined that in relation to the money loaned, Perez had not asked the respondent for legal advice, but had voluntarily given him the loan. Ultimately, the trial judge was most swayed by the finding that Perez had not proven that she had relinquished her decision-making power with respect to the loan or that the respondent had the ability to exercise unilateral discretion over it.

The Court of Appeal:
As at trial, the major issue before the BCCA was whether the respondent had breached a fiduciary duty owed to Ms. Perez. After a review of the case law, Rowles J., writing for the majority, determined that a mutual understanding that one party had relinquished its own self-interest so as to act solely in the interest of the other party was not a necessary element of a fiduciary relationship.

Unlike the recent case of Strother v. 3463920 Canada Inc.[2007] 2 S.C.R. 177, the case at bar was not one that could be entirely defined under the rubric of a solicitor-client relationship (a per se fiduciary relationship). As such, and largely applying the dissenting logic of McLachlin J. (as she was then) in Norberg v. Wynrib [1992] 2 S.C.R. 226, Rowles J. found that the relationship in question could be better defined under the broader concept of “power-dependency:”

In the circumstances this case presents, I am of the view that evidence of a “mutual understanding”…was not required in order for the court to make a finding that fiduciary obligations arose. The evidence overwhelmingly supports the conclusion that the respondent took advantage of the trust reposed in him by the appellant, who was in a position of vulnerability in terms of her employment, her knowledge of the firm’s prospects and her knowledge of legal rights and obligations.

Thus, it would seem that Rowles J. was most influenced by her determination that the respondent had exploited Perez’s trust, and that an overly-narrow approach to the definition of fiduciary duty would bar her from recovering. Perez was thus granted judgment in the amount of $200,000; an award which, if upheld by the SCC, will likely involve the respondent’s professional liability insurer. Ultimately, on a broad and equitable approach to the law of fiduciary duty, the decision seems to be a sound one. However, the value of such an unusual and context-driven case is likely to prove rather limited.

Asset Back Commercial Paper (ABCP) is a sophisticated financial instrument, which is generally a short-term investment with a low interest yield. Generally marketed as “safe” investments, they are considered “asset backed” because the case used to purchase these notes is used to create a portfolio of financial assets or other asset interests, which are security for the repayment of the notes. When the market was strong, maturing ABCP notes were paid off using the cash from the purchase of new ABCP notes or maturing notes were rolled over into new ones. Further, liquidity providers provided funds to investors who wished to redeem their maturing ABCP notes in certain circumstances.

The assets used to back these ABCP notes were varied, ranging from auto loans to residential mortgages, however, their nature was generally long-term, which posed a problem because of the “inherent timing mismatch” between the cash needed to repay maturing ABCP notes and the cash that these assets generated. In the summer of 2007, uncertainty spread throughout the ABCP marketplace, causing investors to stop purchasing the ABCP product and existing noteholders to case the rollover of their maturing notes. Soon, there was no cash to redeem the notes and liquidity providers generally refused to fund the redemption of the notes, which lead to a “liquidity crisis” in the ABCP market. One of the main issues behind this crisis was the lack of transparency in the ABCP scheme, as investors were unable to determine which assets backed their notes. Investors became worried that crumbling assets related to the U.S. sub-prime mortgage crisis backed their ABCP notes and they were unable to redeem their maturing notes.

On August 13, 2007, approximately $32 billion of non-bank sponsored third-party ABCP in the Canadian market was frozen after an agreement between the major Canadian participants. This “freeze” was pending an attempt to resolve the crisis through a restructuring of the market. The Pan-Canadian Investors Committee was created, introducing a creditor-initiated Plan of Compromise and Agreement, which was sanctioned June 5, 2008. Essentially, this Plan converts the noteholders’ frozen paper into new, long-term notes with a discounted face value that could be traded freely, in the hope that a strong secondary market for the notes would emerge in the long run. Part of the Plan requires that market participants, including Canadian banks, Dealers, Noteholders, Asset Providers, Issuer Trustees, and Liquidity Providers, be released from any liability related to ABCP, with the exception of certain narrow fraud claims.

At the Ontario Court of Appeal, the appellants, holders of ABCP notes including a wireless provider, mining company, tour operator, airline, pharmaceuticals retailer and several energy and holding companies, opposed the Plan on the basis that it requires them to grant releases to third party financial institutions against whom they allege they have claims for relief arising out of their purchase of ABCP notes. They claimed that the Companies’ Creditors Arrangement Act R.S.C. 1985, c. C-36 would not permit such a restructuring that required creditors to provide releases to third parties who were themselves insolvent and not creditors of the debtor company. Further, they argued that the application judge erred in sanctioning the Plan under the CCAA and holding that the Plan, with its releases, was fair and reasonable.

While the Ontario Court of Appeal allowed the appellant’s application for leave to appeal, the appeal itself was dismissed. In coming to its conclusion, the court explained that the CCAAM allowed for the court to sanction third party releases in an arrangement or plan of compromise where such releases were “reasonably connected” to the proposed restructuring. The wording, objects, purpose and scheme of the CCAA supported the court’s authority to sanction the proposed Plan, including the third-party releases and the Court of Appeal held that the Plan was fair and reasonable in the circumstances.

On September 2, 2008, the appellants sought leave to appeal to the Supreme Court of Canada, claiming that the Ontario Court of Appeal decision was based on an “erroneous reading” of the CCAA. In a submission to the Supreme Court, James Woods, a lawyer for the appellants, explained that the case raises “issues of public and national importance, which will impact upon may Canadian companies, individuals, debtors, creditors and investors as well as numerous other participants in the Canadian investment and business community.” Further, the application states that the case involves “fundamental issues relating to the proper interpretation and application of insolvency legislation”, as the appellants allege that Canadian bankruptcy law does not allow the sanctioning of such releases. They claim that the Court of Appeal decision creates “a dichotomy in bankruptcy and insolvency law and practice between, at a minimum, the provinces of Quebec and Ontario”, which will lead to “acute uncertainty on a national scale as to the security of commercial transaction and relationships and open the door to abuse of the CCAA mechanism designed solely for insolvent companies.” The investors committee, on the other hand, requested that the SCC refuse to hear the appeal, as the majority of noteholders agreed with the plan and the Plan’s costs, including the requirement that investors give up their right to sue unless in limited circumstances of fraud, are outweighed by the its benefits.

The effect of the SCC’s forthcoming decision on whether or not to hear Metcalfe extends beyond ABCP investors. As a case which deals with important issues regarding the interpretation and application of insolvency legislation, Metcalfe has implications for all future Canadian restructurings.

Now, obviously the Metcalfe & Mansfield case is a serious one, as it involves the disposition of $32 billion in assets, and just as obviously every client wants a speedy resolution to their legal dispute. Neither of these facts are comment-worthy. What is comment-worthy is the unspoken subtext in the article: that business matters should be considered more important by the Supreme Court of Canada than others.

Bluntly: the involved parties in Metcalfe & Mansfield hold $32 billion of investments that are questionable, to say the least (backed as they are by subprime mortgage investment tools). It is particularly understandable in this instance that they want their case settled and done, one way or the other; their asset-backed commercial paper isn’t going to get more valuable with the progression of time and indeed will most likely depreciate sharply the longer they wait. (They’ve already lost money on these investments; the only remaining question is how much more they will lose, and how they’ll lose it.) And, as this writer has said before, given the magnitude of finances at stake, the Supreme Court should and most likely will hear the case.

But prioritizing a business-oriented case simply because of its scope is insensitive to the needs of other Canadians waiting for their cases to be resolved by the SCC. Parents desperately seeking a resolution by the SCC on the question of whether government is required to pay for the intensive early behavioural therapies which are widely considered to be the only effective intervention for autism no doubt feel for the individuals holding mountains of worthless commercial paper, but their case has been preceding through the courts for over three years at this point – and they’ve been lucky that it was that quick.

No one disputes the seriousness of the matters in Metcalfe & Mansfield, because you can’t dispute that $32 billion isn’t important – both to the holders of that capital and to the Canadian economy as a larger whole. But most cases that make it to the Supreme Court of Canada pose important legal questions that must be answered, and behind most of those legal questions lies human suffering. Allowing a business-oriented case to take precedence over the other cases the Supreme Court of Canada must consider – to effectively jump the queue – is to effectively assign dollar value to tragedy and decide on case decisions that way.

The parties in Metcalfe & Mansfield should be heard by the Supreme Court – and they should also have the grace to wait their turn. Nobody forced them to buy potentially shoddy assets.