Deepening insolvency in Canada?

• Author: Girgis, Jassmine

The Canadian legal landscape on corporate directors' liability has been quiet since the release of the Supreme Court of Canada's landmark decision in Peoples Department Stores Inc. (Trustee off v. Wise. In Peoples, the Court decided against imposing a duty on directors to consider the interests of creditors when carrying out their fiduciary duties to a corporation approaching insolvency. It appears, however, that an American doctrine that holds directors and related third parties liable for "deepening the insolvency" of the corporation when its life has been wrongfully prolonged, and one that is on the radar in Canada, has the potential to affect the way Canadian courts view director liability. Peoples may have closed the door to imposing director duties to creditors but the American doctrine of "deepening insolvency", if adopted in Canada, has the potential to do an end run around Peoples by indirectly providing protection for creditors when the corporation is facing insolvency.

The author discusses the implications of adopting the deepening insolvency doctrine in Canada and concludes that the doctrine is not necessary, as Canadian business law already has several functionally equivalent or similar remedies to address the harms deepening insolvency seeks to overcome. Most importantly, the oppression remedy, a doctrine deemed by the Supreme Court of Canada to deal with situations of near insolvency, could be expanded to address the concerns of creditors. Other potential avenues include claims for breach of fiduciary duties and duties of care, as well as claims for negligent or fraudulent misrepresentation.

Le paysage juridique relatif a la responsabilite des administrateurs de societes est devenu tranquille depuis la decision de la Cour supreme du Canada dans l'affaire Magasins a rayons Peoples inc. (Syndic de) c. Wise. Dans Peoples, la Cour a decide de ne pas imposer aux administrateurs une obligation fiduciaire envers les creanciers d'une societe quand une societe approche l'insolvabilite. Par contre, une doctrine americaine qui declare la responsabilite des administrateurs et des tiers pour l'approfondissement de l'insolvabilite d'une societe lorsque sa vie est injustement prolongee, et qui a suscite un certain interet au Canada, semble avoir le potentiel d'affecter la facon dont les tribunaux canadiens percoivent la responsibilite des administrateurs. Peoples a peut-etre ferme la porte a la responsabilite des administrateurs envers les creanciers, mais cette doctrine americaine a le potentiel de surmonter l'obstacle pose par Peoples en offrant une protection indirecte aux creanciers lorsqu'une societe est proche de l'insolvabilite.

L'auteure analyse les implications d'une adoption potentielle de la doctrine americaine au Canada et conclut que la doctrine n'est pas necessaire. Le droit canadien des affaires contient deja plusieures voies de droit qui sont similaires ou fonctionnellement equivalentes du point de vue des torts que la doctrine vise a rectifier. La plus importante est le recours en cas d'abus, une doctrine que la Cour supreme du Canada considere comme applicable a des situations d'insolvabilite et qui peut etre etendu afin d'adresser les soucis des creanciers. D'autres avenues potentielles incluent des demandes fondees sur un manquement a l'obligation de fiducie et de diligence, ainsi que des demandes alleguant des representations erronees, negligentes ou frauduleuses.

Introduction I. Duties to Creditors of Corporate Directors in Canada II. The Doctrine of Deepening Insolvency in the United States A. What is "Deepening Insolvency"? B. Recognition of Deepening Insolvency III. Deepening Insolvency and the Business Judgment Rule IV. Analysis: Canada's Adoption of Deepening Insolvency? A. Oppression Remedy: A Functionally Equivalent Canadian Doctrine 1. What is the "Oppression Remedy"? 2. Differences between the Oppression Remedy and Deepening Insolvency and Whether They Matter a. Identity of the Plaintiffs b. Identity of the Defendants c. Quantifying Damages 3. Conclusion on Oppression Remedy B. Claim for Breach of Duty: Another Functionally Equivalent Canadian Doctrine C. Claim for Negligent or Fraudulent Misrepresentation: Similar but not Identical Conclusion Introduction

The Canadian legal landscape regarding the liability of corporate directors has been quiet since the release of the Supreme Court of Canada's landmark 2004 decision in Peoples Department Stores Inc. (Trustee of) v. Wise. (1) Prior to Peoples, the Canadian position had slowly been moving toward the recognition that directors' fiduciary duties take into account the interests of creditors as a corporation approaches insolvency, a position similar to the statutory duty imposed in the United Kingdom under its "[w]rongful trading" provisions. (2) This move was sharply halted when the Court in Peoples decided against imposing such duties and determined that although directors' duties of care could encompass various constituents, their fiduciary duties are owed only to the corporation (3) and do not change to encompass creditors as the corporation approaches insolvency.

It appears, however, that Peoples may not be the last word on the subject of Canadian directors' liabilities in cases of looming insolvency. An American doctrine that holds directors and related third parties liable for "deepening the insolvency" of the corporation has the potential to affect the way Canadian courts view director liability. Peoples may have closed the door to imposing on directors duties to creditors, but the American doctrine of deepening insolvency, if adopted in Canada, has the potential to do an end run around Peoples by indirectly providing protection for creditors when the corporation is facing insolvency. This paper will discuss the implications of adopting the deepening insolvency doctrine and conclude that the doctrine is not necessary, as Canada already has remedies to address the harms deepening insolvency seeks to overcome.

The duty rejected in Peoples called for the consideration of creditors' interests when a corporation is in the "'vicinity of insolvency'". (4) The duty imposed by the deepening insolvency doctrine is different. Deepening insolvency holds directors liable for harms suffered by the corporation when its life is wrongfully prolonged. The doctrine imposes on directors a duty to the corporation, but it also indirectly benefits creditors: first, by bringing money into the debtor's estate to repay creditors if the claim against the directors is successful, and second, by restraining the actions of directors when the corporation is suffering financially, through the threat of liability.

The doctrine of "deepening insolvency" originated in the United States in 1980 (5) and has gained ground most significantly in the last seven years. Since the seminal decision Official Committee of Unsecured Creditors v. R.F. Lafferty & Co. (6) determined that deepening insolvency constituted a valid cause of action under Pennsylvania law, (7) numerous claims for deepening insolvency have been made throughout the United States. The reactions of U.S. courts to these claims, however, have fallen along a spectrum and have ranged anywhere from recognition of the doctrine as an independent tort, to its recognition as a theory of damages, to a rejection of the doctrine altogether. The doctrine's development has been a cautious and uneven one, but over the last twenty years its contours have been coming into focus and it has become, albeit somewhat grudgingly, a commonly recognized phrase in American jurisprudence.

Although jurisprudence on deepening insolvency has been gaining momentum, the doctrine's validity was recently dealt a significant blow in the United States. The Supreme Court of Delaware, through its affirmation of the Delaware Chancery Court's far-reaching decision in Trenwick American Litigation Trust v. Ernst & Young, LLP, (8) refused to recognize deepening insolvency as a cause of action, leading some commentators to question whether the decisions have effectively brought an end to the deepening insolvency doctrine. (9) While making a determination of this nature is still premature, the future of the deepening insolvency doctrine has been brought into question. That is not to say, however, that all proponents of the doctrine have fallen sway to the recent criticisms. Indeed, some commentators continue to believe that the doctrine remains a viable theory that can, and should, be salvaged. One commentator bases such a view on the well-known adage "bad facts make bad law" to explain the decision reached in Trenwick. (10) Courts have also continued to recognize deepening insolvency, both as a viable doctrine and as a theory of damages. Subsequent to the Trenwick decision of the Delaware Chancery Court, the United States District Court for the Southern District of New York recognized that a claim for deepening insolvency would lie where the defendant either breached a duty owed to the company or "committed an actionable tort that contributed to the continued operation of [the] corporation and its increased debt." (11) With regard to use of the doctrine as a viable theory of damages, the United States Bankruptcy Court for the District of Columbia maintained that the "deepening of a company's insolvency can be harmful," and refused to disallow deepening insolvency as a viable theory of damages unless told otherwise by a higher court in its own circuit. (12)

The lack of consistent treatment indicates that much has yet to be settled before the fate of the deepening insolvency doctrine in the United States is determined. However, regardless of the current unrest in the United States, questions about the doctrine's application in Canada have made their way across the border, as Canadian lawyers continue to look at the doctrine's functionality and applicability to Canadian law. Reports on the doctrine have questioned its "emergence...