Enhancing the Bankrupt Estate

• Author: Roderick J. Wood
• Pages: 188-235

188

CHA PTER 7

ENHA NCING THE

BA NKRUPT ESTATE

Anticipating a bank ruptcy, a debtor will sometimes transfer assets to

another person in a pre-bankr uptcy transaction. Gifts of property may

be given to friends or relatives. Assets may be sold at a price that is

signif‌icantly less than their value. Favoured creditors may be selectively

paid off, leaving less property to be shared in bank ruptcy among the

remaining cred itors. As the debtor no longer owns these assets at t he

date of bankruptcy, they cannot vest in the tr ustee. The possibility th at

a debtor will engage in such activities t hreatens the integr ity of the

bankruptcy process, since the creditors will be prejudiced by t hese ac-

tions. Bankr uptcy law gives the trustee extensive powers to impeach

pre-bankruptcy transactions. The trustee ca n use these powers to claw

back the asset or its value from the recipient. This w ill swell and en-

hance the bankr upt estate, and ensure that more assets will be avail able

for division among the participating creditors.

A. IMPEACHING PRE-BANK RUPTCY

TR A NSAC TIO NS

The trustee has a var iety of powers that can be used to i mpeach pre-

bankruptcy t ransactions. There are many different terms that are used

to describe the exerci se of these powers. Judges and commentators

have referred to this process as “avoiding,” “annulling,” “reversing,”

“rescinding,” “setting aside,” “reviewing,” “impugning,” or “impeaching”

Enhancing t he Bankrupt Estate 189

the transact ion in question. This usage is misleading to the extent that

it suggests that the process, when successful, necessar ily results in the

avoidance of the transaction and a recover y of the property that was

transferred. Some of the powers do not have this effect but respond by

giving the tr ustee a personal right against the recipient of the property.

In order to capture the full ar ray of outcomes, these powers are referred

to collectively as impeachment powers. Below, terms that refer to an

avoidance of the underlying transaction will be used only in connec-

tion with impeachment powers t hat specif‌ically provide th is type of

re me dy.

1) The Sources of the Impeachment Powers

Several of the impeachment powers t hat are available to trustee s have

their source in provisions of the BI A. However, a trustee is not limited

to these provisions when seek ing to impeach pre-bankruptcy trans-

actions. The BIA expressly provides that the trustee may invoke laws

or statutes relating to property and civil rights th at are not in conf‌lict

with the BIA “as supplementary to and in addition to the right s and

remedies provided by this Act.”1 The Supreme Court of Canada in Rob-

inson v Countrywide Factors Ltd2 held that provinci al legislation that

gave creditors the right to impeach a transfer of property as a fraudu-

lent preference is not rendered inoperative by the fact that the BIA also

contains preference provisions. As a re sult, a trustee may impe ach a

transaction by using the BIA provi sions, provinci al law, or both.

The Bankruptcy Act of 1919 gave the trustee the power to impeach

preferences and settlements. In 1961 amendments to the bankr uptcy

statute gave the trustee additional impeachment powers against di stri-

butions to shareholders and against reviewable tr ansactions with rel at-

ed persons or other non–ar m’s length parties. The 2009 amendments

to the BIA eliminated t he settlement a nd reviewable t ransact ion provi-

sions and substituted a provision deali ng with transfers at under value.

There are now four distinct impeachment powers contained in the

BIA. A pre-bankr uptcy transaction may be impeached as:

• a transfer at undervalue;

• a preference;

• a post-initiation transfer; or

• a distribution to a shareholder.

1 BIA, s 72 .

2 [1978] 1 SCR 753.

BANKR UPTCY AND INSOLVENC Y LAW190

The f‌irst two powers have the widest potenti al application and therefore

are the most signif‌icant. The th ird power is limited in scope, covering

only transactions that occur after insolvency proceedi ngs are initiat-

ed but before the date of bankruptcy. For example, in an involuntary

bankruptcy it would cover tran sactions that occur after an applicat ion

for a bankruptcy order is f‌iled by a cred itor but before the court grants

a bankruptcy order.

Provincial law g ives creditors avoidance powers in respect of

fraudulent preferences and in respect of fraudulent conveyances. In

all provinces, fraudulent preferences law is der ived from a provincial

statute. The source of the avoidance powers in respect of fraudulent

conveyances varies somewhat from one province to another. Fraudu-

lent conveyances law is derived from the Statute of Elizabeth3 of 1571.

This Act was received into the law of the var ious provinces. Some of the

provinces have re-enacted its prov isions in a provincial statute called

the Fraudulent Conveyances Act.4 The matter is complicated by the fact

that the provincial fraudulent preferences legislation also contains a

single provision covering fraudulent conveyances. Court s have held

that this wa s not intended to impliedly repeal the Statute of Elizabeth.5

As a result, there are three bases upon which a tran sfer may be im-

peached through use of provincial law. First, it may be challenged as a

fraudulent conveyance under the Statute of Elizabeth or the provi ncial

statutes that re-enact it. There are no substantive differences between

these two sources of fraudulent conveyances law, and hereafter refer-

ences to the Fraudulent Conveyances Act will encompass both. Second,

a transfer may be challenged as a fraudulent conveyance under the

special provision found in provinci al fraudulent preference legisla-

tion. Third, it may be challenged as a f raudulent preference pursuant to

provincia l fraudulent preference leg islation.

2) The Objectives of the Provisions

The general objectives of the impeachment powers are easy to iden-

tif y. The provisions are directed again st transactions that diminish the

value that would otherwise be available for distribution to the credit-

ors, or that undermine the statutory scheme of distribution among the

creditors. The f‌irst kind of tran saction results in less for all cred itors.

The second kind of transaction does not af fect the total amount avail-

3 13 Eliz I, c 5.

4 See, for exa mple, Fraudulent Conveyance Act, RSBC 1996, c 163.

5 Bank of Montreal v Re is, [1925] 3 DLR 125 (Sask KB); Bank of Montreal v Crowell

(1980), 34 CBR (NS) 15 (NSSC).