Enhancing the Bankrupt Estate

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

188

CHAPTER 7

ENHANCING THE

BANKRUPT ESTATE

Anticipating a bankruptcy, a debtor will sometimes transfer assets to

another person in a pre-bankruptcy 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 bankruptcy among the

remaining creditors. As the debtor no longer owns these assets at the

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

a debtor will engage in such activities threatens the integrity of the

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

tions. Bankruptcy law gives the trustee extensive powers to impeach

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

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

hance the bankrupt estate, and ensure that more assets will be available

for division among the participating creditors.

A. IMPEACHING PRE-BANKRUPTCY

TRA NSAC TIO NS

The trustee has a variety of powers that can be used to impeach pre-

bankruptcy transactions. There are many different terms that are used

to describe the exercise 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 Estate189

the transaction in question. This usage is misleading to the extent that

it suggests that the process, when successful, necessarily results in the

avoidance of the transaction and a recovery of the property that was

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

giving the trustee 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 that specif‌ically provide this type of

remedy.

1) The Sources of the Impeachment Powers

Several of the impeachment powers that are available to trustees have

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

to these provisions when seeking to impeach pre-bankruptcy trans-

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

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

with the BIA “as supplementary to and in addition to the rights and

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

inson v Countrywide Factors Ltd2 held that provincial 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 result, a trustee may impeach a

transaction by using the BIA provisions, provincial law, or both.

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

preferences and settlements. In 1961 amendments to the bankruptcy

statute gave the trustee additional impeachment powers against distri-

butions to shareholders and against reviewable transactions with relat-

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

to the BIA eliminated the settlement and reviewable transaction provi-

sions and substituted a provision dealing with transfers at undervalue.

There are now four distinct impeachment powers contained in the

BIA. A pre-bankruptcy 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.

BANKRUPTCY AND INSOLVENC Y LAW190

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

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

only transactions that occur after insolvency proceedings are initiat-

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

bankruptcy it would cover transactions that occur after an application

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

a bankruptcy order.

Provincial law gives creditors avoidance powers in respect of

fraudulent preferences and in respect of fraudulent conveyances. In

all provinces, fraudulent preferences law is derived 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 provisions 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. Courts have held

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

As a result, there are three bases upon which a transfer 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 provincial

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 provincial fraudulent preference legisla-

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

provincial fraudulent preference legislation.

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 transaction results in less for all creditors.

The second kind of transaction does not affect 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).