Enhancing the Bankrupt Estate

• Author: Roderick J. Wood
• Profession: Faculty of Law University of Alberta
• Pages: 173-218

173

cha Pter 7

ENHANCING THE

BANKRUPT ESTATE

Anticipating a b ankruptcy, a debtor will sometimes transfer assets to

another person in a pre-bank ruptcy tran saction. Gifts of property may

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

signif‌icantly less than their value. Favoured creditors may be select-

ively paid off, leaving less property to be shared in bankr uptcy among

the remai ning creditors. As the debtor no longer own s these asset s at

the date of bankr uptcy, they cannot vest in the tr ustee. The possibility

that a debtor w ill engage in such activities threatens the integrity of

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

actions. Bankruptcy law gives the trustee exten sive powers to impeach

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

back the asset or its value from t he 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-Bank ruPtcy

tr a nsac tiO ns

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

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

to describe the e xercise of these powers. Judges and commentators

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

BANKR UPTCY A ND INSOLVENCY L AW174

“rescinding,” “setting aside,” rev iewing,” “impugning,” or “impeach-

ing” 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 array of outcomes, these powers are referred

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

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

tion with impeachment powers that specif‌ically provide th is type of

re me d y.

1) The Sources of the Impeachment Powers

Several of t he impeachment powers that are available to tr ustees have

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

to these provisions when seeking to impeach pre-bankr uptcy trans-

actions. The BIA expressly provides that the t rustee may invoke laws

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

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

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

inson v. Countr ywide Factors Ltd.2 held that provi ncial legislation that

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

lent preference is not rendered inoperative by the fact that the BIA a lso

contains preference provisions. As a result, a trustee may impe ach a

transaction by usi ng the BIA provi sions, provincial law, or both.

The Bankruptcy Act of 1919 gave the trustee t he power to impe ach

preferences and sett lements. In 1961 amendments to the bankruptcy

statute gave the trustee additional impeachment powers against dist ri-

butions to shareholders and against reviewable transactions with related

persons or other non-arm’s length partie s. The 2005/2007 amendments

to the BI A eliminated the settlement and reviewable transaction pro-

visions, and substituted a prov ision dealing with transfers at under-

value.

There are now four distinct impe achment 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

1 Bankruptcy an d Insolvency Act, R.S.C. 1985, c. B-3, s. 72 [BIA].

2 [1978] 1 S.C.R. 753.

Enhancing t he Bankrupt Estate 175

• adistributiontoashareholder.

The f‌irst two powers have the widest potential application and therefore

are the most signif‌icant. The third power i s 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 a fter an application

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

a bankruptcy order.

Provincial l aw 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 stat-

ute. The source of the avoidance powers in respect of f raudulent con-

veyances varies somewhat from one province to another. Fraudulent

conveyances law is derived f rom the Statute of Elizabeth3 of 1571. This

Act was received into the law of the various provinces. Some of the

provinces h ave re-enacted its provisions in a provincial statute called

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

that the provincia l fraudulent preferences legislation also contains a

single provision covering fraudulent conveyances. Courts have held

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

As a result, there are three bas es upon which a transfer may be im-

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

fraudulent conveyance under the Statute of Elizabeth or the provincial

statutes t hat 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 legislation. Third,

it may be cha llenged as a fraudulent preference pursuant to provi ncial

fraudulent preference legislation.

2) The Objectives of the Provisions

The general objectives of the impeachment powers are easy to identif y.

The provisions are directed against transactions that diminish the value

that would otherw ise be available for distribution to the creditors, or

that undermine t he statutory scheme of distr ibution among the credit-

3 13 Eliz. I, c. 5.

4 See, for example, Fraudule nt Conveyance Act, R.S.B.C. 1996, c. 163.

5 Bank of Montreal v. Reis, [1925] 3 D.L.R. 125 (Sask. K.B.); Bank of Montreal v.

Crowell (1980), 34 C.B.R. (N.S.) 15 (N.S.S.C.).