A. Impeaching Pre-Bankruptcy Transactions

Author:Roderick J. Wood
Profession:Faculty of Law. University of Alberta

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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 trustee. 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 actions. 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 enhance the bankrupt estate, and ensure that more assets will be available for division among the participating creditors.

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,"

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"rescinding," "setting aside," reviewing," "impugning," or "impeaching" 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 connection 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 transactions. 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."1The Supreme Court of Canada in Robinson v. Countrywide Factors Ltd.2held that provincial legislation that gave creditors the right to impeach a transfer of property as a fraudulent 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 distributions to shareholders and against reviewable transactions with related persons or other non-arm’s length parties. The 2005/2007 amendments to the BIA eliminated the settlement and reviewable transaction provisions, and substituted a provision dealing with transfers at under-value.

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

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· a distribution to a shareholder.

The first two powers have the widest potential application and therefore are the most significant. The third power is limited in scope, covering only transactions that occur after insolvency proceedings are initiated 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. Fraudulent conveyances law is derived from the Statute of Elizabeth3of 1571. This Act was received into the law of the various provinces. Some of the provinces have re-enacted its provisions in a provincial statute called the Fraudulent Conveyances Act.4The 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.5As a result, there are three bases upon which a transfer may be impeached 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 references 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 challenged as a fraudulent preference pursuant to provincial fraudulent preference legislation.

2) The Objectives of the Provisions

The general objectives of the impeachment powers are easy to identify. The provisions are directed against transactions that diminish the value that would otherwise be available for distribution to the creditors, or that undermine the statutory scheme of distribution among the credit-

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ors. The first kind of transaction results in less for all creditors. The second kind of transaction does not affect the total amount available for creditors but results in a different distribution than would otherwise prevail in bankruptcy. The favoured creditor receives a greater share, and the other creditors receive less.

Although the general objectives are relatively uncontroversial, the means by which bankruptcy law attempts to implement them is highly contested. In particular, there is considerable debate as to precisely what kinds of conduct or transactions should be subject to impeachment. The traditional approach has been to focus upon the intent of the debtor. Avoidance of a transaction is available where a debtor intended to defeat, hinder, or delay creditors or intended to play favourites and prefer one creditor over the others.

The underlying rationale of the law is to prevent the debtor from engaging in conduct that harms some or all of the creditors. However, it does not seek to achieve its objective by punishing the debtor. Instead, the chief impact of the provisions is directed against the person who received the transfer of property from the debtor. This has given rise to a competing objective - that of preserving the finality of legitimate commercial transactions. There is a constant tension between this objective and the objective of protecting creditors against the harmful acts of the debtor. More recently, some of the impeachment powers have shifted their focus away from the bad intentions of the debtor and towards the detrimental effect of the transaction on creditors.

Unfortunately, the various impeachment powers do not adopt a consistent approach. Some look to intent, while others look to effect. Some of them draw distinctions based upon the type of transaction, i.e., whether it involves a payment of money as opposed to a transfer of other kinds of property. Some are triggered by a close relationship between the debtor and the recipient. Some require that the debtor be insolvent at the time of the transaction, while others do not. Some require that the recipient participate in the fraud, while others are satisfied if the recipient has not paid fair value. Each provision also establishes a different time period within which the transaction may be impeached. This produces a distressing degree of complexity in the law. The different provisions all operate under their own special rules, and it is difficult for courts to develop an overarching approach since the provisions frequently adopt contradictory strategies.6

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3) The Nature of the Remedies

Two different approaches to remedies are found in the impeachable transaction provisions. The first provides for the avoidance of the transaction. This form of remedy is adopted in the federal and provincial preference provisions, in provincial fraudulent conveyances law, and in the post-initiation transfer provision of the BIA. The second approach gives the trustee a right to recover a judgment against the recipient of the transfer. This type of remedy is adopted in the BIA provision governing distributions to shareholders. The BIA’s provision regarding transfer at undervalue gives the court a discretion to choose between avoidance of the transaction and granting judgment against the recipient.

Statutes that provide for avoidance of the transaction permit the trustee to proceed against the property that was transferred by the debtor to the recipient. The precise legal effect of avoidance under provincial law differs from that under the BIA. If a transaction is avoided under provincial law, there is no revesting of property in the debtor. The transaction remains valid as between the...

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