C. Involuntary Bankruptcy

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

Page 53

1) The Application for a Bankruptcy Order

One or more of the creditors may bring an application for a bankruptcy order. To succeed, it must be proven that a debt of at least $1,000 is owing to the applicant or applicants, and that the debtor committed an act of bankruptcy within a six-month period immediately before the filing of the application.39The application must be filed in the court

Page 54

having jurisdiction in the judicial district of the locality of the debtor.40

This is defined as the principal place of business or the residence of the debtor.41

The application must be accompanied by an affidavit of the applicant or an authorized person who has personal knowledge of the facts. Because of the very serious consequences to the debtor of a bankruptcy order, courts have required the strict proof of the facts alleged in the bankruptcy application.42Bankruptcy law does not afford the applicant creditor any process for discovery or examination of the debtor in aid of the bankruptcy application.43A debtor who wishes to dispute the application must file a notice setting out the contested allegations.44The bankruptcy court may stay proceedings on the application and direct a trial of the issue on the disputed facts.45In a disputed application, the debtor may cross-examine on the affidavit of truth.46The Act provides that an application cannot be withdrawn without leave of the court.47An application for a bankruptcy order is a collective proceeding that is for the benefit of all the creditors of a debtor. For this reason, it is inappropriate for the application to be withdrawn by virtue of a bilateral agreement for settlement of a debt between one creditor and the debtors until the court is satisfied that it will not prejudice other creditors.48

An application for a bankruptcy order has a wider legal significance beyond its function of bringing the matter before the bankruptcy court. The filing date of the application is one of the events described in the definition of "date of the initial bankruptcy event."49The BIA gives a trustee the power to impeach certain types of pre-bankruptcy transactions. These provisions are limited by a time period that runs backwards from the date of the initial bankruptcy event.50As well, non-consensual security interests in favour of the Crown enjoy secured creditor status only if they are registered at the date of the initial bank-

Page 55

ruptcy event.51Finally, transactions that are entered into after the date of the initial bankruptcy event are invalid unless they are made for adequate valuable consideration.52

2) The Requirement of a Debt

The Act defines a creditor as a person who has a claim provable in bankruptcy.53This covers both liquidated and unliquidated claims.54Although a person who has an unliquidated claim can prove this claim and participate in the bankruptcy, that person does not have sufficient standing to bring an application for a bankruptcy order. The application can be brought only by one or more creditors who are owed debts amounting to $1,000.

The monetary threshold of $1,000 has not been altered since 1949, and it is increasingly unlikely to pose much of a hurdle. The requirement that the claim be in the nature of a debt is more likely to create difficulties for an applicant. A debt is a sum payable in respect of a liquidated money demand, recoverable by action.55The characterization of a claim as a debt depends upon the liquidated nature of the claim rather than upon the source of the obligation. A claim in the tort of negligence for damages is an unliquidated claim. If the plaintiff obtains a judgment for the loss, the claim will be converted into a liquidated claim. Although most debts arise by virtue of a contract between the parties, there are many contractual claims that do not qualify as debts. An action for damages for breach of contract merely gives rise to an unliquidated claim,56but it can be converted into a liquidated claim if a judgment is obtained. The claim will be characterized as one for the recovery of a debt if it is subject to a liquidated damages clause that can be ascertained by calculation or fixed by positive data. But, if the contractual provisions merely set out the methodology and depend upon the underlying opinion of experts, it will be characterized as a claim for damages.57

Page 56

A secured creditor can apply for a bankruptcy order but must either surrender the security for the benefit of the creditors or give an estimate of the value of the security.58A secured creditor is unlikely to surrender its security unless the collateral is valueless,59since one of the major reasons for taking security is to give the secured creditor priority over unsecured creditors. If the value of the collateral is less than the obligation it secures, the secured claim qualifies as a debt only for the balance in excess of the value of the collateral.

Claims in unjust enrichment for the recovery of money are considered debt claims.60This characterization extends as well to claims for the recovery of the value of services rendered despite the fact that a court must assess the value of the services.61The idea that claims founded in unjust enrichment qualify as debts is based on the now discredited quasi-contractual theory that such claims are premised on an implied promise to pay. Canadian law departed from this position and now regards unjust enrichment as a third subdivision within the law of obligations (the other two being contract and tort).62Given this, courts may be willing to re-examine the reasoning in these cases and to conclude that they are unliquidated claims rather than debts.

A reference to a "debt" is sometimes intended to cover a debt that is immediately payable. At other times it is intended to include an existing debt that becomes payable at a certain future time (referred to as a debitum in praesenti, solvendum in futuro). Canadian cases are divided on whether the debt must be immediately payable, although the weight of authority is that it is sufficient that the debt be payable at a future time.63This latter view fits better with the aims and objectives of bankruptcy law. A failure to pay debts as they generally become due is

Page 57

an act of bankruptcy, but there are many other acts of bankruptcy that do not require any default in payment. The purpose of the debt requirement is simply to ensure that the claimant has a sufficiently certain claim to justify the invocation of bankruptcy proceedings. If the debtor has made a fraudulent conveyance or preference or an admission of insolvency, the fact that a debt is not yet payable is not of any relevance. However, if the payment obligation requires some future performance on the part of the person to whom it is owed or if the obligation is conditional on the occurrence of some future condition or event (other than the mere passage of time), the obligation will not constitute an existing debt.64

It is not enough to show that a debt was owed at the time of the hearing. It must be shown that the debt was in existence at the time the application for a bankruptcy order is filed.65Although there is English authority for the view that the debt must also exist on the date that the act of bankruptcy occurs,66this conclusion is difficult to justify. The Act does not stipulate this as a requirement and it runs counter to its underlying policy, which is simply to ensure that the person pursuing the bankruptcy order has a sufficiently certain claim.

The debtor may dispute that it owes a debt to the creditor. In such cases, the court will either stay the application or dismiss it so that the matter can be resolved in the civil courts.67The court is not compelled to dismiss the application whenever the debtor disputes liability. It can make a bankruptcy order if it concludes that the dispute is not bona fide68or that at least $1,000 is owing even though there is a dispute as to total amount owing.69The debt requirement was likely intended to screen out claims that are either subject to a contingency or more likely to be disputed. It is questionable whether it succeeds in this function. Debt claims are often disputed, and bankruptcy courts frequently dismiss applications for bankruptcy orders on the ground that the existence of a debt was not clearly established. Furthermore, the requirement can produce hard-

Page 58

ship for claimants who are unable to quickly reduce their claims to judgment debts. Persons who merely have claims for damages are unable to invoke bankruptcy even if the debtor is insolvent and judgment enforcement creditors are taking active steps to satisfy their claims from the debtor’s inadequate assets. An enterprising claimant might obtain an assignment of a creditor’s claim in order to acquire standing to bring the application,70but this is not always a feasible option. American bankruptcy does not limit standing to claimants who are owed debts. Instead, it requires that the claims be non-contingent and not subject to a bona fide dispute,71and this seems better designed to achieve the aims of bankruptcy law.

3) Proceedings against Securities Firms

Although the general rule is that only creditors may bring an application for a bankruptcy order against a debtor, the BIA provides a special rule where the debtor is a securities firm.72Provincial securities commissions, securities exchanges, customer-compensation bodies, and receivers or liquidators of a securities firm are permitted to apply for a bankruptcy order...

To continue reading