Although priority rules are important in restructurings, they do not operate in precisely the same manner as they do under liquidation regimes such as bankruptcy and receivership. In a liquidation, the assets are sold and the proceeds are distributed according to the priority ranking of the various claimants. Matters are less clear-cut in a restruc-
turing. A creditor’s recovery is not determined by the application of a statutory scheme of distribution or a set of priority rules. Instead, the recovery is determined by the terms of the plan.
Priority rules nevertheless play a crucial role in the restructuring process. Creditors are usually divided into different classes. Each class is afforded different treatment under the plan, and each class votes on whether to approve it. The appropriateness of the classification scheme depends upon a comparison of the legal rights held by the claimants within a class.41The classification scheme that is employed in a plan is therefore directly influenced by the background priority rules. In deciding whether to accept the plan, each class of creditors will compare what they are offered under the terms of the plan against what they would obtain in the event of a liquidation. Creditors will not vote for the plan and courts will not approve it unless the plan gives the creditors at least as much as they would in a bankruptcy. Priority rules also provide each class of creditors with a basis for comparing the deal they are offered with the deal that is offered to each of the other classes of creditors.
The priority status of secured claims is governed by the ordinary rules and principles that establish the validity and priority of security interests in real and personal property. A failure to perfect a security interest in personal property does not result in a loss of priority in restructuring proceedings. Although personal property security legislation subordinates an unperfected security interest against a trustee in bankruptcy, this provision does not apply in respect of a restructuring.42
Although a failure to perfect a security will not result in its subordination to a monitor or trustee in restructuring proceedings, it may cause a loss of priority in respect of a claimant who asserts a competing interest in the collateral. This may reduce or obliterate the value of the secured creditor’s security interest. For example, suppose that both SP1 and SP2 take a security interest in a piece of equipment. The value of the equipment is $100,000. SP1’s security interest secures an obligation in the amount of $50,000, and SP2’s security interest secures an obligation in the amount of $150,000. Although SP1 was the first to enter into a security agreement with the debtor, SP1 failed to perfect its
security interest. As a result, SP1 is subordinate to SP2. Although SP1 has an enforceable security interest, it is rendered valueless because of SP2’s prior ranking security interest. SP1 should therefore be afforded the status of an unsecured creditor in any restructuring proceedings.
Unlike secured creditors, unsecured creditors have no proprietary right in the assets of the debtor, and therefore they have no right to claim priority over other claimants who are able to assert proprietary rights in the debtor’s assets. The situation can change once the unsecured creditor obtains a judgment and pursues judgment enforcement measures. A writ or judgment that is registered in a provincial land registry system will typically have priority over a subsequently created interest in the land. Personal property security legislation in some of the provinces provides for registration of a writ in the personal property security registry.43The judgment enforcement creditor obtains a priority status that is similar to that of a secured creditor. The judgment enforcement creditor will thereby obtain priority over a prior unperfected security interest and subsequent security interests. There is nothing in either the BIA or the CCAA that alters the priority status of judgment enforcement creditors in restructuring proceedings. If the application of these provincial priority rules results in the subordination of a secured creditor to a judgment enforcement creditor, this subordination should continue in the restructuring proceedings.44
It is not uncommon for creditors to enter into subordination agreements under which they agree to postpone their claims until the claim of some other creditor or class of creditors is paid.45It is also possible for a creditor to postpone its claim until all other creditors are paid. The fact that a creditor subordinates its interest to only some of the other creditors does not give the creditors who did not receive the benefit of the subordination any right to demand that their claims should also
obtain the benefit of the subordination.46It is not necessary to place the subordinated claims in a separate class or exclude them from voting.47
The contractual subordination that they agreed to is simply given effect, and the amount that they would have received in the absence of the subordination is turned over to the parties who were entitled to the benefit of the subordination.
The same approach to the priority of Crown claims48in bankruptcy is applied in respect of restructurings under both the CCAA and the BIA.49
The Crown is able to assert a security interest if it is of a kind that is ordinarily available to other creditors. This condition is satisfied if the Crown enters into a security agreement with the debtor. If the Crown relies upon a non-consensual interest created by statute that confers an interest in the debtor’s assets to secure the liability owing to the Crown, the Crown claim will be afforded only the status of an unsecured claim unless it is registered under the appropriate provincial real or personal property registry system. An exception is made in respect of the federal statutory garnishment device that is used to recover source deductions of income tax, CPP, and EI. These enjoy a secured creditor status without the need for registration. The statutes governing these devices give them priority over most competing security interests.
In the case of a BIA restructuring, the operative date for testing the validity of the registration of a Crown claim is the date of filing of a proposal or a notice of intention to make a proposal.50In the case of a CCAA restructuring, the operative date for testing the validity of the registration of the Crown claim is the date of the initial...