Priority Creditors

• Author: Stephanie Ben-Ishai; Thomas G. W. Telfer
• Pages: 295-323

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CHAPTER 8

Priority Creditors

I. INTRODUC TION

Canadian insolvency law has long been respectful of secured creditors’ rights and this con-

tinues to be the case. For example, the Bankruptcy and Insolvency Act, RSC , c B- (BIA),

section  provides that the debtor’s property vests in the trustee subject to the rights of

secured creditors, and BIA, section .() provides that a secured creditor is not subject to

the automatic bankruptcy stay of proceedings.

There are two explanations for the favourable treatment of secured creditors in Can-

adian insolvency law. The rst is political: in England and Canada, banks and other nancial

intermediaries have historically played and continue to play an inuential role in the shap-

ing of bankruptcy rules: see Anna Lund, “Engaging Canadians in Commercial Law Reform:

Insights and Lessons from the  Industry Canada Consultation on Insolvency Legislation”

()  Canadian Business Law Journal . The second reason is conceptual and economic.

Anglo-Canadian common law permits a creditor to secure a business debt with all of the

debtor’s present and after-acquired property. This liberal tradition is continued in the per-

sonal property security legislation now in force in all the common law provinces and terri-

tories. In Quebec, sûreté mobilières were also greatly liberalized in the new Civil Code of :

Anthony Duggan and Jacob Ziegel, Secured Transactions in Personal Property, th ed (Toronto:

Emond Montgomery, ), ch . Obviously, secured creditors are anxious to ensure that

bankruptcy law recognizes their pre-bankruptcy claims, because it is on the debtor’s insol-

vency that secured creditors most often nd it necessary to enforce their security. The BIA

allows secured creditors to enforce their claims after the debtor’s bankruptcy. The rst part

of this chapter describes how the BIA regulates the exercise of secured creditor’s rights.

This solicitous attitude vanishes when the claimant is the Crown and the proprietary right

that secures the obligation is created by statute rather than through a consensual agreement

between the parties. The Crown often occupies the position of a creditor in insolvency pro-

ceedings. This may result from the debtor’s failure to pay an obligation owing to the Crown,

such as a workers’ compensation assessment levied on an employer, or to remit amounts col-

lected by the debtor from third parties on behalf of the Crown, such as when a debtor collects

and remits sales tax from its customers. Federal and provincial governments have attempted

to use two techniques to confer an elevated priority status on their claims. First, they have

enacted statutes that give the Crown a proprietary right in the debtor’s property, akin to a

secured creditor. The statute usually creates a statutory lien or charge on the debtor’s assets.

Sometimes the statute also provides a priority rule that gives the statutory lien or charge

priority over a prior-in-time secured creditor. Second, the Crown has created statutory deemed

trusts in its favour. The legislation deems that the debtor’s property is held in trust for the

Crown, even if the common law requirements of a trust are lacking. The legislation sometimes

 BANKRUPTCY AND INSOLVENCY LAW IN CANADA: CASES, MATERIALS, AND PROBLEMS

also includes a priority rule that gives the statutory deemed trust priority over a prior secured

creditor. The Crown’s ability to rely on such devices to claim a secured status was originally

curtailed by the judiciary, and then by amendments to the BIA in . The second part of this

chapter describes how Crown-secured claims and statutory trusts are treated in bankruptcy.

II. SECURED CREDITORS’ CLAIMS

A. Introduction

One of the fundamental principles of Canadian bankruptcy law is that only the property of the

bankrupt is made available to satisfy the claims of the bankrupt’s creditors. A trustee in bank-

ruptcy therefore has no right to conscate the property of a third party, notwithstanding that

it may be in the possession or control of the bankrupt. This principle applies even if the third

party has only a limited proprietary right in the property, as opposed to full ownership of it.

This explains the treatment of secured creditors in bankruptcy. Secured creditors have limited

proprietary rights in the debtor’s property, and they can enforce these rights against the debt-

or’s property if the debtor defaults on its obligations to the secured creditors. What amounts

to a default may be set out in legislation or contract. For example, section () of the Personal

Property Security Act, RSO , c P- (PPSA) denes default as a failure to make a payment

or otherwise perform an obligation when due. A security agreement may require a debtor to

insure its property, and failure to carry adequate insurance could be an act of default.

The proprietary rights of a secured creditor are largely unaected by the bankruptcy of the

debtor. Upon default, the secured creditor may enforce the security interest through seizure

and sale of the property or through foreclosure of the security interest. A secured creditor

thereby withdraws the asset from the bankrupt estate. If there is a surplus after the secured

creditor and any subordinate interests are satised, it must be paid over to the trustee in

bankruptcy. If there is a deciency (the proceeds from the sale of the collateral are insu-

cient to satisfy the obligation secured), the secured creditor may prove for it as an ordinary

unsecured creditor in the bankruptcy of the debtor. The trustee in bankruptcy has only a lim-

ited ability to interfere with the right of a secured creditor to enforce its security.

There is an exception to the principle that the rights of a secured creditor are largely

unaected by a bankruptcy. Under provincial law, secured creditors may need to comply with

certain registration or perfection requirements in order for a security interest to have priority

over a trustee in bankruptcy. Provincial personal property security legislation provides that an

unperfected security interest is subordinate to a trustee in bankruptcy: see for example PPSA,

section ()(b). The Supreme Court of Canada in Re Gien, []  SCR  (excerpted in Chap-

ter , Part II) upheld the constitutionality of these provisions. Provincial statutes governing real

property do not contain equivalent provisions that subordinate an unregistered interest in land

to a trustee in bankruptcy. A secured creditor is therefore able to enforce its security in real prop-

erty against the trustee in bankruptcy despite its failure to register its interest in a land title or

land registration system: Citinancial Canada East Corp v Morrow Estate (Trustee of),  NBQB

; Re Canadian Engineering & Contracting Co (),  CBR (d)  (OntCt J (GenDiv)).

B. Denition of Se cured Creditor

Secured creditor is dened in section  of the BIA to include “a person holding a mortgage,

hypothec, pledge, charge or lien on or against the property of the debtor or any part of that