B. The Bankrupt’s Estate

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

Page 81

1) Property Vesting in the Trustee

Upon the occurrence of a bankruptcy, the debtor’s property vests in the trustee in bankruptcy.7The definition of property is very wide and encompasses any type of property "whether real or person al, legal or equitable, as well as obligations, easements and every description of estate, interest and profit, present or future, vested or contingent, in, arising out of or incident to property."8The definition covers both personal rights and property rights that are held by the bankrupt at the time of the bankruptcy. The vesting of property in the trustee occurs through operation of law without the need for any document or act of conveyance to give effect to the transfer.

The assets that vest in the trustee are subject to all the limitations or defences that could be asserted against the bankrupt.9This is what is

Page 82

meant when it is said that the trustee "steps into the shoes" of the bankrupt.10Another way of putting it is that the trustee obtains the property "warts and all."11This principle does not operate where bankruptcy or other legislation gives the trustee a power to subordinate or avoid certain property rights of third parties. In such cases, the trustee may have a better right to the asset than that held by the bankrupt.

The principle that the trustee takes the property subject to any limitation affecting it is nicely illustrated in the case where the debtor obtains property from another through fraud or other circumstances that entitle the transferor to rescind. At the time of the bankruptcy, the debtor holds legal title to the property and the transferor has merely a right of rescission in respect of the property. A right to rescind is lost when the asset is transferred to a bona fide purchaser for value and without notice. However, the trustee does not occupy the position of a purchaser but is subject to the same limitations that could be asserted against the bankrupt. The right of rescission can therefore be exercised against the trustee, thus causing the property to fall out of the bank-rupt’s estate and revest in the transferor.12If the debtor’s property is determinable on the occurrence of a particular event, the trustee will equally be bound by that limitation on the interest. This holds true even where the event of defeasance is the bankruptcy of the holder of the interest. If A settles property on B with a gift over to C in the event that B becomes bankrupt, B’s interest will come to an end and the property will not vest in the trustee.13How-ever, if the property is transferred to B but made subject to a condition that the property will revest in the transferor on the bankruptcy of the transferee, the condition will be void and the property will form part of the bankrupt’s estate.14The reason for this difference is that the first type of transfer involves a limitation on the interest granted, while the type of transfer involves an outright transfer that is defeasible by virtue of the condition subsequent. The condition is rendered void because it is inconsistent with the outright transfer of ownership and conflicts

Page 83

with bankruptcy policy in attempting to prevent the bankrupt’s property from being available to satisfy the claims of creditors.15

The operation of this principle can also be observed in relation to shared property rights. A bankrupt may share ownership of property with another person through joint ownership or co-ownership. Only the bankrupt’s interest in the property will vest in the trustee. In the case of a joint tenancy, the occurrence of bankruptcy changes the nature of the interest. The vesting of the interest in the trustee results in the loss of the unity of title. This severs the joint tenancy and converts it into a tenancy in common.16The trustee obtains an undivided one-half interest in the property, and a death of one of the co-owners that occurs after the bankruptcy is of no consequence because the right of survivorship is lost upon severance. The trustee does not have the right to sell the entire interest in the property to a buyer and pay out the other co-owner with a portion of the sale proceeds.17If the property is land, the trustee may commence proceedings for the partition and sale of the property, but the trustee has no better right than the bankrupt in respect of this application, and a court may refuse to grant the order where it causes serious hardship.18Similar proceedings are not available in respect of personal property, which renders such interests less marketable since the purchaser of the bankrupt’s interest will hold the interest in common with the other co-owner.

The trustee in bankruptcy may claim that a third party who has legal title to property holds that property in trust for the bankrupt. The bankrupt’s interest in the trust property clearly falls within the definition of property. Some courts have been hesitant to give full effect to this principle. The British Columbia Court of Appeal in Blackman v. Davison19indicated that actions for remedies based on a resulting or constructive trust are matters that are "strictly and exclusively between the spouses" and are not available to creditors. There is little justification for the view. Resulting trusts and constructive trusts arise in a number of different circumstances and encompass both commercial

Page 84

and non-commercial activity.20The trust principles apply to relations between spouses, cohabitants, parents and children, friends, and strangers. The same trust law principles are applied in all these different contexts without differentiation, and there is no basis in law for the view that trust claims in a marital setting are subject to their own unique rules.21Other courts have recognized that a trustee in bankruptcy can assert trust claims to such assets.22The crucial date for the vesting of the property is the date of the bankruptcy - the date of the bankruptcy order in the case of an involuntary bankruptcy, and the date of the filing of the assignment in the case of a voluntary bankruptcy. If the debtor disposed of the asset prior to that date, then the asset will not vest in the trustee. The trustee under certain circumstances is given the power to avoid pre-bankruptcy transactions. When this happens, the asset is clawed back into the bankrupt estate. Assets that are acquired by the bankrupt following the bankruptcy also vest in the trustee.23

2) Non-Transferable Property

Many contracts provide that a party cannot assign or transfer his or her rights to another. Ordinarily, the trustee in bankruptcy is in no better position than the bankrupt in exercising contractual rights that have vested in the trustee, and therefore the trustee would be bound by this limitation on transfer. However, the BIA has modified this rule in order to give the trustee the power to transfer the right in circumstances where the debtor would have been unable to do so.

This power was originally restricted to the assignment of a lease of real property. The BIA did not directly confer this power on trustees. Instead, it incorporated provincial law by providing that the rights of lessors were to be determined according to the law of the province in which the leased premises are situated.24Provincial legislation gave courts the power to approve an assignment of a lease by a trustee in bankruptcy notwithstanding a non-assignment provision contained in the lease agreement.25The court could not make the order unless the arrears in rent were paid to the landlord and the assignee agreed to ob-

Page 85

serve and perform its terms of the lease and not conduct a more objectionable or hazardous business than that conducted by the bankrupt.

The 2005/2007 amendments to the BIA expand the court’s power to assign the rights and obligations of the debtor to a specified person who agrees to the assignment.26The new provision applies to all contracts except for post-bankruptcy contracts, eligible financial contracts, and collective agreements.27The power can be exercised in respect of an individual only if the individual is carrying on business and only to the extent that the rights and obligations that are assigned relate to the business.28In deciding whether to make the order, the court must consider whether the person to whom the rights and obligations are to be assigned is able to perform the obligations and whether it is appropriate to assign the rights and obligations to that person.29The court is not permitted to make the order unless it is satisfied that all monetary defaults will be remedied before the date specified in the order.30

The new provisions apply to commercial leases and replace the provincial law concerning the assignment of leases by a trustee that was formerly incorporated by the BIA.31Nevertheless, some of the case law decided under the provincial statutes remains useful. In deciding whether a person is able to perform the future obligations under the agreement, it is likely that a court will continue to require evidence of the proposed assignee’s business reputation in the community or creditworthiness.32Commercial shopping mall leases frequently contain restrictive covenants that limit the kinds of business that can be carried out on the leased premises by the tenant or which limit the power of the landlord to permit the premises to be used for certain purposes. These types of clauses are designed to ensure that the mix of stores and the layout of the mall produces an economically viable enterprise for the benefit of all the tenants. Prior to the 2005/2007 amendments to the BIA, the trustee had the power to assign a lease without the consent of the landlord under provincial statute, but the assignee was subject to

Page 86


To continue reading