The Effects of Bankruptcy and Insolvency Proceedings on Security Interests

AuthorRonald C.C. Cuming, Catherine Walsh, Roderick Wood
A. InT RoduCTIon
When a debtor defaults on his credit obligations, it is very common
that a range of creditors’ claim s are affected. If bankr uptcy or insol-
vency proceedings have been invoked either by the debtor or by one or
more creditors, a regime different from that other wise applicable to the
regulation of the various cla ims comes into play. This regime draws on
federal bankruptcy a nd insolvency law, provincial or territorial judg-
ment enforcement law and rules contained in t he PPSA that expressly
apply to insolvent or bankrupt debtors who have given securit y inter-
ests in their propert y. The most signif‌icant features of this regime are
examined in t his chapter.
InsolvEnCY l AW on THE RIGHTs of
sECuR Ed CR EdIToRs1
1) The Def‌inition of Secured Creditor under the
Bankruptcy and Insolvency Statutes
The Bankruptcy and Insolvency Act (BIA)2 def‌ine s secured creditor as
1 See also Sec tion F, below in th is chapter.
2 RSC 1985, c B-3.
The Effects of Ban kruptcy and Insolvency P roceedings on Securit y Interests 519
“a person holding a mortgage, hypothec, pledge, charge, or lien
on or against the propert y of the debtor or any part of that property as
security for a debt due or accruing due to the person from the debtor . . . .”
A similar def‌inition is provided in the Companies’ Creditors Arrangement
Act (C C AA ).3 In one respect, this def‌inition is wider than that in the
PPSA, while in another respect it is narrower. It is wider in that the def-
inition extends to non-consensual security interest s, whereas the PPSA
def‌inition does not. It is narrower in t hat the BIA def‌inition does not
cover transactions that are deemed to be security interests under the
PPSA. A judgment creditor whose claim is given the st atus of or equiva-
lent to that of a secured creditor under provincia l judgment enforcement
law is also not treated a s a secured creditor in bankruptcy proceedings.4
Several courts have inter preted a simil arly worded def‌inition in the
Income Tax Act (ITA)5 as covering secur ity interest s in which a security
interest is granted in t he debtor’s assets, but as excluding t itle retention
devices and securit y leases in which the ownership is retained by the
creditor to secure the obligation.6 This line of authority should not be
extended as it would seriously undermine severa l key bankruptcy law
policies.7 As well, it is inconsi stent with the approach of the Supreme
Court of Canada in Re Giffen8 which t reats the holders of these devices
as secured creditors.
Unfortunately, the co-existence of statutory priorit y provisions
that assign differing meanings to t he def‌inition of a secured creditor
can produce unstable priority rankings.9 For example, a priority com-
3 RSC 1985, c C-36.
4 Canadian Credit Men’s Trust Assn v Beaver Trucking Ltd (1959), 38 CBR 1 (SCC);
Re Sklar and Sklar (1958), 26 WWR 529 (Sask CA).
5 RSC 1985, c.1 (5th Supp.).
6 DaimlerChrysler Financial Ser vices (Debis) Canada Inc v Mega Pets Ltd, 2002
BCCA 242; Minister of National Reve nue v Schwab Construction Ltd, 20 02 SKCA
6; Bank of Nova Scotia v Turyders Trucking Ltd (2001), 32 CBR (4th) 14 (Ont SCJ).
7 See RJ Wood, “The Def‌inition of Se cured Creditor in Insolvency L aw” (2010), 25
BFLR 341 at 351–55.
8 (1998), 155 DLR (4th) 332 (SCC), rev’g (1996), 16 BCLR (3d) 29 (CA). Until
recently, the charac terization problem remai ned alive in Quebec since the Ci vil
Code treat s retention or transfer of tit le as conceptually dist inct from hypoth-
ecary sec urity in the strict s ense: compare Re Giffen, ibid, w ith Ouellet (Trustee
of), 2004 SCC 64 and Le febvre (Trustee of ); Tremblay (Trustee of), 2004 SCC 63. To
resolve thi s uncertainty, the def‌inition of “s ecured creditor” in s 2 of the BIA w as
amended to expl icitly include title-based s ecurity arrange ments arising under
Quebec law other t han f‌inancing lea se and leasing arra ngements. Unfortunately,
the CCAA wa s not amended so as to include a simil arly extended def‌inition.
9 See RJ Wood, “The Structure of Secur ed Priorities in Ins olvency Law” (2011) 27
BFLR 25.
petition may arise i n respect of a statutory deemed trust for source
deductions under the ITA, a statutory charge in respect of unpaid pen-
sion contributions under the BIA, and a conditional sa les agreement.
The BIA provides that the statutory deemed trust (DT) ranks ahead of
a pension contribution charge (PC). The conditional sales agreement
(CS) ranks ahead of the deemed trust because of the restricted def‌in-
ition of secured creditor in the ITA. But if the BIA uses a w ider def-
inition of secured creditor that includes conditional sales agreements,
this means that the pension contribution charge prevail s over the con-
ditional sales agreement. The result is that DT has priority over PC; PC
has priority over CS; but CS has pr iority over DT. This creates a circul ar
priority problem.
The federal priority provisions were designed to create an integrat-
ed scheme of priorities that ranks the various ty pes of interests that
arise in in solvency proceedings. They will only properly work together
if they use the same def‌inition of a secured creditor.
The simplest solution to this problem is for Parliament to amend
the def‌inition of secured creditor in the ITA and in the federal insol-
vency statutes to ensure th at they cover title retention devices by u sing
a formulation similar to th at found in provincial secured transactions
law. Failing this, the matter will fall to the courts.
2) The Traditional Approach
Upon the occurrence of a bankr uptcy, unsecured creditors lose their
ability to recover their claim s through the provincial judgment enforce-
ment system, and must instead prove their cla ims through the federal
bankruptcy process. Secured creditors are not so restr icted. From its
inception, bankruptcy law has been viewed as a regi me that does not
directly affect the posit ion of secured creditors of the bankrupt.
The hands-off approach to secur ity interests in bankrupts’ propert y
is highlighted in sect ion 136 of the BIA. This section sets out the pri-
ority structure t hat must be applied by a trustee in ban kruptcy when
distributing t he property of the bankrupt among the various claim-
ants to it. All the priorit y rules set out in the section are made “subject
to the rights of secured creditors.” This approach is al so evident in
section 70(1) that states the effect of an assignment or bankruptcy or-
der on the rights of creditors of the bankrupt. The “rights of secured
creditors” are excepted from the precedence that bank ruptcy has over
the creditors’ rights ar ising outside of bankruptcy. Section 71 vests the
bankrupt’s property in t he trustee “subject to … the rights of secured
creditors.” Section 69.3, which stays enforcement of creditors’ rights

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