The Effects of Bankruptcy and Insolvency Proceedings on Security Interests

• Author: Ronald C.C. Cuming, Catherine Walsh, Roderick Wood
• Pages: 518-551

518

CHAPTER 10

THE EFFECTS OF

BANKRUPTCY

AND INSOLVENCY

PROCEEDINGS ON

SECURITY INTERESTS

A. InTRoduCTIon

When a debtor defaults on his credit obligations, it is very common

that a range of creditors’ claims are affected. If bankruptcy 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 claims comes into play. This regime draws on

federal bankruptcy and insolvency law, provincial or territorial judg-

ment enforcement law and rules contained in the PPSA that expressly

apply to insolvent or bankrupt debtors who have given security inter-

ests in their property. The most signif‌icant features of this regime are

examined in this chapter.

B. THE EffECT of BAnKRuPTCY And

InsolvEnCY lAW on THE RIGHTs of

sECuREd CREdIToRs1

1) The Def‌inition of Secured Creditor under the

Bankruptcy and Insolvency Statutes

The Bankruptcy and Insolvency Act (BIA)2 def‌ines 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 Interests519

“a person holding a mortgage, hypothec, pledge, charge, or lien

on or against the property 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 (CCAA).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 interests, whereas the PPSA

def‌inition does not. It is narrower in that 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 status 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 interests in which a security

interest is granted in t he debtor’s assets, but as excluding t itle retention

devices and security 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 several key bankruptcy law

policies.7 As well, it is inconsistent with the approach of the Supreme

Court of Canada in Re Giffen8 which treats the holders of these devices

as secured creditors.

Unfortunately, the co-existence of statutory priority provisions

that assign differing meanings to the 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.

PERSO NAL PROPERT Y SECUR ITY LAW520

petition may arise in 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 sales 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 wider def-

inition of secured creditor that includes conditional sales agreements,

this means that the pension contribution charge prevails 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 types of interests that

arise in insolvency 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 using

a formulation similar to that found in provincial secured transactions

law. Failing this, the matter will fall to the courts.

2) The Traditional Approach

Upon the occurrence of a bankruptcy, unsecured creditors lose their

ability to recover their claim s through the provincial judgment enforce-

ment system, and must instead prove their claims through the federal

bankruptcy process. Secured creditors are not so restricted. From its

inception, bankruptcy law has been viewed as a regime that does not

directly affect the position of secured creditors of the bankrupt.

The hands-off approach to secur ity interests in bankrupts’ propert y

is highlighted in section 136 of the BIA. This section sets out the pri-

ority structure that must be applied by a trustee in bankruptcy when

distributing the property of the bankrupt among the various claim-

ants to it. All the priority rules set out in the section are made “subject

to the rights of secured creditors.” This approach is also 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 bankruptcy has over

the creditors’ rights arising outside of bankruptcy. Section 71 vests the

bankrupt’s property in the trustee “subject to … the rights of secured

creditors.” Section 69.3, which stays enforcement of creditors’ rights