The Effects of Bankruptcy and Insolvency Proceedings on Security Interests

AuthorRonald C.C. Cuming/Catherine Walsh/Roderick J. Wood
ProfessionUniversity of Saskatchewan, College of Law/McGill University, Faculty of Law/University of Alberta, Faculty of Law
When a debtor defaults on their credit obligations, it is very common th at
a range of creditors’ claims are a ected. If bankruptcy or in solvency pro-
ceedings have been invoked either by the debtor or by one or more credit-
ors, a regime dierent from that other wise applicable to the regulation of
the various claim s comes into play. This regime draws on federal bank-
ruptcy and insolvency law, provincial or ter ritorial judgment enforcement
law, and rules contained in the PPSA th at expressly apply to insolvent
or bankrupt debtors who have given secur ity interests in their proper ty.
The most significant features of th is regime are examined in thi s chapter.
1) The Definition of Secured Creditor Under the
Bankruptcy and Insolvency Statutes
The Bankr uptcy and Insolvency Act (BI A)2 defines secured creditor as
“a person holding a mortgage, hypothec, pledge, charge, or lien on or
1 See also Sec tion F, below in th is chapter.
2 RSC 1985, c B-3.
against the property of the debtor or any part of that property as secur-
ity for a debt due or accruing due to the person from the debtor.” A sim-
ilar definition is provided i n the Companies’ Creditors Arrangement Act
(CC A A).3 In one respect, this definit ion is wider than that in the PPSA,
while in another respect it is n arrower. It is wider in that the definition
extends to non-consensua l security interest s, whereas the PPSA defin-
ition does not. It is narrower in that t he BIA definition does not cover
transactions that are deemed to be securit y interests under the PPSA.
A judgment creditor whose claim is given the status of or equivalent to
that of a secured creditor under provinci al judgment enforcement law
is also not treated as a s ecured creditor in bankr uptcy proceedings.4
Several courts have inter preted a similarly worded definition in the
Income Tax Act (ITA)5 as covering secur ity interests in which a security
interest is granted i n the debtor’s assets, but as e xcluding title retention
devices and security leases in which the ow nership 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 inconsi stent with the approach of the Supreme
Court of Canada in R e Gien,8 which treats the holders of these devices
as secured creditors.
Unfortunately, the co-existence of statutory priority provisions that
assign diering meanings to the definition of a secured creditor can
produce unstable pr iority rankings.9 For ex ample, a priority competition
may arise in respect of a statutory deemed trust for source deductions
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; Canada (De puty Attorney Ge neral) 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 a t 351–55.
8 (1998), 155 DLR (4th) 332 (SCC) [Re Gien], rev’g (1996), 16 BCLR (3d) 29 (CA).
Until recently, the cha racterization problem rem ained alive in Quebec since t he
Civil Co de treats retent ion or transfer of title as concept ually distinct from hy poth-
ecary sec urity in the strict se nse: compare Re Gien, ibid, wit h Ouellet (Trustee
of), 2004 SCC 64 and Lefe bvre (Trustee of ); Tremblay (Trustee of), 2004 SCC 63. To
resolve thi s uncertainty, the definition of “se cured creditor” in section 2 of t he BIA
was amended to ex plicitly include title-ba sed security arr angements arising un der
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.
The Eects of Bank ruptcy and Insolvency Pro ceedings on Security I nterests 575
under the ITA, a statutory charge in respect of unpaid pension contribu-
tions under the BIA, and a conditional s ales agreement. The BIA provides
that the statutory deemed t rust (DT) ranks ahead of a pension contribu-
tion charge (PC). The conditional sales ag reement (CS) ranks ahead of
the deemed trust bec ause of the restricted definit ion of secured creditor
in the ITA. But if the BIA uses a wider definition of secured creditor
that includes conditional sale s agreements, this means that the pension
contribution charge prevails over the conditional sales agreement. The
result is that DT has pr iority over PC; PC has priority over CS; but CS
has priority over DT. This creates a circular priority problem.
The federal priority provisions were designed to c reate an integrated
scheme of priorities that ranks the various ty pes of interests th at arise
in insolvency proceedings. They will only properly work together if
they use the same defin ition of a secured creditor. The simplest solution
to this problem is for Parliament to amend the definit ion of secured
creditor in the ITA and in the federal insolvency statutes to ensure that
they cover title retention devices by using a formulation similar to that
found in provincial secured transactions law. Failing this, t he matter
will fall to t he 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 cl aims through the federal
bankruptcy proce ss. Secured creditors are not so restricted. From its
inception, bankruptcy law h as been viewed as a regime t hat does not
directly aect the position of secured creditors of the bankrupt.
The hands-o approach to security interests in bankrupts’ property
is highlighted in sect ion 136 of the BIA. This s ection sets out the priority
structure that must be applied by a t rustee in bankruptcy when distrib-
uting the property of the ban krupt among the various claimant s to it. All
the priority rule s set out in the section are m ade “subject to the rights of
secured creditors.” This approach is also evident in sect ion 70(1), which
states the eect of an assig nment or bankruptcy order on the rights of
creditors of the bankr upt. The “rights of sec ured creditors” are excepted
from the precedence that bankruptcy has over the creditors’ right s aris-
ing outside of bankruptcy. Section 71 vests the bank rupt’s property in
the trustee “subject to . . . the rights of secured creditors.” Section 69.3,
which stays enforcement of creditors’ rights again st a bankrupt, aects
secured creditors, but only in very limited circumstances a nd for only a
short period of time.

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