The Effects of Bankruptcy and Insolvency Proceedings on Security Interests

• Author: Ronald C.C. Cuming/Catherine Walsh/Roderick J. Wood
• Profession: University of Saskatchewan, College of Law/McGill University, Faculty of Law/University of Alberta, Faculty of Law
• Pages: 573-608

573

CHAPTER 10

THE EFFECTS OF

BANKRUPTCY

AND INSOLVENCY

PROCEEDINGS ON

SECURITY INTERESTS

A. INTRODUCTION

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 insolvency 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 claims 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 that expressly apply to insolvent

or bankrupt debtors who have given security interests in their property.

The most significant features of th is regime are examined in thi s 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

“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.

PERSO NAL PROPERT Y SECURI TY LAW574

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 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 definition

extends to non-consensual security interests, whereas the PPSA defin-

ition 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 equivalent to

that of a secured creditor under provincial judgment enforcement law

is also not treated as a secured creditor in bankruptcy 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 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 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 nterests575

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 trust (DT) ranks ahead of a pension contribu-

tion charge (PC). The conditional sales agreement (CS) ranks ahead of

the deemed trust because of the restricted definition of secured creditor

in the ITA. But if the BIA uses a wider definition of secured creditor

that includes conditional sales agreements, this means that the pension

contribution charge prevails over the conditional sales agreement. The

result is that DT has priority 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 types of interests that 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 definition 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, 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 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 trustee 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 assignment 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’ rights aris-

ing 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 against a bankrupt, aects

secured creditors, but only in very limited circumstances a nd for only a

short period of time.