A. The Role of the Creditors

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

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1) The Creditor Control Model

Insolvency regimes vary considerably as to the administrative model that is used to govern this decision-making process. Three models of administrative decision making within insolvency regimes can be identified: the judicial control model, the creditor control model, and the official control model. Under the judicial control model, a bankruptcy

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judge occupies a central role in making decisions. In the creditor control model, it is the creditors who make the important decisions. And, in the official control model, a state official takes on this role.

The bankruptcy regime in Canada uses a modified creditor control model that contains some elements of official control.1A model that promotes the participation of creditors seems sensible on first impression. After all, it is the creditors who have a direct financial interest in the outcome. The administrative decisions that are made directly affect the size of the bankruptcy dividend that the creditors will receive. However, the reality is that creditors rarely have an adequate incentive to carry out these responsibilities. This phenomenon is sometimes called rational apathy. The amount that is recovered by an unsecured creditor by way of a bankruptcy dividend is often only a small fraction of the original claim. In many cases, it simply does not make economic sense for a creditor to expend time and effort given the small return. Moreover, creditors who choose not to involve themselves at all obtain the same recovery as those who participate in the decision making.

Bankruptcy systems that are based upon a creditor control model are susceptible to abuse if the creditors do not take an interest in the administration of the bankrupt estate. Although a trustee’s primary legal duty is to act for the benefit of the creditors, the reality is that most bankruptcies are voluntary ones that have been initiated by the debtor. In practice, it is debtors rather than creditors who choose the trustee. One need only look to the yellow pages under the bankruptcy trustee heading to see that the advertising is directed to debtors and not to creditors. Even in involuntary bankruptcies, the creditor who initiates the bankruptcy often is a secured creditor wishing to obtain a more favourable priority for its claim.2Having attained this objective, the secured creditor often has no further interest in the administration of the bankruptcy. Under these circumstances, there exists a potential for abuse. A trustee may engage in conduct that is not in the interests of the creditors but that benefits the debtor, a secured creditor, or the trustee. Indeed, a perception of dishonest administration contributed to the wholesale repeal of Canadian insolvency legislation in 1880.

Canadian bankruptcy law departs from a pure creditor control model in order to curb the potential for conflict of interest and abuse that arises out of creditor indifference. It does so by regulating, licensing, and supervising those who are permitted to act as trustee. This

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has created a professionalized group of bankruptcy trustees. Canadian bankruptcy law also contains conflict-of-interest rules that restrict a trustee’s ability to act in certain cases.

Despite the problems inherent in the creditor control model, it undoubtedly provides a powerful means through which a creditor can legitimately influence the administrative decision making in a bankruptcy. In those cases where a creditor’s claim is sufficiently large and there are adequate assets to justify participation, engagement in the process can be effectively invoked to advance the interests of the creditors.

2) The First Meeting of Creditors

The trustee3calls the first meeting of creditors by determining the names and addresses of the creditors and notifying them of the meeting.4The notice must be sent within five days of the trustee’s appointment, with the meeting held within twenty-one days of the appointment.5The notice must be accompanied by a list of the creditors and the amount of their claims, a proof of claim, and a proxy. In the case of an individual bankrupt, the notice must also provide information about the bank-rupt’s financial situation and, if applicable, the bankrupt’s obligation to make payments of post-bankruptcy surplus income.6A first meeting of creditors is not required in a summary administration bankruptcy unless there is a request for one by the official receiver or creditors holding 25 percent of the proven claims.7The official receiver or nominee chairs the first meeting of creditors.8If the official receiver has conducted an examination of the debtor before the first meeting of creditors, he must give a report to the creditors on the debtor’s responses to the questions.9Two formal matters

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are carried out at the first meeting of creditors: the affirmation of the appointment of the trustee or substitution of another, and the appointment of inspectors.10The trustee will give a report on the preliminary administration of the estate.11The meeting provides creditors with a forum in which they can communicate with one another as well as with the trustee. The bankrupt is required to attend the meeting and is required to answer questions asked by the creditors.12The meeting also affords the creditors the opportunity to give instructions to the trustee on matters relating to the administration of the estate.

A single creditor entitled to vote constitutes a quorum for a meeting of creditors.13Only creditors who have filed proof of claims with the trustee are permitted to vote at a meeting of creditors,14although creditors who have not done so may attend the meeting.15Proxy voting is permitted, except that the debtor cannot be appointed a proxy to vote.16Votes on ordinary resolutions are calculated by counting one vote for each dollar of every claim that is not disallowed.17A person who acquires the claim of another creditor either before or after the bankruptcy is permitted to prove the claim and vote. The only limitation to this principle is that a person who acquires a portion of a claim after the bankruptcy cannot vote that claim.18

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The chair has the power to admit or reject a proof of claim for the purposes of voting at a meeting, and this decision may be appealed to the court.19However, the chair has no discretion to admit a claim for voting if the trustee has disallowed the claim.20Unliquidated or contingent claims do not permit the claimant to vote until the trustee has valued the claim.21Secured creditors can assess the value of their security and prove for the balance.22In determining the outcome of a vote, the chair must exclude the vote of a creditor who did not deal at arm’s length with the debtor in the year prior to the initial bankruptcy event up until the date of bankruptcy, unless a court directs otherwise.23Certain creditors who are related to the debtor are also not permitted to vote on the appointment of a trustee or inspectors.24

Although affirmation of the trustee requires an ordinary resolution carried by a majority, a decision to substitute another trustee is a matter that requires a special resolution.25A special resolution is defined as a dual majority in which there is both a majority in number of the creditors and three-fourths of the value of the proven claims in favour of the resolution.26The first meeting of creditors is usually also the last, but it is possible to call further meetings of creditors. A trustee may call a meeting of creditors at any time, and must do so when directed by the court, or when requested in writing by a majority of inspectors or by 25 percent of the number of the creditors holding 25 percent of the value of the proved claims.27

3) The Appointment and Duties of the Inspectors

At the first meeting of creditors or at a subsequent meeting, the creditors may appoint up to five inspectors of the estate of the bankrupt or

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agree not to appoint any inspectors.28A person need not be a creditor to be appointed as an inspector,29but a party to a contested action by or against the bankrupt estate cannot be appointed.30Inspectors do not need to be appointed in summary administration bankruptcies.31Meetings of the board of inspectors are usually called by the trustee but may also be called on the request of a majority of the inspectors.32

The powers of the inspectors are exercised by a majority vote.33If there is a tie, the trustee casts the deciding vote.34The meetings can be carried out in whole or in part by telephone or via other means if all the inspectors consent.35Inspectors are entitled to recover their travel expenses and a prescribed fee for meetings, but the fees are very modest.36

The inspectors must authorize most of the significant decisions concerning the administration of the estate. In particular, the permission of the inspectors is required in respect of the following matters:

· the sale, lease, or other disposition of the assets of the bankrupt estate, the carrying on of the business of the bankrupt, and an election to retain, disclaim, or assign a lease;37· the institution or continuation of legal proceedings relating to the property of the bankrupt and the compromise or settlement of claims by or against the bankrupt estate;38

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· the borrowing of money or incurring of other obligations and the granting of security on the bankrupt assets in priority to the claims of the creditors;39· the division in specie among the creditors of property that from its peculiar nature or other special circumstances cannot be readily or advantageously sold;40

· the appointment of the bankrupt to aid in administering the estate;41· the divesting of any real property by a...

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