CQP Introduction to Insolvency PDF 2023
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2023
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Summary
This document is an introduction to insolvency course. It covers topics on credit types, business structures in Canada, and the language of insolvency. The course is geared towards students interested in a rewarding career in the insolvency and restructuring field.
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INTRO DUCTIO N TO INSO LVENCY CO URSE CQP Introduction to Insolvency | 2023 1 TABLE O F CO NTENTS CO URSE INTRO DUCTIO N AND O VERVIEW.........................................................
INTRO DUCTIO N TO INSO LVENCY CO URSE CQP Introduction to Insolvency | 2023 1 TABLE O F CO NTENTS CO URSE INTRO DUCTIO N AND O VERVIEW............................................................................................ 5 Co u rse Le a rn in g O b je c t ive s....................................................................................................................................................5 Co u rse St ru c t u re.............................................................................................................................................................................6 Mo d u le St ru c t u re............................................................................................................................................................................6 Re q u ire d Re a d in g s................................................................................................................................. 6 Se lf-a ss e ssm e n t s.................................................................................................................................... 6 Illu s t ra t ive Ca se s..............................................................................................................................................................................7 Ass ig n m e n t c a s e.............................................................................................................................................................................7 Fin a l Exa m in a t io n...........................................................................................................................................................................7 Co u rse Su p p o rt.................................................................................................................................................................................7 Su g g e s t e d St u d y Ap p ro a c h................................................................................................................................................... 8 Ne xt St e p s........................................................................................................................................................................................... 8 Mo d u le 1 – Ba c k g ro u n d o f In s o lve n c y.................................................................................................... 9 O ve rvie w................................................................................................................................................................................................9 Co m m o n d e fin it io n s.....................................................................................................................................................................9 Le a rn in g O b je c t ive s......................................................................................................................................................................9 To p ic 1.1 Typ e s o f c re d it..........................................................................................................................................................10 Le a rn in g O b je c t ive s....................................................................................................................................................................10 Re q u ire d Re a d in g.........................................................................................................................................................................10 Exa m p le 1.1 – In st a llm e n t lo a n............................................................................................................................................... 11 To p ic 1.2 Bu s in e s s s t ru c t u re in Ca n a d a..................................................................................................................... 15 Le a rn in g O b je c t ive s.................................................................................................................................................................... 15 Re q u ire d Re a d in g......................................................................................................................................................................... 15 To p ic 1.2.1 So le p ro p rie t o rs h ip s a n d p a rt n e rsh ip s.................................................................................................. 15 To p ic 1.2.2. Co rp o ra t e s t ru c t u re s.........................................................................................................................................18 To p ic 1.2.3 Co rp o ra t e c re d it............................................................................................................ 20 To p ic 1.3 Th e la n g u a g e o f in s o lve n c y....................................................................................... 22 Le a rn in g O b je c t ive s................................................................................................................................................................... 22 Re q u ire d Re a d in g........................................................................................................................................................................23 To p ic 1.3.1 D e fin e d t e rm s in t h e in s o lve n c y-re la t e d le g is la t io n........................................... 24 To p ic 1.3.2 Th e st a ke h o ld e rs.......................................................................................................... 25 To p ic 1.4 Ne c e s s it y fo r in s o lve n c y le g is la t io n......................................................................... 31 CQP Introduction to Insolvency | 2023 2 Le a rn in g O b je c t ive s............................................................................................................................................................... 31 Re q u ire d Re a d in g................................................................................................................................................................... 31 To p ic 1.5 In s o lve n c y le g is la t io n a n d t h e ro le o f t h e c o u rt s......................................................................34 Le a rn in g O b je c t ive s..............................................................................................................................................................34 Re q u ire d Re a d in g........................................................................................................................................................................34 To p ic 1.6 Na t u re o f in s o lve n c y p ro c e e d in g s.........................................................................................................39 Le a rn in g O b je c t ive s...................................................................................................................................................................39 Re q u ire d Re a d in g........................................................................................................................................................................39 Mo d u le 2 – Typ e s o f In s o lve n c y P ro c e e d in g s.................................................................................... 4 3 O ve rvie w.............................................................................................................................................................................................4 3 Le a rn in g O b je c t ive s...................................................................................................................................................................4 3 To p ic 2.1 Ba n k ru p t c y...............................................................................................................................................................4 3 Le a rn in g O b je c t ive s...................................................................................................................................................................4 3 Re q u ire d Re a d in g s.................................................................................................................................................................... 4 4 To p ic 2.2 P ro p o s a ls.................................................................................................................................................................. 4 9 Le a rn in g O b je c t ive s.................................................................................................................................................................. 4 9 Re q u ire d Re a d in g s.................................................................................................................................................................... 4 9 To p ic 2.3 In fo rm a l a rra n g e m e n t s (o t h e r o p t io n s )........................................................................................... 53 Le a rn in g O b je c t ive s................................................................................................................................................................... 53 Re q u ire d Re a d in g s.....................................................................................................................................................................53 To p ic 2.4 Re c e ive rs h ip s a n d CCAA re s t ru c t u rin g............................................................................................54 Le a rn in g O b je c t ive s...................................................................................................................................................................54 Re q u ire d Re a d in g s................................................................................................................................................................54 Mo d u le 3 – Typ ic a l In s o lve n c y Ac t ivit ie s o f a n LIT........................................................................... 59 O ve rvie w.............................................................................................................................................................................................59 Le a rn in g O b je c t ive s...................................................................................................................................................................59 To p ic 3.1 Et h ic s in t h e p ra c t ic e o f in s o lve n c y..................................................................................................... 6 0 Le a rn in g O b je c t ive s.................................................................................................................................................................. 6 0 Re q u ire d Re a d in g s.................................................................................................................................................................... 6 0 To p ic 3.2 As s e s s m e n t o f t h e s it u a t io n..................................................................................................................... 6 8 Le a rn in g O b je c t ive s.................................................................................................................................................................. 6 8 Re q u ire d Re a d in g s.................................................................................................................................................................... 6 8 To p ic 3.2.1 As s e s sm e n t o f t h e c u rre n t sit u a t io n............................................................................ 6 9 To p ic 3.2.2 As s e s sm e n t o f t h e e n d g a m e (in t e n d e d o u t c o m e s ).............................................. 7 2 To p ic 3.3 Ap p o in t m e n t d o c u m e n t a t io n a n d n o t ic e t o s t a ke h o ld e rs................................................78 CQP Introduction to Insolvency | 2023 3 Le a rn in g O b je c t ive s...................................................................................................................................................................78 Re q u ire d Re a d in g s.....................................................................................................................................................................78 To p ic 3.3.1 No t ic e t o s t a ke h o ld e rs..................................................................................................... 8 0 To p ic 3.4 Ad m in is t ra t ive m a t t e rs..................................................................................................................................8 1 Le a rn in g O b je c t ive s....................................................................................................................................................................8 1 Re q u ire d Re a d in g s......................................................................................................................................................................8 1 To p ic 3.5 In t e rim re p o rt in g................................................................................................................................................8 3 Le a rn in g O b je c t ive s...................................................................................................................................................................8 3 Re q u ire d Re a d in g s.....................................................................................................................................................................8 3 To p ic 3.6 O b t a in in g a u t h o riz a t io n / d ire c t io n t o a c t.......................................................................................8 5 Le a rn in g O b je c t ive s...................................................................................................................................................................8 7 Re q u ire d Re a d in g s.....................................................................................................................................................................8 7 To p ic 3.7 Ad m in is t e rin g o p e ra t io n s ………………………………………………………………………………………………………………87 Le a rn in g O b je c t ive s...................................................................................................................................................................8 7 Re q u ire d Re a d in g s.....................................................................................................................................................................8 7 To p ic 3.8 Ad m in is t e rin g c o m p e t in g c la im s ……………………………………………………..……………………………………….8 8 Le a rn in g O b je c t ive s.................................................................................................................................................................. 9 0 Re q u ire d Re a d in g s......................................................................................................................................................................9 1 To p ic 3.9 Ma n a g in g t h e b a n k ru p t o r in s o lve n t p e rs o n w h o file d a p ro p o s a l…………………………..93 Le a rn in g O b je c t ive s...................................................................................................................................................................9 3 Re q u ire d Re a d in g s......................................................................................................................................................................9 1 To p ic 3.10 Fin a liz e a s s e t d is p o s it io n ………………………………………………………………………………………………………………97 Le a rn in g O b je c t ive s...................................................................................................................................................................9 7 Re q u ire d Re a d in g s......................................................................................................................................................................9 1 To p ic 3.11 Fin a liz e re p o rt in g a n d d is t rib u t io n t o s t a k e h o ld e rs ………………………………………………………..99 Le a rn in g O b je c t ive s...................................................................................................................................................................9 9 Re q u ire d Re a d in g s......................................................................................................................................................................9 1 To p ic 3.12 O b t a in p ra c t it io n e r’s d is c h a rg e …………………………………………………………………………………………………101 Le a rn in g O b je c t ive s..................................................................................................................................................................10 1 Re q u ire d Re a d in g s......................................................................................................................................................................9 1 CQP Introduction to Insolvency | 2023 4 CO URSE INTRO D UCTIO N AND O VERVIEW W e lc o m e t o t h e In t ro d u c t io n t o In s o lve n c y c o u rs e ! Insolvency is a dynamic field. This introductory course is the first step in a program that can lead to a rewarding career as a Chartered Insolvency and Restructuring Professional (CIRP) and, ultimately as a Licensed Insolvency Trustee (LIT). Those who choose this path will find that LITs perform a wide variety of roles beyond simply administering insolvency proceedings. They are problem-solvers, consultants, business advisors, and counsellors, depending on the circumstances. This course is also designed for those interested in the field of insolvency but who may not be intending to become CIRPs. You may be working in an insolvency office, at a financial institution, in a credit counselling office, or anywhere you have encounters with the insolvency process and/or its participants. At the end of this course, you will have a good overall understanding of the field. Canadian insolvency legislation is intended to be rehabilitative: financially overburdened individuals can access the legislation to get relief from their debts and go on to regain a positive position in Canadian economic society. Business can restructure to recover from a money-losing business cycle or an uninsured disastrous event with the result that the business can continue to employ people and make a positive contribution to the Canadian economy. This course will outline how LITs administer the mechanisms and procedures available through insolvency legislation in a fair and transparent manner to help all stakeholders in the process and to achieve financial rehabilitation for the debtor. You will quickly learn that insolvency is much broader than just bankruptcy! Co u rs e Le a rn in g O b je c t ive s At the end of this course, you should: understand the purpose of the insolvency system in Canada, the context within which it operates, and the role of the various stakeholders in the process explain the various legislation, in general terms, that govern insolvency proceedings and understand the interplay between provincial and federal insolvency related laws and regulations explain the ethical duties and obligations of a CIRP and an LIT, and understand their underlying principles understand the various options available to debtors and when they are applicable explain in general terms each step involved in a formal insolvency process and how it may differ, depending on debtor characteristics and other factors CQP Introduction to Insolvency | 2023 5 Co u rs e St ru c t u re The course is divided into three content modules. Module 1 — Background of insolvency: covers the key areas you need to understand in the context of insolvency, including insolvency terminology, credit, business structures, and the stakeholders and organizations involved in the process. Module 2 — Types of insolvency proceedings: covers aspects of the available proceedings and how to differentiate when and why one might be more appropriate than the other. Module 3 — Typical insolvency activities of an LIT: covers the range of processes an insolvency practitioner follows to resolve an insolvency problem. Mo d u le St ru c t u re Each module has an overview, and a set of learning objectives. The module is further divided into topics, each with specific learning objectives and required readings. Required Readings The required readings are generally links to sections of relevant legislation. You are not expected to memorize the sections but rather gain an awareness of how the legislation operates and how it relates to the topic. The salient points of the legislation and its application will be covered in the course material. The readings related to Office of the Superintendent (OSB) Directives are referenced in generic terms, without mention of the version number (for example, Directive 1R instead of 1R7). Links are to the most current version at the time of publication of the course. As Directives are updated periodically, you should ensure that you are consulting the latest version of the Directive. Note that in some cases the links to the legislation will take you to the page where the specific section appears, so you may have to scroll to find the correct section. Self-assessments A set of review questions with solutions, either short-answer or multiple-choice is available for each module in the self-assessment section of D2L. You are strongly encouraged to complete these review questions to help you gauge your understanding of the module material and identify where further review may be required. CQP Introduction to Insolvency | 2023 6 Illustrative Cases Two cases with solutions, one illustrating a consumer insolvency file and the other a corporate file, are included in the course material. They provide simulated real-world examples of how the course material applies in practice and as well, help you assess your progress in achieving the course learning objectives. You are encouraged to answer each question in the cases before consulting the solutions. Assignment case A comprehensive case is included under the Assignment section of D2L. The case carries through all the steps of the insolvency process covered in Module 3, integrating knowledge from all Modules. As with the illustrative cases, you are encouraged to answer all the questions. You must submit an answer file through D2L to gain access to the solutions. (consult the instructions to submit your file) Final Examination Once you have completed the course, including the illustrative and assignment cases you will automatically be given access to the final examination through CAIRP’s online Learning Management System (LMS). The final exam consists of 50 objective questions and you will have two (2) hours to complete it. The exam will be scored immediately by the LMS. You will have two attempts at the final examination to obtain a passing grade of 60%. Upon successfully passing the examinations, you will receive a certificate of completion. Course Support Technical support is available through the CAIRP’s Learning Management System or by contacting CAIRP directly. Content questions/support can be posted to the Course Discussion board. They will be answered within 48 hours by a CIRP/LIT. Alternatively, if you are enrolled in the CQP program and have a sponsor, you may direct your questions to them. CQP Introduction to Insolvency | 2023 7 Suggested Study Approach Although everyone has their own study method, the following is a suggested approach that may prove useful: Begin your study at Module 1 and proceed sequentially to the next one- each module builds on the previous one. For each module, o review the module learning overview and learning objectives to understand the expectations o proceed to each topic with a review of the learning objectives, then skim read the required readings o carefully read through the topic material and review the required readings again, by following the links embedded in the topic material as they occur o once you have completed the topic, review the learning objectives again to see if you achieved them After you have completed all topics in a module, attempt the review questions without consulting the solutions. Review the solutions, then go back to the course material relevant to any of the questions you answered incorrectly. Once you have completed all the modules, attempt the illustrative cases without consulting the solutions. Compare your answers with the suggested solutions and review any areas you answered incorrectly. Complete the assignment case and submit your answer file to access to the solutions. Once you receive the solutions you should review the course material relevant to the sections of the case that were not answered correctly. Take the final exam that will appear in D2L once you have completed the course. Next Steps Once you have completed the Introduction to Insolvency course, you will have a basic overview of the insolvency system. If you are working in insolvency, meet the entrance requirements, and have not already enrolled in the CQP, this course will hopefully entice you to do so, to join the ranks of CIRP and LITs. CQP Introduction to Insolvency | 2023 8 Mo d u le 1 – Ba c k g ro u n d o f In s o lve n c y O ve rvie w This module lays the foundation for your introduction to the field of insolvency. It introduces the different types of credit available in Canada and the types of business structures to help you better understand the insolvency context. The language of insolvency is covered, outlining the key stakeholders and organizations. The purpose of insolvency legislation and activities are also discussed, as well as the nature of the insolvency process. Co m m o n d e fin it io n s The Glossary (on the top D2L menu bar) contains the definition of common and important terms used in the insolvency industry. These are not necessarily the legal definitions of each term, but rather the meanings as used by insolvency professionals in the administration of insolvencies. Please study them carefully as you move through the course material. Le a rn in g O b je c t ive s understand and differentiate between installment credit and revolving credit understand and differentiate between secured debt and unsecured debt explain the general types of credit products and the differences between them explain different business structures in Canada understand the role of shareholders, officers, and directors in a corporation understand the role of shareholders and related corporations differentiate between directors’ liabilities and responsibilities explain the responsibility of the corporation regarding debt understand the difference between an act, a rule, and a directive or circular as it relates to insolvency legislation understand the defined terms used in the context of insolvency identify the primary stakeholders in insolvency proceedings and explain their role identify the potential third parties in an insolvency and how they may be affected understand and explain the purpose of insolvency legislation recognize and differentiate between federal and provincial insolvency and related legislation understand and explain the role of the courts in insolvency proceedings understand the interaction of federal and provincial legislation. CQP Introduction to Insolvency | 2023 9 recognize that Canada is a bijural (two coexisting legal systems) country. understand and explain the difference between restructuring and bankruptcy. explain the general characteristics of a bankruptcy and a receivership. explain the general characteristics of various restructuring options, including proposals and CCAA proceedings. To p ic 1.1 Typ e s o f c re d it Le a rn in g O b je c t ive s Understand and differentiate between installment credit and revolving credit. Understand and differentiate between secured debt and unsecured debt. Explain the general types of credit products and the differences between them. Re q u ire d Re a d in g Credit options, Financial Consumer Agency of Canada How credit cards work, Financial Consumer Agency of Canada Revolving vs. Installment Credit arrangements generally fall into one of two categories: installment credit or revolving credit. Installment credit Installment credit is generally used for a single purpose purchase such as the purchase of a car, a boat, furniture, or a specific home improvement project. Installment loans can also be referred to as “term loans.” These loans are generally for a specific purpose, to be repaid over a fixed period through payments of a fixed amount. Installment loan balances are generally intended to always be declining balances until the loan is repaid in full. At that point in time, the debtor–creditor relationship has been satisfied and neither party has any ongoing obligation to the other. A borrower can always reapply for another loan with the same lender and, provided the lender is content to advance funds again, a new relationship is established. Revolving credit Revolving credit involves the creditor establishing a credit limit for the borrower, based on credit-granting criteria such as employment stability, earnings, equity in assets, and repayment history. (Equity in assets is the value of a person’s assets minus the debts of that person. It is often referred to as “personal net CQP Introduction to Insolvency | 2023 10 worth”). Once a credit limit is established, a borrower is free to use, repay, and reuse the credit facility within the authorized limits. Credit reporting agencies such as TransUnion and Equifax track an individual’s credit activities and histories and, on request, will make the findings available to the credit granting community. The borrower’s credit score, as established by the credit reporting agencies, can factor into the lender’s decision to establish the credit limit, interest rate, and other loan terms. Generally, the lower the credit score, the less the borrower is deemed to be credit worthy by the agencies. Example 1.1 – Installment loan Tee decides to borrow money to buy a car. The loan will be for $30,000, with an interest rate of 10% annually, repayable in monthly payments of $968.02. The balance of the loan will increase each month by the amount of interest for the period and decline by the amount of the payment each month. In this example, Tee’s loan will be repaid in full in 36 months, provided all payments are made. In the first month, the interest is $250.00 ($30,000.00 x (10%/12months) and the rest of the payment goes to repay the principal. At the end of Month 1, the loan balance is $30,000 – [$968.02 –$250.00] = $29,281.98. In the second month, the interest is $29,281.98 x (10%/12 months) = $244.02, and the loan balance at the end of Month 2 is now $29,281.98 – [$968.02 –$244.02] = $28,557.98. Here’s what the repayment schedule looks like for the first 12 months of this loan: Interest Payment Balance 10% annually 30,000.00 1 250.00 968.02 29,281.98 2 244.02 968.02 28,557.99 3 237.98 968.02 27,827.95 4 231.90 968.02 27,091.84 5 225.77 968.02 26,349.59 6 219.58 968.02 25,601.15 7 213.34 968.02 24,846.48 8 207.05 968.02 24,085.52 9 200.71 968.02 23,318.21 10 194.32 968.02 22,544.52 11 187.87 968.02 21,764.37 12 181.37 968.02 20,977.73 CQP Introduction to Insolvency | 2023 11 Car and equipment leases work in much the same way. In a lease, there is a stated purchase value of the car (or equipment), a stated lease end value and the difference between the two represents the value the lessee is going to consume in having the car/equipment available to them. Those costs, plus the cost of financing the lease over the duration of the lease, are then paid over a fixed period by a fixed payment. At the end of the lease term, the asset (car/equipment) is then made available to be purchased at the lease end value. If the agreement is a lease to own, there is a stated purchase value, the lease end value is zero, and the lessee pays the value of the purchase on fixed terms over a fixed period. At the end of the lease term, title passes to the lessee, provided all payments have been made. Mortgage loans are also a form of installment loan, with fixed terms of repayment, and usually based on a declining balance of the loan amount. Mortgages generally involve a security interest registered over a debtor’s land and buildings. It is worth mentioning that leases on cars and equipment are generally subject to a security interest as well. This will be covered in more detail under Secured and Unsecured Debt. Revolving credit The two most common types of revolving credit are the credit card and the line of credit. In either situation, the creditor establishes an amount of credit that they are willing to advance to a borrower. As already mentioned, that amount is established based on the amount requested by the borrower but authorized by the lender based on credit worthiness, which is based on criteria such as credit history with the lender, employment stability, earnings and equity (personal net worth), and possibly a credit score as calculated by a credit reporting agency. Example 1.2 – Revolving credit Suppose Tee has limited equity but a good income and no unfavourable items noted on a credit history. Tee is starting a new job and is establishing a household in a new community. There will be some moving costs, utility hook ups, first and last month’s rent, and other moving related expenses. Tee thinks that a $15,000 line of credit would be useful. When that credit gets used, interest will be charged periodically (usually monthly) and Tee will be required to make a payment periodically, usually monthly. In the first few months, the line of credit activity might look like this: CQP Introduction to Insolvency | 2023 12 Available Credit 10,328.12 Item Advances Payments Balance Transfer to cheq A/C 2020-01-01 5,000.00 5,000.00 Interest (10%/annum) 2020-01-31 41.67 5,041.67 Payment rec'd 2020-01-31 2,500.00 2,541.67 Transfer to cheq A/C 2020-02-15 5,000.00 7,541.67 Payment rec'd 2020-02-27 1,000.00 6,541.67 Payment rec'd 2020-02-28 1,000.00 5,541.67 Interest (10%/annum) 2020-02-15 10.59 5,552.26 Interest (10%/annum) 2020-02-27 31.42 5,583.68 Trsf to cheq A/c 2020-03-03 5,000.00 10,583.68 Interest (10%/annum) 2020-03-31 88.20 10,671.88 Payment rec'd 6,000.00 4,671.88 Note the Available Credit reported in the upper right corner of the worksheet. That number represents available credit minus the credit being used or, stated slightly differently, credit limit minus debt. The numbers are available credit = $15,000 (approved credit) minus $4,692.44 (current debt) = $10,307.56. Credit cards work in the same fashion. A credit limit is established on the card and the debtor/cardholder is at liberty to make purchases (and repayments) on the card, so long as the balance does not exceed the approved credit limit. Credit card holders sometimes exceed their credit card limits and, in so doing, open themselves to the additional charges specified in the cardholder agreement, usually called “over limit charges” and additional interest charges. With a credit card, if the cardholder pays the monthly statement balance in full, there are no interest charges. Annual fees can be charged to cardholders to use the cards. Annual fees generally apply to credit cards that provide additional benefits (cash-back, airline points, etc.). Secured and Unsecured Debt Secured debt Secured debt was described earlier as money advanced by a lender to a borrower, where the borrower grants and the lender takes a security interest in assets (collateral) owned by the borrower or guarantor. A security interest can be granted by a borrower, and taken by the lender, regardless of whether the loan is an installment loan or revolving credit. When a security interest is granted and taken, that creditor becomes a secured creditor. Secured creditors have different rights than unsecured creditors. To be valid CQP Introduction to Insolvency | 2023 13 and enforceable against third parties (such as a trustee in bankruptcy or a receiver), a security interest must be validly registered in accordance with the registration regime of the province in which the property/collateral is located. Once the security interest has been registered, it is considered “perfected” and capable of enforcement against the debtor and/or any other party in possession of collateral. It should be noted that there are different rules for registering security interests in real and personal property in each province. In example1.1, Tee borrowed $30,000 to buy a car. If the lender requested and if Tee granted a security interest in that car, Tee would sign an agreement that included, among other things, a stipulation that, in the event that Tee defaulted on the terms of the loan, the lender could seize and sell the collateral — in this instance, the car. If Tee were to buy a house, the purchase would involve Tee making a down payment of some amount and borrowing the balance of the purchase price. Borrowing to buy a house nearly always involves applying to a financial institution for a mortgage. In that instance, a mortgage is just a security interest whereby Tee, the soon-to-be-owner of the real estate, grants to a lender and the lender takes a security interest in that real estate. That documentation is called a mortgage. A debtor can put a mortgage on all sorts of different assets, but the customary use of the language is in relation to real estate. Again, as with the security interest in Tee’s car, Tee grants and the lender takes certain rights against the real property, in the event that Tee defaults on the loan. These rights are specific to the relationship between a debtor and a creditor and are limited to the assets (collateral) described in the agreement. If and when there is default in the performance of the terms of the lending agreement, a secured creditor can take steps to realize on the collateral — in other words, to sell the collateral in an effort to collect the outstanding balance of the loan. If and when such an event happens, it does not happen immediately: there is a process that the secured creditor must follow to recover against the collateral. There will be more on this in Module 3 to follow. Unsecured debt Unsecured debt was described earlier as money advanced to a borrower, solely on the borrower’s promise to repay. In other words, in granting unsecured debt, a creditor does not take any security interest in assets, but rather relies on the debtor’s capacity and personal integrity to honour the debtor–creditor relationship. In example 1.2, Tee used a line of credit to get settled into new circumstances. Advances were taken on the line of credit and payments were made. Tee still has available credit. The job is going well and Tee CQP Introduction to Insolvency | 2023 14 decides that a vacation is in order and plans are made for a cross-country trip in the new car. Tee goes to the bank (where the line of credit is) and applies for a credit card. A card is issued with a credit limit of $10,000. Tee is now at liberty to use the credit card to make purchases and payments, with the goal that the card balance does not, on any given day, exceed the authorized limit. Tee’s monthly credit card statement would look similar to the line of credit statement in any given month. There will be a more detailed discussion later about the process for an unsecured creditor to recover their debt from a debtor. For now, in an unsecured debtor–creditor relationship, be aware that there are no assets available to be seized and sold without the involvement of the courts. To p ic 1.2 Bu s in e s s s t ru c t u re in Ca n a d a Le a rn in g O b je c t ive s Explain different business structures in Canada. Understand the role of shareholders, officers, and directors in a corporation. Understand the role of shareholders and related corporations. Differentiate between directors’ liabilities and responsibilities. Explain the responsibility of the corporation regarding debt. Re q u ire d Re a d in g Choose the right structure for your business, BDC Canada Type of corporation, Government of Canada Note: While this reading has a taxation perspective, you should focus on the general characteristics that differentiate each type of corporation. Share structure and shareholders, Corporations Canada Director and Officers, Corporations Canada Canada Business Corporations Act (CBCA) Sections 119, 122 To p ic 1.2.1 So le p ro p rie t o rs h ip s a n d p a rt n e rs h ip s The example of Tee that we have been following so far deals only with consumer spending. Let’s now expand the discussion to business spending and business debtor–creditor rights. CQP Introduction to Insolvency | 2023 15 The required readings outline three principal forms of business structure in Canada: sole proprietorships, partnerships (including limited liability partnerships), and corporations (both public and private). A sole proprietorship is an individual who carries out business on their own. It could be a simple business or a complex business, it could be a business with nominal annual sales or one with multi million-dollar sales, but the structure of the business is that it is owned and operated by a single individual. The assets and liabilities (debts) of a sole proprietorship are not distinguished from the personal assets and liabilities of the proprietor. In that instance, if the business fails to pay its creditors, the creditors can look to the personal assets of the proprietor to satisfy their debt. Likewise, if the sole proprietor fails to pay their personal debts, those personal creditors can look to the assets of the proprietorship to satisfy their claim. In other words, a sole proprietor is personally liable for the debts of the proprietorship. A partnership is more than one individual who carry on business together for their mutual benefit. Again, it could be a simple business or a complex business, and it could be a business with nominal annual sales or one with multi million-dollar sales. But the business is owned and operated by more than one individual, as individuals. The assets and liabilities of a partnership are not distinguished from the personal assets and liabilities of the partners; in other words, the partners are jointly and severally liable, personally, for the debts of the partnership. In the case of Limited Liability Partnerships (LLPs), the partners have more liability protection than they would have as general partners, in as much as they do not have personal liability for any shortfall suffered by the creditors of the partnership if there are insufficient partnership assets to satisfy all of the partnership debts. However, each partner does remain liable for their own negligent acts or omissions and those of any employees that they directly supervise. LLPs are generally only allowed in professional environments, such as lawyers, engineers, or accountants, in most jurisdictions where the daily business activities of each partner have minimal overlap. Some provinces have made LLPs available to a wider variety of businesses. In the case of Limited Partnership, which is slightly different than a Limited Liability Partnership, there is one General Partner who controls a majority interest, and the other partners (referred to as limited partners) participate on the basis of their capital contribution to the partnership. The General Partner has unlimited liability for the partnership debts while the liability of each of the limited partners is limited to their capital contribution to the partnership. So, let’s see how a proprietorship and a partnership might work for our friend Tee. CQP Introduction to Insolvency | 2023 16 Example 1.3 – Sole proprietorship and partnership Tee is entrepreneurial and wants to set up a small business. There is no one else involved, so Tee calls it Tee’s Travel Agency (TTA). This is a small enterprise, booking travel arrangements for people, mostly prepaid by the customer. Tee’s existing credit card limit and line of credit are more than sufficient to manage the finances of the business. TTA earns some income, incurs some expenses, and makes a profit (net earnings) at the end of the year. Given that this is a proprietorship, Tee has to add those net earnings to their personal income tax return as self- employed earnings. Tee knows that there is personal liability for TTA’s debts, but the business is still small and TTA really doesn’t have debts of its own, so Tee is fairly safe. TTA suddenly gets a growth opportunity. A major tour operator identifies Tee as a service provider who renders exceptional service to clients and the tour operator wants Tee to look after all the tour operator’s bookings, to which Tee agrees. It soon becomes apparent that Tee cannot manage this venture alone any longer. Faced with the choice of hiring staff, with all the attendant administration and responsibility to meet payroll and so on, Tee decides to take on a partner, Ess. Tee and Ess enter into a partnership agreement that details their arrangements, which includes the business will continue as TTA the business will receive and record revenues and pay its bills Tee and Ess will split the net earnings 60/40, in favour of Tee With the expanded operations, Tee’s credit card and line of credit aren’t enough; TTA needs to establish its own financing and a few commercial accounts. The commercial accounts are set up in the partnership’s accounting records as Trade payables. Tee’s bank sets up a line of credit for the partnership TTA, with Ess and Tee each signing as partners. Things progress nicely and the business enjoys manageable growth. Tee and Ess decide to expand again. There are two additional people who want to join the business: El and Cee. They all meet to discuss what the business structure ought to be. El points out that in a partnership, the partners each have unlimited personal liability for the partnership debts. A discussion ensues but Ess objects to the idea that they might have 100% liability but only a 40% share of the net earnings. That is, however, exactly how it works in partnerships, joint and several liability notwithstanding: an unequal participation in the net earnings of a partnership. Needless to say, they decide to form a corporation. CQP Introduction to Insolvency | 2023 17 To p ic 1.2.2. Co rp o ra t e s t ru c t u re s Corporations are a legal person in law. As such, a corporation can, through proper authorizations, borrow money, establish trade accounts, purchase assets and equipment, hire (and fire) employees, and pay taxes, just like an individual. The corporation relies on directors to make decisions on how to operate. If you think of the corporation as a person, the corporation itself is the body, the officers and employees are the hands and feet that allow the company to operate, and the directors are the head and brain making the decisions. Structurally speaking, a corporation looks like this: Shareholders are the persons who own the shares of a corporation. Shareholders are entitled to vote on issues put to the shareholders at Annual Shareholders Meetings or other properly called shareholders meetings. Generally speaking, shareholders do not assume the debts or personal obligations associated with the corporation. Shareholders, at a regularly called meeting of the shareholders, elect certain people to form the Board of Directors. These people are referred to as Directors of the Corporation. The number of directors is governed by the articles of incorporation or the corporate by-laws. Directors are empowered to make decisions as to how the company operates, enter into contracts on behalf of the corporation, approve financing, and so on. The Board of Directors appoints Corporate Officers to serve in the positions of President, Secretary, and Treasurer. These officers direct the day-to-day operations of the corporation. They execute the plans and directions given by the Board of Directors. The officers hire the Management Team. Managers generally manage the day-to-day operations, involving the production and delivery of goods and services by the corporation. The managers hire operational employees and administrative staff. Employees and administrative staff are the front-line workers of a corporation. More specifics regarding corporate structures are available in the readings. Corporations in Canada are incorporated either under federal legislation known as the Canada Business Corporations Act (CBCA) or under the corresponding legislation of any province or territory. Corporations are governed by a Board of Directors. The role, responsibilities, and liabilities of a director are not to be taken lightly. Directors have two overarching duties: CQP Introduction to Insolvency | 2023 18 a duty of care a fiduciary duty Stemming from these are other duties such as a duty to remain informed a duty to prevent conflicts of interest The duty of care requires that directors take reasonable care to avoid acts, or omissions, that could harm the corporation. Directors should remain informed about the business activities of the corporation and whether the corporation is in compliance with governing legislation and any regulatory requirements by which the corporation is regulated, and ensure that the corporation’s obligations are met as they ought to be. Fiduciary duty requires that a director act honestly, in good faith, and in the best interests of the corporation. It includes ensuring that there are no conflicts of interest that would, or could, be adverse to the interests of the corporation. It further requires that, where conflicts arise between the corporation and certain stakeholders or among stakeholders themselves, the directors ensure that such conflicts are resolved fairly and in the best interests of the corporation. Directors are responsible to the shareholders for the operations of the corporation; however, they are not permitted to advance the interests of the shareholders (or the corporation) to the prejudice of other stakeholders. Such is the duty of care. Several statutes, both provincial and federal, create an onus on directors to remain informed about the financial status of the corporation. This is to ensure, among other things, that the corporation can make its required remittances for such things as employee payroll deductions and GST/HST collected, and to meet the corporation’s payroll and vacation pay obligations to its employees. Many of these statutes legislate that directors are jointly and severally liable with the corporation for these obligations. These are referred to as directors’ liabilities. (see CBCA Section 119). Corporations can be either private or public. Private Corporations A private corporation is usually (but not always) a corporation with few shareholders, often related parties or a small group with a common interest, such as a group of interested parties who come together in a corporation to buy and hold a particular asset, such as a piece of real estate. Federal and provincial legislation limit the number of shareholders who can be solicited to buy shares in a private corporation before a prospectus is required. A prospectus details the corporation’s plans and provides potential CQP Introduction to Insolvency | 2023 19 shareholders with forward looking financial projections, cash flow statements, and other information to enable a prudent investor to ascertain the risk/reward of the investment. There are usually restrictions on the acquisition and disposition of shares in private corporations. Public Corporations A public corporation is (usually) a large corporation, with significant operations and with shares listed on a stock exchange. The shares are available to be purchased and traded by the general public. But whether a corporation is a small private corporation or a large public corporation, the rights, roles, and responsibilities of directors, officers, and shareholders apply. To p ic 1.2.3 Co rp o ra t e c re d it Corporations are referred to in law as a person, so any legislation that talks about the responsibilities, liabilities, or activities of a person also refers to a corporation. As such, a corporation can obtain unsecured credit, such as overdraft protections, lines of credit, credit cards, operating loans, bonds, and so on, and secure credit such as mortgages or term (installment) loans, issue secured bonds, and purchase and finance vehicles or equipment loans. A corporation is responsible for its own debt; its shareholders are not liable for the debts of the corporation, nor are the officers, directors, or managers, other than those referred to earlier as directors’ liabilities. Within a privately held corporation, creditors can, and often do, seek the personal guarantee of one or more of the shareholders of the corporation, particularly when it is a small business owned perhaps, by two to four people. The main reason a shareholder would be asked for a guarantee is to increase the likelihood of the lender being repaid even if the corporation’s financial situation deteriorates. Example 1.4 - Corporation Let’s look back on Tee and friends at TTA. They decided to form a corporation. First, Tee and Ess have to close down the partnership, which they do. They file the necessary GST/HST returns pay all the creditors close off the books and records prepare the income statement split the income 60/40, as agreed, to be reported on their next personal tax return CQP Introduction to Insolvency | 2023 20 They then approach their lawyer to prepare the documentation to open a corporation. They instruct the lawyer to prepare the Articles of Incorporation with the following stipulations: The stated purpose is to provide travel and accommodation services, without restriction, across Canada. A head office will be located in Tee’s apartment. The four shareholders are Tee, Ess, El and Cee. Each shareholder pays $100 in exchange for 100 shares each. Further offerings of shares to anyone are prohibited except with the consent of a majority of the shareholders of record at the time of the vote. Trading or sale of shares outside of the group of four original shareholders is prohibited. Tee, Ess, and Cee are appointed as directors of the corporation. (El is in an occupation that prohibits them acting in the capacity of director of a privately held corporation.) Oh and Jae CPAs are named as the corporation’s accountants. Bee and Dee, Barristers and Solicitors LLP, are named as the corporation’s solicitor. The Board of Directors of TTA Inc. meets immediately to appoint Tee as President, Ess as Secretary, and Cee as Treasurer, authorize Tee and Cee to make the necessary arrangements to open a bank account at the bank, authorize either Tee or Cee to sign cheques up to $1,000, but require both Tee and Cee to sign cheques in excess of $1,000. The lawyer also suggests that the shareholders consider signing a shareholders’ agreement to govern the disposition of shares in the event of disastrous future events such as divorce, incapacity, or death, but they decline to issue those instructions at the moment. With all that done, and $400 in hand from the shareholders, Tee and Cee open the necessary bank account and deposit the money. CQP Introduction to Insolvency | 2023 21 TTA Inc. Opening Balance Sheet As at Month 1, 202X Current Assets Cash In Bank $400.00 Total Assets $400.00 Current Liabilities Trade Payables $ 00.00 Total Current Liabilities $ 00.00 Shareholders’ Equity 400 Shares Issues & Outstanding $400.00 Retained Earnings $ 00.00 Total Shareholders Equity $400.00 Total Liabilities and Shareholders Equity $400.00 The structure of the business will become relevant in the event of an insolvency in determining how it might impact both the business and the shareholders. To p ic 1.3 Th e la n g u a g e o f in s o lve n c y Le a rn in g O b je c t ive s Understand the difference between an act, a rule, and a directive or circular as it relates to insolvency legislation. Understand the terms defined in the insolvency related legislation (BIA, CCAA, etc.) and their application in the context of insolvency proceedings. Identify the primary stakeholders in insolvency proceedings and explain their role. Identify the potential third parties in an insolvency and how they may be affected. CQP Introduction to Insolvency | 2023 22 Re q u ire d Re a d in g BIA Sections 2, 243 The major pieces of (federal) legislation that deal with bankruptcy and insolvency are the following: The Bankruptcy and Insolvency Act (BIA) The Bankruptcy and Insolvency General Rules (BIA rules) directives and circulars (issued by the Superintendent of Bankruptcy) The Companies’ Creditors Arrangement Act (CCAA) The Farm Debt Mediation Act The Wage Earner Protection Program Act (WEPPA) Do not consider this to be an exhaustive list; there are many pieces of federal and provincial legislation that interact with the BIA in given circumstances. But for the purposes of our study, we will be working with this list. Before we begin this topic, let’s look at how these pieces of legislation came to be. In our Canadian parliamentary system of democratic government, there is a national Parliament that is responsible for developing and enacting legislation in the areas of federal jurisdiction. When that legislation is enacted and becomes law, it is called an act, as in the Bankruptcy and Insolvency Act, or the Companies’ Creditors Arrangement Act. So, the acts in the list have each been enacted by Parliament. Within certain pieces of legislation, the Governor in Council, made up of government officials, is authorized to set out certain rules and regulations related to the enforcement of acts passed by Parliament. In this way, the Bankruptcy and Insolvency General Rules are issued under the authority of the Governor in Council, independent of Parliament. It also means that those rules and regulations can be altered and revoked by an Order in Council without parliamentary involvement. In the exercise of its authority and, more specifically, its authority under the BIA, the Governor-in-Council appoints a Superintendent of Bankruptcy. The BIA (Section 5(4), in part) then proceeds to authorize the Superintendent of Bankruptcy to (among other things): issue such directives as may be necessary to give effect to any decisions made by the Superintendent pursuant to this Act or to facilitate the carrying out of the purposes and provisions of this Act and the General Rules, including, without limiting the generality of the foregoing, CQP Introduction to Insolvency | 2023 23 directives relating to the powers, duties and functions of trustees, of receivers … Thus, we have the directives and circulars, which are the instructions and direction of the Superintendent of Bankruptcy to the profession, the Licensed Insolvency Trustees of Canada (LITs), as to how those LITs are to execute their responsibilities under the Bankruptcy and Insolvency Act, and the Bankruptcy and Insolvency General Rules. To summarize, the Bankruptcy and Insolvency Act was created and amended by an act of Parliament the Bankruptcy and Insolvency General Rules were created and amended by the Governor-in- Council directives and circulars are created and amended by the Superintendent of Bankruptcy To p ic 1.3.1 D e fin e d t e rm s in t h e in s o lve n c y-re la t e d le g is la t io n Section 2 of the BIA sets out the working definitions of some 45 words and terms in that statute. Section 2 of the CCAA addresses the same topic, as does Section 2 of the Farm Debt Mediation Act. As a guide to the Bankruptcy and Insolvency Act or General Rules, you can refer to the Table of Contents. As you consider any section of any act or any rule related to that act, you should always ask the following: Is there a defined term in this section? Is there a rule governing this section? Is there a directive governing an LIT’s administration of this section? If the answer is yes to any of these questions, then be guided by the definitions, the rules, or the directives. The next section answers the following questions: Who are the stakeholders in an insolvency? Who’s involved, and who is impacted by an insolvency proceeding? CQP Introduction to Insolvency | 2023 24 To p ic 1.3.2 Th e s t a k e h o ld e rs Section 2 of the BIA defines a debtor as an insolvent person (who is not yet bankrupt) who, at the time an act of bankruptcy was committed by them, resided or carried on business in Canada where the context requires, includes a bankrupt This is the first occasion we’ve had to observe the difference between what a word means in plain language and what a word means in the context of a specific piece of legislation, namely the BIA. What exactly does the term “an insolvent person” mean? Refer to the definition in Section 2 of the BIA. When you are discussing certain sections of the BIA that pertain to an insolvent person, it refers to a person who meets all three of these conditions: is not a bankrupt resides, carries on business, or has property in Canada has liabilities to creditors provable as claims under this act that amount to one thousand dollars AND meets at least one of these conditions: is for any reason unable to meet their obligations as they generally become due has ceased paying their current obligations in the ordinary course of business as they generally become due, or the aggregate of their property is not, at a fair valuation, sufficient, or, if disposed of at a fairly conducted sale under legal process, would not be sufficient to enable payment of all their obligations, due and accruing due What does it mean to be a bankrupt? Again, refer back to Section 2 of the BIA. Recall that insolvency is a circumstance where the debtor lacks sufficient income or assets to satisfy the claims of creditors, whereas bankruptcy is a legal state of either having made an assignment in bankruptcy or having had a Bankruptcy Order issued against the debtor. Also, a bankrupt is insolvent, but an insolvent person does not always become a bankrupt. CQP Introduction to Insolvency | 2023 25 There are many defined terms in the BIA. Try to develop the practice of always asking if a term could be a defined term; it will make a difference. Refer again to Section 2 of the BIA for the definition of a creditor. In Topic 1.1, you read about secured and unsecured debt. The holders of that debt are secured and unsecured creditors and will have different priority rankings in the distribution of assets in the event of an insolvency proceeding. Inspectors are representatives of the general body of creditors. They are elected by the creditors and vary in number depending on the type of proceeding. Once inspectors are elected, administrative control is exercised through them, unless a subsequent creditors meeting is considered necessary to deal with specific issues. There are no inspectors in summary administrations (see Module 3) unless the creditors decide to appoint them. It is important to note that any person can be elected an inspector; they need not be a creditor or a representative of a creditor, but they must be an individual (not a corporation). A receiver is someone who receives the property of others. When a person is appointed as a receiver, they have a legal right to take possession of the property of a third person. Receiverships will be described in more detail in Module 2. A receiver can only seize and sell the property of the debtor. A receiver-manager generally has the capacity to carry on the business of the debtor and protect and liquidate the assets covered by the security agreement for the benefit of secured creditors. An interim receiver is a trustee appointed by the Court to protect the property of a debtor during the period an insolvency proceeding is pending. A monitor regularly reviews the debtors’ activities and generally provides reports to the creditors and in some cases to the courts. Monitors can be appointed privately, usually, by a secured creditor who is concerned about the viability of the debtor’s business and the realizable value of the property subject to the security agreement. Generally speaking, where a monitor is privately appointed, the monitor reports to the appointing creditor. An LIT automatically has a role to monitor the affairs of an insolvent person who has filed a Proposal or a Notice of Intention to File a Proposal under Part III of the BIA. An LIT acting as a monitor under the BIA has a fiduciary duty to the stakeholders as a group and must treat all parties reasonably and fairly. CQP Introduction to Insolvency | 2023 26 A monitor must be appointed by the Court in the case of a company seeking protection under the provisions of the CCAA. An LIT acting as a monitor under the CCAA has a fiduciary duty to the stakeholders as a group and must treat all parties reasonably and fairly. A BIA insolvency counsellor is a person authorized by the Office of the Superintendent of Bankruptcy (OSB) to provide insolvency counselling under the BIA and includes an LIT. They must meet the requirements outlined in the OSB Directive 1R7 (paragraph 10). All individual debtors that make a consumer proposal or become bankrupt must attend two counselling sessions. A liquidator is a person appointed by the Court or shareholders to wind up a company. Canadian Association of Insolvency and Restructuring Professionals (CAIRP) is the Canadian association responsible for the education, standards, and advocacy of insolvency and restructuring professionals (CIRPs). Its mission and vision can be found on its website. CAIRP has developed a set of Rules of Professional Conduct and Standards of Professional Practice that members must adhere to in their practice of the profession. Through a Memorandum of Understanding between CAIRP and the Office of the Superintendent of Bankruptcy (the MOU), CAIRP develops and delivers the learning programs for candidates to the profession that lead to credentialing as a Chartered Insolvency and Restructuring Professional (CIRP). Once that designation is achieved, candidates are then invited by the Superintendent of Bankruptcy to sit an Oral Board Exam in order to obtain a license as an LIT. The Office of the Superintendent of Bankruptcy (OSB) licenses and regulates the insolvency profession; supervises the administration of estates in bankruptcy, commercial reorganizations, consumer proposals, and receiverships; maintains a public record of BIA and CCAA filings; records and investigates complaints from debtors and creditors regarding the insolvency process; and ensures compliance through maintenance and enforcement of the regulatory framework. The OSB operates as a zero net revenue organization, with its costs recovered from the fees and levies collected through the insolvency process. The OSB has two principal points of contact with the public and with the profession: Official Receivers and Bankruptcy Analysts. The role of the Official Receiver (OR) is to maintain public records of each BIA and CCAA filing, and to supervise estates and matters to which the BIA applies. On an estate-by-estate basis, ORs enforce the provisions of the BIA and the CCAA to ensure statutory compliance by debtors, creditors, and LITs. ORs are Officers of the Court, appointed by an Order in Council, and have wide investigative and enforcement powers. While a Bankruptcy Analyst may also be an OR, they are separate appointments. CQP Introduction to Insolvency | 2023 27 The role of Bankruptcy Analysts (a BA) is in support of the OSB’s role as a regulator of the insolvency profession. There are various grades of BAs, from ABAs (Assistant Bankruptcy Analyst), to BAs (Bankruptcy Analysts) to SBAs (Senior Bankruptcy Analysts). As you can imagine, the more significant matters are dealt with by more senior, experienced staff. The role of SBAs would typically include practice reviews (Licensed Insolvency Trustee office visits) where they attend the office of a practitioner and perform assessments and audits of the practice processes to ensure compliance with the act, rules, and directives. In addition, analysts monitor debtor compliance and, where necessary, oppose bankrupts’ applications for discharge. From a high-level view, the role of an OR pertains to a specific estate, whereas the role of the BA pertains to the overall practice of an LIT. Additionally, the OSB examines candidates to become Licensed Insolvency Trustees, issues licenses, and regulates the industry. Licensed Insolvency Trustees (LIT) are the professional insolvency practitioners who are licensed individually or through a corporately licensed insolvency trustee to administer estates under the BIA. No debtor or creditor can avail themselves of the provisions of the BIA without having an LIT appointed to administer the estate. For the purposes of this course, it is important to note that LITs and ORs are Officers of the Court. As such, an LIT is required to act honestly and impartially to administer the BIA with care and even- handedness. The courts rely on LITs to provide accurate, timely reports and recommendations. Predictably, but unfortunately, insolvency proceedings often impact other stakeholders beyond the debtors and creditors. In an insolvency proceeding, there is an insolvent person who may file a proposal or make an assignment in bankruptcy or be subject to a receivership, and of course there are the creditors. When the debtor’s insolvency proceedings are all done (or in some cases even before the proceedings are all done), creditors who have rights against third parties may well pursue their claims against those third parties, particularly if there is a better chance to recover from those third parties than from the insolvent person. Examples of other stakeholders/third parties include the following: Guarantors: A creditor may, for any reason, and usually at the outset of the debtor/credit relationship, ask that a third party provide their personal guarantee for the borrower’s debt. The guarantor is often a family member or, in a small private corporation, one of the shareholders. CQP Introduction to Insolvency | 2023 28 What that means is that the creditor then has two (or more) parties to pursue in the event that the debtor fails to perform the terms of the agreement (referred to as a default). If there is a proposal or an assignment in bankruptcy or a receivership by the primary debtor, that would generally be considered an event of default, which then entitles the creditor to seek repayment from the guarantor. Bear in mind that being or becoming a guarantor is a choice, not a requirement. The lender may not wish to advance funds if there isn’t a guarantor but no one can be required to become a guarantor. Shareholders: If it is a corporation that is going through an insolvency proceeding, shareholders are the last group to recover any money. Generally, the scheme of distribution of the debtor’s assets (property) is, in order, as follow: 1. trust claimants (Section 81 claims, including statutory trust claims by the government for payroll withholdings), then 2. secured creditors, then 3. preferred creditors, including the costs of administering the estate (trustee’s fees and disbursements), then 4. ordinary unsecured creditors, then 5. any balance of funds to the shareholders (It is uncommon for the recoveries in an insolvency proceeding to be sufficient to fully pay the debts owed to creditors; consequently, shareholders are unlikely to receive any recovery of their investment.) Officers and directors: As mentioned earlier, officers and directors are considered to be the directing minds of a corporation. That being the case, they may be held liable, and financially responsible, for the conduct of the corporation. For example, if a corporation was a GST/HST registrant and charged GST/HST but did not remit that GST/HST properly, the directors may be held liable for that debt. The same applies to a corporation that is an employer, if that employer deducted Employment Insurance (EI), Canada Pension Plan (CPP) premiums, and income taxes from its employees but did not properly remit those amounts. Personal liability for unremitted GST/HST and source deductions are a common problem for officers and directors of corporations in insolvency proceedings. Occasionally, where the affairs of the corporation have been left mostly in the hands of an officer (as opposed to a director), that officer may be found financially liable for the unremitted amounts. Officers and directors have a duty of care with respect to the conduct of the corporation and they ought not to execute or condone any activities that would enrich the corporation to the prejudice of a supplier or creditor. In those instances, actions can be started CQP Introduction to Insolvency | 2023 29 against the officers and directors personally to hold them financially accountable and responsible for losses incurred. Joint debtors: Joint debtors and guarantors are similar in that they share in the debt obligation. A guarantor is involved if or when the borrower defaults, whereas a joint borrower shares in the debt obligation from the beginning. Spouses, for example, are often joint debtors with each other on credit cards, cars loans, installment loans, and mortgages. If one joint debtor enters an insolvency proceeding that will result in some or all of their share of the debt being left unpaid, the other joint debtor will remain liable to pay all of the remaining debt. The lender may not wish to advance funds if there isn’t a joint debtor or perhaps a guarantor, but no one can be required to become a joint debtor. Joint property owners: If property (real estate, cars, boats, etc.) is owned jointly between an insolvent person and a solvent person, the solvent person does not lose their property rights. In a bankruptcy, the bankrupt’s interest in the joint property passes to the trustee (subject to certain exemption rights, which will be covered later in the course) while the solvent person retains their property rights. It is then up to the trustee and the solvent person to resolve how that property will be dealt with within the insolvency proceeding. Spouses: In Canada, spouses are not automatically responsible for each others’ debts. That statement is news to many people. If one spouse guarantees the debt of the other spouse, then the guarantor is liable for that debt if the spouse who is borrowing defaults on the debt. Similarly, if spouses both sign on for the debt jointly, as co-borrowers, then they are each liable for the full debt — not half the debt, the full debt. The terminology is “jointly and severally liable,” which means as debtors together or standing independently. To be clear, creditors can only look to the signatories on the credit application/credit agreement to establish liability. Employees: If an insolvent employer enters an insolvency proceeding, there are several ways that its employees can be affected. First, they may lose their employment if the employer is shut down or downsized as a result of the insolvency proceeding. Also, employees may end up participating as creditors in the insolvency proceeding if they are owed outstanding wages, commissions, or recoverable expenses at the time of the insolvency filing. Landlords and suppliers: In addition to any outstanding amounts that may be owing to an insolvent tenant’s landlord or suppliers (for which they will participate as a creditor in the insolvency proceeding), these parties may have an expectation, based on contractual or informal CQP Introduction to Insolvency | 2023 30 arrangements, of an ongoing economic relationship with the debtor. That ongoing relationship, and therefore the financial health of the stakeholder, may be impacted by the insolvency proceeding. The foregoing is by no means an exhaustive list of third parties impacted by insolvency proceedings. Anytime an LIT (or legal counsel) is contemplating any strategies to deal with a person’s debt situation, consideration should always be given to the impact the contemplated proceedings and resulting actions may have on third parties. Those impacts are generally predictable and rarely favourable. On the other hand, the ongoing support or cooperation of certain stakeholders may be necessary to effect a successful restructuring or an orderly liquidation, so these parties may need to be dealt with carefully. To p ic 1.4 Ne c e s s it y fo r in s o lve n c y le g is la t io n Le a rn in g O b je c t ive s Understand and explain the purpose of insolvency legislation. Re q u ire d Re a d in g Canada’s Insolvency Framework (History, Economic Implications, and Objectives of Insolvency Policy) Purpose of Insolvency Legislation Historically, bankruptcy was thought to be a punitive process whereby a debtor who could not repay their debts was punished; for example, debtors’ prisons, debt servitude, and debt slavery. As societies became more civilized, the focus of insolvency legislation turned toward the rehabilitation of debtors. As such, one of the current stated purposes of the Bankruptcy and Insolvency Act is to allow the honest but overburdened debtor to be released from their debt obligations so that they can make a fresh start and resume their place in the community. Summarizing from The Annotated Bankruptcy and Insolvency Act 2020 1, the overriding purpose of Canadian insolvency legislation is to provide for financial rehabilitation of the insolvent persons 1 Houlden, Morawetz, Sarra The Annotated Bankruptcy and Insolvency Act,2020 Carswell Thomson Reuters, 2020 CQP Introduction to Insolvency | 2023 31 provide for orderly and fair distribution of the property of the bankrupt allow an investigation to be made of the affairs of the bankrupt permit the setting aside of preferences, and transactions at under value so that all ordinary creditors may share equally in the value realized provide a regime whereby creditors pursue their claims by collective action, through the trustee, so that assets of a bankrupt can be realized and distributed on an equitable basis subject to priorities of preferred creditors and rights of secured creditors Let us review each element in more detail. Financial Rehabilitation It could be argued that insolvency legislation is required because of lax credit granting criteria, competitive credit markets, and rampant consumerism. Some or all of those things may be correct, however, the reality is that if or when a debtor cannot meet their monthly obligations, something has to change. Income has to go up or debt obligations have to go down. When someone (a person under the BIA) becomes insolvent, there are a number of options available to them to deal with their debts. They can use informal methods, such as negotiating a repayment plan directly with each creditor, or they can pursue formal methods, covered under the BIA, to either make a repayment proposal to all the unsecured creditors or make an assignment in bankruptcy. When someone makes a proposal under the BIA, they retain control over their assets and the proposal is presented to creditors for approval. If creditors fail to approve the proposal, the person may be deemed to have made an assignment in bankruptcy or they may choose to make such an assignment. Orderly and Fair Distribution of the Property of the Bankrupt When someone makes an assignment in bankruptcy, they assign and abandon their assets to the trustee for the general benefit of their creditors. There are certain assets that are exempt from seizure, but we’ll discuss that later. Once an assignment in bankruptcy has been made, there are duties and responsibilities that a bankrupt must complete, and there is a passage of time at the end of which a bankrupt is entitled to apply to be discharged from bankruptcy. A discharge from bankruptcy is automatic for first- and second- time bankrupts who fully comply with their duties and obligations and who are not significant personal income tax debtors. High personal tax debtors fall into a separate category to be discussed later. If a CQP Introduction to Insolvency | 2023 32 discharge is not automatic and a court hearing is held, the Court will consider, among other things, whether or not the bankrupt is an “honest but unfortunate debtor.” The point of that consideration is that the courts have ruled that the Bankruptcy and Insolvency Act ought not to be a clearing house for debts. Therefore, to the extent a bankrupt has the capacity to contribute to the estate for the benefit of the creditors, that should occur. Commercial insolvencies are only modestly different. If or when a commercial enterprise faces a materially adverse event, such as the cancellation of a lucrative contract, a dramatic increase in operating costs, or legislative changes that render a product line or process obsolete, it is a real risk that the commercial enterprise cannot continue to operate. The materially adverse events listed here are by no means an exhaustive list and do not include property damaging events such as hurricanes, floods, fire, or other catastrophic events such as the COVID-19 pandemic. While a business may or may not be insured for catastrophic property damage, it may find itself unable to recover and reposition itself in the marketplace. In that case, the workforce and business assets need to be redeployed, and an insolvency proceeding can effect that. If the business has more assets than debts, then an orderly liquidation or a merger or sale without an insolvency proceeding is possible and even desirable. However, if there are not enough assets to satisfy all creditors, an insolvency proceeding will allow for an orderly and fair distribution of the assets. Investigation of the Affairs of a Bankrupt The BIA provides for an investigation to be made of the affairs of the bankrupt (either personal or commercial). If a stakeholder (usually creditors or parties related to the bankrupt) raises a concern about a bankrupt’s inappropriate dealings relating to their property, the BIA allows for an LIT or a creditor or an OR to initiate an investigation into the matter. These investigations are serious and generally expensive. An investigation of allegations of wrongdoing may be undertaken. Then, an economic assessment will follow to establish whether or not there is likely to be any economic recovery to the bankrupt estate from the investigation. If the allegations prove to be unfounded, then the matter is often left for a creditor to pursue on their own, through appropriate applications to the Court. If the matter is criminal in nature or involves an offence under the BIA, the LIT will advise the OR and the OR will put the matter to the RCMP. Setting Aside Preferences, and Transfer at Under Value “Desperate people do desperate things in desperate times.” Some of those “things” may involve attempts by an insolvent person to better the position of a specific creditor or of themselves, by inappropriately dealing with their assets. A transfer at undervalue involves disposing of an asset, usually to a friend or CQP Introduction to Insolvency | 2023 33 family member, at less than market value and usually with the intention that the insolvent person will regain the asset post bankruptcy. A preference or preferential payment occurs when an insolvent person enters an economic transaction (usually a money payment) that favours one creditor over the rest and gives that creditor an economic recovery greater than what would be available to that creditor in a distribution under the rules of the BIA. A bankrupt enters a fraudulent transaction when they knowingly falsify documents relating to their property. The BIA has various sections that allow these sorts of transactions to be challenged by the LIT or the creditors and to have them set aside by the Court. The result of setting aside a transaction is that the title to the property can be put back where it was before the disputed transaction, such that it can be dealt with by the trustee. Where title cannot, for whatever reason, be put back, the Court can render judgment against whomever benefitted from the transaction. The point of challenging preferences and transactions at under value is to put the pool of assets back the way it was, so that all ordinary creditors can share in the value realized in a distribution under the rules of the BIA. Provide a Regime Whereby Creditors Pursue Their Claims by Collective Action By providing for a scheme of distribution that respects the various (and different) rights of secured creditors, preferred creditors, and ordinary unsecured creditors, the BIA enables the creditors to pursue their claims collectively through the actions of the trustee. Were each creditor left to pursue their claim on their own, it would be a diverse set of principles at work, with each creditor scrambling to realize on assets ahead of competing creditors. To p ic 1.5 In s o lve n c y le g is la t io n a n d t h e ro le o f t h e c o u rt s Le a rn in g O b je c t ive s Understand the interaction of federal and provincial legislation. Recognize that Canada is a bijural (two coexisting legal systems) country. Recognize and differentiate between federal and provincial insolvency and related legislation. Understand and explain the role of the courts in insolvency proceedings. Re q u ire d Re a d in g Canada’s judicial structure Civil Law Harmonization Act, No. 1 S.C. 2001 c. 4 Preamble BIA Sections 183(1), 184, 192, 243 CQP Introduction to Insolvency | 2023 34 Interaction Between Federal and Provincial Legislation The opening notes of the Annotated Bankruptcy and Insolvency Act 2020 2 read, in part: Section 91(21) of the Constitution Act, 1867, conferred on the Parliament of Canada exclusive jurisdiction to enact laws in relation to “bankruptcy and insolvency” and Section 92(13) of the Constitution Act assigned to each of the provinces the exclusive right to enact laws in relation to “property and civil rights.” When it comes to matters of bankruptcy and insolvency, federal statutes take precedence, or are paramount, over provincial statutes. That means that the provinces cannot enact legislation that purports to change or alter the regime set out in federal legislation. The provinces do in fact have legislation that impacts matters of bankruptcy and insolvency and debtors and creditors can look to those statutes to enforce their rights until there is a formal proceeding initiated under a federal statute, at which time the federal statute takes precedence. That said, there are sections of the BIA that specifically refer to matters covered by provincial legislation. For example: Section 67 (1) The property of a bankrupt divisible among his creditors shall not comprise … (b) any property that as against the bankrupt is exempt from execution or seizure under the laws applicable in the province within which the property is situated and within which the bankrupt resides … In various provinces, there is provincial legislation governing preferential payments and fraudulent transfers of property. This of course makes sense because the provinces each have jurisdiction over property. If and where necessary, a trustee in bankruptcy (or a receiver) is permitted to use these statutes for the recovery of property. There are two separate and distinct legal systems in Canada. Most provinces follow the common law tradition, whereas the Province of Quebec relies on the civil law tradition. The main difference between the two systems is that civil law is more statute based, while common law is based both on statutes and precedents established through jurisprudence (case law). Laws enacted by the federal government have to respect both the civil law tradition of Quebec and the common law tradition of the other provinces, and also has to interact harmoniously with provincial legislation in force in the provinces and territories. 2 Houlden, Morawetz, Sarra The Annotated Bankruptcy and Insolvency Act, 2020 Carswell Thomson Reuters, 2020 CQP Introduction to Insolvency | 2023 35 Federal Legislation Here are some of the federal statutes that relate to bankruptcy and insolvency, over which the Parliament of Canada has exclusive jurisdiction. Again, for the purposes of this course, this list is not exhaustive. The Bankruptcy and Insolvency Act (BIA) o governs the administration of proceedings under the BIA The Companies’ Creditors Arrangement Act (CCAA) o governs the restructuring of corporations and other entities having more than $5 million in debt The Winding-up and Restructuring Act (WURA) o governs the winding-up and restructuring of certain companies and financial institutions The Wage Earner Protection Program Act (WEPPA) o governs obligations for payment to individuals in respect of wages owed to them by employers who have entered insolvency proceedings The Farm Debt Mediation Act o provides for mediation between insolvent farmers and their creditors The Canadian Business Corporations Act (CBCA) o governs federally incorporated business corporations and provides for restructuring under certain circumstances (see CBCA, Section 192) The Excise Tax Act (ETA) o governs the application of the Goods and Services Tax (GST) and certain other taxes. The Income Tax Act (ITA) o governs taxation of income in Canada Provincial Legislation There are provincial statutes relating to property and civil rights, over which the provinces have exclusive jurisdiction. Remember that debtors and creditors are free to rely on provincial statutes governing debtor– creditor relations until such time as a federal statute kicks in. Note also that the purposes of the BIA are equally applicable to much of provincial law. acts respecting personal property (and security interests) o governs the registration, perfection, and priority of security interests registered against a debtor’s assets acts respecting real property (and security interests) CQP Introduction to Insolvency
