THE CREATION BY THE FEDERAL PARLIAMENT OF SECURITY MECHANISMS IN THE BANKRUPTCY AND INSOLVENCY ACT

2. The legal framework for the security mechanisms created in the B.I.A.

How a security mechanism is designated is only one aspect of the problems raised by its inclusion in the B.I.A. When Parliament creates a security mechanism, as it does in the B.I.A., it must not only do so in an area that in principle is governed by provincial private law, but must do it taking into account its own self-imposed rules. These rules concern, first, the creation of a security mechanism, second, the granting of a right of preference and, third, realizing on the security.

2.1. The creation of securities on property

In principle, in Quebec, legal hypothecs take effect by registration.[51] As an exception, the C.C.Q. recognizes that a legal hypothec may be created as of right without publication. This is true for a builder's legal hypothec.[52] However, the hypothec is extinguished if the holder fails to publish it in the appropriate register within thirty days after the work has been completed.[53] It may subsist by publication of a notice but is extinguished after six months unless the creditor, in order to preserve the hypothec, publishes an action against the owner of the immovable or registers a prior notice of the exercise of the hypothecary right.[54]

With regard to the securities on property granted to the Crown, Parliament imposes, in the case of a bankruptcy or a proposal, a special condition for the validity of securities granted to it under a federal or provincial statute.[55] Under subsection 87(1) of the B.I.A., for a security to be valid, it must be registered in the appropriate register[56] before the earliest of the dates listed.[57] The obligation to register securities on property to protect the claims of the Crown probably derives from Parliament's intention to treat creditors equally. It follows that a trustee in bankruptcy would not recognize a security on property expressly granted to the Crown unless it appeared on the appropriate register or if had been registered after the earliest of the dates listed in subsection 87(1) of the B.I.A. The Crown would then rank as an unsecured creditor.[58]

The issue of the validity of the securities on property granted to the Crown by Parliament or a provincial legislature raises an interesting problem with respect to the security provided for in subsection 14.06(7) of the B.I.A. The purpose of this security mechanism is to guarantee payment of Crown claims for the costs of remedying environmental damage, for example when corporations discharge large quantities of pollutants into rivers. In Quebec, when this type of environmental pollution occurs, the ministère de l'Environnement du Québec may clean up the pollution if it considers it necessary to do so, particularly on private immovables.[59] The Ministère may then claim the cleanup costs by presenting the invoice to the property owners.[60] If the owner of a property thus cleaned up by the Ministère becomes bankrupt or makes a proposal, the claim by the Ministère is immediately secured by a immovable security on the immovable of the debtor that is contiguous thereto; this security guarantees payment of the claim by the Ministère, which ranks above any other claim. The claim by the Ministère is enforceable "in the same way as a mortgage, hypothec or other security on real property".

Parliament does not expressly require registration for the security so created to be valid. Should the general obligation of registration in subsection 87(1) of the B.I.A. be relied upon? There are three possibilities to consider. First, the nature of the principal rights giving rise to the Crown's claim; second, the technical problems due to the moment of birth of this security and, finally, the exceptional nature of this security.

The nature of the principal rights giving rise to the claim

It has been claimed that the registration rule imposed on the Crown for its securities, although it is not expressly excluded in subsection 14.06(7) of the B.I.A., would not apply in this case since the Crown's rights would be in the nature of an interest in land.[61] "Interests in land" do not have to be registered at common law.[62] In Quebec, where dual domain is recognized, the situation is quite different.[63] It would appear that the rule of registering securities granted to the Crown on property should apply. In this case, there would be a real discrepancy between the situation in Quebec and that in the other provinces. But there may also be other problems.

The technical problems flowing from the date of birth of the security

For technical reasons, it may be wondered whether the Crown could comply with the registration obligation imposed on it. According to subsection 87(1) of the B.I.A., in order for the Crown to take advantage of its security, it would have to have registered it before one of the times listed: the date the petition is filed against the debtor, the date the debtor makes an assignment, the date the debtor files a notice of intention or the date on which a proposal is filed. It must be remembered, however, that the security granted the Crown to secure repayment of the cost of remedial action is not created until the date on which a proposal is filed or the date on which the debtor declares bankruptcy. In other words, this security is not created until after one of the dates listed in subsection 87(1) of the B.I.A. It may then be wondered how the Crown could have registered that security in advance? How could it register a security device that is not yet created in order to comply with the times imposed by Parliament? There indeed is a technical problem. But there is still another aspect to consider.

The exceptional nature of the security

Parliament gives the Crown almost absolute top ranking for the latter's claim for costs of remedying environmental damage. This preference is granted "notwithstanding any other provision of this Act or anything in any other federal or provincial law." The use of "notwithstanding" terminology would appear to indicate that the intent of Parliament was to give the Crown a particular treatment, which could probably be explained by the public interest significance of government intervention in a case of environmental damage. However, it might be asked what the position of a trustee in bankruptcy would be in such a claim if the Crown had failed to register its security in accordance with the procedure set out in subsection 87(1) of the B.I.A. Would the exceptional nature of this security be sufficient to ensure recognition of its validity despite the subsection 87(1) obligation to register?[64] We submit that it would.

In conclusion, it is well to point out the absence of any reference to a registration obligation for the security granted to farmers, fishermen and aquaculturists as well as that granted to an interim receiver.[2] In the latter case, the procedure whereby the security is created is still more uncertain for the civilian lawyer since it depends on judicial discretion.

2.2. Granting a preference

Since the reform of the Civil Code in 1994, the sole reasons in the C.C.Q. for a preference are prior claims—a legal security—and hypothecs—a legal or conventional security. In applying the B.I.A., it is necessary to refer to the scheme of distribution set out in subsection 136(1) of the B.I.A., which establishes the ranking of the various creditors, subject to the rights of secured creditors.[66] If the claim of the secured creditors is not listed in subsection 136(1) of the B.I.A., then the secured creditors may choose to participate in the bankruptcy insofar as their claim is presented in the prescribed form,[67] or they may enforce their security under provincial law, in which case the preferences provided in the provincial legislation will apply.[68] However, the B.I.A. grants to the federal and provincial Crowns, the interim receiver, farmers, fishermen and aquaculturalists, securities that give them preference over the rights of other creditors.

A preference that ranks ahead of the rights of other creditors

To illustrate, Parliament provides in subsection 14.06(7) of the B.I.A. that "notwithstanding any other provision of this Act or anything in any other federal or provincial law," the claim of the Crown in relation to environmental damage that is secured by a charge gives it first preference.[69] The use of the words "[the charge] ranks above any other claim, right or charge against the property" indicates Parliament's intention to ensure that no other security can rank higher than the Crown's. The purpose of this is to keep other creditors from benefiting from a windfall gain due to the increase in the value of the immovable as a result of the remedial action. This superiority applies whether or not the claim arises before or after the bankruptcy and whether or not the Crown participates in the bankruptcy.[70] Moreover, it confers a ranking higher than that given hypothecary creditors who registered their claims previously in the land register in respect of contiguous immovables of the debtor.[71] This means that the benefits conferred by a civil law hypothec are subordinate to repayment of the Crown's claim for the costs of remedying the environmental damage.[72]

A preference that ranks ahead of the bank's claim

The security attributed to the interim receiver for repayment of his expenses and fees also confers a preferential ranking, if the Court permits.[73] This gives the interim receiver a preference over all the secured creditors,[74] including a bank that holds a bank guarantee.[75] The court must however ensure that the secured creditors have been notified. Before making an order, it may allow them to make representations.[76] The determination of the security may be effected at the hearing for the appointment of an interim receiver or at a subsequent hearing.[77]

A preference that ranks ahead of the claims of the Crown secured by deemed trusts

Subsection 81.2(1) of the B.I.A. creates a security for the benefit of farmers, fishermen and aquaculturists to secure their claims in respect of the unpaid amount of the products that they have delivered to the debtor who has become bankrupt or made a proposal.[78] This security charges all the inventory of or held by the purchaser. It is in addition to the right of repossession provided for in subsection 81.1(1) of the B.I.A.[79] It provides an almost absolute security for the repayment of the farmer, fisherman or aquaculturalist. In fact, this security gives the latter a preferential right over any other claim, right, charge—regardless of when it arose—against the purchaser's inventory.[80] In addition, it ranks ahead of the Crown's rights in respect of its deemed trust for its tax claims.[81] Interestingly enough, the deemed trust was created so that it would prevail over the sui generis right of ownership of the banks that follows the guarantee provided for in section 427 of the Bank Act.[82] In theory, it should follow that the inventory secured by the charge does not form part of the bankrupt's property.

In fact, only the supplier's right to repossession of the goods under subsection 81.1(1) of the B.I.A. takes precedence over the preference conferred by subsection 81.2(1) of the B.I.A. Lastly, subsection 81.2(1) of the B.I.A. specifies that if the disposition of the bankrupt's property causes the value of the bankrupt's entire inventory to be decreased below the value of the latters' claim, the trustee himself is liable for the amounts covered by that security.[83]

The creation of these securities interferes with the benefits granted under Quebec civil law to hypothecary creditors. They are, in sum, "super-preferences" that benefit some creditors to the detriment of the others, despite the secured creditor status granted them under the B.I.A., including, with regard to the charge granted to farmers, fishermen and aquaculturalists, the Crown, despite the "super-preference" created by the deemed trust. In the latter case, the property on which the security can be realized is simply removed from the patrimony of the debtor even before it is transferred to the trustee in bankruptcy to administer the bankruptcy. In the case of the security granted to the interim receiver, the latter only has to apply to the court to obtain a preference over the rights of such secured creditors as the banks. In fact, it is only the Crown's realizing on the security granted it in respect of its claims relating to environmental damage that raises questions from the standpoint of provincial private law. That is the next topic to be covered.

2.3. The exercise of remedies

In 1994, the Quebec legislature considerably amended the law of security on property and, in particular, the rights related to the exercise of the hypothecary remedies. In sum, it extended the rules relating to the exercise of these remedies to certain contracts such as the trust by onerous title established by contract to secure the performance of an obligation,[84] the sale with right of redemption to secure a loan,[85] and instalment sales involving the published reservation of property.[86] It follows that the differences between "security ownership", "security trusts" and "traditional securities" have been considerably lessened.[87]

The system of hypothecary remedies established by the Quebec legislature provides four types of remedies: taking possession for purposes of administration,[88] taking in payment,[89] sale by the creditor by public auction, by agreement or by a call for tenders[90] and sale by judicial authority.[91] The exercise of these remedies must, however, be preceded by the issuance of prior notice of the creditor's intention to avail himself of one of the remedies against the debtor after twenty days, in the case of a movable property, or after sixty days, in the case of an immovable property.[92]

Where a debtor becomes bankrupt or files a proposal, the hypothecary creditor will be considered as a secured creditor for the purposes of a bankruptcy case.[93] He may realize on his security, subject to the stay provided for in sections 69 to 69.31 of the B.I.A., as if he were a stranger to the bankruptcy.[94] There are, however, two exceptions to this principle: the specific features that Parliament gives the securities it creates in its own legislation and the obligations to act honestly and in good faith provided for in Part XI of the Act.

The special features given by Parliament to the security it creates in its own legislation

Under subsection 14.06(7) of the B.I.A., the Crown could decide not to take part in the bankruptcy and to realize on the security protecting its claim for the costs of remedying the damage caused to the environment—as Parliament provides, "in accordance with the law of the jurisdiction in which the real property is located, in the same way as a mortgage, hypothec or other security."[95] What does this mean? Should it be concluded that this is a reference to provincial private law in the area of securities on property? Do the rules governing hypothecary rights, in particular, apply?

It has been argued that, despite Parliament's apparently explicit intent, the realisation of this security "in the same way as a mortgage", presents certain problems of a substantive nature.[96] Under provincial private law, the debtor's failure to pay a debt or perform an obligation allows hypothecary creditors to realize on their security. [97] But in this case, what allows the Crown to realize upon its security is the fact that the debtor has become bankrupt or has filed a proposal. However, could it not be considered that, by reason of the fact that he is insolvent, the debtor is de facto in default?[98] The difficulty stems from the fact that the security is not created until after the debtor's insolvency or bankruptcy.

The Crown could, in principle, assert its "super-preference" securing its claim for remedial costs on the gross realizable value of the property charged.[99] The trustee in bankruptcy, in order to protect the assets' interests, may try to recover any surplus generated by the sale of the immovable by the Crown.[100] This may prove to be a delicate transaction because of the fluctuations in the value of the property that, first, has been environmentally damaged and, then, remedied by the Crown.

The obligation to act with honesty and good faith in Part XI of the Act

Since 1992, the B.I.A. has contained provisions governing the exercise of the remedies of secured creditors. Parliament imposes on secured creditors obligations of honesty and good faith in administering and liquidating the debtor's property.[101] However, such rules do not apply until a receiver takes possession of the debtor's property in order to administer it.

Parliament defines in subsection 243(2) of the B.I.A. "receiver" within the meaning of Part XI of the B.I.A.[102] There are two basic aspects to this definition. First, the receiver described is the one who takes possession of the property of an insolvent debtor. Second, the receiver must be appointed under a court order or a security agreement. The definition is worded ambiguously, however, and permits of two contradictory interpretations.

On a broad and liberal construction, the words "a person who has been appointed to take (…) [possession of the property]", on the one hand, and "or has taken" on the other hand, present a conceptual alternative: the traditionally accepted concept of a receiver and what would appear to be a new concept of a "receiver". Thus, the "receiver" described in this definition can be the one who is traditionally appointed under a security agreement or court order, but he may also be a creditor who simply takes possession of the property that forms part of the security agreement in order to realize upon it.

According to the narrow interpretation, on the other hand, subsection 243(2) of the B.I.A. refers only to the traditional receiver. It follows that the "receiver" described in this definition is the one who takes possession of the property of an insolvent debtor in conformity with a security agreement or a court order.[103]

These were the arguments submitted to Baynton J. of the Saskatchewan Court of Queen's Bench.[104] Baynton J. began by acknowledging the merits of the two interpretations, but then opted for the narrow interpretation. Taking into account the purposes of Part XI of the B.I.A., he added, however, that a secured creditor could be a "receiver" as defined in subsection 243(2) of the B.I.A. provided that he was appointed under a security agreement or a court order to take possession of the property of his debtor.

Applied to Quebec, this would mean that subsection 243(2) of the B.I.A. could not apply to the situation of hypothecary creditors.[105] The legal basis for hypothecary creditors to enforce their rights in the event of the debtor's default is not found in a contract of security or a court order but in the C.C.Q. itself.[106] It could be added that the use of the concept of "receiver" in the context of subsection 243(2) of the B.I.A. probably refers to a concept that was traditionally recognized solely in common law. The sequestrator under civil law is more akin to a depositary.[107] In civil law, the provisions governing the administration of the property of another apply.[108]

The method of realizing on the securities described in subsection 243(2) of the B.I.A. was, in Quebec, the taking of possession of a company under a trust deed in order to liquidate the debtor's inventories, accounts receivable and assets. The S.P.C.A. permitted a trust deed to be created for the benefit of the obligees under which they could enter into possession of the property of the debtor issuer and administer or liquidate it should the debtor default.[109] However, the disappearance of the trust deed with the reform of the Civil Code can give the impression that Part XI of the B.I.A. is a dead letter in Quebec.[110]

However, this blunt statement must be qualified. In the first place, there are creditors in Quebec with securities under other legislation besides the C.C.Q. that can be realized on by the intervention of a "receiver".[111]

In the second place, some rules in Part XI apply to all creditors with claims secured by a security. Subsection 244(1) of the B.I.A. imposes on all secured creditors the obligation to send a notice to an insolvent creditor before executing on their security.[112] In particular, a secured creditor cannot execute on his security before the expiration of a ten-day period.[113] The C.C.Q., however, provides for the immediate surrender of the debtor's property where there is reason to fear that otherwise recovery of his claim may be endangered, or where the property may perish or deteriorate rapidly.[114] At first glance, there would appear to be an inconsistency between the possibility of obtaining an immediate surrender of the debtor's property and the obligation to provide 10 day's notice under subsection 244(1) of the B.I.A.[115]

Another comment concerns the defence under section 252 of the B.I.A. Parliament allows the secured creditor in any proceeding, where it is alleged that a secured creditor or a receiver contravened one of the obligations under Part XI of the B.I.A. (for example, concerning the sending of a notice under section 244 of the B.I.A.), to show that he had reasonable grounds to believe that the debtor was not insolvent. This section is addressed to the secured creditor himself and to the receiver defined in subsection 243(2) of the B.I.A., which means that this defence is open to any secured creditor even if he does not qualify as a "receiver".

It is apparent that the exercise of the remedies to which Parliament refers for realization of the security it grants the Crown for its claims related to environmental damage raises some questions because of the hybrid and exceptional nature of this security. The application of Part XI of the B.I.A. is limited in Quebec to the rare cases where creditors whose claim is secured by a security on property exercise their remedy against a debtor by appointing a receiver under a security agreement. An example might be a bank with a bank guarantee whose remedies do not appear in section 427 of the Bank Act. but in the security agreement.

General conclusions

After this rapid overview of the situation created by Parliament's introduction of new security mechanisms in the B.I.A., we can offer a few comments in lieu of a conclusion. From the terminological point of view, it is not incorrect to assert that the word "charge" designates a hypothec. However, in order to avoid confusion with the common law meaning of "charge", it would be preferable to use the terminology recognized by the C.C.Q.; "sûretés" or "garantie" for example.

From the standpoint of substantive rights, while Parliament has sufficient jurisdiction over bankruptcy and insolvency to put in place any security mechanism that it desires, nevertheless, by creating security mechanisms outside those provided for in provincial private law and Quebec civil law in particular, it confuses relationships among creditors. However, for creditors to be reasonably able to govern their conduct, some stability is required in the legal framework in which they operate. An analysis of some of the security devices created by Parliament in the B.I.A. seems to show, however, that creditors' rights are subject to significant variations in terms of the rules for setting up, preferences and remedies. Such variations are probably a matter for concern in the legal community. The harmonization program implemented by the Department of Justice Canada cannot serve as a forum to address these concerns except by respecting in the federal legislative corpus the terminology and concepts in force in Quebec private law.

These questions, and many more, are presently the subject of studies within the Justice Department in collaboration with Industry Canada.

Date modified: