Issues For Litigation

This paper is a summary of some of the litigation issues facing counsel in bankruptcy and insolvency matters and will briefly highlight the following areas:

Fraudulent Preferences and Transfers at Undervalue Section 138 Claims Appeals from Disallowances of Claims by Trustees: True Appeals or Hearings de novo? Section 163 Examinations Waiving Solicitor/Client Privilege on behalf of a Bankrupt Company Claiming Legal Costs in an Insolvency Proceeding Ethical Issues in Bankruptcy and Insolvency – Ex Parte orders 1. Fraudulent Preferences and Transfers at Undervalue

The Bankruptcy and Insolvency Act, RSC 1985, c. B‐3 (the "BIA") was recently amended to repeal the settlement and reviewable transaction sections of the Act, and replaced these sections with provisions regarding transfers under value and preferences. The aim of these new provisions is to prevent bankrupts from unfairly preferring certain creditors over others and to prevent bankrupts from transferring assets for significantly less than they are worth.

1.1 Fraudulent Preferences (Section 95 of the BIA)

Under section 95, a trustee is able to attack any transfer where the bankrupt makes a transfer with the intent to prefer one creditor over others. The trustee bears the burden of proving that the bankrupt intended to give a preference to that creditor, although a transaction will be presumed to have the requisite intent if it has the effect of giving a creditor a preference. It is then the responsibility of the bankrupt and the transferee to rebut this presumption. A trustee may attack any transactions creating a preference that occur in the time beginning three months prior to the initial bankruptcy event and ending on the date of bankruptcy, provided the transferee is at arms' length with the transferor. This time is extended to one year prior to the initial bankruptcy event if the transferee is not at arms' length with the transferor. It is important to note that, for the purposes of section 95 and 96, related persons are only presumed to deal not at arms' length and such a presumption can be overcome with evidence that they were, in fact, dealing at arms' length.

1.2 Transfers at Undervalue (Section 96 of the BIA)

Section 96 provides the trustee with a mechanism for attacking transactions between the debtor and persons who provide the debtor with either no consideration or inadequate consideration for the asset, goods, or services provided. If the debtor is in the business of providing services, the provision of such services for no fee or for a fee undervalue can be attacked under section 96. The purpose of section 96 is to prohibit the debtor from disposing of its assets for inadequate consideration. The transferee need not be a creditor of the debtor to have the transaction attacked, but only needed to provide inadequate consideration in the transaction. If the parties to a transaction were dealing at arms' length, a transaction can be found void if it was completed in the year prior to the initial bankruptcy event, the debtor was either insolvent at the time or became insolvent because of the transaction, and the debtor intended to delay, hinder, or defraud a creditor. All the aforementioned conditions must be met to vacate such a transaction. If the parties are not dealing at arms' length, all transactions for undervalue can be found void if they were completed in the year prior to the initial bankruptcy event, or if the transaction occurred between five years and one year before the initial bankruptcy event, the debtor was either insolvent at the time or became insolvent because of the transaction, and the debtor intended to delay, hinder, or defraud a creditor.

1.3 Voidable Transfers under Provincial Statutes

However, the fact that a trustee does not meet the requirements under either section 95 or section 96 does not mean that the transaction is incapable of being attacked. A trustee may also seek to void a transaction under provincial legislation, such as the Fraudulent Conveyance Act, RSBC 1996, c. 163 (the "FCA") or the Fraudulent Preference Act, RSBC 1996, c. 164. While any conflict between either the BIA or the Companies' Creditors Arrangement Act, RSC 1985, c. C‐36 (the "CCAA") and provincial legislation will result in the federal legislation being applicable, it is important to note that provincial legislation is available to trustees to use in certain circumstances. The FCA is a particularly useful statute for trustees, as it allows the trustee to attack transactions made prior to the debtor having any creditors, so long as the trustee can prove that the debtor intended to delay, hinder or defraud creditors or others. This is exactly the action the trustee took in the recent case of Botham Holdings Ltd. (Trustee of) v. Braydon Investments Ltd., 2008 BCSC 1547, aff'd 2009 BCCA 521 ("Botham").

In Botham, the owner of Botham Holdings Ltd. engaged in several transactions which had the effect of transferring all the assets of Botham to Braydon Investments Ltd., which was owned by the same shareholders, in the same proportions as Botham, prior to entering into a risky partnership. When the partnership failed and Botham and the partnership went bankrupt, Botham's trustee in bankruptcy sought to apply the FCA to the transaction. The Court held that, despite no dishonest intent, the transaction could not stand as the transferor still intended to delay or hinder its creditors. While the trustee had also sought to set the transaction aside under the BIA's former provision on settlements, the Court chose to determine the matter under the FCA. Botham highlights the usefulness of the FCA to trustees or creditors seeking to attack transactions that fall outside of the scope of sections 95 and 96 of the BIA.

2. Section 38 Claims

   Section 38 provides a mechanism by which a creditor can take the place of the trustee in any proceeding where the trustee refuses or fails to act. Essentially, the creditor stands in the place of the trustee and, if successful in the proceeding, is entitled to keep all proceeds, except those that exceed the total of the creditor's claim and the creditor's costs of the proceeding. Any surplus proceeds received by the creditor are the property of the bankrupt's estate. A creditor is not, however, entitled to interest on these claims.1 In order to make an application under section 38 a creditor must show that they have asked the trustee to take action in a proceeding and that the trustee refused or neglected to do so. An affidavit setting out these facts, and the fact that the debtor is insolvent, will be sufficient under a section 38 application.2

   There are a number of conflicting authorities on whether a creditor is required to make out a prima facie case before the Court will grant leave.3 As such, it is preferable to err on the side of caution and provide the court with...