Key Developments In Canadian Insolvency Case Law In 2020

• Published date: 19 February 2021
• Subject Matter: Finance and Banking, Real Estate and Construction, Insolvency/Bankruptcy/Re-structuring, Charges, Mortgages, Indemnities, Financial Services, Financial Restructuring, Insolvency/Bankruptcy, Landlord & Tenant - Leases
• Law Firm: Blake, Cassels & Graydon LLP
• Author: Ms Pamela Huff, Linc Rogers, Aryo Shalviri and Caitlin McIntyre

In 2020, several significant judicial decisions were rendered across Canada relevant to commercial lenders, businesses and restructuring professionals. This bulletin summarizes the core issues of importance in each case and provides status updates on the cases reported on in our January 2020 bulletin, Key Developments in Canadian Insolvency Case Law in 2019.

CHARACTERIZATION AND TREATMENT OF ELIGIBLE FINANCIAL CONTRACTS

Bellatrix Exploration Ltd. (Action No. 1901-13767)
Date of Decision: February 4, 2020

Bellatrix Exploration Ltd. (Bellatrix) obtained protection under the Companies' Creditors Arrangement Act (Canada) (CCAA). At the time of the CCAA filing, Bellatrix was party to certain contracts with an energy producer (EP) for the purchase and sale of natural gas (Contract). Bellatrix sought to disclaim the Contract and cease delivery of natural gas to the EP.
The EP argued that the disclaimer notice provided by Bellatrix was invalid because the Contract constituted an eligible financial contract (EFC) for the purposes of the CCAA. Under section 32(9) of the CCAA, a debtor company is not permitted to disclaim contracts that are EFCs. Pursuant to the express terms of the Contract, the parties acknowledged that the Contract was an EFC.

Pursuant to regulations promulgated under the CCAA, a contract will be considered an EFC if it is:

1. a financial agreement;
2. a financial agreement which is a derivatives agreement; or
3. a derivatives agreement settled either by payment or delivery which derivatives agreement either
   1. trades on a futures, options exchange, board or other regulated market, or
   2. is the subject of recurrent dealings in the derivatives markets or in the over-counter securities or commodities markets

In addition to arguing that the Contract was not properly characterized as an EFC, Bellatrix argued that the court should apply a "fair results" test under which it may determine that, even if the form of contract constitutes an EFC, the court may decline to characterize the contract as an EFC if it would be unfair to do so.

The court found that fairness may enter the analysis when deciding the threshold question as to whether an agreement meets the definition of an EFC. Accordingly, the court concluded that it has some latitude where the true characterization is at issue, and such characterization has implications for the court's ability to fulfil the objectives and purposes of the CCAA. The court, however, drew a distinction between this approach and the proposition advanced by Bellatrix that an agreement which clearly meets the definition of an EFC may nevertheless be declared by the court not to be one, on the basis of fairness. The court also noted that it is problematic to suggest it should be permitted to substitute its view of fairness for that reflected in Parliament's decision to provide an exception to disclaimer for EFCs in section 32(9) of the CCAA. The court rejected Bellatrix's argument, holding that to disallow an agreement that meets the criteria of an EFC, to be called an EFC, would be to allow the court to effectively rewrite such agreement.

The court found that the Contract was both a financial agreement and a derivatives agreement which should enjoy EFC status and was therefore exempt from disclaimer.

Status

Leave to appeal this decision of the Court of Queen's Bench of Alberta was allowed on May 1, 2020. The appeal was heard by the Alberta Court of Appeal (ABCA) on October 22, 2020. At this time, no decision has been rendered.

Takeaway

Subject to appellate review, where a contract clearly meets the definition of an EFC, a court does not have the discretion to recharacterize the agreement to permit a disclaimer on the basis of fairness.

SECURITY POSITION OF ADVANCES IN EXCESS OF THE PRINCIPAL FACE AMOUNT OF A MORTGAGE

Forjay Management Ltd. v 625536 BC Ltd., 2020 BCCA 70
Date of Decision: February 27, 2020

In the context of a receivership proceeding commenced in respect of a failed residential real estate development, a dispute arose between multiple mortgagees in respect of the proceeds of realization. The first and second mortgagees claimed that all funds advanced by them to the borrower were secured by their mortgages in priority to amounts advanced by a third mortgagee. The third mortgagee submitted that amounts advanced by the prior registered mortgagees in excess of the face amount of their respective mortgages were not secured by the first and second mortgages and, as a result, the third mortgagee had claims to the proceeds of realization. The face amount of a mortgage is the principal amount of the mortgage stated on the registered mortgage form.

The British Columbia Court of Appeal (BCA) affirmed the decision of the Superior Court of British Columbia, finding that advances made by first and second mortgagees in excess of the face amount of a registered mortgage were secured and ranked in priority to a third mortgage.

In doing so, the BCA considered the common law principle of "tacking", and whether or not the obligation of a borrower to repay money advanced under a first-in-time mortgage, after a subsequent mortgage has been registered, takes priority over such subsequent mortgage. The BCA found that where a priority agreement exists among mortgagees, as was the case between the second mortgagee and third mortgagee, it will govern the priority of advances. It was a term of the second mortgage that the third mortgagee would subordinate its loan to advances under the second mortgage, and a priority agreement to that effect was registered on the same day the second mortgage was entered into.

No such priority agreement existed between the first mortgagee and third mortgagee. The BCA, however, held that even where such priority agreement does not exist, a first mortgagee is able to tack when it has no notice in the prescribed form of the existence of a subsequent mortgage. In such circumstances, amounts advanced in excess of the face amount of the mortgage will continue to be secured. The form of notice required is governed by section 28(2) of the Property Law Act (British Columbia) which requires the subsequent mortgagee to provide formal written notice. Actual notice will not suffice.

The first mortgagee had actual notice of the existence of the third mortgage and was aware that the third mortgage was registered on title. Actual notice was provided in the form of a passing reference to the third mortgage in an email to the first mortgagee's counsel. The BCA found that this notice was not sufficient to constitute notice in compliance with the Property Law Act (British Columbia).

Accordingly, the first mortgagee was found not to have had notice for the purposes of tacking and the full amount of the first mortgage, including the advances in excess of the registered face amount, were valid and the obligation of the borrower to repay such amounts ranked in priority to the obligations secured by the third mortgage.

Status

Leave to appeal this decision to the Supreme Court of Canada (SCC) was denied on October 1, 2020. This decision is now final.

Takeaway

In British Columbia, where a subsequent mortgagee wishes to limit the amount of debt that ranks in priority to it, the subsequent mortgagee must provide formal written notice of the existence of its mortgage to prior mortgagees in accordance with the requirements of the Property Law Act (British Columbia).

EFFECTIVENESS OF STATUTORY CONSTRUCTION LIEN PROVISIONS IN INSOLVENCY PROCEEDINGS

Urbancorp Cumberland 2 GP Inc. (Re) (2020), 2020 ONCA 197
Date of Decision: March 11, 2020

The Ontario Court of Appeal (OCA) considered the scope and effectiveness of section 9(1) of the Construction Lien Act (Ontario) (CLA) which creates a trust over sale proceeds of real property in favour of unpaid contractors in the construction industry that add value to such real estate by their provision of work and materials. The CLA has now been superseded by the Construction Act (Ontario); however, the CLA was the relevant statute at the time.

In this case, a residential condominium developer filed a Notice of Intention to file a proposal under the Bankruptcy and Insolvency Act (Canada) (BIA) and subsequently continued its proposal proceedings under the CCAA. Unsold units in a condominium project the developer constructed were among its assets and were ultimately sold during the CCAA proceeding. Pursuant to an order of the OCA expanding its statutory powers, the sales agreements were entered into by the court-appointed monitor and the proceeds of sale were received directly by the monitor. The appellant unpaid contractors supplied work and materials in respect of the sold units and were owed significant sums. The appellants claimed that, pursuant to the CLA, a trust arose over the proceeds of sale to the extent of the amounts owing to them, giving them priority over these amounts ahead of secured creditors.

The motion judge rejected the trust claim because the sale proceeds were not received by the owners of the sold units directly and were instead received by the monitor. The germane provision, section 9(1) of the CLA, contemplates a sale of property by an owner, and not by a representative of the owner.

The OCA reversed the decision of the motion judge and confirmed the effectiveness of section 9(1) of the CLA in insolvency proceedings. In doing so, the OCA held that the fact that the agreements of purchase and sale were entered into by the monitor and not by the owner itself did not detract from the fact that the owners were ultimately the vendors of the units.

The OCA also addressed the interaction of the provincial CLA with the federal CCAA from the perspective of the doctrine of federal paramountcy, which provides that where validly enacted provincial legislation conflicts with validly enacted federal legislation, the federal legislation governs, and the provincial legislation is inoperative to the extent of the conflict. Based on federal...