Proceedings of the Standing Senate Committee on
Banking, Trade and
Issue 13 - Evidence - November 4 Sitting
OTTAWA, Monday, November 4, 1996
The Standing Senate Committee on Banking, Trade and Commerce, to which was
referred Bill C-5, to amend the Bankruptcy and Insolvency Act, the Companies'
Creditors Arrangement Act and the Income Tax Act, met this day at 5:05 p.m. to
give consideration to the bill.
Senator Michael Kirby (Chairman) in the Chair.
The Chairman: This is the beginning of our set of hearings on Bill C-5, the
Bankruptcy and Insolvency Act, the Companies' Creditors Arrangement Act and the
Income Tax Act.
Our purpose this evening is to have officials and their outside legal counsel
take us through the proposed amendments. I have suggested to officials that we
would try to go through this fairly slowly and systematically, rather than in
the form of a long presentation followed by questions.
If you are to go through one section of the bill at a time, Mr. Tobin, it would
be helpful if you did a section and then we talked about that. We could then
cover the next section. I think that would work well.
I understand that you have an overview presentation, which will take
approximately 20 minutes. We would then like to get into the details of the
With us today is, David Tobin, whom you met before during our corporate
governance hearings. He is the Director General of the Corporate Governance
Branch of the Department of Industry.
Mr. Tobin, Please introduce your colleagues and then proceed with your
presentation. We will then have a discussion and, at the end, I should like to
make some comments about our process from here through to the end. Thank you
for coming here tonight.
Mr. David Tobin, Director General, Corporate Governance Branch, Department of
Industry: With me today is Marc Mayrand, Acting Superintendent of Bankruptcy.
The Chairman: That is part of the Department of Industry; is that correct?
Mr. Tobin: That is right; it was formerly part of Consumer and Corporate Affairs
and was part of that reorganization in June of 1993.
The Chairman: Is that a quasi-regulatory position?
Mr. Marc Mayrand, Superintendent of Bankruptcy, Department of Industry: It is a
GIC appointment, yes.
Mr. Tobin: Mr. Mayrand can certainly walk through the duties of his office,
particularly as they relate to some of the amendments put in place in 1992 and
further pursued in 1995.
Also with me tonight are Jacques Hains, a director of the Corporate Law Review
Branch within Industry Canada, who has been involved with not only these
amendments but the ones in 1992; Max Mendelsohn, a bankruptcy and solvency
expert from Montreal; and Gordon Marantz, Legal Advisor, who is with Osler,
Hoskin in Toronto and was involved in the 1992 amendments and in the BIAC
process leading up to the amendments that you have before you in Bill C-5.
There are several other officials with us from the Department of Justice, as
well as our own department, who are also available to answer questions.
The Chairman: Please proceed with your presentation, which is largely an
overview. When we get to the act itself, given its very technical nature, it is
important that we cover the broad sections of the act piece by piece.
Mr. Tobin: Because the act is not divided in an organized fashion, there are a
number of ways of dividing it up. Perhaps I can stop after parts of this
presentation and then take questions. It might be helpful to do it that way.
Bankruptcy legislation, like other pieces of legislation that have been before
this committee, is one of the framework laws actually administered by the
Department of Industry. You mentioned in your opening remarks the CBCA. Other
examples include the Copyright Act, the Patent Act, and a number of acts that
are administered by this department.
Both the Bankruptcy Act and the Companies' Creditors Arrangement Act encourage
risk taking, business reorganization, and the preservation of existing jobs and
rehabilitation of consumer debts. It is important to recognize, as with most
framework law, that there are divergent interests at stake here. In these
amendments, we tried to come up with a reconciliation of those interests or,
where not possible, a compromise between them. In this case, we are dealing
with debtors versus creditors, sometimes creditors versus creditors themselves,
and reorganization of an existing business versus its liquidation.
To appreciate fully the 1995 amendments, it is useful to go back to 1992 to
touch upon the highlights that were dealt with at that time. I say that
because, largely, the 1995 amendments are built on 1992.
In 1992, Parliament included in the bill a three-year review clause, which is
what we are dealing with now, namely, the requirement to look at the 1992
amendments three years after their coming into force. Bill C-5 largely reflects
what happened during that review process.
The 1992 amendments were the first substantial amendments in over 40 years.
There were approximately six or seven attempts to try to amend the Bankruptcy
Act. I see people shaking their heads. I think some people were involved from
time to time in some of those attempts that did not succeed. The main focus in
the 1992 amendments was a shift to reorganization, shifting away from
liquidation and trying to facilitate reorganizations of existing businesses.
Again, the objective was saving businesses and trying to preserve jobs.
The main feature then was a revised commercial reorganization scheme based on
the notion of staying creditors. Companies could put forward proposals and,
during that time, creditors would be stayed. There were also new consumer
proposal regimes, which allowed consumers with less than $75,000 in debts to
put forward proposals. Consumer proposals may provide for partial payment of
debts, as opposed to the orderly payment of debts which required 100 per cent
There were measures to streamline the bankruptcy administration; summary
bankruptcy was made available to non-corporate debtors with up to $5,000 in
debts, and there was automatic discharge for first-time bankrupts after nine
One of the other major provisions of the 1992 amendments dealt with unpaid
suppliers. This allowed suppliers to repossess goods delivered to a bankrupt if
they had been delivered 30 days prior to the bankruptcy taking place. The goods
would also have to remain unaltered. It allowed a creditor to go in and take
those goods back. That did not apply in the case of a proposal. If a proposal
had been filed, the creditor would be stayed from going in and trying to
retrieve those goods. Again, that balance was to allow the most optimistic
point for a proposal to succeed. These measures were put forward in 1992.
I have some statistics on how it has worked since 1992. There have been over
3,000 commercial reorganizations since 1992. It has involved roughly 17,000
jobs, which is the best calculation we have, and over 50 per cent of these are
still active. There is no guarantee when you go into a proposal that they will
succeed, but, based on the data we have thus far, 50 per cent are still active.
In terms of the consumer proposals, there have been more than 6,000 of them
since 1992 and 70 per cent are active.
The Chairman: Rather than my using our formal procedure to call upon individuals
for questions, will you address them as they arise?
Mr. Tobin: Yes. If I see a hand, I will stop.
The Chairman: Thank you.
Senator Meighen: Is there anything to compare that figure of 3,000 to? If you
take the years before 1992, is that good, bad or indifferent?
Mr. Tobin: We should have to understand that before 1992, the reorganization
proposals were much more complex. The 1992 proposals allowed smaller companies
to avail themselves of them. I would ask Mr. Marantz or Mr. Mendelsohn if they
have any anecdotal information on it.
Mr. Gordon Marantz, Legal Advisor to the Department of Industry: The
superintendent's statistics indicate that there has been an increased use of
small business proposals. Those that succeed and do not fail represent a
positive step forward.
Mr. Mayrand: The number of reorganizations more than doubled after 1992
compared to what we saw before. More important, the number prior to 1992 is made
up of consumer, individual and business reorganizations; so it is hard to
compare. There is a substantial increase.
Mr. Tobin: Before getting into the proposals in 1995, it is worthwhile to
explain to you what exactly we did between 1992 and 1995.
When confronted with the notion of a three-year review, we thought it best to
try to involve private sector stakeholders; so we formed a committee, which we
named the Bankruptcy and Insolvency Advisory Committee, whose purpose was to
expressly help the government with the three-year review period. All major
stakeholders were represented in the BIAC consultative group -- that is
representatives from business, consumers, the lending industry, legal
profession, bankruptcy trustees, and virtually anyone involved in the
marketplace who might touch upon insolvency.
There was a steering committee of about 25 people chaired by the Deputy Minister
of Consumer affairs. That continued when it became the Department of Industry.
There were eight working groups serving that overall steering committee and
numerous task forces dealing with specific issues.
Over 100 individuals were represented, and some 50 organizations. The amendments
in Bill C-5 largely -- I say "largely", not exclusively -- were based
on the recommendations of BIAC. As with most advisory committees, it was
simply, as the name implies, advisory. It was left to the government to make
We broke it down into four broad areas. The first segment deals with promoting
fairness; the second encourages responsibility; the third fosters commercial
reorganization; and the fourth improves administration. I propose to take you
through this along those lines. We can stop at any time or right after any of
In terms of promoting fairness, the first issue I will touch upon is that of
spousal and child support orders. The objective was to increase protection for
spousal and child support orders. Child and spousal claim support orders are
claims provable for both the periodic amounts accrued plus any lump-sum payment
ordered or agreed upon. Preferred creditor status was granted to spousal and
child support claims.
The Chairman: What is preferred creditor status?
Mr. Tobin: They were given a ranking. In the Bankruptcy Act there is a ranking
for creditors. Previously, spousal and child support claims were not given a
ranking. Now they are. We ranked them fifth, after such things as funeral
expenses and the cost of administration.
The Chairman: This is a ranking among unsecured creditors?
Mr. Mendelsohn, Legal Advisor to the Department of Industry: It may be
worthwhile to explain in very general terms how the system of ranking works.
Secured creditors are entitled to the rights that arise from their particular
security. They have a security rank; they do not have a rank given to them by
the Bankruptcy Act. The Bankruptcy and Insolvency Act sets out a ranking for
creditors other than secured creditors, and there is a sort of hit parade of
what follows what, and it works its way down to the general category of
ordinary unpreferred creditors.
So when one talks about giving a creditor a rank, that is aside from the rights
of secured creditors and is ahead of ordinary unsecured creditors.
The Chairman: It may be 75th on the list.
Mr. Mendelsohn: The list is not that long. There are about seven or eight
categories of preferred creditors.
Senator Meighen: Can you indicate where the Crown ranks normally?
Mr. Mendelsohn: Since 1992, except as regards certain areas, the Crown does not
rank as a preferred creditor. It used to be that the Crown, in whatever
manifestation, ranked before all unsecured creditors.
The Chairman: Mr. Mendelsohn, you say there are seven or eight. Can you tell us
who they are?
Mr. Jacques Hains, Director, Corporate Law Policy Directorate, Department of
Industry: It is section 136 of the BIA.
The Chairman: That does not help, because I do not have the act before me.
Mr. Tobin: For example, funeral expenses are ahead of it. The cost of the whole
administration of the bankruptcy is ahead of it.
The Chairman: You mean ahead of the trustee or of the government?
Mr. Tobin: Both.
Mr. Mendelsohn: It is the legal cost of running the bankruptcy office.
Mr. Tobin: As Mr. Mendelsohn said before, it does not refer to ordinary Crown
claims; it is the office of the superintendent. Wages and salaries is the fourth
one, and we put this one in after wages and salaries but before municipal
Senator Angus: Was there much opposition to the spousal support order?
Mr. Tobin: Not really, no.
The Chairman: This is not as strange a clause as I thought it was when I first
read the press release.
Mr. Tobin: There was not a lot of debate on giving it this sort of a status.
There was some question about where to put it in terms of ranking.
Senator Meighen: Was there any debate on the reordering of the ranking,
forgetting about the insertion the spousal aspect?
Mr. Tobin: Not a lot.
Mr. Marantz: One thing that should be borne in mind is that, although all other
debts are extinguished by bankruptcy, the alimony and support debt is not. It
survives. There has been something additional given to the spouse who is the
beneficiary of the support order.
The Chairman: To that extent, the ranking is less a gain than the fact that it
is not extinguished.
Mr. Marantz: It historically has not been extinguished. It was also not
provable, so the spouse did not have a claim in the bankruptcy. The spouse has
now been given a claim in the bankruptcy and given a priority within the
ranking in the bankruptcy administration.
Senator Hervieux-Payette: What is the ranking for provincial and federal income
tax and of contributions to any workman's compensation regime?
Mr. Tobin: The priority for government claims are income tax withholding, CPP
contributions and UI.
Senator Hervieux-Payette: Are provincial income taxes on the same level?
Mr. Tobin: Yes.
Senator Hervieux-Payette: They were previously as secure as the banks. You are
saying that they are no longer in that category?
Mr. Tobin: I am saying that they are. Those are the three areas in which the
government has priority, including provincial income tax.
Senator Hervieux-Payette: They have priority, but they are not in the gang of
Mr. Mendelsohn: Perhaps I could just add that prior to 1992, the Crown had
priority as a preferred creditor. It set up what was known as presumed trusts.
These no longer exist, except for source deductions and other similar things.
Regardless of whether we are dealing with federal or provincial tax issues,
source deductions are secured through presumed trusts.
Mr. Tobin: There are two areas not covered. You mentioned workman's
compensation boards. Those do not have the same protection that was just
referred to. As well, the GST does not have that same level of protection.
Senator Hervieux-Payette: We have all this in the bill. We have these black
books which were given to us.
Mr. Mendelsohn: This is not obvious in the letter.
Senator Hervieux-Payette: It was in this class that I argued the most with
Mr. Tobin: It is an important point you raise, senator, because one of the
discussions in the 1992 amendments was exactly that: What do you do with Crown
priorities? The conclusion of 1992 was that source deductions, as described,
should be given that protection but other ones should not.
With regard to seizure exceptions, in Bill C-5, to better protect debtors'
assets to ensure that essential needs are met, there were seizure exemptions;
in other words, they would not become part of the pool of which creditors could
avail themselves for low-income benefit payments. An example is GST refunds.
They would not become part of the pool which creditors could access. They would
be freed up for low-income people. The idea was that the debtor should at least
have access to funds which ensure his or her essential needs.
As well, federal and provincial rules both now apply to property exemption from
seizures. What type of property is exempt from seizure can vary from province to
province. For example, in some places workmen's tools could be exempt from
The third area is petitioning of farmers and fishermen. There has been a
provision in the Bankruptcy Act for some time that they cannot be petitioned.
The Chairman: What is the rationale for that?
Mr. Tobin: It is a longstanding provision. It has existed since 1949.
Senator Angus: It started with Sir Wilfrid Laurier.
The Chairman: That was not my question. My question was: What makes them
Mr. Hains: It is because technically for part of the year they are insolvent
because of the seasonal nature of their work. Because of their importance to
the Canadian economy, when the Bankruptcy Act was drafted in 1949, it was
determined that this technical insolvency for part of the year should not be
used by creditors to petition farmers into bankruptcy since, over a longer
period of time, they are solvent. The decision was based on the seasonal nature
of the business and on the importance of the sector to the Canadian economy at
The Chairman: That is an unbelievably creative rationale for a purely political
policy. I presume they are solvent during other parts of the year.
Mr. Hains: Comparing 1949 to today, today we tend to think of the process of
going bankrupt as rehabilitative and almost a right rather than a penalty or
oppressive kind of thing. However, in 1949, bankruptcy was thought of as an
oppressive thing and farmers and fisher people were being protected.
The Chairman: That was in 1949. Are you proposing to change that?
Mr. Tobin: We have changed it, because the existing act says "solely"
engaged. In other words, that had to be your job, and you were solely engaged
in farming or fishing. Now it has been changed to "individuals whose
principal occupation and means of livelihood". This recognizes that from
time to time they are engaged in activities other than farming or fishing,
given the nature of farming and fishing in this day and age. That change has
been recommended, and obviously it is strongly supported.
The second area had to deal with encouraging responsibilities, which is a broad
category. The first item here dealt with student loans.
There has been evidence to suggest that the number of defaults on students loans
has been increasing. It has gone from $20 million to $60 million over the last
two or three years. The provision in Bill C-5 would provide that if a student
goes bankrupt within two years of finishing his or her studies, the student
loan would not be dischargeable.
The Chairman: May I ask you a question about your data? I am not disputing it;
however, I am questioning the cause and effect.
When you look at the number of university students who have been unable to
obtain employment upon graduation, it is hard to argue that that is their
fault. However, you tell me the number has gone from $20 million to $60
million, and by making it non-dischargeable in the first two years you are
essentially imposing a penalty on those students. The rationale for that must
be that in some sense it is their fault that they did not get a job.
If the increase from $20 million to $60 million is a societal economic problem,
why would you increase the penalty on the students?
Mr. Tobin: There was pressure from some quarters to try to make it longer than
two years. In the U.S., it used to be seven years in which it was not
dischargeable. It then dropped to five and has now been put back up to ten.
Some quarters suggested we should have a similar provision in Canada.
We are suggesting in this bill that for two years it would be non-dischargeable.
If, at the end of that two-year period, the former student, the person who owes
the debt, has still not been able to find a job and still cannot pay the debt,
that person can go to the court and ask that the loan be discharged. We are
trying to avoid situations where someone declares bankruptcy simply to get rid
of the student loan and then finds a job. If within a two-year period one is
still struggling and has not found a job, then it is legitimate that they can
go to the court and ask that it be discharged. There is no question of trying
to facilitate or trying to get out of the bankruptcy.
The Chairman: There is an underlying implication in what you have just said. You
have a suspicion -- I do not mean you personally, but the department -- that
there are in fact a significant number of students who are declaring bankruptcy
precisely in order to get out of their student loans. That is the rationale for
Do you have evidence of that, or are you looking at the effect, that is, the
increase from $20 million to $60 million, and assuming a cause?
Mr. Tobin: The evidence suggests that some 65 to 70 per cent of the bankruptcies
do occur within the first two to three years of graduation. We picked the
two-year period because, under the student loans arrangements, there is a
six-month period where there is no requirement to pay back that loan. Then
there is a further 18-month period where there is assistance on the interest
payments. It coincides with that 24-month period in which the student is
already given period of grace to deal with the repayment of the loan.
You ask why the two years. We found that most of the bankruptcies were occurring
in that period of time. As well, it was felt that if in fact it is still
occurring after the two-year period, the former student can then go to the
court and get the loan discharged.
The Chairman: I am sorry to press you. You are coming back to describing the
facts, namely the effects and the percentage that have gone under, and so on.
That is not what I am asking.
You have devised a policy to deal with the fact of a significant increase in the
number of bankruptcies in the first two years. Presumably the policy is
designed to deal with what you believe is, in some sense, the cause of that
effect. What is the evidence that the cause is in some sense phoney or the
cause is in some sense people doing it to get out of paying the student loan,
versus a real, genuine bankruptcy? If it is a real, genuine bankruptcy, why
change the policy?
Mr. Tobin: In this instance, if it is a real, genuine bankruptcy during that
two-year period, the student loan program already provides assistance for the
students, so they are not overly penalized during that two-year period where
the loan cannot be discharged.
Mr. Hains: The first six months is a total grace period, and then there is up to
an additional 18 months of interest relief where the government pays the
interest on behalf of students so that the total debt does not accumulate.
Therefore, it is not a burden yet on students who qualify and who are in
financial difficulty. They do not have to pay anything, and the government pays
the interest so that the debt does not accumulate.
It is not a burden on them while they have those relief mechanisms;
nevertheless, the statistics show that 70 per cent of them go bankrupt during
that period when it is not yet a burden on them. They go bankrupt in that
period of time where they have relief mechanisms available, so they should use
those first. Then, after that two years, what happens if they are still without
a job and are still in financial distress? They have exhausted all their relief
mechanisms, so then they should be able to get the student loan discharged, and
Bill C-5 provides for that. You are still out of work after two years. Will you
carry this heavy debt load with you? Not if the court agrees with you.
The Chairman: Mr. Hains, if the student goes bankrupt in the first two years,
and given the fact that it is not the student loan that is driving them under,
because you have given them the relief, the bankruptcy may in fact be a genuine
bankruptcy, in which case the student loan should be treated like any other
loan. Why would you then non-exempt it?
Mr. Tobin: It is treated differently for the provisions described.
The Chairman: It is treated differently in terms of what he owes you during the
two years. Why would you treat it differently after the fact?
Mr. Hains: They are not treated differently for the rest of their debt. They can
genuinely go bankrupt in that two-year period, and they can be discharged of
all their other debts which are a burden on them, but not student loans which
are not a burden on them during that period. They should first use up the
relief mechanism available to them. Once they have used that up, that is, after
24 months, if they still cannot carry that debt, they have a way out. There is
no harassment here.
The Chairman: Let me try once more, and then I will give up.
You are singling out the student loan to be treated differently from any other
debts a student has following graduation. Why? Why should a student loan not
simply be a debt that the student has like any other loan the student has? I
understand the fact that it is a loan with particular provisions. However,
loans can have all kinds of provisions. You can lease a car with a balloon
payment at the end. You can do all kind of things. Why are you treating the
student loan as different than any other loan?
First, do we agree that that is what you are doing?
Mr. Tobin: Yes, we are. We are making it non-dischargeable.
The Chairman: Other than the fact that the loan is a loan from the government,
and it is trying to get its money back, what is the public policy rationale for
ranking a government debt ahead of any other kind of debt by making it
Mr. Tobin: A student loan is also not a loan like others in terms of how it is
procured. I am not an expert in the student loan program, but I do not believe
the criteria are the same as they would be to get a car loan, in respect of
credit checks and things of that nature. Qualifying for a student loan is not
quite the same as qualifying for another type of loan.
The Chairman: For one thing, you must be a student.
Mr. Tobin: Yes, that is probably the qualification to get the loan, but the
credit rating and things of that nature are not done in the same way as for a
car loan, for example. A student loan is granted under different premises. I do
not have the exact criterion here but it is different.
The Chairman: I do not know why the criteria for granting a loan would be the
issue. What happens once you have the loan?
Mr. Tobin: It would be different, because a credit institution which grants car
loans can refuse to grant a loan if the credit risk is not good enough. The
same provisions for refusing are not there in the case of student loans. The
program is not set up like that. It is set up to try to give people the funds
to continue with an education. The criteria then are easier to meet than when
applying for a car loan.
The provision states that if, two years after graduating, you are still
bankrupt, you can go and have the loan treated in the same way as other loans.
You can apply to have it discharged. During that two-year period, a car could
be repossessed for non-payment. In this case, the lenders will not go back to
The Chairman: I understand all that. You keep coming back to the process. I am
saying that you have singled out a student loan to be treated differently from
any other loan in the event of bankruptcy. My question to you is simple: Why?
Senator Angus: It is different from any other loan. He has explained that it is
a totally different loan. It would not be a loan in the normal course of
business. There would not be that debt.
Mr. Tobin: It is a different type of loan. Ihere is not the same risk assessment
as used in a normal, commercial type of loan. We want the loan system to remain
viable without being abused at either end. We have suggested a provision to
avoid discharge of the loan in that period immediately after graduation.
Nonetheless, if the financial difficulties continue two years after graduation,
one can apply to have the loan discharged.
The Chairman: I am happy to remain unconvinced. Meanwhile we had better move
on. Being Chairman, I can return to it when I so choose.
Mr. Tobin: We will try to come back to it later on.
The other provision deals with surplus income. This was under the heading of
trying to encourage responsibility, to encourage bankrupts to make
contributions to the estate in accordance with their ability to pay.
The bill suggests we impose a duty on bankrupts to pay surplus income to the
estate. The surplus income would be a portion of the total income that exceeds
the necessary level to maintain a reasonable standard of living. The trustees
would set the amount of surplus income to be paid as per directives from the
superintendent. If that did not work, mediation by an official receiver could
be put in place to try to determine the exact amount of surplus income.
Again, the theory here is that the person who has access to income should still
be in a position to pay off part of his or her debt but, at the same time, to
maintain some sort of minimum standard of living.
Senator Meighen: Is this a new concept?
Mr. Tobin: The provision is new to the bill; that is right.
Senator Meighen: We were just saying that the whole thrust of the 1992
amendments, and certainly those in this bill, are totally different. I do not
claim any virtue one way or another. I once worked with this act in a time when
it was considered not the greatest thing in the world to go bankrupt. Nasty
people like credit agencies always put that on your record. It was not a good
thing. I guess now there is a different thrust.
Mr. Tobin: Certainly, the thrust of 1992 was to make it easier for debtors to
reorganize on a commercial level. That was the thrust in trying to save jobs.
Senator Meighen: Is that particularly true for individual debtors?
Mr. Tobin: Yes, I would say both corporate and individuals were affected.
Certain provisions allowed proposals for individual debtors as well.
Senator Meighen: What is surplus income? Do you think, when people struggle to
make ends meet and then go bankrupt, that there will be surplus income for a
mediator to turn over to the estate?
Mr. Mendelsohn: The various provinces have different rules as to what portion of
earned income is seizable. This was an attempt to try to introduce some
uniformity to the process. We wanted some guidelines for calculating that and
some mechanism to make bankrupts pay something into the bankruptcy.
Senator Meighen: This is a process, then, of evening things across
Mr. Mendelsohn: It is an attempt to achieve that.
Senator Meighen: Presumably it will work differently in different places, in
Mr. Mendelsohn: The reality is that, even when the same rules are in place, they
tend to work differently in different places. That is true. Nonetheless, this
is an attempt to harmonize it.
Mr. Mayrand: Our figures show that about 25 per cent of debtors who go bankrupt
today have a certain amount of surplus income, that is, a discretionary income
of over $100 per month. That amount should be made available to the estate to
pay back the creditors. That is precisely the reason for these provisions.
These are clear rules for what will be expected from debtors with respect to
payments into the estate while they are bankrupt. Those payments will be
distributed to creditors.
There is a great variation of income, of course, among debtors who avail
themselves of bankruptcy. The amount of surplus income will depend on their
cost of living, on the region of the country where they live, and also on their
ability or special circumstances. That is what the bill recognizes.
Senator Meighen: Thank you. Who sets the basic amount? It used to be the judge.
Who sets it now?
Mr. Mayrand: The basic amount will be set through directives in the
The Chairman: That is your office.
Mr. Mayrand: Yes. We will be setting out standards to establish the amount. The
precise amount in any given file will be determined by the trustee based on the
standard. It will be "X" dollars depending upon the cost for lodging,
clothing, et cetera. Income above that would be paid into the estate.
Senator Meighen: Who would enforce that?
Mr. Mayrand: The trustee would discuss the subject matter with the debtor. If
there is agreement, the trustee will advise the creditors. If creditors do not
agree with what they see in the file, they may seek mediation.
If there is no agreement between the trustee and the debtor as to the amount to
be paid, there could also be mediation. If mediation fails, a motion could be
presented to the court for enforcement.
Senator Meighen: That is the basic amount?
Mr. Mayrand: Yes. The court will be using the same standards set out in the
One goal is to make more predictable the payments that creditors can expect to
receive from debtors through the estate. Right now, that is less than
Mr. Marantz: One should not lose sight of the fact that these provisions will
only come into play when there is no agreement. They will probably only be
useful in a small number of bankruptcies, particularly when looking at
professionals and others.
Senator Meighen: That is an agreement between whom?
Mr. Marantz: There would usually be agreement between the debtor and the trustee
on the appropriate amount to be paid.
Senator Meighen: That would be the trustee who is acting for the creditors?
Mr. Marantz: Yes. It works that way now. However this provision, in effect,
takes any areas of contention out of the realm of the court.
The Chairman: Is it also fair to say that this provision would apply largely to
professionals and others who have potential for sheltered income. The vast
majority of people earn marginal incomes, so it is not an issue for them; am I
Mr. Tobin: That is fair to say.
Mr. Marantz: So much of what goes into the legislation which looks punitive is
designed to deal with precisely the abuse sections or the very odd circumstance,
such as the high income earner.
The Chairman: What do you mean by the "abuse sections"?
Mr. Marantz: To avoid people abusing the bankruptcy process to shelter future
income. The rules get complicated because of that.
Senator Angus: Speaking of abuse provisions, we heard witnesses on another
subject last week saying that every partner of a certain major professional
organization had his assets in his wife's name, specifically to avoid
creditors' claims. Do you have anything in this legislation that would deal
with those kinds of activities?
Mr. Marantz: There are existing provisions under the Bankruptcy and Insolvency
Act for dealing with settlements, where property is given to someone with the
idea of enjoying it in the future or through preferential payments. All of the
provinces have legislation dealing with fraudulent conveyances, when property
is disposed of for the purpose of defeating creditors. There is a well
established body of law in that area.
The Chairman: I do not think the situation Senator Angus was referring to would
classify as a fraudulent conveyance. I think this was a situation where partners
in a particular firm had put away all their assets, not as a fraudulent
conveyance, but on an ongoing, annual basis.
Senator Angus: No, they had been sued for a lot of money.
The Chairman: I apologize. I was under the impression they did it regularly.
Senator Angus: The trustees were outraged, of course. However, I wonder what Mr.
Mendelsohn thinks about that.
Mr. Mendelsohn: I think that the trustees may not be quite as outraged as we
think. I do not know.
Before people become insolvent they are entitled to organize their affairs in
such manner as they wish.
Senator Angus: Is there a time limit, in other words, like a preference?
Mr. Mendelsohn: Very much so.
Senator Angus: I do not know what it is.
Senator Meighen: What is it now?
Mr. Mendelsohn: Any gift within a year of bankruptcy is void. Any gift within
five years is voidable if there was a state of insolvency at the time.
Mr. Marantz: Under common law rules relating to fraudulent conveyances, there is
a view that there should be a 20-year time limit.
Senator Angus: Is this like the "action paulienne".
Mr. Tobin: Yes, it is analogous to the "action paulienne." Related to
what we have been talking about in terms of surplus income is the question of
the discharge. The bill contains provisions that would allow a trustee to set
the terms of a bankrupt's discharge order. The trustee would be able to
recommend whether a bankrupt's discharge order is conditional, and the
recommendation could be based on the issue we were just talking about, the
compliance with surplus income payments or whether a consumer proposal should
have been filed. These things could come into account when the trustee advises
whether a bankrupt should be discharged.
Assault judgments and orders is the final category with respect to encouraging
responsibility. This is designed to prevent perpetrators of assault from making
voluntary assignments into bankruptcy as a means of avoiding payment of court
ordered restitution. This situation occurs when someone has been assigned
responsibility in an assault case. These would become non-dischargeable debts in
terms of a bankruptcy.
The Chairman: What is the rationale for singling out those specific abuse case
payments as opposed to others? Why did you single them out over other potential
debts that could be non-dischargeable as well?
Mr. Tobin: I seem to recall that we had some cases brought to our attention
where this had actually happened.
Mr. Marantz: Yes, that is right.
Mr. Tobin: A few cases were brought to our attention during the BIAC process,
where people had escaped from their responsibility.
I think the conclusion of the BIAC was that these were types of cases in which,
because of the personal nature of them, people should not be allowed to declare
bankruptcy to avoid meeting their responsibility.
As with spousal payments, it was felt there was a broader societal need that
would make these responsibilities non-dischargeable.
The Chairman: Did you put these charges in a special category?
Mr. Tobin: I guess that is one way of saying it. There are a number of them.
The Chairman: Were there any other potential inclusions in the same category of
charges that would be made non-dischargeable and that you decided not to
include, or was this just a one-item short list?
Mr. Tobin: There were a number of them already.
The Chairman: Such as?
Mr. Mendelsohn: Money owing as a result of fraud and defalcation, or fines and
things of that nature, are not dischargeable. This broadens that category.
The Chairman: While you were considering adding this one, were there any others
that you considered adding but decided not to?
Mr. Tobin: I do not seem to recall anything else coming up.
The Chairman: Were there any requests that others be added?
Mr. Tobin: No. As I say, we moved the spousal one in, and we not only left it
there, but we moved it into the preferred status and then this one was added.
I would now ask Jacques Hains to describe commercial leases falling under
Mr. Hains: Mr. Chairman, with respect to commercial insolvency, there are five
or six important elements in Bill C-5.
The first relates to commercial leases. In 1992, Parliament passed an amendment
allowing a business to disclaim a commercial lease in order to stay afloat and
In 1992, Parliament agreed to let the debtor pay six months' rent and to
unilaterally terminate his commercial leases if he was insolvent and if he
submitted a reorganization proposal. In so doing, Parliament was making an
exception for one particular category, that is for commercial leaseholders.
The bill proposes to do away with this exception and, in the case of commercial
leaseholders, while they would still be able to disclaim the lease, but they
will no longer be able to get off with a six-month lease payment. They would
still be required to submit a proposal to their creditors, and to all other
creditors involved in the bankruptcy. The owners can choose either to accept or
to refuse the commercial reorganization proposal.
Senator Meighen: Will the proposal cover all of the debtor's affairs or only
those pertaining to commercial leases? Are the property owners the only ones
who will vote on the proposal?
Mr. Hains: Yes. They would be placed in a separate category and given the
proposal to vote on. We are talking here about commercial leases, about the
retail trade and about businesses that lease premises. If these businesses are
insolvent and wish to submit a reorganization proposal, they can unilaterally
terminate their leases, but they will have to make a proposal to the owners.
The owners will then vote on this proposal.
Senator Meighen: If the owners reject the proposal, can they make a counter
Mr. Hains: Rejection of the proposal could lead either to a counter offer being
made or to the company declaring bankruptcy, in which case the owners would, as
preferred creditors, be entitled to three months' worth of lease payments and,
as unsecured creditors, to the balance outstanding on the lease.
There is an incentive in the act for them to be reasonable and to accept a
reasonable offer which would salvage the business and save jobs.
Senator Meighen: Then it would seem that there is a choice to be made. Who makes
this choice? You say that in some cases, rejection of the proposal could result
in bankruptcy. Is that correct?
Mr. Hains: Yes.
Senator Meighen: In other cases, if I understood you correctly, rejection could
lead to a counter offer being made?
Mr. Hains: We're talking about the dynamics of the negotiation process. That is
really what we are talking about. First, the lessee examines the situation and
says: I have seven leases and seven different locations; I'm losing a lot of
money at four locations, and this places my three money-making operations at
risk. It is still possible to salvage the business and save jobs at these three
The lessee, in order to survive, decides to unilaterally terminate these four
leases. He submits a proposal to the leaseholders, whoever they are and says:
normally, I would owe you $1.5 million, if each of these leases ran for the
full term and if I paid you in full; I am offering you $75,000 or $80,000. This
is part of the dynamics of negotiating. The leaseholders might say: We want to
talk to you, Jacques, could you come and see us and sweeten your proposal. That
is what I mean when I say that there may be some counter offers made.
Senator Meighen: However, if the proposal is formally rejected, are you saying
that that is the end of it?
Mr. Hains: If the lessee or the business ultimately stands firm and says: Here
is the proposal, you can either take it or leave it, than the owners can come
back and say that it is unacceptable. If this happens, the lessee is
automatically declared bankrupt and the owners would be entitled to three
months' worth of lease payments as preferred creditors and to the outstanding
balance as unsecured creditors. They would stand to lose a great deal. It is in
their interest to listen to the lessee and perhaps accept a reasonable offer.
That is the first step.
Senator Meighen: Thank you, Mr. Chairman.
Senator Hervieux-Payette: Is this provision included in the 1992 legislation or
is it a subsequent amendment?
Mr. Hains: Yes, it is.
Senator Hervieux-Payette: I must say that substantial improvements have been
made to the 1992 legislation in the past three years. A considerable number of
amendments have been passed.
Mr. Hains: Experience has taught us a great deal.
Senator Hervieux-Payette: I was wondering if this was a customary practice or if
this was viewed as an impractical solution, one resulting in abuse or
confusion? Is it not a fact that a reorganization proposal is more attractive
to the business world in general?
Mr. Hains: It is really a customary practice. The proposal helps both parties,
in that in some cases, companies in financial difficulty facing the prospect of
terminating their commercial leases were required to pay six months' rent up
front and this proved too costly. In other cases, the proposal benefits the
leaseholder who can look forward to getting a better offer if the real estate
market recovers, as we expect it will. A reorganization proposal is a more
flexible bargaining tool than a rigid six-month rule.
Senator Hervieux-Payette: Thank you.
Mr. Hains: Another area under commercial reorganization is the area of
environmental liability. Again, Bill C-5 is proposing to alter the 1992
provisions approved by Parliament. What Parliament tried to do in 1992 was to
provide a relief to insolvency practitioners -- essentially these are receivers
and trustees, although it was only trustees in 1992 -- because they were at
risk when they accepted a mandate to liquidate an insolvent business. That was
so because, technically and legally speaking, they are vested with the assets
of the bankrupt individual; they become more or less the owner of those assets
and are in control of them. Under environmental laws, therefore, they could
have been subject to personal liability to clean up the environment. I am
speaking of personal liability here, meaning "out of their own pockets."
Of course, they were quite concerned about that provision.
In 1992, they approached the government and said, "Look, we are
professionals working on a for-fee basis. We are trying to do creditors,
debtors and society at large a service, but we are exposing ourselves. We are
not going to approach any insolvent estate that has any risk of environmental
liability. It is too risky for our pockets." The result was that we saw a
lot of so-called "orphan sites" in the country, where the business
was insolvent, the debtor was out of it, and the site was unattended. It might
or might not have had an environmental problem, such as the spilling of
pollutants, for example, but the environmental regulators would never find out
or would find out only by accident.
That was the big problem which the 1992 amendment tried to address, and it did
so in this way: The 1992 provision said that, if you are a trustee and you
accept a mandate such as that, you shall not be personally liable, out of your
own pocket, for any environmental damage that occurred prior to your accepting
the mandate, and you shall also not be personally liable if you exercise due
diligence after you accept the mandate. We thought that that would help.
Three years later, almost all trustees have come to us and said that that
approach does not work. They ask: "What does `due diligence' mean? We are
potentially facing millions of dollars in personal liability. Thank you very
much for the `due diligence', but it is not enough."
The Chairman: As a matter of curiosity, why is that not sufficient? To a lay
person, it sounds like it ought to be sufficient.
Mr. Hains: It is just that the standard is too vague. No one knows what it does
and it may vary from one case to another. With the vagueness of the standard
and what may be required to satisfy it, and with the risk of personal
liability, the trustees were not even interested in investigating how they
might exercise due diligence.
The Chairman: This takes us back to another issue that we looked at for you
people a few months ago. I am going to the broad issue of corporate governance,
not the Bankruptcy Act, and my colleagues may want to comment on this. It was
clearly argued before us, by both lawyers and senior executives across the
country at the time, that the due diligence defence would be adequate to ensure
that directors would not be personally liable for some of the things for which
they are now liable, if, in fact, they had clearly exercised due diligence.
Many of us who are directors were at peace with that recommendation. Are you
telling me now that the due diligence defence is not worth the paper it is
Mr. Hains: I have two comments. First, environmental laws across the country
provide for due diligence, as they should from a public policy point of view,
because those laws deal with the owners or managers of the business. They
should be diligent when they run their business and manage their business to
ensure that they satisfy environmental regulations. Here we are talking about
for-fee professionals whose job it is to try to salvage the business, if not
liquidate it. They are different from the owners or managers of the business.
Secondly, due diligence is reasonably safe to exercise in instances such as
discharging due diligence for redemption of shares and things like that, because
people have the feel for what they need to do to show due diligence. In the
area of environmental liability, and the Bata case comes to mind, it is pretty
risky business. Again, it is risk versus the exposure element, but perhaps my
learned colleagues may wish to add something.
Mr. Marantz: The main point with due diligence is that in a financial area, such
as directors' responsibilities, the guidelines are fairly clearly defined and
understood. When you come to an environmental issue, due diligence is industry
specific. If you have an apartment building with a trash compactor, due
diligence is different from the way it is if you are the receiver of a paper
mill. Because the standards are so industry specific, the professional trustees
tried to write a due diligence standard, but it was meaningless and unhelpful.
In response to that, the amendments to the bill were reached in consultation
with the CCME, the Canadian Council of Ministers of the Environment, and there
is now agreement across a broad sector as to how we set the standard.
Mr. Hains: There are three elements, therefore, to the proposal in Bill C-5. The
first element deals with standards of personal liability for insolvency
practitioners. We are replacing "due diligence" with "gross
negligence or wilful misconduct".
The second element of the proposal in Bill C-5 is that, when trustees are on the
premises and they are issued a cleanup order by a regulator, they will have
four options, two of which exist now in provincial and federal environmental
law. First, they can comply with the order, in which case it becomes a cost of
administration and ranks high up in the preferred claim. Second, they can
contest the order. They can say, "We do not agree." Then it will go
to the relevant court to be debated.
Bill C-5 then adds two more options. The first is the possibility for trustees
or receivers -- insolvency practitioners -- to seek time from courts to say, "I
need to assess the economic viability of the proposal." Regulators would
be there to say, "There is a health hazard; therefore, you have 24 hours,"
or "You can take two to three weeks." The court will give that time.
Moreover, knowing that the bill will be too expensive and will not be
economically viable, the trustees are then out of it and can abandon that piece
of property subject to the order.
That is when the third element of the proposal kicks in. For the first time, the
Canadian Bankruptcy and Insolvency Act will give environmental claims an
absolute first-rank priority over banks, over all secured creditors, over the
real property that is the object of the order, plus any contiguous property
related to the activity that caused the contamination. They will have an
absolute super-priority, recognized in law, over the banks. A super-lien.
The Chairman: It also ranks ahead of wages, I presume.
Mr. Hains: That is right. It is on this real property. Those assets would go.
You have to compare that to the current situation. What happens now when a site
is abandoned like that? A trustee would never go in. A trustee would say, "I
am out of here," and the site is abandoned.
What is happening now has to do with legal chaos and a vacuum. No one knows who
holds the title or who is responsible for cleaning that up. If the regulator
cleans it up and restores the land to a marketable value, technically, the
owner of the land still has the title, not the regulator. Well, this proposal
will clear that up. It will stipulate that whoever owns that property has an
absolute super-priority. The proceeds from selling this clean asset will first
go to reimburse society for the cleanup.
The Chairman: I want to be sure I understand your underlying philosophy. I
totally agree with your issue of protecting the trustee. What is your rationale
for giving environmental claims a super-priority? Is that because the
environment is now the "flavour of the year" or the "flavour of
Mr. Hains: It has that benefit as well. This is a recognized benefit. However,
the prime objective is to encourage insolvency practitioners to get on the
premises and salvage a business which might have environmental problems. If
they cannot salvage the business, they will liquidate it.
The Chairman: I do not understand how it works as an incentive. A suspicious
part of me says that, because the Crown would pay to clean up the environmental
damage, the Crown, as usual, is taking care of itself by giving itself
super-priority. Is that just my inherently suspicious mind, or am I
Mr. Mendelsohn: Perhaps we can shed some light on that, Mr. Chairman.
If the site is environmentally damaged to begin with, it is damaged goods
already. From an economic point of view, that super-priority is there, not
because the law says so, but because that property cannot be dealt with by
anyone without first addressing the situation of contamination. All this
provision does is to recognize that reality and create an orderly context in
which the situation can be played out. If there is net economic value to the
property after the contaminated situation is dealt with, this super-priority
will be irrelevant, because the owner of the property, or the bank, if it
forecloses, will have to attempt to clean it up anyway. This creates a situation
such that when there is no net economic value to the property, the Crown or the
authorities have a legal instrument through which to take possession of the
property and deal with it. We think it is really economically neutral.
Senator Angus: Let us assume that a small business owns a service station and
there is a fire. There is contamination due to seepage through cracks in the
concrete tanks, and the company has gone belly-up. The people have disappeared
and the bankruptcy is being resolved. Would this be a case where people would
be able to move in and clean up the mess?
Mr. Mendelsohn: Yes, indeed.
Senator Angus: That would rank first over all claims, over income tax and any
other claim. Someone has made a value judgment there.
Mr. Mendelsohn: Remember that when we talk about ranking first before income tax
and so forth, we are talking about real rights. It is only over the real
estate. It would be ahead of the mortgage.
Senator Angus: I think that is a key point.
The Chairman: That helps a lot.
Mr. Marantz: The issue is: How do you convert the real estate to cash? It has to
be sold, but anyone who buys it has to deal with the problem.
Mr. Hains: Mr. Chairman, I said there were three elements. I have just looked at
my notes and I find that there is a fourth element and a fifth element. They
are also very important, Mr. Chairman.
Senator Angus: There were the commercial leases, the environment, and what was
the third element?
Mr. Hains: Within the environment, I mentioned three: lowering the standards to
wilful misconduct, the four options to deal with a cleanup once a cleanup order
is issued, and the super-lien.
If the super-lien is not enough to reimburse the Crown totally, the unsatisfied
claim would now be recognized as an ordinary unsecured claim on the remainder
of the estate of the bankrupt enterprise. That is the fourth one, which is
important. It is a net gain for environmental regulators.
Senator Meighen: Is that just for the capital amount, or does interest run on
that as well?
Mr. Hains: It is the cleanup cost, and I think that is to be defined. I do not
think we define it here.
Mr. Marantz: Interest under the Bankruptcy Act does not run after the date of
Mr. Hains: The last and fifth element, which is not specific in Bill C-5 but
which is obvious, -- and, again, the environmental regulators wanted some
assurance in this respect -- is that once practitioners are on the premises,
they fall under environmental laws. If they see something, they must report it
to the environmental regulators right away. Nothing here will diminish that
Mr. Hains: The third element, Mr. Chairman, with respect to the commercial
reorganization of businesses, concerns directors' liability. I know that you are
very interested in this subject. The objective is to ensure that when a
business becomes insolvent, the directors are the ones who must, first and
foremost, make the difficult decisions and suggest that the creditor, for
example the Crown, receive less than he is owed in order to salvage the
Senator Meighen: Instead of stepping down immediately.
Mr. Hains: That is my point. Directors often leave themselves open to further
legal action as a result of the creditors' losses. Instead of fighting to
salvage the business, directors often do not want to assume too big a risk.
They abandon ship as it is set to go down.
In addition, the proposal in Bill C-5 does three things. Pursuant to section 101
of the Bankruptcy and Insolvency Act, directors must be satisfied that the
business is solvent before buying back shares. This is known as absolute
liability. We are amending this provision to read with "due diligence".
We are doing this for directors in case of insolvency.
Senator Angus: This is in the declaring of dividends that would impair the
Mr. Hains: That is right. In clause 101 of the BIA, it is an absolute liability.
You have no defence whatsoever. We will now say, "The directors had
reasonable grounds to believe that when they made that decision it was solvent."
Senator Angus: Because management told them it was.
Mr. Hains: That is right.
The Chairman: The thrust of that change is absolutely consistent with the thrust
that we gave you on corporate governance?
Mr. Hains: Yes.
Senator Angus: With regard to giving a disincentive to resign or an
encouragement to stay on and help salvage the failing enterprise, has there
been an attempt, in coming up with this proposal, to harmonize the 150 laws
which impose responsibility on directors for things related to environment
and/or insolvency? Those laws are quite controversial and not well catalogued.
Mr. Hains: There is a developing standard in the CBCA, for example, and in
federal financial legislation, that defines "due diligence" in some
ways. It says that you must have been as reasonable and prudent as a reasonable
person with your expertise would have been in the same circumstances. This is
the standard that not only federal statutes but also provincial statutes are
now trying to adopt. They are trying to use the very same phrases in order that
the courts have something harmonized to deal with.
Senator Angus: The most onerous and identifiable statutory liability imposed on
a corporate director under present legislation is the liability for unpaid
wages. The irony is that these provisions were not in the Bankruptcy Act but
were in the Companies Act and other acts. That is what my question is directed
Mr. Mendelsohn: Perhaps this is anticipating Mr. Hains' next topic, but there is
a first step in this revision, according to which, up until now, the only party
in favour of whom debts could be compromised was the debtor himself. It is now
suggested that the proposal contain a provision to include a compromise of the
debt, not only for the benefit of the debtor corporation, but also for the
benefit of the directors, who are statutorily liable. If you take the example
of a wage claim, it would be possible, not only to compromise the unpaid wages
in favour of the corporation, but also to get the directors off the hook by
having the corporation pay whatever is proposed.
That will form part of the proposal. It is part of what is voted on. Presumably
the employees can vote for or against, but the directors can obtain relief
through that mechanism.
Senator Angus: That is in the case of a proposal, but what if it is voted down?
Mr. Mendelsohn: If it is voted down, the company is bankrupt and that is it.
This addresses itself solely to statutory liability; not to contractual
liability. You cannot blow off a director's or a guarantor's guarantee through
Mr. Hains: To return to why there are proposals here dealing with directors'
liability, it is to encourage directors to stay on as opposed to resigning en
masse and to favour reorganization as opposed to liquidation. For liquidation,
they have liability. For proposals, they can make a proposal to classes of
creditors, which would include their own personal and statutory liability.
It is again providing an incentive to favour --
To favour reorganization over liquidation of the business.
Senator Meighen: Suppose this operates to encourage them to stay on. They stay
on; they make a proposal; the proposal is defeated; they are now in bankruptcy.
Are we now back at square one?
Mr. Hains: That is right.
Senator Meighen: Why would I want to stay on with the chance of the proposal
Mr. Hains: Many people have asked us whether it will work.
Senator Kenny: Why would any creditor accept a proposal that kept the board
fireproof in any way? You would keep their feet to the fire right to the very
Mr. Mendelsohn: You must bear in mind that this compromise only relates to the
past and not to the future. Often one is faced with a choice. For example, if
it is wages, do you accept the compromise, have an ongoing entity and still
continue to earn wages? Or do you bankrupt the company, retain your recourses,
but lose your jobs?
Senator Kenny: These are folks who have not been earning wages for a while.
Mr. Mendelsohn: The act tries to create a context in which people can act with
Senator Meighen: I had better be as good a campaigner as Senator Kirby to ensure
that I will win my vote.
Mr. Hains: I think Mr. Mendelsohn is talking about a situation or crisis where
insolvency results in the closure of a business and in job losses. The unions
will have a very difficult decision to make: Should they allow the collective
agreements to be reopened? Workers will also have a very difficult decision to
make: Do they want to keep their jobs and in the process lose $200 or $300? The
outcome will be dictated by the market and by the negotiation process.
There is no clampdown so it is creditors who will decide what is best for them
owing to the proposal on the table.
The Chairman: To pick up on Senator Meighen's point, let us take the specific
example of the PWA bailout of directors. I am not at all clear as to how this
proposal would work, if the protection disappears if the proposal is defeated.
Perhaps you can tell us how it will work, because some of us may, sooner rather
than later, be in that position.
Second, if the proposals that the committee put forward with respect to
directors' liability under the CBCA were enacted, what impact would those
changes in the CBCA have, if any, on the Bankruptcy Act? In other words, have
we picked it up in one place even if it is not here?
Mr. Hains: The CBCA applies to federally incorporated corporations.
The Chairman: I will make it easy. I understand that if it is a non-CBCA
company, it does not have any impact. Suppose it was a CBCA company. If our
proposals on corporate governance had been accepted and these changes had been
made, which would prevail?
Mr. Hains: Both would prevail.
The Chairman: Both cannot prevail. One must be before the other.
Mr. Hains: If I understood correctly your proposal under the CBCA, you are
proposing to replace the current reliance on the "good faith" defence
now in the CBCA with a full "due diligence" defence. Their being
accepted in the CBCA is still the standard. When CBCA corporations become
insolvent, the rights of workers are contained therein. The directors have a "due
diligence" defence, a mechanism which they can use to defend themselves.
However, workers' rights are also found in employment and labour standards in
provinces in which CBCA corporations might have done business. I do not know
what is contained in those employment and labour standards laws. The majority
of them have "due diligence" defences; others do not. The ones which
do not, have an absolute liability which extends not only to wages and salaries
but also to the "primes de départ." For instance, that is the
case in B.C. Both would apply to directors.
Suppose that in your example the proposal before you would also be law.
Directors could then say, "If the proposals fail, I will be facing these
liabilities. If I am to stay on, I will try to work a deal that will be
acceptable to the creditors." I think this is an incentive to work a
compromise among the directors, corporations and employees. However, if it
fails, I recognize your first point, which is that directors are subject to
The Chairman: Take me back to PWA and tell me why I would stay.
Senator Angus: With PWA, they set up a trust fund. They took the money out of
the company, which probably caused its insolvency.
Mr. Marantz: There are a number of problems. PWA is a good example with regard
to any business. Generally, you find the employees are paid currently in any
business of any size, certainly one that is contemplating a reorganization
plan. They get paid every two weeks. If the company fails at any given point in
time, there are probably three weeks of wages in arrears. That is what you are
looking at, plus accumulated vacation pay.
If a company does a plan, the proposal has to provide for the payment of wages
in priority, but only to the measure prescribed under the Bankruptcy Act, which
is not a great deal of money. Thus, you do have this risk. As a practical
matter, the directors take a risk of carrying on the business when they know
that the company is insolvent. There is a question as to whether they have
exercised due diligence, if they have not set up a trust fund.
The Chairman: Let me try to put my question simply. Mr. Hains said that the
public policy rationale for this proposal was to persuade directors to hang in
there to help solve the company's problems and to make a proposal for the
solution. In response to a question from Senator Meighen, Mr. Hains said that,
if the directors make a proposal and the proposal is defeated, then the
liability comes back on the directors.
Since that scenario has some not insignificant probability of occurring, my
sense is that you have not given directors a good incentive for hanging in
there. If that was the intent of the public policy, my guess is you missed it.
Mr. Marantz: The section is flawed in that respect; I do not disagree with that.
The Chairman: How do we fix it?
Mr. Marantz: The next question is this: If they go forward and there is a
failure, did they exercise due diligence in the circumstances so as to avoid
personal liability? I do not know the answer to that question.
Senator Meighen: In going forward?
Mr. Marantz: Yes.
Senator Meighen: There are two stages. The first stage is: "We got into
Mr. Marantz: Before you even get to the proposal, the proposal is rejected, it
goes down; they may have been in there for three or four weeks or three months.
You will be stuck with the last three weeks of wages again. Did they exercise
due diligence in carrying the plan forward? I do not know the answer to that
question. There is probably a good argument that they did, unless you
specifically provide that there is no personal liability on directors and
officers for these claims in the event that they file the proposal and the
proposal is defeated.
Senator Meighen: Unless they are guilty of gross negligence.
Mr. Marantz: Yes. Then, of course, you will encourage directors and officers,
when they are at risk of exposure, to file a proposal.
Mr. Hains: At the beginning, Mr. Tobin said that the proposals here are based on
recommendations made by BIAC, the Bankruptcy and Insolvency Advisory
Committee. Private sector experts, business and consumer people, worked with us
to develop these proposals. Mr. Tobin also mentioned the steering committee and
the eight working groups. One of the eight working groups dealt with directors'
liability. I stress that these groups were made up of private-sector senior
people, such as lawyers and people from the lending community, and so on.
Their conclusion was the same as yours, Mr. Chairman, namely, let us not pretend
this will solve all those problems. However, it is a step in the right
direction, one that might work in certain circumstance -- although perhaps not
in the PWA case; I do not know. I am not familiar enough with that case.
Senator Meighen: More important, it will not make the risk any greater.
Mr. Hains: That is right.
Senator Meighen: If it does not make it any greater, then you might as well give
it a try.
Mr. Hains: That is right.
My two colleagues know better than I that it is being done now under certain
CCAA cases in which directors have made part of the CCAA proposals a proposed
settlement of their own personal liability as directors. That has been
sanctioned or not by the courts and approved or not by creditors. In many
cases, it has been approved. In some cases it may work.
Mr. Tobin: To return to Senator Meighen's point, not only does it not make it
any worse, as he described, but perhaps you have introduced a regime, albeit in
a limited fashion, that would allow the directors to be willing to take a
second look at it, and during a period of time for which it does not get any
worse than what you have described. To make it foolproof, you will probably
have to absolve them of all liability. I do not think that is something that
would be accepted by the community at large.
Senator Angus: In the committee which dealt with directors and which had the
private sector input, there may have been proposals that went further than you
have gone in Bill C-5. I may be wrong in that regard. However, since the next
review is contemplated to be in five years, there is an analysis of directors'
liability going on. It is generally recognized, certainly as far as I know,
that the present law is unsatisfactory, especially with the increase of suits
against professionals and so on. Would this not be the time to go further
rather than have a "première saucette" sort of thing in this
After I read the press release and some other documents about Bill C-5, I was
surprised that you did not go further in terms of directors' liability.
Mr. Hains: There were not many other options contemplated by the BIAC working
group. Some other options that were contemplated were contemplated by this very
committee in your corporate governance deliberations. Capping liability, for
example, was also debated in that BIAC working group. It was considered whether
or not there should be a BIA amendment capping that. They came to the same
conclusion to which your committee came, namely, that this is not the way to go
at this time.
They recognized what your chairman was saying, namely, that in some cases it may
not work and in others it will, such as this five-year review, which was seven
at the time. They want to continue working at that to see what the experience
under the new provisions will be. They want to see when it will work and when
it will not work. Based on that knowledge, perhaps the next time round, they
will improve the process here. Their recommendation, which the government
accepted, was to go this route for the time being.
The Chairman: I assume that each of these working groups gave the government
some sort of report or document.
Mr. Tobin: Yes.
The Chairman: Could we have a copy of the report given to the government on this
specific point? I presume that the document contained other options. We would
like to look at it ourselves.
Mr. Tobin: We can send it to the clerk.
Clauses such as the five-year review clause are put in to try to ensure that it
will be looked at, at least within that time frame. Of course, if a crisis or
something precipitates or requires a more hasty examination, there is nothing
to preclude that.
We made these recommendations because these laws were not being looked at for
up to 10, 12, or 20 years or longer. There was a feeling that in today's economy
we had to try to guarantee some sort of re-examination within a minimum period
Mr. Hains: With regard to directors' liability, another major area that Bill C-5
is proposing to amend is the Companies' Creditors Arrangement Act.
The objective of this long series of amendments to the CCAA is to bring it more
in harmony with the commercial reorganization provisions of Bill C-5. I will
mention just a few.
One is to adopt similar financial disclosure requirements on debtors wishing to
reorganize under the CCAA, such as those with which debtors must comply when
they try to reorganize under the BIA. Initially, it is up to 30 days, similar to
what you have in the BIA, and a second application is required to extend that
under the CCAA.
The stay exemptions say that eligible financial contracts -- swap agreements,
letters of credits, guarantees and that sort of thing -- cannot be stayed under
CCAA. That was very vague. Some court cases had stayed them; some others had
not. The BIA says no, those cannot be stayed. Therefore, the CCAA is being
harmonized with the BIA.
With respect to extension of credit and supply of goods, the provisions adopted
will be similar to the BIA, whereby creditors and suppliers will no longer be
obliged to extend further credit or supply goods on credit once the
reorganization regime, the statutory regime, is in place.
The Crown claims that provisions of the BIA are being mirrored in the CCAA.
Previously, the Crown could not be stayed under CCAA. Now they will be, to a
similar extent as under the BIA.
To avoid forum shopping as between one regime and the other, Bill C-5 proposes
to harmonize the proportions to approve proposals. It is three-quarters now of
creditors in the CCAA and two-thirds in the BIA. We are harmonizing at
We are also adopting similar standard forms. Those I just referred to as
proposed under the BIA in the area of environmental liability and directors'
liability will also be made under the CCAA.
The last major amendment to CCAA which is being proposed now is to put a
threshold to be eligible to access CCAA reorganization. That threshold proposal
is $10 million. Debtors must have at least a $10 million liability threshold.
If they are under that, we are trying to force the SMEs to come within the BIA
regime and leave the more flexible CCAA to the larger, more complex financial
Senator Angus: Is it desirable that there be the two regimes? Many members of
this committee have asked why. We also have the Winding Up Act with financial
institutions, and CCAA, which in very general terms in the mind of the lay
person is Canada's version of Chapter 11. Would that be a fair analysis of it?
Mr. Tobin: As we said before, we have tried to amend the Bankruptcy Act on many
occasions; during the 1992 deliberations there were some serious questions
raised as to whether we needed to keep both the CCAA and the BIA. It was felt
that if we were to be successful in trying to amend the BIA, then we should
deal with the BIA and amend it, with the realization that we would look at it
again in 1995.
When it came up again in 1995, it was felt that, yes, we need two different
statutes. In some cases, you have a situation where the court involvement must
be much more active and flexible. You need that type of arrangement. It is
difficult to spell out in precise detail everything that would be needed to
accommodate large regimes or large bankruptcies. It was felt we should keep
them both. However, in the second step, we said we should harmonize where we
could harmonize and try to prevent forum shopping, or going from one track to
the other. We would try to define a threshold, by which we could say that, if
you were below a certain level, you would be directed to that.
It is difficult to say if the two statutes will eventually be merged in the long
run. We have tried to reduce the anomalies between the two of them and quantify
who would qualify for one statute versus the other. I am not sure if you could
say in five years hence, when the next review comes up, whether someone should
say, "Let's roll them in." You will always need a regime of some sort
to deal with those complex cases that require a great deal of court
deliberation, with both parties intervening and having the court make a
determination based on those sets of facts, as opposed to one that spells out
the details in the statute.
Senator Angus: As one of the first to use that CCAA in the early 1970s, I found
it was a sort of dust-covered law that was brought in in the 1930s in special
Mr. Tobin: Yes.
Senator Angus: People were saying, "What is this?" I was expecting, in
this step of the revision, if not in 1992, that we would have gone much
further; I thought we might have started from scratch to have something akin to
the American model. I know it is rather anathema to suggest we have the
American model; however, Japan has the American model on reorganization. Even
though I have a bias against the U.S. thing, I keep seeing successful Chapter
In terms of your guiding principles with this legislation, why would we not have
gone to the drawing board and had a new statute? We still have a lot of the old
anomalies in the CCAA. It is sort of a square peg in a round hole type of
Mr. Tobin: It might be useful to ask Mr. Mendelsohn or Mr. Marantz for some
comparisons to Chapter 11, which is being re-examined in the U.S. because of
some of the difficulties they have had with it.
Mr. Marantz: The Chapter 11 process in the U.S. does not require a debtor to be
insolvent. Our system requires insolvency. There is a real difference.
The Chairman: I must pick up on Senator Angus' point about the basic principles.
Forget about asking why we have not followed the American model, because that
may throw an element of prejudice into the answer. There is a public policy
reason why the American model does not require insolvency. I presume that we do
not agree with that reasoning. What is the reason, and why do we not agree with
Mr. Marantz: In Canada, there is the existence of contractual right, which is
recognized by the courts and protected. Thus, any provision for proposals or
CCAA interferes with contractual rights. There has been a lot of discussion
about how the United States regime is debtor-friendly -- indeed, so much to the
prejudice of creditors that it skews the system.
The success ratios under Chapter 11 in the United States are very small. Some
studies that have been done recently, which go back a few years, show that
there is not a high ratio of success.
The Canadian regime is much more strict, imposes more discipline, and has a
higher success ratio because of the rigors of going through the system. There
is not much favour in the insolvency community -- lenders, trustees, and
lawyers -- in adopting a U.S. model, which is overly technical and has reams
and reams of special exemptions dealing with special interest groups. It is not
a statute of general application because so much has been carved out.
There is a real view that in Canada we have a better system. That is not being
chauvinistic. We have a better system that facilitates the organization. There
is a considerable amount of discretion given to the courts in dealing with it.
We should point out that when we were working on what to do with the CCAA, and
I was part of the process, we met with a number of judges who were active in
CCAA and bankruptcy. They all encouraged us to keep the statute on the books
because they did not want to throw out the baby with the bath water. We knew
how it worked. The rules had become much more formalized. The courts had a
better understanding of it, and they said, "Do not get rid of it until we
know that the Bankruptcy and Insolvency Act is capable of dealing with the
problems that we get."
We are not saying that it should stay forever, but we are gradually trying to
harmonize the legislation.
Senator Kenny: If I heard you correctly, you said that in the United States the
rules are skewed for the benefit of the debtor as opposed to the creditor, and
they have a lower success rate at the end of the day. Without having examined
the figures, it would seem to me that, if you are skewing the rules to the
benefit of the debtor, you are giving them an opportunity to stay in business
longer and an opportunity to keep the operation working more and eliminating
the likelihood of some mean bank or unreasonable creditor pulling the plug and
saying, "Sorry, but I'm out of here, because I am at the top of the list."
I do not follow your reasoning.
Mr. Marantz: That ignores the issue of economic viability. Many businesses may
not be terribly economically viable, but they continue to hang on. The system
here is much more rigorous.
Before we ever had reorganization as a fashionable thing, there was a form of
reorganization known as receivership, which was fairly brutal. The banks would
go in and sell off the assets as a going concern to a buyer who would in many
cases continue the business. That was fairly brutal. Why should the equity
shareholders in the business have any remaining stake in it if they got it into
In the States, the system is skewed towards not just the business but the
shareholders or the management who may have caused the problem.
Senator Kenny: Are you saying that the shareholders are taking the money and
running, or are they taking more time and having a greater opportunity to put
things together so that there is a working entity at the end of the day?
Mr. Marantz: Or are they just taking out salary and perks as they go along in
the hopes of getting all they can out of the business?
Senator Kenny: You are saying that Chapter 11 lets you take out perks?
Mr. Marantz: Chapter 11 lets the thing stretch on, sometimes for years.
Senator Kenny: People are getting paid a salary and they are still working and
the business is still functioning. That sounds to me like people are still
employed. So far the story is good.
Mr. Marantz: There is a fallacy there, because you are assuming that, if there
is no reorganization, then there are no jobs, but in many cases the business is
Senator Kenny: But there is an "end of the day" under Chapter 11,
Mr. Marantz: And the businesses often fail.
Senator Kenny: You are quite right. It is a question of a soft landing or a hard
landing, an early or a late landing. You can make a great case for a soft
landing, particularly if you are a participant.
Mr. Marantz: The debtors' point of view is always different from the lenders', I
Senator Kenny: Are you saying that lenders are worse off under Chapter 11,
Mr. Marantz: I could not say "consistently", but lenders are treated
better here and work on a more level playing field than in the United States.
Senator Kenny: If you are high on the list and you are well secured, it is kind
of nice to sell out immediately and cut your losses. Having said that, perhaps
it should be part of the deal to keep players in the game and to keep
management in place or to keep some folks in place so that this entity may
The complaint here is that the best-secured creditor walks away happy, but with
a whole list of losers behind him, because the game did not last long enough.
Had it kept up a little while longer, they might have come out whole or at
least with a few more cents on the dollar.
Mr. Tobin: We should not fall into simply comparing Chapter 11 with CCAA. The
thrust of the Bankruptcy and Insolvency Act was reorganization. I would argue
that that is exactly what you have said: How can you design insolvency law to
have things reorganized and to have jobs preserved and so on?
There is a whole series of measures spelled out in the BIA to say that creditors
shall be stayed. They do have recourse in cases of abuse, where those stays can
be lifted. The CCAA allows both parties to go to the courts and have the courts
rule on issues based on the facts at the time, as opposed to laying them out,
which we did do in the BIA.
I do not know the number of cases of CCAA versus BIA recently; however, the
thrust of insolvency legislation here is reorganization -- in other words,
preserving the jobs.
Mr. Marantz is saying that there is a different starting point in Chapter 11
compared to CCAA. We must remember, though, that CCAA does not represent all of
the cases of insolvency in this country. In fact, we are trying to say it will
represent only the larger ones and the smaller portion of them.
Senator Angus: Arising out of what you said about the threshold of insolvency,
there are cases now that are very high profile in this country.
What is the definition "insolvency"? Is it being unable to meet your
obligations as they come due in the normal course of business?
In the case of CCAA, why did you not decide to have other conditions of entry?
Then maybe you could get in there sooner and get some of the senior debt to
Mr. Marantz: You would have a constitutional problem, because bankruptcy and
insolvency legislation is under the federal domain. The CCAA can only operate in
an insolvency situation.
Senator Angus: That is a very good answer.
The Chairman: We have been marginally side-tracked, but since we are discussing
comparatives in the U.S. with Chapter 11, I would ask a related question.
You have not included in any of these changes any elements of the cram-down
provisions which exist in the United States. Why?
For the record, perhaps you should explain the cram-down provisions. Then tell
us why you rejected that concept.
Mr. Marantz: It was not so much rejected as never considered on the table.
The Chairman: That is interesting. For the record, explain the cram-down
provisions and then come back to why.
Mr. Marantz: In a cram-down in the United States, every single secured creditor
can constitute a separate class. If a subordinate or junior creditor gets less
than its entitlement under its contract, then the creditor above him can be
forced to take a compromise.
The Chairman: That would be enforced by the courts?
Mr. Marantz: That is right. That creditor would then get an equivalent value in
terms of the pay-out under the plan. It forces the debtor to deal with each
individual creditor or class of creditors on a separate basis. Generally, that
means individual mortgage lenders.
Basically, the Canadian system provides that creditors, be they mortgage lenders
or whoever, are put in a variety of classes. If the statutory majority votes in
favour of a plan, then those who dissent are brought into the plan whether they
like it or not.
The Chairman: They are forced in.
Mr. Marantz: Yes. In one case, there is a specifically tailored solution for one
creditor. In the other case, the minority is forced to go along with the
majority of the group.
The Chairman: What are the disadvantages of the cram-down provision, which you
say was never considered.I find that surprising.
Mr. Marantz: The big problem with cram-down is that it gets the courts into the
process of valuing security and claims. It forces them to make estimates of the
value of real estate, and other things. Traditionally, our courts have not gone
into that exercise.
Mr. Mendelsohn: Mr. Marantz said earlier that the U.S. Chapter 11 system is very
debtor-friendly. It is even more lawyer-friendly.
One eminent accountant-trustee once described the Chapter 11 system by saying, "Everybody
goes to court, where they thrash around for three or four years until all the
money is gone, and then they go home."
Here in Canada, our system is less court-driven. We hear about the high profile
cases, which succeed under Chapter 11 in the U. S. and under the CCAA here in
Canada. The vast majority of commercial reorganizations, however, happen under
the BIA, where there is relatively limited court involvement. The process is
not as cash-voracious as the CCAA or Chapter 11 process. As a result, many
reorganizations get done which could never get done because they are too complex
and expensive under our large corporation system, the CCAA, or under Chapter
Mr. Hains: The next major area is a complicated area of securities firm
insolvencies and the need to have modern and efficient rules in that area.
The issue here is that, whenever a securities firm becomes insolvent, the
current rules are very archaic, responding to 30-year old situations where the
vast majority of securities instruments were registered in the name of the
owners. Today, that is not the usual case.
I may have to turn to one of my colleagues to assist in answering your
questions. However, Bill C-5 is proposing to do away with the impossible
situation of having to trace the owner. A pooling of the securities assets of
the securities firm should be done.
The first pool would contain situations where 1920s securities certificates that
are registered to names would go back to the owners. The second pool is the
vast majority, those who are not registered. These would be pooled and
distributed on a net-equity basis, and any deficiencies would be covered by the
Canadian Investment Protection Fund.
The Chairman: By "net equity" you mean "pro rata"?
Mr. Hains: That is right.
The third pool would be furniture and other kinds of assets, which would follow
the BIA list of distributions. If there are secured creditors there, they will
be paid first. We then go into the preferred classes of creditors, and so on.
This will require extra powers or special powers for trustees to move in fast
and to legally take possession and do these poolings. This also requires the
involvement of the securities commissions and Canadian Investors Protection
Fund, and so on. That is the proposal on the table.
Senator Meighen: I wish to ask you about the second class. These are the ones
where the ownership could not be readily identified.
Mr. Hains: That is right. It is not registered in a given name.
Senator Meighen: It is registered in a street name?
Mr. Hains: It is through intermediaries and all kinds of things.
Senator Meighen: Would an attempt be made to register or would they be
Mr. Hains: Let me explain how it works. This pre-supposes that there are
customers who have entitlement to the following shares, and there is a whole
list; one is IBM; another is AT&T, and so on.
Under the old tracing system, if there were enough IBM, all the people who were
entitled to IBM would get it. If they were short on AT&T, someone would
figure it out and they would take the loss. Here we do it differently. You find
out if there is less than there is supposed to be and the loss is shared
amongst everyone, regardless of whether someone's particular entitlement could
have been covered.
Senator Meighen: Is this in addition to any insurance that the securities firm
Mr. Hains: That is before the insurance is taken into account.
Mr. Marantz: Then you have the Canadian Investors Protection Fund that steps in
and makes up the shortfall.
Senator Meighen: This proposal sounds dauntingly complex in detail, but not so
complex in its basic principle, which Mr. Hains explained so well.
Was this supported by your advisory committee?
Mr. Hains: There was a working group on this subject only. BIAC Working Group
No. 3 spent two years on this. The Canadian Investors Protection Fund was also
There were some technical amendments to some definitions of instruments that
were made in the other place, inspired by the brief from the Quebec Security's
Commission, and things like that.
Senator Meighen: Essentially, it was as recommended?
Mr. Hains: That is right.
The next subject is international insolvencies with globalization and, as more
and more Canadian businesses might have assets in other jurisdictions and vice
versa, this is becoming an issue. This did not just become an issue yesterday;
it became an issue a few years ago.
Canadian courts have had to deal with that in the area of recognizing, for
example, foreign representatives. This area expands on what we do in Canada
when there are proceedings going on in other jurisdictions.
Bill C-5 is a first attempt at addressing this situation by codifying the court
cases that we have had over a number of years, by providing for court
recognition of foreign representatives, and by providing Canadian courts with
clear authority. It will now be clear in law; authority will be in place to
facilitate or coordinate international insolvencies.
Once recognized by Canadian courts, foreign representatives would be allowed to
commence proceedings in Canada on the Canadian assets, but as per Canadian
rules. It would be either the BIA or CCAA rules applying, not chapter 11.
Senator Meighen: Are representatives defined? Can it be lawyers, trustees, et
Mr. Marantz: A person such as a trustee or a receiver would be defined.
Mr. Hains: The foreign stays of proceedings, for example, would not be
recognized or applicable in Canada.
Senator Meighen: Would that apply ipso facto?
Mr. Hains: Yes, ipso facto. The foreign representatives could apply, though,
under the BIA for the 30-day stays, and so on.
There was another BIAC working group by which the Canadian lending community
were well represented, where the point was expressed that Canadian assets should
first be used to satisfy Canadian creditors. This is what is being proposed
here, by recognizing at all times that Canadian rules shall apply -- BIA, CCAA
-- and not foreign regimes.
That is in the area of commercial re-organization.
Mr. Tobin: I have one point, which was raised by Senator Hervieux-Payette about
the number of amendments. About half of all amendments from a volume point of
view are technical amendments designed to improve the act. These improvements
would address drafting anomalies, allow for joint proposals from people who are
related parties and for counselling people in respect of bankruptcies.
Senator Meighen: What is great is that in five years we look at them again, and
these will not drift off as their predecessors did.
The Chairman: I would ask you about another area that you will probably want to
have answered by Mr. Mendelsohn or Mr. Marantz. This concerns the bankruptcy
process vis-à-vis incorporation, especially small businesses.
We will be having witnesses from the large accounting firms, who run the
bankruptcy practice, and others from banks, who deal with special loans groups
within the banks. It is important that we understand the process.
Is there adequate incentive, when a company has a loan which gets in trouble? Is
there adequate incentive for the banks to assist, or let's say the monitors,
bearing in mind that the company has not yet gone under? Is there adequate
incentive in the system to offer all possible assistance in order to get the
company back on its feet? Or, as my perception would have it for both the banks
and the monitors, is it the case that incentives in the system are skewed
towards "Let's put the company under quickly, thus getting rid of the
problem and getting our money out. We'll be selling off the bad loan at 60
cents on the dollar, so why do I care if I am the bank any more?" Then
saying to the monitor, "Yes, you can be the monitor, but, by the way, if
you are not successful and the company goes under, you can be the trustee."
As one of us said here one day, that is like sending your dog to a guy who is
both a vet and a taxidermist. Either way, you get your pet back.
One must wonder whether the incentives in the system are not heavily skewed
against the banks and the monitors really trying hard to work it out versus a
quick "Let's get it over with and it's done" policy.
Do you want to address that? I have some specific questions, and I have already
had some correspondence with Mr. Mendelsohn on this point, but would you like
to get into that discussion?
Mr. Mendelsohn: In order to do that, we must put it in historical perspective.
It used to be said that Canada was a secured creditor's paradise. In the 1960s
or the 1970s there was not only a perception but perhaps a reality of banks
making what we typically used to call midnight raids, where we would send in a
guy waving a piece of paper and saying, "Please pay $6,000,543.26, and you
have 42 minutes to do it." There used to be some old English cases that
said you were supposed to give the person enough time to go to his bank and get
the money. Then the receiver would come in and the assets would be sold
The reality is that there has been significant evolution and that situation does
not arise any more, for any number of reasons. I will return to the reasons,
but going ahead to how the law changed, the 1992 amendments created a quantum
leap away from that, to the extent that it was necessary because the evolution
had happened anyway, in that it provided for the ability of a debtor, which
never existed before, to send a notice of intention to file a proposal under
the BIA, which immediately and automatically imposed a stay on the secured
creditor. Everyone said, "That will be awful because secured creditors
will want to jump before that notice comes."
There is also a provision in the BIA that says that a secured creditor
exercising on a significant portion of assets must give a 10-day notice. In the
industry, that creates a situation of dynamic tension <#0107> that is the
best term I can use -- because the debtor knows that the creditor cannot jump
without giving the notice; there is no point in the creditor's being in a hurry
to give the 10-day notice, because he knows when he gives it that there are 10
days in which he can be iced anyway; so there is a significant incentive for
the parties to sit down together, haggle and come to a conclusion. The reality
is that it has helped tremendously in preventing receiverships.
There are a few other reasons why we do not see much of receiverships any more.
If you analyze it, this receivership stuff is a myth, because there are no
receiverships in Canada any more. There is a perfect defence against any
receivership in Canada happening. All a debtor must do is call up the banker
and say, "I need your advice. One of my foolish employees spilled some
horrible contaminating slop over all of the place and I don't know how to clean
it up." That person will never hear from the banker again, unless there is
There are also all kinds of statutory liabilities and priorities at play that
are not hospitable to the concept of receivership. Accordingly, virtually
everything that happens under insolvency nowadays happens within the context of
either the BIA or the CCAA. One must realize that we have become -- and we use
the term in reference to chapter 11 -- more debtor-friendly. We are a lot more
debtor-friendly than we used to be as a result of the changes in the BIA,
certain jurisprudence and the other factors that I have mentioned; but the
reality is that sometimes insolvent companies do not belong in business any
more. That is a reality. One cannot expect every company to be reorganized.
Some companies cannot be. Some enterprises must go out of business because they
are not viable.
Businesses that have a chance of becoming viable are getting a much better shot
at it nowadays than they ever got before. Banks are certainly less
trigger-happy in enforcement than they were before; very much so.
The Chairman: I think you gave a terrific answer, but I am not sure that you
addressed my question. I will narrow it to two specific areas. First, should
someone a bank sends in as a monitor also be allowed to become the trustee? In
that case, the incentive on the monitor to actually help the company work it
out is substantially less if they know -- to get to back to my vet and
taxidermist problem -- that the guy has the business either way.
My second question relates to the way fees charged by monitors are charged back
immediately to the company on an ongoing basis as opposed to being capitalized
and included in the bank's debt. Frankly, my experience when I was
restructuring the fishing industry, having dealt with a number of cases like
this, indicated to me that there is no incentive on the monitor, or indeed on
the bank, to minimize the amount of professional time that goes into the
monitoring process, since the fees immediately get charged directly back to the
company. It seems to me that some slight skewing of the situation by, for
example, not allowing those fees to be paid immediately, but rather having them
go into the debt owed to the bank, would help to minimize the literally
hundreds of thousands of dollars that frequently get charged against companies
that are hanging on by their fingernails. I do not want to criticize accounting
firms, but they are the typical monitors, and they come in and hit these guys
with a lot of professional fees, and there is no constraint on that. The bank
does not care how much is charged in professional fees, even though the
monitors are there acting on the bank's behalf, because it is not increasing
the bank's level of debt.
In those two specific cases, all the incentives work against getting the problem
solved and work in favour of putting the company under quicker than might
otherwise be required. Am I right or wrong?
Mr. Mendelsohn: Let me start with question one. It involves an issue to which I
have given some thought over the years. I have produced a few articles on the
Receivers and trustees are professionals, and professionals must act
professionally. Sometimes professionals do not act professionally and should be
criticized for it.
This kind of potential self-dealing manifests itself in every area of life and
the professions. For example, whenever someone approaches a lawyer in order to
obtain advice on whether to sue someone else, there could be a self-interest
issue on the part of the lawyer. If he gives the guy advice that legal
proceedings should be instituted, the lawyer has himself a case and a stream of
When someone goes to a doctor to find out why he has a stomach ache, the doctor,
if he is a surgeon, knows that, if he tells the patient he has appendicitis, he
will be the surgeon who will remove the appendix. No one would suggest that
there be a rule that the surgeon who gives the advice must be someone other
than the surgeon who performs the surgery.
When a monitor or a consultant is analyzing a situation for a bank, he simply
has to call the shots in the most professional way he can. True, an
unscrupulous monitor may hustle himself a receivership mandate. On the other
hand, if there is a rule that he cannot be a receiver, an unscrupulous monitor
may convince the bank to continue supporting the insolvent debtor so as not to
make a receivership and disqualify himself.
We must start from the premise that professionals are professionals and, equally
significantly, that the banking community -- the lenders -- are skeptical,
professional people themselves, who are able to call the shots in an intelligent
One of the realities is that the consultant on the spot learns where the light
switches are. This individual gets to know that business better than any other
person from the same profession will get to know the business.
If you create a rule, as I know one of the banks once did, to the effect that a
consultant cannot be the receiver afterwards, you create an artificial
situation in which, when it makes sense for the same person to perform the
function, the person cannot perform the function.
In talking to this group earlier today, I pointed out that in my professional
practice dealing with insolvency and receivership, in the vast majority of
cases where there was a consulting or monitoring situation which later became a
receivership situation, the same party was used, and this with the clearly
expressed consent of the debtor.
Senator Angus: To the advantage of everyone.
Mr. Mendelsohn: Yes. There may be cases where that is not right. There may be
cases where the chemistry is wrong between the consultant and the debtor. There
may be all kinds of cases where it is not appropriate, but I suggest that in
many cases it is appropriate. A policy preventing that dual role would be
constricting and not in the interests of anyone.
The Chairman: For the record, I should point out that the policy you just
described as restricting and not in the interest of many people is in fact the
policy of the Royal Bank.
Mr. Mendelsohn: Yes. The first of those articles that I sent you was written in
response to the policy of the Royal Bank. From time to time, various account
managers will go through hoops so as not to get caught by that policy -- and I
am not referring specifically to the Royal Bank -- but from time to time the
account managers make sure that they do not document the appointment of the
consultant so as not to get caught by such a policy. The point is that
sometimes it makes sense and sometimes it does not make sense.
The Chairman: That is a little like a discussion this committee had over the
issue of whether a CEO should also be chairman. The answer is that in the vast
majority of cases it does not make sense, but one wants some flexibility.
Perhaps you could move on to my second question, which disturbs me more than my
Mr. Mendelsohn: In those cases where the bank will take a haircut at the end of
the day, it is irrelevant. Let us start there. This is only relevant to the
extent that you have a company which in the final analysis will be able to pay
the fees to which you make reference. If at the end of the day they are not
able to pay --
The Chairman: But they pay it on an ongoing basis.
Mr. Mendelsohn: Yes, but whether they pay it on an ongoing basis or not, if at
the end of the day the bank takes a loss, the bank pays it even though it fools
itself into thinking the debtor is paying.
The Chairman: I am not sure about that. It is quite conceivable that several
one-hundred-thousand-dollar fees to consultants to be paid as an ongoing process
could easily be the trigger that ultimately pushes the company under.
Mr. Mendelsohn: That is true.
The Chairman: In other words, one issue is the magnitude; the other is the
timing. If that money were still available as working capital, cash flow to the
company, the fact is that the company might not be pushed under. Do you think I
am right or wrong on that?
Second, there is absolutely no incentive for the consultants sent in by the bank
to constrain and minimize the fees whatsoever, whereas I think the bank would
act as a considerable brake and disincentive for the spending of money if the
bank thought that money was being added to the bank loan.
Mr. Mendelsohn: In answer to the first part of your question, you are correct
that there can be an occasion or a set of circumstances where the burden of the
fees is the straw that breaks the camel's back and makes the line of credit get
used up when otherwise some of it might be available. It is certainly possible
that there could be such a circumstance.
I find it difficult to assess the degree to which the magnitude of the fees --
because I think what you are addressing is the magnitude -- is affected by the
fact that in one case it is the bank writing the cheques, even though it gets
added to the loan, and in the other case the debtor writes the cheques from day
to day. Frankly, I do not have an intelligent answer to that. I do not know the
degree to which that would be relevant. Certainly, there could be circumstances
in which it would be relevant.
The Chairman: If a financial institution lends a company money and then decides
that it needs to send someone in to look after its interest, should that cost
not be a cost to the bank as opposed to a cost to the company? After all, it is
something the bank is doing to protect its interest.
Mr. Mendelsohn: There are some market issues at play. It may be the kind of
situation where the bank says, "Look, as far as I, the bank, am concerned,
I am ready to call this situation quits. I am ready to call the loan. I am not
prepared to entertain the corporation's request, for example, for a facility to
take it through the next season." The bank may say, "However, if I,
at no cost to myself, am provided with the appropriate professional advice that
satisfies me that your request is a viable proposition, that may help the
situation along so as to urge me to make the funds available."
Again, there are some circumstances where what you suggest would work; there are
other circumstances where I think it would just frustrate the process and make
the banks more intransigent.
Senator Kenny: It may also be a situation where some ratio that the lender has
covenanted for in making the loan precipitates the bank to move. The company may
well be in functioning shape, but in order to get its loan or get its loan
extended or obtain some form of concession from the bank, it may have
covenanted to maintain certain ratios that become violated. The bank suddenly
finds itself in the driver's seat for the company. I am not sure that the
company is necessarily inoperable. In fairness, the company agreed to this
situation of artificial ratios in order to get the loan. The company went into
it with its eyes open.
I should like to return to your second opinion. I was comfortable with it until
you gave the operation analogy about whether you want the same doctor to
operate on you who suggested that you should have the operation. I, for one, am
keen on a second opinion. This goes back to Senator Kirby's comment about the
taxidermist and the vet. I have a real problem with someone being in both of
those professions or owning both of those professions. When you are talking
about putting someone under, I am not sure that the guy who is pulling the plug
or doing the assessment should have any interest in it.
You talked about the natural self-interest that folks have in life, whether it
is a lawyer, and so on. You can carry the argument on ad absurdum in talking
about a lawyer trying to sell his or her wares. That is one example.
Once you put someone in a situation where they will be deciding to pull the
plug, I think you get a much more objective view if it is clear to everyone
around that they do not have an interest in the play. I recognize that there
are problems. There is a transfer of information involved. There is the
difficulty of getting a second party up to speed on what is going on. Having
said that, there is a certain clarity if the plug is pulled by someone who does
not have any motives other than the case before him.
Mr. Marantz: I will respond to that by telling you about a situation from my own
experience. Some years ago I was acting for the Royal Bank in a very
significant transaction. They sent a monitor in to look at the business. The
monitor did extensive analyses and reports and came back with the suggestion
that the business should be supported by the bank and the difficulty should be
The bankers looked at the report of the monitors. They went all the way up to
the chairman's office and decided that the company should be put into
liquidation; they were not prepared to support it. The vice-president of the
Royal said to me, "You see; it's that damn policy. The monitor knows that
if there is a bankruptcy or a liquidation, he will not get the file. Therefore,
he recommended that it be worked out."
It works on both sides of the street, senator. There is no simple answer.
The Chairman: That is not my point. My point is this: Where should the incentive
lie? The doctor analogy is that we would all be suspicious of the surgeon who
also owned the only funeral home in town.
My concern is that in a competitive market for professional fees, in which
everyone is driving down the price for professional fees on everything,
professionals will go in to work on a company with no incentive whatsoever to
economize on fees. They do that because they know that they will be paid right
away and because it is not really costing the guy who hired them any money; it
is only costing the debtor money.
I think it was Mr. Mendelsohn who said earlier that one of the differences
between Canada and the United States is that our system is more
creditor-friendly, while the U.S. system is more debtor-friendly. My instinct
is that perhaps we have gone too far in being creditor-friendly and, perhaps,
there ought to be some incentive on people to behave in an efficient manner.
Clearly, there is none.
In my own experience, when we were restructuring the East Coast fishing industry
there were all kinds of examples where the monitor did all kinds of analyses
that, frankly, were not required. They got paid for it up front.
It is the balance in the system that is bothering me.
Senator Kenny: How do you legislate a bonus at the end of a successful workout?
Mr. Tobin: You raise a number of issues. As you know, the situations which you
describe involving the monitor are all pre-insolvency. The company is not
insolvent. The capability of the insolvency legislation to deal with that
situation is something that would have to be examined.
Under the scenarios you describe, you could take it further and say that the
company, or the enterprise, felt that the monitor placed by the creditor was
abusing the position in some way. You could then find yourself with the company
or the enterprise saying, "The monitor must get out," and then
confront the creditor with the proposal.
The Chairman: Let's be practical.
Mr. Tobin: The question is, senator, at what point are you assuming that the
bank, or the creditor in this case, really wants to close him down? That is
where it leads to.
The Chairman: Frankly, I am trying to put some considerable heat on the monitor
or consultant to do everything he can to work it out and spend as little money
as possible. My view right now is that neither of those constraints occur. As
there is increased pressure for professionals to earn money, I think some
constraints on the system would be highly desirable. That is all I am saying.
Right now, it is skewed ludicrously in the other direction.
Mr. Tobin: There is no onus the part of the creditor in this case to have the
monitors come forward with, as you say, some constraints on the bills they are
putting forward, if in fact it is the timing or volume that leads to the
failure of the company.
Mr. Marantz: The banks are getting very sensitive, and have been for quite a
while, about the level of professional fees they have to pay. In most of these
cases the money is not coming out of the creditors; it is coming out of the
secured lender who has hit a shortfall. They want to know that they are getting
The Chairman: You and I would debate whether what you just called the
sensitivity is actually being translated into practice in terms of any genuine
constraint on the consultants or the monitors. I can tell you it is not.
Therefore, my question is: Is there not something we can do to change just a bit
the incentives or pressure in the system?
Mr. Mendelsohn: In the final analysis, start from the premise that it is
unlikely that one would want to legislate that lenders have to lend more than
what they have agreed to lend in the first place. If they are told that in
those circumstances in which a consultant is appointed -- and these consultants
are always appointed with the consent of the company, although I grant you that
the bank has a lot of clout to get the company to consent -- their fees can be
capitalized but not paid by the company from period to period, then one of two
things will happen. Either the amount is being taken into account in terms of
the usage of a line of credit, in which case we are back to where we started in
the first place; or it is being added as additional debt, which extends beyond
an agreed line. I do not know how it can be legislated that a lender has to
lend to a deeper level than where it agreed to lend in the first place.
I do not know how you can prevent a lender from saying to a debtor, "I am
prepared to consider your request, if I get the proper advice to do it, but you
will have to pay for the process." If one were to legislate against that,
I do not know if the result would be positive.
The Chairman: Thank you for your assistance, gentlemen.
The committee adjourned.