Proceedings of the Standing Senate Committee on
Banking, Trade and
Commerce
Issue 15 - Evidence (December 5 Sitting)
OTTAWA, Thursday, December 5, 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 11:05 a.m. to give consideration to the bill.
Senator Michael Kirby (Chairman) in the Chair.
[English]
The Chairman: Senators, we are back to continuing our discussion on Bill C-5, the bankruptcy bill.
We have with us today Mr. Denis Belcher from the Bank of Nova Scotia, Mr. Ed Lundy from the Royal Bank, and Mr. Andy Kent from McMillan Binch. Mr. Kent does legal work for banks.
These witnesses are here at our request because we felt we wanted to understand the credit-granting process as well as the other issues that have been discussed. We wanted to understand a bit about the process by which companies were initially troubled and subsequently went into bankruptcy. We can understand that from the lender's point of view, so we asked a couple banks to come and appear before us.
Please proceed.
Mr. Denis Belcher, Bank of Nova Scotia: Generally, the banks support the amendments to the Bankruptcy and Insolvency Act proposed in Bill C-5. Many of its provisions will correct flaws that were revealed in the years since the enactment of the Bankruptcy Act in 1992. We also support the reform of the CCAA, subject to one reservation which I will speak about later.
We regret that a number of the recommendations made by the Bankers Association and the Insolvency Institute of Canada of a minor and non-contentious nature were not included in the bill. They attempted to clarify some aspects of the bill.
We do see two or three problems with the bill.First, the amendment made by the Industry Canada standing committee to the Companies' Creditors Arrangement Act, an amendment made without consultation with major stakeholders, will create very serious difficulties for restructuring major companies in Canada. The amendment requires the applicant debtor when it applies for an extension of the first CCAA order, which is only in effect for 30 days, to prove that no creditor would be materially prejudiced if the order applied for were made.
The Chairman: That is the section 124 amendment, is that correct?
Mr. Belcher: That is correct. This is a virtually impossible standard, since the typical CCAA proposal deals essentially with the balancing of prejudices.
If it is good public policy to nurture the rehabilitation of availing companies, we think that this amendment will frustrate any policy, especially in regard to single-asset lenders. Incidentally, the banks are single-asset lenders as well. The BIA has proven inadequate in the restructuring of major corporations in the past few years. As a consequence, insolvency practitioners have made use of the relatively rule-free CCAA and sometimes the CBCA because the CCAA has its limitations. Unitel, for example, was restructured under the CBCA.
In my opinion, the restructuring of businesses such as Algoma Steel, Cadillac Fairview and Dylex would not have been possible without the judicial discretion available under the CCAA. All of this will be lost if this amendment is allowed to stand.
The second issue we would like to mention briefly relates to the definition of "security" and "derivative instruments". We are concerned at the inclusion of derivative instruments, including eligible financial contracts, in the definition of "securities". Derivative instruments such as eligible financial contracts are not securities. They are swaps and options and things of that nature.
We feel that derivative transactions by banks are part of the business of banking and subject solely to federal jurisdiction. We are concerned that federal legislation, such as the proposed definition of "securities" in Part VII of the BIA, can be interpreted as supporting provincial claims for jurisdiction over these instruments. Since it is proposed that eligible financial contracts be removed from the customer pool fund, there seems little purpose in including such instruments in the definition of "securities".
Finally, I would like to speak to director liability. It is imperative that boards of directors remain in place when problems arise. It is equally important that officers do not resign. Protections for directors and officers, including deemed directors and officers that are created by virtue of certain provincial corporation acts, should be enshrined in all of the statutes dealing with bankruptcy.
That is all we have to say of any note on the amendments.
The Chairman: Mr. Lundy, do you wish to add anything?
Mr. Ed Lundy, Royal Bank: I would follow up on my associate's comment on section 124. We believe that a number of examples would have turned out differently had the 30-day rule been in place where if any one creditor was prejudiced, the courts could have called an end to it. The Dylex restructuring, in which I was personally involved, is a situation that comes to mind where one creditor argued before the courts that their position had the potential of being prejudiced. I think in the O&Y case, Justice Blair of the Ontario court summed it up best. He said that under the CCAA, it is a case of balancing all of the prejudices. You are trying to get a win-win situation for as many as you can and not have a win for one creditor or one small group to the detriment of all other creditors. In the Dylex situation, we have managed to get that restructured through the CCAA, providing new funds and, at the end of the day, saving something in the area of 3,500 jobs which otherwise may have gone by the wayside. We believe that is the foremost change that should be re-examined.
The other issue, which Mr. Belcher also mentioned, is directors' liability. We have seen high-profile entities lately where that has become a significant issue.
The Chairman: With respect to directors' liability, this committee did a study at the request of the Minister of Industry and issued a report three or four months ago on directors' liability questions with respect to Canada Business Corporations Act companies. We addressed exactly this question and concluded that a due diligence defence was the way to go. We have been told by the government that all of our recommendations on corporate governance with respect to the CBCA companies will be incorporated when the act is changed next year.
Is that sufficient or do we need to cover the same issue, or almost the same issue, in the Bankruptcy Act in order to pick up, for example, companies which are not CBCA companies, or is it adequate to simply leave it in the Canada Business Corporations Act and assume that, as has historically happened, provincial statutes will be adjusted to parallel CBCA statutes down the road?
Mr. Lundy: This issue is important.
Mr. Andy Kent, McMillan Binch: As you know, Canadian Airlines is not organized under Canadian law. It is an Alberta corporation.
Senator Angus: It is, yes. It was founded as PWA.
Mr. Kent: I think the recommendation you have made is excellent. I think those members of the community who practice in the insolvency area would very much support having it incorporated in federal bankruptcy legislation because many corporations are not organized under federal law, and it would be a very beneficial amendment. It is a very practical problem. There are some cases that I am involved in right now, of which I cannot speak, where it has been a problem. It was a problem in Dylex and Unitel. It would be very beneficial to the system to address it on a timely basis.
Senator Angus: Regarding directors' liability, I am inferring from what you were starting to say, sir, that the provisions in Bill C-5 are not adequate, in your opinion, with respect to directors.
Mr. Belcher: It is my belief that a director who acts in good faith -- absent gross negligence, wilful misconduct, fraud, and things of that nature -- should receive protection.
Senator Oliver: The due diligence defence.
Mr. Belcher: The due diligence defence should give him protection from liability. As things stand at the moment, he can do all of the right things and still acquire significant liability. As a result of that, directors are very prone to resigning just at the time you need them the most.
The Insolvency Institute of Canada, of which I am a director, presented a brief a couple of days ago. Their view was -- and I agree with them -- that the provisions you are talking about in the CBCA should probably be mirrored in the CCAA and other insolvency legislation. It should be very clear, so there is no subsequent argument, that directors are protected under the legislation.
Senator Angus: In other words, this would be an opportune time to legislate in that area by putting in that amendment.
The Chairman: They are the amendments on directors' liability which were contained in the Insolvency Institute brief. I believe the banks are sympathetic.
Mr. Belcher: Mr. Lundy and I are both members, and I am a director.
Senator Angus: If you look carefully, nearly all the witnesses who have appeared seem to have been members of the BIAC and the Insolvency Institute. There is a lot of overlap, and yet some of their recommendations did not get in the bill.
Mr. Belcher: We do not agree entirely with each other, but there is a big overlap. I think you will find later that Mr. Lundy and I do not agree entirely with each other.
The Chairman: Perhaps I can ask a question on a different topic.
On the issue of the ease of availability of credit, Professor Ziegel appeared before us. I am paraphrasing and simplifying his argument, but just to put the point on the table, he said one of the difficulties is that credit is so easy to obtain that it entices individuals into getting far more credit than they can afford. That creates a problem at the consumer level. Some of us responded by asking whether it is the responsibility of government to protect people from themselves. That is the other side of the coin. Perhaps you could comment.
Before you do, let me ask you a second question relating to corporate bankruptcies. Could you tell us about the process banks go through? Let me tell you why I ask that.
Fifteen years ago, when I was involved in restructuring the fishing industry on the East Coast -- which very much involved Mr. Belcher's bank -- you did not have then the equivalent of the special loans departments you have now. I would like you to talk about how a company is viewed as a troubled company and then gets into the special loans department and whether that process is better or worse. It is obviously better from the bank's point of view. It is the only reason they would have done it, I presume. Could you also tell us what the impact is in terms of customers? There is a perception that banks are less patient -- thinking back to my fishing industry days -- than they were 20 years ago in the sense of hanging in with a customer and helping them work through the problems. Perhaps one of the reasons for this has been the creation of special loans departments.
Those are two separate questions, one on the consumer side and one on the corporate side. Perhaps you could each comment on those.
Mr. Lundy: If I could talk about the corporate side first, you asked how accounts get into special loans and whether there is a change in how banks deal with their problem accounts today versus 20 years ago. If we start by discussing the period around 1982, with the oil patch problems and the worldwide petro-dollar problems, and talk about the approach employed on debt restructuring then versus today, I think it can be said that the banks have learned a lot. Clearly, going straight to liquidation is not the answer on how to best recover your maximum position. In fact, when a file gets into our special loans department, the objective is: How do we create a survivor? Creating survivors who can continue in their particular endeavour ultimately gets the best returns for lenders and unsecured creditors and keeps employment. We are very cognizant today that you cannot simply pull a trigger and go to liquidation. That is the absolute last resort one should employ in trying to recover funds.
The Chairman: Because you get less?
Mr. Lundy: Yes, because you get less.
The Chairman: Forget about the companies; it is in your interest.
Mr. Lundy: It is not in my interest to pull the trigger and get less money for our shareholders. Our objective in many situations -- and I come back to Dylex -- is to put more money out, where prudent, and to find a solution to keep the company going. That is how I will ultimately get the maximum return for myself and for the unsecured creditors and the employees of the company.
That does not necessarily mean that the owners of the entity may keep their ownership position. They are at the bottom of the totem pole for obtaining the liquidation or the recovery. Clearly, with respect to the broad range of creditors, including employees, a going-concern entity is the optimal way to obtain recovery.
How do files get into our special loans department? Each bank will have their own procedure. At our institution and others, we have what we refer to as a debt rating system. When a credit reaches a substandard level of rating -- and this is an internal assessment of the quality and direction the company is going -- first, we refer it into our diagnostic review. We try to pick up the early warning signals to make sure that we understand the company. For example, can things be done immediately so that the company does not go to our special loans department? Sometimes it is a further understanding of the company, its industry or the transition it is going through. However, once it reaches this next level, it moves to the special loans group. Frankly, it is not that they are much smarter with respect to how to deal with the problem, but it is the time that it takes to deal with the problem. We need to dedicate our available manpower full time to dealing with the problem. The demands in trying to find a solution are such that one cannot expect that group to carry as many accounts in order to find solutions. Therefore, we dedicate considerably more resources to far fewer situations to try to find those solutions. If we do enough restructurings, we begin to take experiences from company "A" over to company "B" and company "C" and try to benefit from the synergies of this process.
The Chairman: In terms of compensation of the people in the special loans department, how does the incentive system work? Does it work to get rid of the problem? Do they get extra points for a save rather than a bankruptcy? What is the psyche and what are the incentives driving their behaviour?
Mr. Lundy: In every internal document I issue in our institution, at the top of the page it says "in the midst of difficulty lies opportunity". Finding a solution to a borrower's problem where we can create a survivor is what I refer to as the "psyche advantage" or the "positive".
We do not pay our people to liquidate files quicker or sooner to get out from under. It is a balance. We set plans and objectives against our total portfolios.
The Chairman: Mr. Belcher, do you wish to comment on the same consumer question area?
Mr. Belcher: I will start with the business question first. Neither Mr. Lundy nor I are consumer experts, but we will try to answer your question.
In terms of the corporate side, our philosophy is somewhat different from the Royal Bank's philosophy. Our philosophy of an account which belongs in a special loans group is that it should be an account of significant size that will be very time consuming or of significant complexity. It could be a complex smaller account. Size does not always equal complexity. As well, it could have cross-border elements, or something of that nature.
We are staffed with few people. Presently, in Toronto, I only have five or six people in the group that reports to me. We are staffed with people who have considerable experience in these areas and are not constantly going up the learning curve when they are faced with problems. The vast majority of our "work out" problems at the bank are dealt with at the branch level and the regional level in the normal course.
In terms of compensation, my people are compensated on the same basis as I am, which is based on total bank results. We are not compensated for any particular success in collection.
Our emphasis is the same as Mr. Lundy's. I tell my staff that we are not undertakers. We are not interested in burying companies. Anyone can do that. One hires an accountant and tells him to liquidate the business and tell me how it turned out. We are interested in structuring things so that businesses can survive. That is why we put together the people with the skills who can do that. We have been doing it now for a good many years.
The Chairman: Do you sell off troubled loans? I know you have done it in Third World countries, but what about troubled corporate loans?
Mr. Belcher: In the United States, there is a fairly strong secondary market for troubled loans. It is somewhat insane at times with the things they buy given the research they do, but it is there. It is a source of liquidity.
In the United States, we find that we are often middle- to small-level players in large syndicates led by much bigger banks. We do not have much to say to the solutions. We are often not told very much. In those circumstances, if we think the price in the secondary market is right, we will sell our exposure. We have done that at the Bank of Nova Scotia.
In Canada, we have sold only one loan.
The Chairman: Is there not the market in Canada that there is in the United States?
Mr. Belcher: There is not a deep market in Canada, but there is a market. The United States houses are coming north now and buying, as you saw in the case of Cadillac Fairview and as we saw and caused us considerable problems in the Unitel file when certain Canadian banks sold their interests to U.S. vulture funds.
There is a developing market in Canada in this area, but it is mostly at the corporate level. They are interested in the large loan. There is little activity in commercial or small business loans. No one is interested in buying those.You would probably sell the major corporations -- Dylex, for example, or something of that nature -- if you decided to get out.
The Chairman: Selling off the loan essentially takes you out of the business of helping the company to be nursed along and rehabilitated because at that point you are out, correct?
Mr. Belcher: It brings someone else to the table who might have a different agenda, yes.
Senator Kenny: They are not doing that anyway. In those circumstances, you are in a syndicate and the syndicate leader or manager is supplying the help, really.
Mr. Belcher: In Canada, it is different. It is something more of an oligopoly and there are relatively few players.
The Chairman: You are likely to be "a" leader if not "the" leader, right?
Mr. Belcher: We will be a leader somewhere. We roll it around, depending on our credit judgment at the time several years ago. However, all of us will certainly be in most of these major Canadian crowds.
It is relatively rare of Canadian banks, certainly amongst the larger banks, to sell their exposures. Certain banks do it as a matter of course but most do not.
Mr. Lundy: The Royal Bank has been more active in the secondary market in the United States. That is where the secondary market evolved. We have done some transactions in Canada. It was recorded approximately one year ago that the Royal Bank sold off a portfolio of impaired real estate loans. Again, this was in the upper- to mid-commercial market.
One makes a judgment call on where the real estate markets are going? This particular investor purchased a chunk at once, for which we felt they overpaid. We were quite satisfied with the price. It will depend on where your corporation's relative position is in dealing with its total problems.
The Chairman: If you are the lead or one of the lead creditors, then you are unlikely to sell your position; is that correct? That is what I inferred from what you said.
Mr. Lundy: In the United States, we are often a bit player in a larger transaction.
We were involved in a situation six or eight months ago. We had a substantial sum of money. We were still a bit player. We felt that the company was going in the wrong direction and not listening. We undertook to dispose of our position while others moved in. It is one's perception of where the ultimate outcome will be, but in Canada, where we are in a lead position, we do not sell our positions.
Senator Kenny: An expression which comes to mind frequently is that you do not put good money after bad. I got the impression that that is not the case and that you have departments now which are quite prepared to do that under certain circumstances.
Mr. Lundy: I refer again to Dylex. We put out $40 million or $50 million of new money to try to make that rescue work. We are prepared, as I know other banks are, to try to make a company survive.
Senator Kenny: I suppose in that case it was good money you put out in the first place.
Mr. Lundy: Yes.
Senator Hervieux-Payette: Who were you salvaging in Royal Trust? Who were the big losers when you took it over? There must have been something left which you were interested in buying back. The name was appropriate for you, but what was it besides the name?
Senator Meighen: The clients.
Mr. Lundy: When corporations make acquisitions, they do not always buy 100 per cent of the entity. They will often buy subcomponents which meld in with their own business. If you can acquire a component of a business which is complementary to your own, it has real value. There were certain aspects of that entity which we did not acquire. At the end of the day, the shareholders, who supply venture capital money in our country to keep companies alive, paid the bill; the depositors did not.
Senator Kenny: You bought the assets; not the corporation.
Mr. Lundy: That is right.
The Chairman: Early in these hearings, it was suggested to us that when a company gets into your special loans division and you appoint a monitor to oversee it and help the company work through its problems, whichever major accounting firm you appoint to perform that monitor function for you, it should not be allowed to become the receiver in the event that the company goes under.
The rationale behind that prohibition was that you should not allow someone to be both a veterinarian and a taxidermist. It is true that you get your pet back either way, but it is not a desirable process. There appears to be an inherent conflict of interest in telling someone that their job is to help save a company but that they should not worry if the patient dies because they will also get to help look after the body.
Would you care to comment on that?
Mr. Belcher: A monitor does not go in to save the company. Generally speaking, banks put monitors into companies because they are concerned with what is going on and they want someone on site to watch the cash flows, watch what is happening in the business and report back to the bank if they see things with which they are unhappy. However, they do not involve themselves with management.
The Chairman: Are you saying that when you put a monitor in, the job of that individual is solely to keep you informed of what is going on on a day-to-day basis and not to interfere with management decisions?
Mr. Belcher: We are very specific in our documentation that they are not permitted to interfere with management because serious lender liability issues arise if they do.
Senator Kenny: Are there not covenants in the loan arrangements which hamper how managers manager the corporation? Do you not effectively manage the corporation by placing these covenants in the loan in the first place?
Mr. Belcher: You have often reached the position that you have lost confidence in the management. If you need a monitor, you do not trust management.
Senator Kenny: I understand that, but you are saying that you are not managing the organization.
The Chairman: De facto, they are managing.
Senator Kenny: If you read the agreement, you discover that the parameters between which the manager manages are clearly defined by the bank.
Mr. Belcher: Generally speaking, we will put conditions on the basis on which we will lend in terms of maintenance of working capital ratios, debt covenant ratios, capital expenditure ratios and things of that nature. We would rarely give long-term money with no covenants, nor would lenders in the bond market.
Senator Kenny: You would not characterize that as managing.
Mr. Belcher: No, we would not. I do not believe that counsel would either.
The Chairman: Senator Kenny, I now understand what you mean by not managing. The monitor goes in and does not manage.
Mr. Belcher: He is not managing the business. If he does, I think the bank can be held liable by other creditors for what he does. De facto, we are suddenly running the business, and it is not in any kind of proceeding. We are very careful about that in our language.
Often the monitor is asked at the same time to do a look-see to assess the viability of the business. Sometimes the assessment of the viability of the business would result in the appointment of a receiver. Often the person who assessed the viability is appointed as a receiver.
I personally think it should be left up to the judgment of the financial institution as to whether that is the case because we do not always do that.
A number of issues arise from that. First, all receivers are not private appointments. Many of them are court appointments. In certain parts of this country, they are mostly all court appointments. That is the case in Alberta, for example. There is rarely a letter of appointment in Alberta; it is almost always a court appointment.
Similarly, a bankruptcy trustee is a court appointment. Anyone who objects to the person put up as that trustee or receiver in a court appointment has the right to stand up in court and object, which happens from time to time. The judge can say, "I do not like that fellow, and I want you to use someone else." That does happen.
The only real area of concern is with private appointments, because otherwise people get their day in court. To legislate that it cannot be done would add an unnecessary expense to the process of running a liquidation or a receivership.
The Chairman: Where is the added expense?
Mr. Belcher: The added expense comes in because the monitor, who is the first person going in, has become familiar with the business and with where things are, and you throw him out and start all over again. Someone starts cold and has to learn the business. The cost of that learning curve is considerable.
I think there is adequate protection with the way things are now to ensure that there is no abuse. Obviously, there will occasionally be cases of abuse. We are aware of one or two which have occurred over the years and raised eyebrows. I guess that is a case of bad facts making bad law. The vast majority of times, this is not the case; there is not a problem. To suggest otherwise presupposes that the people we hire, which in our case are mostly the larger accounting firms, are dishonest and that the bankers are fools. We know our own businesses and we know what we are doing. I think it should be left up to the judgment of the banker and the overall integrity of the people with whom we deal.
The Chairman: Mr. Lundy, as I understand it, the Royal Bank has a policy of not doing that.
Mr. Lundy: The Royal Bank has a policy guideline of utilizing a different firm for monitoring than it does for its trustee.
Mr. Belcher's point of duplication of costs is a real one. We have had situations in which we have been sorry we went through the second stage because it cost us more money.
The Chairman: By "the second stage", do you mean the second firm?
Mr. Lundy: Yes, the second firm.
We do not agree that it should be a legislated policy. We make exceptions in situations where there is enough information going in that the likelihood is that there will be a trusteeship, a receivership or a liquidation. In some situations we have not used the second firm because of the cost, and it was not a long period before that decision was made.
The critical issue for the other banks, as well as for us, is that just because the advisor says he thinks we should liquidate a company, we will not necessarily accept that opinion.
There is also the question of bias on the other side. You could have a monitor in there and not liquidate, knowing that there is another firm to take over. When you monitor the death out of it for an extra year or two, it eventually goes to liquidation and everyone loses.
There is a double bias on the issue. We try the high road as much as possible by using independent firms. We also use independent counsel on many of our activities because you want to have your security properly vetted for enforcement.
It is not clear cut that this should be mandated and that it must be there, but we would like to adhere to trying to have independence.
The Chairman: You say it is a strong guideline.
Mr. Lundy: It is a very strong guideline in our institution.
The Chairman: You would not want it to be a regulation.
Mr. Lundy: We would not recommend a regulation. When we make exceptions, we do it with a clear conscience as to what we are doing. We try to follow the policy.
Mr. Belcher: In this country today, there has been a consolidation in the accounting industry. There are not many large accounting firms left. If you are dealing with large insolvencies, to legislate in that way you may find yourselves with no one to connect.
Mr. Lundy: In the last year and one-half, there have been large situations where one could not find a second party to go to who was not already conflicted. One had no choice but to break one's policy.
The Chairman: That consolidation in the accounting sector has created an interesting problem for the accountants about which they keep coming to see us. However, that is another question.
Mr. Kent: Mr. Chairman, in the recession in the early 1980s there were many receiverships. This concern you are speaking of was a concern at that time. I was involved in many receiverships in that recession. In this recession in the 1990s, I have been involved in almost no receiverships. They are very rare. This reflects a change in attitude among the banks. It also reflects a change in circumstances. This is not a problem, certainly from my perspective as a participant in the community. The issue you raise is no longer the problem it might have been 10 years ago.
The Chairman: Mr. Kent, are you suggesting that the difference is that there is now a greater tolerance on the part of financial institutions, whether they be banks, trust companies or insurance companies, to work out situations to keep the patient alive rather than move more rapidly into liquidation?
Mr. Kent: There is a huge difference between going-concern values and liquidation values. Consider Unitel as an example, a case in which I acted for Mr. Belcher. The difference between that company as a going concern and that company being liquidated is enormous. The banks have a huge incentive to find a way to make organizations work in most situations.
Mr. Chairman, you raised a question earlier about whether the banks are more aggressive today, more hard-nosed and less open to reorganization. My experience in my career over the last 20 years is just the reverse. They have become much more tolerant, open, flexible and creative in that period. Part of that is due to the creation of special loans groups where there are people who do a number of these files and who become more patient and flexible with experience.
Senator Kenny: Is this a cyclical thing or a fundamental change?
The Chairman: In other words, if something was fashionable in the 1980s and it is not fashionable in the 1990s, what will it be in the next decade? I think that is the question.
Senator Angus: The new law changed it.
Mr. Belcher: I would not agree with that. I have been working in this area since 1978 when I started in the United States. I have been working in Canada since 1982. The first few insolvencies we did in the 1980s blazed the trail in those early days of real estate for what followed. It was not the change in the Bankruptcy Act that changed this attitude. Clearly, banks have learned the difference between going-concern values and liquidation values. We have learned how to work things out. Frankly, we learned from the Americans. We brought the American experience north under their Chapter 11. I was actively involved in that.
Mr. Lundy: I would like to add one more thing on that same issue. I will use my bank's experience.
Four years ago we surveyed professionals, asking them, "Why do you, external of the bank, believe we lost the amounts of money we lost?" The question referred not just to our institution but to our industry. The resounding response was, "Too slow to identify; once identified, too slow to act." Within our institution, we created an early diagnostic review group so that at the early sign of a problem we can get on it. If we are on it early enough, we can solve it. If one sits back and waits and lets it deteriorate, one ends up liquidating the company because there is no alternative.
The secret is that at the earliest possible sign of a problem, get in, address the problem and correct it so the company can move forward as a viable entity.
Senator Meighen: We heard what I found was somewhat startling testimony a few days ago to the effect that as far as the credit rating agencies are concerned, it does not matter a lot whether an individual has made a proposal and carried it through successfully, or whether they declared bankruptcy. Would any of you gentlemen be able to tell me from a bank's perspective whether, in your assessment of my risk if I were to come looking for credit from a bank, there would be a difference in your mind had I made a proposal and successfully carried it out or whether I had simply declared bankruptcy a few years ago?
Mr. Belcher: I would have to get back to you on that question, senator. The last time I did consumer lending was back in England in 1971.
It is my impression that if you are a discharged bankrupt, immediately after the discharge, having no debts, you are a good credit risk. That is probably one of the reasons you have problems today, which is the relatively benign rules as they relate to consumer bankruptcy.
Senator Meighen: It may also be a change in moral values. It may be that if it does not make a difference whether I declare bankruptcy or make a proposal, why would I make a proposal, which I would have thought would have been the honourable and proper thing to do? Apparently, it does not make a whit of difference.
Mr. Belcher: You could very well be right.
Mr. Lundy: Many proposals put forward in the consumer area are accepted. I think of a gentleman when I was working in British Columbia who had a company as well as personal debt with the bank. Unfortunately, the second generation ran his company and got it into difficulty. It was liquidated. We compromised the gentleman's guarantee. Three or four years after the compromise, he came back to us and said, "Because of how I was treated, I cannot go to my grave without paying off the rest of my debts." While we had legally forgiven them, he came back and paid back that money because he felt he had been properly treated. His son at this point in time still owed the bank money and had to make his payments. Clearly, today, the stigma of bankruptcy is different than it was 20 years ago.
Senator Meighen: I would like to return to clause 124. As you know, there are two schools of thought on this matter. Obviously, there is the school of thought which supports that clause that was added by whomever at the last minute. One of the arguments in support of the subclause we have heard is that it brings the CCAA more into line with the BIA. My question to you is this: In your view, is that a good thing? Should we have one act? Would if be possible to have one act -- which I realize it is not on the table today -- incorporating both the features of the CCAA for larger situations and the BIA for smaller situations? Or do you see a distinct preference for two acts?
Finally, do you have any comment with respect to the $10 million threshold? One suggestion has been that $10 million might exclude certain areas of the country, for instance, the maritimes or Saskatchewan, from having much access to the CCAA. Would you be in favour of moving it down to $5 million or, for example, allowing judicial discretion to move it down to $5 million?
Mr. Lundy: Dealing with your latter point first, we believe there should be discretion. If only one change were allowed on that component, we would recommend that it be the consolidated debts of the borrowing group. Often, you will have a situation in which the debtor may have $8 million in one company and $6 million in another. Under the current wording, he would not qualify to do a CCAA proposal because they are two separate entities. If consolidation permitted it, we believe that would be a positive step.
Mr. Belcher: Back in the 1980s, it was thought that the banks tended to think the CCAA was a terrible thing because there were no rules. Over the last decade or so, rules have been developed through judicial discretion and the like, but rules have been developed nonetheless. The beauty of the act is that the judge can tweak those rules depending on the specific circumstances, and every circumstance is different.
Today the banking view is that there is a need for two acts. In the United States, under their bankruptcy statute, there are a number of sections. Chapter 11 is not the only way to reorganize companies. "Reorganize" is the wrong word to use in dealing with companies. We do have strict liquidation statutes, such as Chapter 7.
As a practical matter in this country for dealing with major reschedulings, we need an act with the flexibility to deal with multiple lenders and multiple creditors and which gives the judge some discretion to find a balance in the interests of all parties.
I do not believe the Bankruptcy Act will do that for you. I do not know too many professionals who believe that. It is a very rigid act. It is probably very appropriate for single-lender, single-client situations. However, I do not believe it would be appropriate in a Dylex or a Cadillac Fairview or accounts of that nature where there are many different interests.
Senator Oliver: My question relates to some significant testimony given here earlier by the health and life insurers and has to do with the super-priority. I do not know if you are familiar with what they said, but I think it is extremely important that you be given an opportunity to account for some of the things that were suggested.
To give you some background, super-priority relates to environmental remediation costs that would rank above all claims, including those of secured creditors such as mortgagees. The environmental clean-up would be paid for through a first charge on the bankrupt debtor's real property and any contiguous real property.
When they appeared before us, they said this was incredibly unfair to life and health insurers because the banks were basically excluded. They said the clean-up costs would, as a result, take priority over the claims of those creditors who had lent money against the security of the real property by providing mortgage loans. Life insurers will be significantly affected by these provisions because they are Canada's largest source of commercial mortgage financing. They currently hold $32 billion in Canadian commercial mortgages, accounting for 21 per cent of their total assets in Canada. For banks, commercial mortgages are only 3 per cent of their Canadian assets. By contrast, equipment -- which is banks -- and other assets of the bankrupt company would not be covered by the environmental super-priority lien even if they were directly involved in creating the environmental contamination.
The health and life insurers are saying that we should consider an amendment to include banks so that they do not carry the whole burden. They also suggested that one of the reasons you were excluded is that you had an opportunity as banks to get to the Department of Industry and talk with them before this was done. I wanted to know if there was anything behind that assertion.
Mr. Belcher: I will deal with the last question first. I was a member of David Baird's committee which was formed pursuant to the BIAC. That committee produced a report which was discussed at a meeting in Toronto of interested stakeholders arranged by the government department responsible a few years ago. That meeting was attended by a number of stakeholders, including provincial representatives and mining companies. I do not know whether the life insurance business was there, but it was a multi-stakeholder meeting. The proposals put forward by the Department of Justice were a result of that meeting which discussed and dealt with the Baird report in general consensus. Not everyone was in agreement, but they did the best they could with the different interests expressed. However, it was based on that meeting.
With regard to your first question, banks are not the only lenders against inventories and fixed assets. In this country today, we have a rising group of lenders known as asset-based lenders, people such as GECC, for example, and others. In addition to that, there are a whole bevy of leasing companies which lease equipment and assets. The insurance company is saying that the legislation should be changed so the banks do not get an advantage, but we are not the only lenders in that area, not by any manner or means. Significant business is provided by asset-based lenders and by leasing companies and others.
As well, if what they propose was done, it would be extremely difficult for any particular borrower. You are dealing with industrial properties, not with most of their portfolio, which is probably large office blocks and things of that nature. We are talking here about industry loans and particular segments of industry, industry where there is a possibility of environmental risk and pollution.
Banks have changed their rules nowadays such that when they make a loan against any of these assets, they do environmental studies. Those studies depend upon what they find at various levels and may result in a decline of the loan, or, if problems are containable, with the approval of the loan. We do that up front and then manage the process thereafter.
If you change the rules along the lines they are talking about, any asset-based lender which wanted to provide any lease or any financing of any equipment to any business would presumably have to do the same kind of environmental due diligence. Environmental due diligence is extremely expensive. I suspect it would make it prohibitively expensive for people to avail themselves of these sources of financing.
Often enough, senator, the assets used were not particularly involved in the pollution in the first place.
Senator Oliver: They very well could have been. A defective piece of equipment could have been the main cause of the pollution, which had nothing to do with the real estate.
Mr. Belcher: That is right, but I think the real estate lender has a responsibility to do proper due diligence in the first place and to do proper follow-up thereafter. One of the problems you tend to get with long-term mortgage lenders that are not banks is that they may do the due diligence in the first place, but they do not do follow-up. They do not do annual reviews, as we do, and periodic inspections. As long as interest and principal is received on time, they are quite happy. We do not do that.
Another thing that would probably happen is you would start getting significant "conditionality" applied to bank loans. Bank loans would be probably less available and certainly more expensive. I know banks always say that, but I do believe that is the case. If you start adding inventory to that, inventory is likely to get knocked out of the borrowing base for certain kinds of industries, thus reducing the availability of credit. Again, banks usually say that, but it is likely to be true in this case.
We do take environmental risk seriously. It is a very difficult area.
We are on both sides of the argument, both single-asset lenders as well as general lenders to corporations. What we lose on the one side, we gain on the other. On balance, just as with the CCAA, the way the act is designed right now is probably the fairest way to do it. As bankers, we do not like it entirely. We do not like the contiguous property aspect.
Frankly, Canada is leading the world with this. I cannot think of a jurisdiction anywhere in the world which has a priority charge for environmental clean-up against fixed charges, including the United States.
Senator Oliver: Should that risk not be spread among more groups? That is the issue.
Mr. Belcher: It is the land which is contaminated. We are on both sides of the argument. There are very strong arguments that you will affect the availability of credit. Certainly you will significantly increase the costs of the maintenance of business if those kinds of changes are made. It is up to Parliament to decide what is in the best interests of businessmen generally. Our feeling is that we do not like the bill the way it is drafted right now, but we can live with it. If you removed it much further than that, I guess we could live with that too, but I think the business consequences would be much more severe if we do.
Senator Oliver: Could we hear from the Royal Bank?
Mr. Lundy: I believe Mr. Belcher's points are valid, but I would go one or two steps further. In asking about sharing the loss amongst all creditors, you are really allowing one class of creditor not to do their due diligence to protect themselves. They will have innocent third parties who went in, perhaps leasing new equipment that had nothing to do with the environmental problem, and you will ask that innocent party to share the loss with the lender to the property. In some cases, it will be the banks. You are asking an innocent party to share in the loss -- in other words, to subsidize their lack of due diligence and follow-up or maintenance of proper criteria in the first place. Is it reasonable to ask an innocent third party to subsidize someone for their own misgivings?
To come back to the 30-day issue, if one creditor were being prejudiced in a reorganization, could you call it at the end of the day? It is nice for that one creditor who gets their asset out, but everyone else loses.
In this case, if you ask others to share the loss from a lender's lack of controls or from negligence in how they lent their money in the first place, everyone else will pay for that person's mistake. Is that reasonable for any lender?
Senator Oliver: The life insurers feel they are the innocent people because all they are doing is advancing money on the real estate. The thing that could be doing the contamination is a piece of equipment financed by the bank. That is the problem.
Mr. Lundy: If they followed the due diligence process with an annual review of where the funds are and whether they are still properly protected, that would resolve the problem.
Mr. Belcher: Are we reasonably suggesting that someone who makes a loan of that nature, an innocent lender lending on a piece of property which is polluted by some rascal, is all that innocent? Surely the lender has a responsibility to look at the business they are dealing with, to look at the asset, and to have conditions on how the property will be used in the future. They must put some constraints on that. If they are concerned about it, it is easy enough to say that they may not engage in certain kinds of business or that they may not change the business without notice. They should do some proper follow-up. It is within their control when they make those loans to do all those things through their covenant packages.
I submit to you that they have a responsibility to do that. They cannot irresponsibly make a loan on a piece of property with no conditions and then turn around and say, "Look what happened to us; it is not our fault." Of course it is their fault; they made the loan.
Senator Angus: I understand that in cases where a rascal is involved, as you say. Often pollution results from pure and simple accidents. This is what is troubling us.
Mr. Belcher: When someone starts a business, they know what they are dealing with and if their business is prone to a certain type of accident.
Mr. Kent: From the credit-granting perspective, the big-dollar issues are not current spills but are past industrial practices. The big problem is the practices that were followed 20 or 30 years. If you take Algoma Steel, the problems on that site are not from what they are doing today. They arise from practices of 30 years ago which are no longer acceptable. You see this all the time.
Senator Angus: Then there should not be a super-priority. Would you argue that?
Mr. Kent: There has been much argument in the industry about whether there should or should not be a super-priority. Let us deal with the practicalities for a moment.
Let us assume you have a site with an historical problem. A lender coming in to finance it needs to know whether that is their risk or not.
Senator Oliver: That is when they do their due diligence.
Mr. Kent: From the credit-granting process viewpoint, it makes sense to identify one group of creditors who will do the due diligence. There is no point in making the borrower pay for every creditor to do the same due diligence. It is a complete waste. It just increases the cost of raising money for a company.
One thing that encourages competition in the industry today is the multiple lenders who are prepared to look at different aspects of loans. My firm acts for some of the creditors who do asset-based lending as referenced by Mr. Belcher, as well as acting for the banks. We see the different interests. It makes no sense to require the same things of every one of those lenders.
Imagine a situation where a borrower was trying to put together a package with a real estate lender and an equipment financier and a bank to provide working capital. If you make the kind of change you are talking about, every one of those lenders must go through the same environmental due diligence process at the expense of the borrower. It makes no sense from the perspective of raising capital.
From the viewpoint of a real estate lender, if you try to sell that property which is contaminated, it will affect the value that you recover. Whether there is a lien or not, as a practical matter, it will affect the value of your collateral.
The real estate lender is stuck with the problem. If their property is contaminated, a buyer will only buy it once that issue is addressed and either remedied or taken into account in the purchase price. It is not actually taking value away from real estate lenders to simply recognize that reality and create the charge. It is the historic problem. Current spills are the problem.
Most current spills will not result from a defect in a piece of equipment; it will be from poor management practices.
If the equipment itself is contaminated, that will affect the equipment lender. That is a risk they understand. They must address it. If the equipment itself is contaminated, which happens, they lose their collateral; that is their problem. This legislation does not affect that result.
From the point of view of making a system work sensibly, it makes no sense to spread the risk around. It belongs where the contaminated property is. None of the people involved are at fault. These are old practices. These mistakes were made in 1965 or 1975; they are not being made today.
It is not a question of fault; it is a question of risk management and how to have the private markets raise the money necessary to clean up these old, historic problems. In system terms, it makes a lot of sense to leave the risk where it is proposed to be. I say that as someone who acts for multiple parties and not because we are trying to favour one particular stakeholder group. We see it from everyone's perspective.
Senator Angus: Do you think it makes sense to stick a lender in 1996 or the year 2000 for these old pollution problems? Why should there be a priority?
Mr. Lundy: The short answer as a lender should be, no, we should not be stuck with it. The fact is, we must do our due diligence. If we do our due diligence at the front end and satisfy ourselves that there is no pollution from 20 or 30 years ago, then the secret in going forward is to ensure that the management practices of the borrower, in case of an early environmental problem, are addressed and cleaned up then and not compounded.
At the Royal Bank, and I am sure at the Bank of Nova Scotia too, there are management practice guidelines on environmental standards that we insist are followed by our borrowers. We want to know their policies in dealing with environmental issues. If we are not satisfied that they are adhering to standards, we do not want them as clients. It is incumbent on us to do our due diligence on that side as it is for the real estate lender to do theirs.
Senator Taylor: I wish to go into a field which Mr. Belcher has already said he does not want to discuss too much. The witnesses who have come here have said that, although there are fewer corporate bankruptcies because problems are being identified and worked out, there is a skyrocketing rate of consumer bankruptcy. Is that because that area is not getting the same amount of attention as corporate bankruptcy? Will that improve with time, or is there something systemically wrong in the credit-granting processes to consumers? Have consumers found a loophole, or have you been too busy patching up your relations with corporations and the consumers got away on you?
Mr. Lundy: Speaking for the Royal Bank, I would not say that we have not been paying attention to the consumer side. It is getting enormous attention. There are a host of issues behind the increased bankruptcies. Part of it is the restructuring of the economy which we have been going through for the last five years. A host of issues have been created by the reconfiguration of entities and the levels of employment.
I brought an article with me, and I will leave it if you care to read it. This is from this month's publication of Robert Morris Associates in the United States. There was a recent conference call with 65 banks and about 2,500 lending officers from across the United States. The topic was: Where do you believe the future problems are for those corporations in the United States?
The resounding response of all of those organizations south of the border was: Consumer credit, consumer credit, consumer credit. It is called "plastic." They are expressing serious concerns south of the border.
I will leave the article with you, senators. I thought it was excellent reading. I passed it to our consumer side and to the CBA to ask whether it has merit in Canada.
Senator Taylor: How would you answer the accusation that the interest rates being collected on plastic are so exorbitant that the innate greed of the institution has been allowed to push the credit out so far?
Mr. Lundy: I am not the expert on the retail side of our operation; nor is Mr. Belcher in his. I have seen some information within our organization, which we are trying to get out to the public. It was on the news just a couple of nights ago. There are plain-vanilla credit cards with considerably lower interest rates than the Classic II and the Visa II and the more high profile and more expensive cards.
Senator Taylor: They are not the poor buggers who are going broke.
Mr. Lundy: I asked this question of our folks: Which card within our institution is causing the loss sides? In talking with the head of our card division yesterday on this particular subject, the plain vanilla card for the Royal Bank is 9.5 per cent against a prime of 4.75 per cent.
When they look at the loss figure, the administrative cost and the overhead, the yields on that component of business, frankly, are low. I know the Bank of Montreal talked about its yield per card a few days ago, and we and others are trying to make sure that we are giving the right number by card layer.
Senator Oliver: One bank said their net revenue from the cards is around $170 million.
Mr. Lundy: I am not sure where that particular number came from.
Senator Oliver: It was in The Financial Post.
Mr. Belcher: I am happy to defer to the premier bank on the issue of credit card interest rates. To my way of thinking, it is not the absolute rate of interest that is the problem on credit cards. It is fact that the borrowers frequently have 10 or 15 of them and they are all borrowed up to the hilt. They only file for bankruptcy when they cannot obtain more credit cards or roll over the money by way of a mini-kiting process through the cards they actually have. You must ask yourself: Why is that the case?
This is personal speculation, but the nineties have been a pretty miserable time. The Bank of Canada has succeeded in getting 2 per cent inflation. The real rate of interest has been relatively high compared to inflation rates. Wage settlements have been low and lots of people have lost jobs. There is not as much cash flow any more. In order for consumers to maintain their standard of living, I think they have started backing into credit cards and other kinds of loans.
The consumer business is fundamentally an actuarial kind of business. If you ask the right questions, you get a certain level of points and the machine will tell you whether or not to make a loan. There are overrides you can put in, but you are a fool if you do that. It is an actuarial business. If you want to decrease the risk, you raise the bar in terms of the questions.
It is a little tough to blame an individual bank or the banking industry generally for why consumer bankruptcies are as high as they are. They are high in the United States as well. I think it is a combination of many factors. Probably the major factors are the high level of unemployment generally -- people simply losing their jobs -- and access to multiple credit cards.
Senator Taylor: I do not want to take the time to get into an argument, but there has been unemployment and stress on family incomes before. Do you not think lenders have some responsibilities? We have laws under which a bartender can be charged after giving a guy too much to drink and then the guy goes out and drives a car. If you supply the booze, you can get in trouble, but if you are supplying the cash, you cannot.
Mr. Belcher: Except it is difficult to tell whether a fellow is drunk when he comes in for a credit card. A bartender can probably see that the fellow has been to six bars previously. It is a little difficult for us.
Senator Kenny: One of the questions you ask when someone applies for a card is: "What other cards do you have?" You generally know that folks have other credit cards when you issue them.
Mr. Belcher: The trouble is they arranged these cards some years before when they probably were good credit risks and backed into them over a period of time. Suddenly something happens and they are in trouble.
One of the things you find today in consumer bankruptcy -- and remember I am out of my field here -- is that there is often no "work-up" to a bankruptcy. One moment the payments are up to date, and the next moment the fellow is in big trouble.
The Chairman: There is no early warning system. On a corporate loan, you get it because first they delay some interest payments. It is an evolutionary process.
Senator Angus: We are off topic a bit.
Senator Kenny: I would like to register this point. I am sure it is obvious to our witnesses that there is a growing feeling in this town that perhaps there is some responsibility on the part of banks to focus on how they are dealing with credit cards and that the problem is not just the reckless consumer.
Mr. Lundy: Without using the words "reckless consumer", there has been a buildup of consumer expectations far in excess of what the capacity in the last four years has been to pay for it.
Senator Kenny: Proportionate to the marketing of the cards?
Mr. Lundy: I believe so, yes.
Senator Stewart: The ground has been laid for my question.
Senator Taylor: Not only laid, it is ploughed and ready for seed.
Senator Stewart: Do you think the present law is adequate for your purposes, insofar as consumer credit is concerned?
Mr. Belcher: I would have to defer to the Bankers Association. Before we came here, I asked whether they had any problems with the bankruptcy changes.
Senator Stewart: No. I am asking you if the present law is adequate.
Mr. Belcher: In terms of consumer bankruptcy?
Senator Stewart: Exactly.
Mr. Belcher: No. We like the changes proposed in the Bankruptcy Act. For the most part, we are happy with them.
Senator Stewart: How do you think they will help the situation that has been discussed in the last 10 minutes?
Mr. Belcher: On the whole, we were not too unhappy with where we were before. I think where you have moved, on a public policy basis, is in some respects to a more benign regime.
Senator Stewart: Benign towards banks?
Mr. Belcher: No, I think in some respects towards the consumer in terms of the ability to obtain bankruptcy relief. It is a lot easier now than it used to be. It is no longer an impediment.
Senator Stewart: Are you pleased with that?
Mr. Belcher: No, we are not pleased that bankruptcy is not an impediment or not a stigma. Twenty-five or 30 years ago you would not dream of filing for bankruptcy. Today, people will do it several times and not bat an eye.
Senator Stewart: That comes back to the situation you described when you answered Senator Taylor. A consumer may have a great number of cards. The attitude of the server is, "I really do not have any current responsibility for the amount of credit I am putting out there." Then you expect Parliament to provide a remedy for the situation which -- not you as an individual or your bank -- the lending industry as a whole has created.
There is an old axiom: Buyer beware. Is there not another one: Lender beware?
Mr. Belcher: I think that is right, but I do not accept what you say. We are concentrating on credit cards, but I think consumer credit is part of the same issue. When someone comes in to borrow money from the bank, they provide a financial statement and answer a series of questions. We do a fairly in-depth review of who they are, where they work, and their credit record.
Senator Stewart: Are you talking about cards specifically, or are you talking about negotiated consumer loans in general?
Mr. Belcher: Consumer loans in general. I think you have to add that to the pot.
Senator Stewart: Could we focus on the cards? That situation, as you said, seems to be dealt with on an actuarial basis, whereas I assume that when a person applies for a loan to make a consumer purchase, the immediate circumstances are examined. The cards apparently, as you said, are given out on an actuarial basis.
Mr. Belcher: The credit assessment tends to be actuarial. You fill in a credit application. I repeat that I am not a consumer expert and know little about it, but people fill in an application form which contains financial and other information, including all other cards held. Investigations are done at credit bureaus and the like. At the end of the day, if they look like a good credit risk, we make the loan. However, even if they have too many credit cards, they may have lied to us and gotten away with it. They may well get the loan, but if they do not reach our criteria for what we think is prudent management, we would not give them a credit card or make the loan.
Senator Stewart: Nevertheless, statistics suggest and I think the testimony this morning is that the number of consumer bankruptcies has gone up, notwithstanding all your precautions.
Mr. Belcher: I think the absolute amount of consumer debt has increased as well.
The Chairman: The point Senator Stewart is making is that the absolute number of consumer bankruptcies has risen dramatically over the last three years, whereas the number of corporate bankruptcies is bobbing around within a typical band width.
Senator Stewart: I think this is quite serious. I do not want to suggest that the banks are villains in this scenario; however, I think a realistic analysis of the problem of rocketing consumer debt and bankruptcy is very important to our economy. The question is: How do you deal with it?
You seem to be saying that there is no way the issuer of a credit card can be expected to really produce a sure survey of what that person's financial competence is going to be, even within a fairly stable economic situation, because he or she may have 20 different cards and, as you say, may have lied to you.
Mr. Belcher: They may be perfectly current on all the cards and things may look fine.
The Chairman: Just so we are clear and we are not deviating off the issue of the rates of credit cards, which some MPs are currently championing, that is not the issue before us. I am happy to talk about the availability-of-credit issue, but not the interest rates on credit cards.
Senator Kenny: I wish to return to Senator Stewart's question about whether there should be remedy in bankruptcy.
If the rationale for the high rate of credit cards is to take into account the fact that there are many non-performing cards, it seems to me that that is how you solve the problem. You do not solve it through legislation.
The Chairman: Going back to a meeting at the beginning of our hearings when the department appeared, it is clear that there is not a detailed understanding of the real causes of consumer bankruptcy. There is anecdotal evidence and a feel as to where the problems lie.
One of the issues which has confronted this committee, and Senator Stewart put it to one of the other witnesses, was the need to understand the detailed causes of consumer bankruptcy because people just do not know. Neither lenders, consumers associations nor the government are aware. That is obviously an issue we will have to deal with in our report.
Senator Taylor: Surely these gentlemen would have some ideas.
The Chairman: I think it is unfair to ask them that.
Senator Oliver: Other witnesses have said there is no empirical data.
The Chairman: Exactly.
Senator Stewart, I am sorry to interrupt, but I just wanted to get us back on track. Have you finished?
Senator Stewart: I think so, Mr. Chairman.
Mr. Lundy went to the point that was emphasized by the lawyers that it is not a case where people are lying and thus misleading the lenders. It is not a case where they are financially incompetent. It is largely a problem of predicting one's financial circumstances in a rapidly changing economic economy. Perhaps that is anecdotal.
If that is the case, I suppose one could argue that the credit card business is a dangerous business. This is not the kind of boat one ought to be launching into that economic sea. The sea is so rough that this particular craft is not a safe craft for those waters. That may be pushing the argument too far, but there may be an element of truth.
Mr. Lundy: Perhaps "pushing too far" is correct. The fallout for either reckless or imprudent or overly aggressive lending, be it credit card, consumer or corporate, falls back to the lenders and their shareholders. If we go back to 1982 and the oil patch problems, no one in Canada or the United States thought the price of oil was heading towards $100 a barrel, and we suddenly had the oil crisis.
Similarly, in 1989-90, in central Canada, real estate values were simply going to double. No one ever thought they could come down.
Senators, when we look at company after company and industry after industry, they are going through a restructuring. Every time an industry or an entity is restructured, there are people implications.
We have seen the single-family income move to two-family income and higher unemployment. We are back to one-family income. Over-extension has occurred.
Thank goodness today we have lower interest rates. Could you imagine this economy with high interest rates at 20 per cent again? It would be devastating.
Senator Stewart: The question I want to leave with you, Mr. Chairman, is this: Given all the uncertainties, is the credit card a suitable lending device in the kind of uncertain economic sea which Mr. Lundy has described?
Mr. Belcher: To quote the Robert Morris article, it is on point with what Senator Stewart was saying:
The increase in bankruptcies in early '96 reflects lower job growth, stagnating income levels and increasing levels of consumer debt in '95.
This is the United States they are talking about.
Those trends reversed themselves in early '96. A plateau is being reached. However, we could see a significant increase in bankruptcies during the next downturn if we weaken credit standards...
The banks are aware of that. We watch our delinquency ratios carefully and review our credit models frequently to try and adjust our credit standards to deal with those issues. Clearly, there are macro-economic issues at stake here in these kinds of delinquencies, and things have not been good for a long time for consumers in this country.
The Chairman: Senators, our next witnesses are departmental witnesses.
Please proceed.
Mr. David Tobin, Director General, Corporate Governance Branch, Department of Industry: Over the last two weeks, senators, your committee has heard a number of well-prepared presentations and interesting suggestions for amendments to this bill. Some would change the thrust of the current act as well as change the thrust of Bill C-5. Some would, in fact, revert back to the pre-1992 situation we had before the act was amended after many years. In other cases, you heard opposing views, and that replicated what we heard in our own deliberations. People came at issues from different sides. That is normal when you have a broadly based, consultative process.
The vast majority of the suggestions made before you would probably alter the consensus arrived at through BIAC, the consultative process the department had in place. These refer to things such as a mediation process, spousal approval and support officers liability. Most of these were discussed through the BIAC process. Witnesses have appeared here today, and they suggested we alter that.
The BIAC process was a key component of the department's and the government's effort at bankruptcy reform. After the 1992 amendments and given the three-year review clause, a great deal of time was spent trying to determine what would be the best way of consulting with stakeholders so the three-year review clause would become a meaningful process. BIAC was set up to assist in reaching hard to get and delicate compromises and consensus by bringing all relevant parties to the table.
The major witnesses appearing before you, including the Insolvency Institute, the Canadian Insolvency Practitioners Association and members of the Canadian Bar, also made comments that the BIAC process was a useful and fruitful one. This does not suggest they agreed with all of the comments or the consensus reached at BIAC, but that is in fact the nature of consensus.
The satisfactory resolution of issues greatly benefits from a multi-stakeholder discussion so that all interested parties have an opportunity to hear each other's view, and sometimes consensus does emerge. Whatever the proposals, we rarely reach unanimity. Consensus is strived for and consensus means that, in some cases, stakeholders' views were not retained or accepted.
As the committee has been told, insolvency law is too important to be left unamended for a long period of time. We do not want to replicate the situation before the passage of the 1992 amendments.
1992 saw a three-year review clause, and this time we have a five-year review clause. We are hoping that five-year review clause will give us an opportunity, if Parliament agrees, to canvass stakeholders during that period of time and to continue to fine tune the act.
In the last two weeks, we have seen in this committee that discussions continue. The issues raised before this committee are all very important and all deserve to be part of the priority agenda for the next phase of bankruptcy reform. At this point, we envisage something in the form of a BIAC to continue that consultative process over the next phase.
Mr. Chairman, we can proceed whichever way you would like, either responding directly to questions from members of the committee with respect to the particular issues raised over the last couple of weeks, or we can lead with a couple of questions ourselves.
The Chairman: I suggest that you lead with the major issues so we get those off the table. We will then move on to the technical issues.
Senator Angus: Mr. Tobin, we are all looking forward to hearing you gentlemen on these subjects. Most of you have been here and heard the discussions. I applaud the consultative process which took place between 1992 and the introduction of this legislation.
Can you deal with this element of the process up front? Another element of the process disturbs me, and that is, all of the elements introduced at the end of October before the House industry committee and all of the substantial issues, including the change to section 124, never had an opportunity to be dealt with at any other stage of the process. I have a problem with that element of the process. I am sure you have a good explanation for it. I need to know how things happened this way.
This is a very important piece of framework legislation. I endorse the efforts and the way you went about it in the first instance. However, I find that the process ran off the rails, and I am very troubled by it.
Mr. Tobin: The process of amending the bill obviously took into account, in large measure, the BIAC process and the comments and suggestions we received. Subsequent to that and the tabling of the bill, many written submissions were received by the government and by the committee itself with respect to the tabled bill.
With respect to the amendments tabled towards the end of the session, I think the normal process was followed. Listening to witnesses, reading submissions, and then coming forward with a series of amendments based on those was, I think, the normal process.
In some cases, they did not follow the written submissions or the testimony. Some of them were in conflict, so a decision had to be made. However, I do not think there was anything by way of unusual behaviour in terms of the amendment process. They generally come towards the end of committee hearings, the same way they would have come here towards the end of a committee hearing, if I understand your question correctly.
Senator Angus: I have no problem that in the normal course of the events you hold hearings, as we do here in the Senate. We are doing our best to deal with the evidence and make constructive suggestions based on our knowledge and experience.
However, it is my sense that a great number of the amendments brought in at the end of the hearings in the other place bore no relation whatsoever to the evidence. I may be wrong, but that is the thrust of my question.
Mr. Tobin: We will get into clause 124 in a few minutes because we do have a detailed set of comments in relation to that section. In a case such as that, we are trying to line up one piece of insolvency legislation with another. That was not the only reason. We were also of the view at the time that clause 124 made better law. We are interested in the comments you have received thus far. In some cases, that was it; it was not as a result of a direct submission. Rather, we thought that would be a better way of going in terms of balancing the interests of the creditors and the debtors.
I am not sure that we have done a calculation on the 70-odd amendments introduced and lined them up next to the submissions.
The Chairman: I wish to make one comment on the process. I am not complaining about the process, but I wish to emphasize it.
In a very complicated piece of legislation, roughly 80 amendments were introduced in the House. They were not fundamentally considered by the House committee. Technically, you could say they were formally passed through the committee very quickly and no witnesses were heard after the amendments were introduced.
There are two elements to the point Senator Angus raised. First, he focused on the extent to which the amendments reflect the consultation process. Second, the first opportunity that any of the witnesses who participated in the BIAC process have had to comment on those amendments is before this committee. Therefore, it should not be terribly surprising to anyone that out of 80-odd amendments, there may be one, two, three, five or a small number which witnesses have concluded are not correct or acceptable. The drafting process is complicated enough, having been through that in my life. No one is perfect. If you can get 75 out of 80, that is a good batting average given the complexity of the issues.
It is important to keep in mind that a great deal of comment before the committee has been based on amendments that, in fairness, no one else has had a chance to comment on until they got to this committee. It is not being critical of the government or the legislative drafters to make the observation that if you make that many amendments, a small number may require further change to make them work. That is the other half of the process question raised by Senator Angus.
I was not necessarily looking for a response, but one ought to understand that for the record.
Mr. Tobin: I see your point of view. When we approached the amendment process in the other place, in large measure, some of them were drafting issues. With respect to drafting, it is as simple as consistency between the two official languages. Others were technical in terms based on submissions we received from outside experts saying that, from a practical point of view, the law would function better it we did "A" rather than "B".
We have a third category, on which you received the majority of comments in this place, with respect to the actual substance of them. We are here today to give you further explanation of why they were put in that way.
The Chairman: Let us proceed to those. Please begin with clause 124.
Mr. Max Mendelsohn, Legal Advisor to the Department of Industry: Senators, this is one of the most difficult things on which to comment because there has been such an outpouring of opposition to the provision from a certain segment of the insolvency community. At the outset, I will disclose to you that I am on the board of directors of the Insolvency Institute; at least, that was the case up until today. I cannot vouch for tomorrow. I was not part of the process of responding to the amendments.
By way of background, I have been involved in the insolvency area for 25 of 30 years of practice, a large portion of my time being spent in trying to lead banks through the process of supporting reorganizations of insolvent borrowers.
I will take a few minutes to attempt to put the clause 124 issue into what I believe is the appropriate context because I do not know if there was a contextual explanation of it by those who oppose it. In so doing, I would like, with your indulgence, to go back to first principles relating to reorganizations.
Legislation on reorganizations, be it under the BIA or under the CCAA, have one special characteristic; that is, they are a derogation from the normal contractual rules to the effect that a creditor is entitled to what that creditor bargained for.
Under reorganization legislation, creditors are told that a debtor may make an offer and the creditor will be bound to that offer even if they do not like it and vote against it, provided a sufficient number of creditors, both in number and in value, accept it. That is what underlies the whole process. That is what I would refer to as the substantive part of the process.
There is a procedural part of the process whereby one says, "In the period that it takes to re-organize or to put forward and deal with a plan of reoganization, there must be a status quo." Therefore, the legislation will provide for what typically, in Ontario, is a called a "stay of proceedings". More colloquially, we call it a freeze or sticking the creditors in the penalty box. Whatever it is, it is to generate a status quo so that the process can be allowed to unfold in an orderly fashion without losing the going-concern entity.
The issue we are now discussing under clause 124 has nothing to do with the substantive element of reorganization. Plans eventually are filed and voted on, but that is not what we are talking about today. We are talking about the procedural aspect; the stay of proceedings aspect.
Under the BIA there is a code of what happens. When someone initiates the reorganization process, there is an automatic stay of proceedings which has an elaborate set of rules attached to it.
Under the CCAA, as many people have correctly indicated before you, there is considerable flexibility on the part of the courts. In practice, the reorganizing entity and its legal counsel craft a draft order to be presented before a court in the image that they would like to see it. They, in effect, write their own private rule book, which is frequently a very elaborate document. It is typically brought to a judge in haste. No judge could possibly fully digest and understand it in order to render an order -- because these things can be 100 pages long with history and all kinds of complexity built into them -- and orders are granted.
It stands to reason that creative counsel will draft these things in the way which is most beneficial to that which they wish to achieve. Over the years they have discovered that you can make facts and create substantive things in these orders, so that by the time you vote on the order, the dye is cast in any event. Many things happened at the stage of the order.
I have not yet reached clause 124. The underlying philosophy is that people's eventual rights are not to be impaired by these orders. That happens later when the plan is dealt with, if it is to happen. There is to be a relative status quo during the period.
It has been realized that many creditors frequently are materially prejudiced by the orders sought and have a great deal of difficulty getting a proper hearing on the issue because there is, understandably, a very heavy bias in favour of reorganizations, as there should be. However, it should not be a bias at all costs, no matter who is hurt by it.
The material prejudice provision, which is argued to be the offensive portion of clause 124, addresses the following: A creditor should not be materially prejudiced by the order. What does a "material prejudice" mean? I suggest it means that if this order is granted against the company going bankrupt today, is the creditor materially worse off by the non-bankruptcy today?
Some suggest that most creditors are materially prejudiced by that standard. In my opinion, that is not the case. I propose to go through the various categories of creditors in summary form to show you why that would not be the case. It is only if, as against today's bankruptcy, the creditor is prejudiced by the stay.
It has been argued before you that this process will require plans to be filed within 30 days. No one suggests that. It is correct, as has been argued before you, that these things cannot be done in 30 days. There is no question about that.
It has further been argued before you that if it is determined by a court that there is a material prejudice to one creditor or another, that will be a stop-the-music event and the reorganization comes to an end. That is not the case.
If a proposed order has been drafted in such a way as to cause material prejudice to a given creditor -- to a small creditor, for example, because that is the example that was used -- then it is the job of the courts, first, to decide whether that is in fact the case.
If the court determines that that is the case, then it is the job of the court to say, "The order in that form is not correct insofar as that creditor or category of creditor is concerned." The order has to be different. In some cases it is appropriate that the creditor has to be carved out of the order. Indeed, yesterday, Mr. Baird made specific reference to creditors being carved out now. That happens as it should happen. In the context of a material prejudice provision in a proper case, that is what would happen and that is what should happen.
The Chairman: When you use the words "carved out", you mean essentially that a creditor is paid off.
Mr. Mendelsohn: No. These orders tend to be very long, elaborate, 100-paragraph books. Different rules are made for different categories of creditors. A "carve-out" would mean that the creditor is paid off; or, if the creditor's asset is a building, then he can take it away and realize on it; or, some rules are made about how much of the income from that asset can be used. There can be any number of ways in which this is "carved out".
It is not the case that it is an all-or-nothing affair -- far from it.
Let me analyze different categories of creditors and different circumstances to show you how I believe that this would work and how it works now under the BIA.
Senator Angus: Are you talking about the CCAA here?
Mr. Mendelsohn: Yes, I am.
Let us start with unsecured creditors. Someone made the argument in the last few days that every unsecured creditor is materially prejudiced by the stay of proceedings. I suggest to you that in the vast majority of cases -- almost 100 per cent -- that is not the case. The ordinary creditor say, "Am I better off with a bankruptcy today or a stay order that may result in a reorganization where I get something?" In most bankruptcies, unsecured creditors get zero. In reorganizations, they sometimes get something. Sometimes, a real, viable entity comes out on the other end.
Someone mentioned the Dylex example as regards unsecured creditors, how active the unsecured creditors were in Dylex, and how, in the face of a material prejudice provision, Dylex could have been brought down. I have some first-hand experience, having been one of the three legal advisors to the organized group of unsecured creditors in Dylex.
First, in Dylex, every unsecured creditor realized that a reorganization was the most important thing and the best thing that could happen. No one could have or would have wanted to suggest that the reorganization process and the stay gave rise to a material prejudice. There were other issues in Dylex having to do with future supply, and so forth, but nothing to do with the appropriateness of an order. Unsecured creditors are not, as a rule, materially prejudiced.
Let us take the real estate example that was put before you. That is interesting because one of the bankers that was before you has been known to publicly make the statement that there is no appropriate reorganization for a real estate company because it is not really a business -- it is just a collection of properties.
Let us look at what happens with a real estate reorganization. Let us suppose that a one-asset lender opposes a CCAA order for a stay of proceedings because he says that the security on his one building will be impaired. First, he is either right or wrong; that is a factual decision for the court to make.
Second, if he is fully secured and if it is held that there is enough value in the building and that that value will be there at the end of the process, he is not materially prejudiced by the proceeding, and his arguments should fall on deaf ears.
Let us take another case. Let us suppose that he is under-secured. Let us suppose that there is a claim against that property, namely, a first mortgage for $1 million, and the value of the property is $800,000. He seeks to use the revenue of that property to participate in the funding of the ongoing restructuring efforts. Is that right? At that point, you are definitively taking away value from that property.
In a final reorganization plan, one thing is clear: That property will have nothing to contribute to the general reorganization. It is under water. There is no available contribution to make. Why should that creditor be asked to stand aside and watch the value of its security trickle away in that example? It would be valid for such a creditor to object to an order.
The appropriate way for the court to deal with that is to carve it out and say, "Yes, that property is under water; take it away." He need not be a philanthropist to contribute to the reorganization efforts. That is the kind of thing the material prejudice provisions seek to prevent.
The Chairman: As a non-lawyer, I appreciated your working illustration of what you called "creative counsel".
You spent approximately 95 per cent of your time explaining why the proposed amendment to section 124 is not a problem and about 5 per cent of your time explaining why the amendment is needed.
You rebutted everyone but never bothered to say why it was there except for your last couple of sentences. In your real estate example, in the current legislation, without this change, does the judge not already have all the discretion required to "carve out" the building? If he does, then your case is a terrific case for the status quo.
Mr. Mendelsohn: I heard someone in the background whisper "harmonization".
Senator Meighen: I did. Mr. Tobin said that.
Mr. Mendelsohn: It is the same provision contained in the BIA as for the analogous circumstance.
Senator Meighen: Tell us why that is good.
The Chairman: Before you do that, I must lay my prejudices on the table. As someone who was a deputy minister provincially and federally, I have always felt that one of the great elements of the federal system is the passionate belief among the Ottawa bureaucracy in general that uniformity and similarity is, by definition, automatically a public good. As someone who comes from one of the smaller provinces, the value of that is tremendously overrated. Having said that, I am happy to hear your answer.
Mr. Tobin: Before Mr. Mendelsohn answers, when I made the comment about harmonization, I said that not only was it harmonization, but it was good law and good policy.
Mr. Mendelsohn: It is not being done because it is harmonization. It is being done because what is in the other place is good and it will be good here, too.
In answer to the chairman's question about whether the courts have discretion to achieve the same result that this provision would seek to achieve, yes, the courts do have discretion. However, we believe that it is helpful to create some kind of a framework for the courts to attach themselves to because the bias -- and I would say the over-bias because there should be a bias to some degree -- in favour of reorganizing entities spills over onto the judiciary. Generally, everyone has a bias in favour of reorganization, but there must be some goal posts.
It is desirable that there be some legislative guidelines to which it becomes a little easier for the courts to attach themselves. The unfettered discretion of the courts in CCAA matters, I believe, has given rise to some overcreativity, if I can put it that way. It is useful to put some limitation to it and to articulate some guidelines.
The Chairman: We as a committee have a dilemma: The insolvency practitioners, the Insolvency Institute, the bar, and the banks have all collectively condemned this clause with not insignificant passion. On the other side of the debate, we have your argument. Given that the bulk of the evidence is overwhelming, do you really think that this provision is worth all of the difficulty that it is clearly causing some sensible and responsible people who know this business inside-out?
Mr. Mendelsohn: Senator, there is an expression in French, "la jurisprudence ne se compte pas, elle se pèse". Case law is not to be counted, it is to be weighed.
I agree that there is an avalanche of opinion against the enactment of clause 124.
Senator Oliver: What is its weight?
Mr. Mendelsohn: On balance, I think it is better that the provision be there than that it not be there. I cannot summon the same degree of passion in the sense that I cannot suggest to the committee that it will be cataclysmic if it is not there. I do not believe, as I mentioned to Senator Meighen the other day, that even Parliament has the ability to legislate a landslide. I do not believe that there will be any significant problem as a result of this provision, and I believe that a substantial amount of good will be done if it is enacted.
Senator Stewart: You are an experienced practitioner in this area and you know the businesses of those who object to the proposed change in the law. Do you have any explanation as to why they object?
Mr. Mendelsohn: I believe for the most part that the parties objecting, in good faith, are positioned on the debtor side of the restructuring equation. Anything that complicates their lives in the area of getting restructuring through is a bad thing. Anything that makes it easier to get restructuring through is a good thing, and understandably so.
Mr. Gordon Marantz, Legal Advisor to the Department of Industry: Mr. Mendelsohn and I have divided our presentation. I should say that I am a retired director of the Insolvency Institute and I retired before this issue arose.
We are faced with what appears to be the united opposition of the restructuring industry in the country. There is an inherent conservatism there. I should also say, in all fairness, that those who appeared here will also appear in court acting for lending institutions, screaming that they are being prejudiced and they want the stay lifted. We have seen them time and time again. When they are counsel, they have one side; when they are lenders, they have another side.
However, under the CCAA originally, there were no tests and no standards. You came into court for your order and got it without anyone being there. Within a period of time, the creditors mobilized and came back to court to ask for relief.
When we started with the amendment process, I chaired a working group dealing with the CCAA problems. I am familiar with the discussions. It was clear that you had to decide who had the burden of proof because when the creditors came back to object, generally it seemed they had to prove that they were being prejudiced and that the debtor had a free ride through the process. The original draft of the bill provided, as this bill does now, that in getting the first order and then the come-back order, the burden of proving that the order is necessary is on the debtor.
We looked at it and decided that this was a freeze; this was a status quo hold. Creditors should not be materially prejudiced. The amendments that have caused all of the objections are there. Of the three subsections to the amendment, no one is upset about the good-faith issue or the fact that a proposal is likely to be put together. What upsets people is the material prejudice issue.
Where did we get it from and what is the experience? Many people have been telling you that the world will come to an end, but no one has talked about what has actually happened. We have had this language in the BIA since 1992. We have it in the extension-of-time section, and in the lifting-a-stay-of-proceeding section, section 69.2. It is there in the BIA and we have had experience with it.
The Chairman: For the record, to be fair, the CCAA, by your own proposal, will only operate with big companies. You prefer a $10 million floor. We will debate $10 million versus $5 million later. However, to make the argument that because a proposal works for small companies it ought to work for big companies, when by your own admission you have said you want a different act for big companies as opposed to small companies, is somewhat illogical even to a simple mathematician such as myself.
Mr. Marantz: Air Atlantic was a fairly big company, and it filed under the BIA. In the Air Atlantic situation, you had the experience of aircraft lessors who wanted the stay lifted so they could get their aircraft back. This dealt with the material prejudice question.
Air Atlantic went back to court on a number of occasions -- I was acting as counsel for the trustee -- and asked for extensions of the stay, and they were vigorously fought in hearings over three days. If there was ever a case to test the concept of material prejudice, it was the Air Atlantic case, and they got all of their extensions of time.
I am suggesting that this language has worked and it has been proven to work. Mr. Justice Farley in Ontario, in the case of Cumberland Trading, said that you determine material prejudice not on a subjective standard but an objective standard. Everyone is prejudiced in every organization. It is clear. Whether that prejudice is material can only be determined by looking at the context of the whole thing.
I understand your concern. We are suggesting that this legislation will not cause the tempest that people fear it will.
We have seen it happen. Birks was reorganized under the BIA. There did not seem to be a problem. You should have a separate statute for very large companies, but it is not fair if one creditor is having the reorganization done on its back. It should be protected. I was before Mr. Justice Houlden in Toronto yesterday afternoon with a CCAA application. A creditor appeared on the motion because we notified them. They were concerned about a lien claim they had filed, and they wanted to be sure they could perfect and pursue that lien claim. If we had not allowed them to do that, they would have been materially prejudiced. Would the reorganization have been thrown out? Would the stay have been thrown out if we had not done that? No. We had it provided for in the order, but the judge would have amended the order to allow them to protect their rights.
This provision does not provide for the end of the world because if you know what you are doing, you will see that the people are adequately protected.
The United States has this concept in Chapter 11, the concept of adequate protection. If a secured creditor -- and this only applies to secured creditors -- does not feel it is adequately protected, that its collateral progress is eroding, it can go to the court and ask for adequate protection. The court then gets into a very complicated valuation exercise.
We suggest this is similar to that concept. Creditors are entitled to be protected but not to stop a reorganization.
Senator Angus: I gather you folks are not offering to withdraw that particular amendment.
Mr. Marantz: I am not in a position to withdraw anything.
Mr. Tobin: That is our initial position.
Senator Angus: While Mr. Mendelsohn was giving his opening remarks, Senator Oliver whispered to me that this was leading up to "notwithstanding all of the foregoing."
Senator Oliver: I have a recommendation for withdrawal.
Senator Angus: Am I right in understanding that you are insisting that it stays in the bill for the reasons outlined by the two counsel?
Mr. Tobin: Our position here is to explain more fully why it is there. Your recommendation would be a recommendation, obviously, senator.
Senator Angus: Mr. Tobin, I must ask the question again. If it is so important to the framework law we are dealing with, why was it not in when the bill was first introduced?
Mr. Tobin: I do not know. It was not discussed in a big way during the BIAC process. The BIAC process did not discuss this level of detail. It came during the subsequent review when we were looking at and preparing for the introduction of the bill. A number of issues were not discussed in the BIAC process.
As Mr. Mendelsohn and Mr. Marantz said, the way we envisaged this, it was not a major addition. There was a fundamental view going into the examination of the provisions of Bill C-5, that CCAA should have some rules attached to it. Right now there are very few rules, but the general thrust was that there should be some rules attached, not the same as the BIA, but there should be more rules surrounding it than there are presently. That was the general consensus around the BIAC process.
We saw this as an attempt to accommodate that. To be honest, we did not anticipate the reaction received by you in this committee because we saw it as an attempt to balance the interests of the creditors and debtors without -- I emphasize this -- necessarily endangering the ability of a proposal to go forward. Rather, this concept of a "carve-out" which Mr. Mendelsohn referenced before would be enshrined with some sort of standard.
Before this, there was no standard. I draw to the attention of members of the committee that, in this case, this must be satisfied by the applicant according to the standard.
Senator Angus: We have had verbal submissions and many letters, some as recently as this morning. They go so far as to say that, generally, Bill C-5 is good and it is an advance in the reform of our bankruptcy and insolvency legislation.
They support the spirit and the basic thrust of this bill; however, in the case of this particular provision, they would go to the wall. They would rather see the bill die, even though there are many other good things about it.
I must come back again to the process. Would you go the other way and say that, without this provision, you do not want to go ahead?
Mr. Tobin: That is a difficult question to answer. Obviously we would want to see the recommendation coming from this committee.
Senator Angus: We would just take it out and leave it the way you had it when you tabled the bill.
Mr. Tobin: The government feels the bill is a step forward in terms of framework legislation.
The Chairman: We understand that, as officials, you cannot reach the compromise which must ultimately be reached between the government and the committee. I do not think Senator Angus was trying to force you to do so. He was trying to get some sense of the relative importance.
Mr. Tobin: Was it a key provision in terms of the BIAC process? Obviously it was not because it was not discussed in the BIAC agenda in any way. It was not one of the key policy thrusts going into nor coming out of the BIAC discussions.
Senator Angus: It is frankly troubling that it was not there. Many of those participants in the process voluntarily worked long years to help make a good bill. They claim they were not consulted and that they were blind-sided. They use words like "draconian" and "very damaging" and that this will undermine the whole effectiveness of the CCAA. That gets to me, big time.
Mr. Tobin: I appreciate that. It is strong language coming from informed people who have been working in this area.
When we saw that, we consulted our own outside experts and asked what the lay of the land is in this area. Mr. Mendelsohn and Mr. Marantz have been candid in saying that they are members of the institute which has come forward to you with a written submission.
Quite candidly, we were somewhat surprised about the reaction of people. We thought it was consistent with the overall thrust going into BIAC. Was it something we dealt with going into BIAC? No. Was it the subject of much discussion in BIAC, similar to some of the consumer proposals? No, it was not of that order of magnitude.
Senator Meighen: If it ain't broke, why try to fix it?
Mr. Tobin: Like many other provisions, we felt some changes were consistent with the discussions we had had, but admittedly were not part of the discussions we had had.
Senator Meighen: Say that again, please.
Mr. Tobin: We did not have a draft bill when we discussed this in the BIAC process. We talked about general policy thrusts, such as the environmental one. We had several discussions on the environmental issue in the BIAC process. Some of them were rejected. We went back with additional ones. It was really not draft language, but it was closer to the environmental one than any other area.
In most of the other areas, we did not proceed with draft language in the consultative process. There was no time and the forum was not appropriate for that process.
In this instance, as we went through the drafting of the legislation, we looked at rules which would be appropriate for the CCAA. We felt that this was an appropriate rule to include. As I said before, we did not anticipate the reaction we had received thus far.
Mr. Marantz: We discussed burden of proof in the BIAC process. When we saw the bill, we said there were no standards as to the burden of proof, so standards were written. That is how it happened.
[Translation]
Senator Hervieux-Payette: If I am not mistaken, during the study of Bill C-24, we heard from everybody who was speaking on behalf of the majority. The voice of the minority could not be heard. Some balance might be necessary to protect anybody who could be prejudiced. The second reason is that you only trust the judge up to a certain point; you think it is always better when more specific guidelines are given to the judge. You know then how the measure will be implemented and people will be more knowledgeable about the rules of the game. There was on one hand the issue about limiting the judiciary discretion and on the other hand the balance to be found between a creditor running the risk to be unduly affected and the majority of the other lenders who choose one direction and say they don't care about that guy.
Mr. Mendelsohn: I will answer the second part of your question first. I may have answered it too quickly when I said that there must be some guidelines for the judges. It goes further than that. It is a good thing if debtors and their counsel know, when they draft their application to the court, that they must meet some test. If they are aware that they must find the right balance so that no creditor can be materially prejudiced, applications will be better balanced and life will be easier for the courts. Things will be much more orderly than they are now.
To answer the first part of your question, it is not necessarily a majority vs. minority issue, because at the order stage, there is no vote. Some temporary solutions are proposed regarding staying the proceedings for various classes of creditors. Some major creditor could be prejudiced.
You have a good illustration of this when a bank loans money on the receivables and the inventory. The debtor wants to use the product of the receivables and sell off the inventory along the way; the bank will often show up and say it is a major creditor and the assets are its only security. It can see from the cashflow that its securities will be eliminated and it will be materially prejudiced. This can happen not only to the smaller creditors or the minority creditors but indeed to all creditors.
[English]
The Chairman: Given the time, I suggest that we proceed as follows. It is clear that we will ask the witnesses to reappear at 10 a.m. on Tuesday, and we must adjourn at 1:55 p.m. today because of the Senate. I suggest we turn to the directors' and officers' liability question. We have had some evidence suggesting there ought to be changes to Bill C-5 in that respect.
Mr. Marantz: The issue of directors and officers was discussed in great length at BIAC. There was not always agreement, but we generally agreed on the most effective thing that could be done now, recognizing that it is not entirely effective.
The question of imposing a due diligence or a good faith standard, as has been discussed here, is something that the government felt was an appropriate issue to be raised as part of what will happen with the CBCA in the next phase of the review process.The Insolvency Institute had a number of suggestions which did not come out at the BIAC process, and they are included their report. I suggest that those suggestions are not practical to impose, and they require a great deal of thought.
One suggestion is that if the standard provided in the proposal is met, the directors should be free, even if the proposal does not succeed or go forward. It is a vague test. It is not an objectively determinable test. They did not raise the question of a due diligence standard, and there are serious questions about where it should go. We do not disagree that there must be protection for directors and officers, but what came out of BIAC -- and all the participants were there -- is what was agreed at this stage to be effective.
Senator Angus: I hear the witness say the same thing I heard him say the other night. You agree that it would enhance the law to have a due diligence defence for directors, but because of conflicting provisions in other laws, this should be deferred until the next phase of the reform process. Does that sum up what you are saying?
Mr. Marantz: Or sooner, but it is an issue to be dealt with.
Senator Angus: Why not? We heard a witness this morning confirm my own experiences. You may read in the daily newspapers about the directors of Westar and PWA or Canadian Airlines and various others, but you do not read about things happening with many others behind the scenes. From another life of mine, I can tell you that it happens frequently. One of the witnesses this morning referred to cases where he was bound by privilege and could not outline them.
You are the experts. I understand there are many complications in changing the law when you have a multiplicity of statutory provisions on the subject. However, it seems to me that this is a window of opportunity. Why would we not seize this opportunity to put in a general provision, a due diligence defence, as a broad statement of public policy in this area now?
Senator Kenny: Where is the harm if it happens now?
Senator Angus: Yes. That was inherent in my question. Thank you, senator.
Mr. Jacques Hains, Director, Corporate Law Policy Directorate, Department of Industry: To add to what Mr. Marantz has said, together with one of the Insolvency Institute members, I co-chaired BIAC Working Group Number 8, whose mandate was to look at directors' liability. That working group was struck in 1993 at about the time when Canada saw massive resignations of board members: Westar Mining, Canadian Airlines, and Peoples' Jewellers. The committee talked about that issue for two-and-a-half years. There were a number of multi-stakeholders. Many of them were making your point, senator, saying that we must do that.
The consensus that resulted after two-and-a-half years of discussion on that issue, as well as issues such as capping liability and all the other issues this committee has considered in its corporate governance hearings, was that we are not totally sure of all the ramifications and consequences of going one way or the other. The three-year review clock is ticking. Let us go with what we have and ensure that, as soon as Bill C-5 is approved, we are reconstituted and keep labouring.
Some of the witnesses here were members of that working group and were in favour of doing something now. The other people there said, "Look, this is big, and we must know what we are doing and what we are chewing on." That is the consensus we arrived at.
Senator Angus: There was a substantial body of opinion that we should do it, and it would only take a few commas and lines.
Mr. Marantz: There is a potential constitutional issue when liability of directors is imposed under a provincial statute, perhaps not even a revenue statute, as to whether it can be interfered with because it is not the individual who is insolvent. There are more issues than appear on the surface.
Senator Angus: As a fellow member of the Canadian Bar Association, I am sure you would not mind if we create a little work for the lawyers.
Senator Stewart: They are badly overpaid now.
Senator Angus: I think you mean overworked. That is a substantial slip of the tongue.
Senator Taylor: That is the only group which takes precedence over bankers for getting paid.
Mr. Mendelsohn: I believe Mr. Baird said yesterday that there are some 100-odd statutes which impose liabilities on directors or officers. If this bill were to be amended now to create a comprehensive system for dealing with directors' and officers' liability, the ground swell of opposition with respect to the section 124 change would pale by comparison to what would happen through representatives of all the provinces who had not been consulted. Quite an elaborate process must be followed in order to achieve that.
Senator Angus: Is there, in your opinion, expert as you are in this field, a sound public-policy reason for retaining the responsibility of a corporate director for wages to the extent that the present law exacts that responsibility?
Mr. Mendelsohn: I feel a very cogent argument can be made towards reforming that aspect of the law. There is no question about it.
Senator Oliver: The answer is no.
Senator Angus: I thought he was going to say that a cogent argument could be made by the CAW.
Mr. Mendelsohn: The answer is no.
The Chairman: Recognizing that amendments will be coming forward next year to the CBCA and that those amendments will deal with, among other things, directors' liability, is it possible to put in one bill the changes to the CBCA and whatever directors' liability changes make sense with respect to the Bankruptcy Act?
Mr. Tobin: Mr. Chairman, you can put it in the same bill, to amend more than one statute, if that is your question.
Senator Angus: I can give you one example with which I am familiar.
In the Carriage of Goods by Water Act, there is a provision stating that this other regime of liability will trigger and replace the one herein set forth when these things happen.
Mr. Tobin: This bill itself amends more than one piece of legislation.
The Chairman: Another procedure would be to change all of the liability affecting all of the statutes at the same time.
Senator Angus: That would be for all of the federal statutes.
The Chairman: Yes.
It is clear to me that you gentlemen would be kind enough to join us for two or three hours at 10:00 a. m. next Tuesday.
Mr. Tobin, I have suggested to our staff that they meet with Mr. Hains. In order to deal with things Tuesday in an orderly fashion, perhaps they can work out a sequence for these issues. In cases where many witnesses complained about the same topic, it would be logical to deal with them issue by issue.
The committee adjourned.