How to act in an insolvency context

In this edition, we look at how executives and their consultant should deal with a bank in an insolvency context. We will also look at the ways in which secured creditors may go about realizing their securities. To do so, we will look at the main advantages and disadvantages for them of realizing the assets by retaining the professional services of a trustee in bankruptcy rather than a receiver.

How to act in an insolvency context

Too often, a company’s legal consultant is unaware of its financial difficulties until legal proceedings are initiated against it. Accountants or auditors, whose engagement is usually limited to the compilation, review or audit of the year-end financial statements, also runs the risk of finding out at the last minute that their client is in a precarious financial situation.

Business Recovery

The crisis will be managed depending on the urgency of the matter and the time needed for the company to turn the situation around.

If the company has a bit of time, the public accountant or auditor could prepare a recovery plan. Once the document is completed, it will be of the utmost importance to contact and inform the bank of the document’s main guidelines. The accountant or legal consultant and the president of the company should meet with the bank to convince them that the plan is feasible and that the company will get back on track to profitability.

There is an emergency when the president of the company cannot guarantee payment of the current week’s salaries, when there is a bailiff at the door waiting to carry out a writ of seizure, or if the company is sufferring significant daily operating losses. The legal consultant or accountant’s recommendations may be particularly harsh, since the company only has a short time in which to act and resolve its liquidity problems.

If there is no time to lose, a notice of intention to make a consumer proposal could precede the filing of a proposal to the creditors. This will provide the company’s consultants with the time needed to finalize the recovery plan prior to filing it with the proper authorities. As well, it is nearly impossible to complete the proposed turnaround without the bank’s support. Therefore, the bank must be kept updated throughout the turnaround process. If the proposed plan is not enough to convince the bank, it will demand payment for its loans and the company will have to come up with an alternate source of financing: no mean feat in an insolvency context.

In the short-term, while it is possible to stay the bank’s proceedings; in the long-term, the company requires its financial support to successfully complete its recovery.

In the event that the company cannot consider a proposal and bankruptcy is the only solution, the bank must be notified in advance prior to declaring bankruptcy. It is better for the bank to be notified by the director, who is also the guarantor in most cases, rather than being informed by receiving a trustee’s notice in the mail.

Realization by the secured creditor

Bad news for the bank: your client informs you that the proposal considered cannot be realized for various reasons, or you learn that your client has closed its doors and ceased all its business operations. Although you hold various securities on your client’s property, how do you go about realizing such property?

Under the Civil Code of Québec, the bank may appoint an interim receiver in order to exercise its hypothecary remedies. It may also retain the services of a trustee in bankruptcy, who has the right to realize the assets assgned to the bank under the Bankruptcy and Insolvency Act (BIA) without having to respect the deadlines of civil proceedings and while reversing the GST and QST priorities.

First off, we should consider the main advantages and disadvantages that go with the realization of assets by a trustee in bankruptcy as opposed to an interim receiver.

ADVANTAGES

Quicker realization of movable hypothecs on inventory and equipment (no 10-day notice as per the BIA and 20-day notice as per the Civil Code of Québec).
Elimination of duties of secured creditors pursuant to sections 243 to 252 of the BIA.
Inversion of certain priorities of the Civil Code of Québec, except the federal and provincial deductions at source (GST, QST, rent, corporate tax). These will be considered unsecured claims as opposed to preferred claims of secured creditors.
Stay of proceedings that prevents other creditors from recovering assigned assets.
Simplified sales procedures (redemption of security rather than initiation of hypothecary remedies)
Use of the trustee’s extensive power of investigation
No occupation rent before the first meeting of creditors, unless the trustee is operating the bankrupt’s business.
Mitigation of the risks indicated in Section 14 of the Act respecting the Ministère du Revenu.
The trustee can take possession of the assets free of lienand can change the locks of the debtor’s premises (it is not necessary to move the assets).

DISADVANTAGES

Trustee withholds 5% of all distributions for superintendent
The inspectors must approve the sale of all assets for the mass of creditors
Taxation of the trustee’s fees and disbursements in respect of the sale of assigned assets.
Trustee has a greater duty of accountability to the various creditors than a receiver

Now, let us look at the main differences between the functions of trustee and receiver.

RECEIVER

APPOINTMENT

By a secured creditor pursuant to a security agreement

DUTIES AND POWERS

Demonstrate caution:

Act honestly;
Act in good faith;
Exercise a reasonable amount of caution;
Not required to act in a perfect manner;
Demonstrate a resonable degree of competency.

A receiver’s primary responsibility consists of protecting the rights of the secured creditor and acting on his behalf and on behalf of the debtor:

Take possession or control of any assigned property.
Secondary responsibility towards the debtor, the guarantor, the lower-ranking secured creditors, the unsecured creditors and the shareholders.
Could be responsible for actions that, according to the security agreement, exceed his powers.
Responsible for putting an end to active sources of contamination when appointed interim receiver.

CONTROL AND PROTECTION OF PROPERTY

Exercises control over the assigned property and the debtor continues operations.
Responsible for the assigned property when appointed interim receiver.

REALIZATION OF PROPERTY

Complies with the procedures set out in the Civil Code of Québec
Evaluates the property
Realizes the assigned property in a commercially reasonable manner and obtains the secured creditor’s authorization.
Obtains the best price under the circumstances.
Ensures that the property is adequately advertized on the market.
N/A

REPORTS

When taking possession of the property and every six months during his receivership.

DISTRIBUTION OF THE PROCEEDS OF SALE

The secured creditor is the first to be paid from the proceeds of the realization of the assigned assets after payment of the following debts:

Preferred claims
First-ranking hypothec
Deemed trust (GST, QST, DAS)

If there is a surplus after the secured creditor’s debt, the receiver will remit it to the company.

FEES AND DISBURSEMENTS

The receiver’s remuneration shall be such as is approved by the secured creditor.

INDEMNITIES

Sections 251 and 252 of the BIA, if acting in good faith.
Liability as of September 30, 1997, Section 14 of the BIA: environmental; employer-successor.

TRUSTEE

APPOINTMENT

By the official receiver in the case of a voluntary assignment or by the court in the case of a receiving order.

DUTIES AND POWERS

Exercise caution, i.e.:

act honestly;
act in good faith;
exercise a reasonable amount of caution;
Not required to act in a perfect manner;
demonstrate a resonable degree of competency.

The trustee’s primary responsibility consists of protecting and realizing the assets free of liens for the mass of creditors:

Taking possession and control of all of the property.
Secondary responsibility towards the secured creditor, the lower-ranking unsecured creditors, the debtor, the garantor and the shareholders.
May be held responsible for actions that give rise to prejudice against one or more creditors who have an interest in the property in the seisin of the trustee.
Responsible for putting an end to sources of active contamination at the time of bankruptcy

CONTROL AND PROTECTION OF PROPERTY

Control over all of the bankrupt’s property.
Responsible for all of the property when there is bankruptcy.

REALIZATION OF PROPERTY

N/A
Evaluates property
Realizes all the assigned property in a commercially reasonable manner after receiving authorization from the secured creditor, mass of creditors or inspectors.
Obtains the best price under the circumstances.
Ensures that the property is adequately advertized on the market
Obtains legal opinion of an external solicitor that the secured creditor’s security is valid (subsection 13.4 of the BIA).

REPORTS

A statement of receipts and disbursements is produced at the end of the administration.

DISTRIBUTION OF PROCEEDS OF SALE

Subject to the rights of secured creditors and deemed trusts for DAS, the proceeds from the realization of assets free of liens is distributed according to section 136 of the BIA.

If there is a surplus after payment of the claims to all of the creditors, the trustee shall remit it to the company.

FEES AND DISBURSEMENTS

Trustee’s remuneration shall be such as is voted to the trustee by ordinary or court-approved resolution at any meeting of creditors.

INDEMNITIES

N/A
Liability as of September 30, 1997, Section 14 of the BIA: environmental: employer-successor.

For the bank, the final decision regarding which method to choose shall be influenced by various factors, such as the type of securities, the debtor’s cooperation or lack thereof, the location of the property, the priorities of the Crown and deadlines for realizing the securities.