NORTH OF THE BORDER UPDATE
This article has been contributed to the blog by Marc Wasserman and Martino Calvaruso. Marc Wasserman is a partner in the insolvency and restructuring group of Osler, Hoskin & Harcourt LLP, and Martino Calvaruso is an associate in the group.
In Tucker v. Aero Inventory (UK) Limited, KPMG Inc., as trustee in bankruptcy (the “Trustee”) of Aero Inventory (UK) Limited and Aero Inventory plc (collectively, “Aero”) brought a motion before the Honourable Justice Morawetz of the Ontario Superior Court of Justice (Commercial List) (the “Court”) to have certain transactions between Aero and Air Canada declared void as preferences pursuant to Section 95 of the Bankruptcy and Insolvency Act (Canada) (the “BIA”). In connection therewith, the Trustee sought the return of U.S. $75 million to Aero’s bankruptcy estate from Air Canada (the “Preference Proceeds”).
Prior to determining the party entitled to the Preference Proceeds, the Court was faced with the following threshold issue: are the proceeds of a preference action under Section 95 of the BIA subject to the rights of secured creditors? Amongst other things, the decision in Aero Inventory is the Court’s determination of this question of law. The Trustee was of the view that the Preference Proceeds, once returned by Air Canada, would be subject to the rights of Aero’s secured creditors. Air Canada argued that any recovery from the preference motion should only be for the benefit of Aero’s unsecured creditors.
Following an extensive review of the relevant jurisprudence and the Trustee’s and Air Canada’s arguments in respect thereof, the Court agreed with the Trustee that the jurisprudence relating to whether the proceeds of a preference action are subject to the rights of secured creditors is “unclear and inconsistent”. However, the Court was of the view that such jurisprudence can be reconciled with a consistent application of (i) insolvency principles; and (ii) personal property security principles.
According to the Court, the key determining factor is whether the secured creditor has rights in the assets at the time they are subject to the preference transaction. If the debtor was in a position to transfer the assets subject to the preference action free and clear of the secured creditor’s interest (i.e., if the assets were subject to a floating charge that had not yet crystallized), then the secured creditor would have no claim in respect of the proceeds from a preference action. However, in circumstances where the assets subject to the preference action were transferred while they were subject to the claims of a secured creditor (i.e., if the assets were subject to a fixed charge), then the secured creditor would retain its ability to enforce its rights in respect of such assets or any proceeds arising from such assets.
The Court then proceeded to consider the analysis above in the context of the framework established by the BIA. The Court confirmed that Section 95 of the BIA is clear that only a trustee has the cause of action to have a transaction declared to be a preference (and therefore to be void as against the trustee). Nevertheless, the Court reasoned that simply because a party has the right to bring an action, such right is not necessarily determinative of whether that the party has the right to the proceeds of such action. The Court noted that the proceeds of any preference action are to be paid into the bankruptcy estate and distributed in accordance with Section 136 of the BIA, which provides that distributions are to be “[s]ubject to the rights of secured creditors”. Accordingly, amounts recovered by a trustee in bankruptcy for the benefit of the creditors of a bankruptcy estate are subject to the rights of the bankruptcy estate’s secured creditors. To the extent that a secured creditor has rights in the assets of a debtor and has a remedy against such assets if they are held by a third party, then such remedy and the resulting priority is not altered because a preference action was commenced by the trustee in bankruptcy.
The Court summarized its disposition as follows:
- a trustee in bankruptcy (or a Section 38 BIA assignee) is the only party that can bring a preference action in bankruptcy proceedings;
- the proceeds recovered by the trustee are brought into the estate;
- distribution under the BIA is subject to the rights of recovery of secured creditors;
- the bringing of a preference action and the recovery of proceeds does not preclude secured creditors from pursuing whatever remedies they may have under the provisions of the security agreement and relevant statutes.
Moreover, according to the Court, “overall, the objective of the preference action is to void preference transactions for the benefit of creditors, while recognizing legitimate security interests”.
To many in the insolvency community, prior to the Court’s decision in Aero Inventory, the state of the law was that the proceeds of a preference action under Section 95 of the BIA were not subject to the rights of secured creditors. As such, to these individuals, the Court’s decision in Aero Inventory represents a significant change in the law. Moving forward, it will be interesting to observe how the decision in Aero Inventory impacts the actions of trustees in bankruptcy and secured creditors.
Lastly, the Court remained silent as to who is the appropriate party to be responsible for the payment of professional fees in connection with a preference motion that is only for the benefit of an estate’s secured creditor(s). If such fees are to be borne by the bankruptcy estate, then unsecured creditors will effectively be funding the secured creditors’ recovery from the alleged preference transaction.
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