Houlden & Morawetz On-Line Newsletter

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1 Houlden & Morawetz On-Line Newsletter Date: June 6, 2011 Headlines The Alberta Court of Appeal considered a situation where the receiver paid occupation rent and the trustee never went into occupation. The landlord successfully claimed, as a preferred creditor, for accelerated rent. The landlord s claim for accelerated rent was not reduced by the amount paid by the receiver on account of occupation rent. See Case Updates [Dancole Investments Ltd. v. House of Tools Co. (Trustee of)]. The Ontario Superior Court of Justice considered a sanction motion under the CCAA in circumstances where questions had been raised by noteholders as to the competency and bona fides of management and management had resigned. The sanction test in respect of strict compliance with statutory requirements and adherence to court orders was, in these circumstances, appropriately directed to the period subsequent to the change in management. See Case Updates [Re Nelson Financial Group Ltd.]. The Ontario Superior Court of Justice dismissed the appeal of Canada Revenue Agency in respect of a section 81 BIA property proof of claim. The test for establishing unjust enrichment was met; however, a constructive trust was not imposed as CRA had no property interest over the asset in question. See Case Updates [Canada (Revenue Agency) v. TNG Acquisitions Inc. (Trustee of)]. Case Updates [Dancole Investments Ltd. v. House of Tools Co. (Trustee of)] Dancole Investments Ltd. v. House of Tools Co. (Trustee of) (2011), 2011 CarswellAlta 774 (Alta. C.A.) The House of Tools Company ( Tools ) agreed to lease premises from the appellant, Dancole Investments Ltd. ( Dancole ) for a period of 10 years, commencing January 1, On April 1, 2009, Tools defaulted and on April 15, 2009, Dancole served a Notice of Default, specifying the default as the failure to pay basic rent, operating costs and taxes in the amount of approximately $48,000. Tools failed to rectify the default and on May 1, 2009, a Notice of Seizure was posted. That same day, Tools obtained an order under the Companies Creditors Arrangement Act ( CCAA ). On May 12, 2009, Tools filed an assignment in bankruptcy under the Bankruptcy and Insolvency Act ( BIA ). The assignment was effective May 13, On May 13, 2009, Bank of America successfully applied to set aside the CCAA order and obtained a receivership order pursuant to section 47(1) of the BIA and the Judicature Act. Pursuant to an agreement with Dancole, the Receiver occupied the leased premises from May 13, 2009 to July 21, 2009, and paid rent to Dancole in the amount of $111, The Receiver delivered up the premises to Dancole on July 21, The Receiver s payments for occupation rent did not include interest or other costs, such as legal costs, incurred by Dancole as a result of the breaches of the lease. The Receiver transferred to the Trustee all funds remaining after payment of the secured claim and its expenses. The Trustee never assumed actual possession of the leased premises and allowed the Receiver to make its own arrangements with Dancole and to use the leased premises to carry out its work under the receivership order. Dancole submitted a Proof of Claim as a preferred creditor under section 136(1)(f) of the BIA for three months accelerated rent as provided for in the lease. The Trustee disallowed Dancole s claim for legal costs and reduced the preferred claim by the amount paid as occupation rent by the Receiver to Dancole.

2 Dancole applied to court seeking declarations that: (1) the rent paid by the Receiver is not to be deducted from the amount of Dancole s preferred claim under section 136(1)(f) of the BIA, and (2) the legal costs incurred by Dancole arising from Tools defaults form part of the rent payable under the lease and are to be included in the calculation of Dancole s preferred claim. The chambers judge upheld the Trustee s disallowance of Dancole s claims, concluding that Dancole was not entitled to claim a preference for accelerated rent, as Dancole had already received occupation rent from Tools assets. He concluded that pursuant to section 136(1)(f) of the BIA, Dancole will not be entitled to both acceleration rent and occupation rent for the same 3 months. The chamber judge also opined that rent, for the purposes of section 136(1)(f) did not include irregular costs that do not accrue day-to-day, such as the legal costs. The appeal raised the following issues: Did the chambers judge erred by failing to distinguish between the Receiver and the Trustee in interpreting section 136(1)(f) of the BIA? Are rent payments made by the Receiver to Dancole amounts payable by the trustee for occupation rent under section 136(1)(f) of the BIA? Are Dancole s legal costs recoverable as part of its preferred claim for accelerated rent? The parties agreed that the issues were subject to the correctness standard, as they involved questions of law regarding statutory interpretation. To the extent that the second issue involved an interpretation of the lease, it was also reviewable on a correctness standard. The Court of Appeal noted that in interpreting the BIA, courts have noted that it is a commercial statute used by business people and should not be given an overly narrow or legalistic approach: see Re McCoubrey (1924), 5 C.B.R. 248, [1924] 3 W.W.R. 587, [1924] 4 D.L.R. 1227, 1924 CarswellAlta 69 (Alta. T.D.); A. Marquette & fils Inc. v. Mercure (1975), 1975 CarswellQue 51, 10 N.R. 239, 65 D.L.R. (3d) 136, [1977] 1 S.C.R. 547, 1975 CarswellQue 51F (S.C.C.); Re Maple Homes Canada Ltd. (2000), 2000 CarswellBC 2017, 21 C.B.R. (4th) 87 (B.C. S.C.). Dancole submitted that section 136(1)(f) of the BIA provides that payments of occupation rent made by or payable by the trustee are to be set off against a landlord s preferred claim for accelerated rent. In enacting the BIA, Parliament has made clear distinctions between the trustee in bankruptcy and a receiver or an interim receiver appointed under sections 46 and 47. Dancole submitted that Parliament would have used explicit language in section 136(1)(f) if the intent was to include occupation rent payments made by the Receiver. The Trustee supported the decision of the chambers judge, submitting that the principal objective of the BIA is to ensure equality and the distribution of the assets of the bankrupt amongst the ordinary creditors. The Trustee submitted that as the accelerated rent and occupation rent were paid out of the assets of the bankrupt, the only reasonable interpretation that meets this objective of the BIA was that adopted by the chambers judge. The Trustee further submitted that double payment of accelerated rent out of the estate of the bankrupt was contrary to the intent of the legislation. The Court of Appeal was of the view that Dancole s submissions were consistent with the appropriate principles of statutory interpretation and were correct. The primary issue to be answered was whether the phrase payable by the trustee included payments made by the Receiver. The Court of Appeal was of the view that it did not. The Court of Appeal noted that the BIA clearly distinguishes between the legal position, the rights, duties and obligations of the trustee in bankruptcy and the receiver. Under section 71 of the BIA, upon the issuance of a bankruptcy order appointing the trustee or upon making an assignment, the bankrupt s right to deal with the property ends and all of its property is

3 immediately vested in the trustee. There is no similar vesting of the bankrupt s property in the receiver. The receiver s authority to take possession of or to deal with the property depends on the terms of the court order appointing the receiver. Further, no legislation requires the interim receiver to pay occupation rent for its use and possession of the leased property under the receivership order. The interim receiver s liability to pay occupation rent is based entirely on the contract, express or implied, between the interim receiver and landlord. Finally, while the legislature saw fit to require the deduction of accelerated rent from any occupation rent payable by the trustee, it did not provide for the deduction of accelerated rent payable by the receiver. The Trustee also submitted the Dancole s interpretation would result in a conflict with the BIA and the Landlord s Rights on Bankruptcy Act, essentially permitting payment of rent in excess of three months or double rent. The Court of Appeal did not agree. The BIA and the Landlord s Rights on Bankruptcy Act both allow the trustee to take possession of the property and pay occupation rent. The amount paid by the trustee is to be deducted from accelerated rent to which the landlord is entitled. Rent payable by the receiver for its use and occupation of the property is distinct from any accelerated rent provided by the lease and does not arise from the same legal foundation. Accelerated rent is not based on use or occupancy of the leased property during the three months following the bankruptcy. As noted in Houlden and Morawetz and Sarra, Bankruptcy and Insolvency Law of Canada, 4th Edition, at pages to 255, accelerated rent is not in reality a sum payable in respect of three months following the bankruptcy; rather, it is a further sum equivalent to three months rent payable in respect of the demised term by reason of its sudden termination. The amount payable is designed to compensate the landlord for the possible vacancy consequent upon loss by the landlord of its tenant and for the loss of the right of distress. The Court of Appeal commented that where a trustee disclaims or surrenders the lease shortly after bankruptcy, the landlord remains entitled to the preferred claim for accelerated rent, even though the landlord is able to rent the property to a third party immediately, or at an increased rental. If the statute contemplated a general duty to mitigate, or an implied prohibition on double recovery, the specific qualification would not be required. Further, the landlord is not required to establish that it actually sustained a loss to establish its entitlement to accelerated rent as a preferred claim under section 136(1)(f). The Landlord need only establish that it was entitled to accelerated rent under the lease. It was therefore not inconsistent for the legislature to recognize the right of the landlord to claim both accelerated rent and occupation rent. In the result, the Court of Appeal concluded that the chambers judge erred in his interpretation of section 136(1)(f) of the BIA and in his conclusion that the rent paid by the Receiver during its occupancy of the leased premises constituted an amount payable by the trustee for occupation rent and permitted the reduction in the accelerated rent to which Dancole was otherwise entitled. No amount was payable by the Trustee for occupation rent, and therefore no deduction of accelerated rent was required. The court then considered whether the landlord s legal costs were recoverable as part of its preferred claim for accelerated rent. The court was asked to consider the meaning of rent and accelerated rent in section 136(1)(f) of the BIA. The Trustee submitted that Dancole was not entitled to add these costs to its preferred claim under section 136(1)(f) on the basis that the provision permits the recovery, on a preferred basis, of rent and expenses that accrue on a regular monthly basis, but not the recovery of unusual or extraordinary expenses. The Trustee relied on Re Shilco Industrial Sales Ltd. (1977), 23 C.B.R. (N.S.) 255, 1977 CarswellOnt 74 (Ont. Bktcy.), where Registrar Ferron concluded that rent costs that do not accrue on a day-to-day basis in the three month period preceding the bankruptcy are not to be treated as preferred claims. The Court of Appeal agreed with the views expressed in Shilco, noting that in the context of section 136(1)(f), the word rent is used in its ordinary sense and refers to payments of rent

4 and expenses that accrue on a monthly basis, but does not necessarily include all extraordinary expenses that may be added to the monthly payment in accordance with the terms of the lease. Further, costs and expenses incurred after bankruptcy cannot be included in deciding the amount of monthly accelerated rent. The Court of Appeal concluded that the chambers judgment made no error in concluding that legal costs were not recoverable on a priority basis under section 136(1)(f). See Houlden & Morawetz, Bankruptcy and Insolvency Law of Canada: G 124 Claims of Landlord Generally G 125 Occupation Rent G 126 Preferred Claim of Landlord for Arrears of Rent and Accelerated Rent [Re Nelson Financial Group Ltd.] Re Nelson Financial Group Ltd. (2011), 2011 CarswellOnt 3100 (Ont. S.C.J.) Nelson Financial Group Ltd. ( Nelson ) brought a motion to sanction a plan of arrangement filed under the Companies Creditors Arrangement Act ( CCAA ). Nelson filed its application under the CCAA on March 22, Nelson had sold to members of the public some $80 million of term promissory notes and preferred shares. As of the date of filing, over $37 million of the promissory notes were outstanding. The sole director, voting shareholder and president of Nelson was Mr. Marc Boutet. Commencing September 2010, Representative Counsel for the holders of the notes issued by Nelson sought the replacement of management, as issues had been raised questioning the competency and bona fides of management. In October 2010 the Representative Counsel s Noteholder Advisory Committee obtained confirmation from more than two-thirds in claim amount that they would not support any plan of arrangement that continued the incumbency of Mr. Boutet. On November 11, 2010, Mr. Boutet resigned all of his positions with Nelson. In exchange, he was provided with a limited release. An Interim Operating Officer ( IOO ) was appointed and the IOO was granted full powers as the chief executive officer and was given particular authority to review the circumstances of the debtor company and its assets and, if practicable, to develop a plan for its restructuring. Under the direction of the IOO, a business plan was developed and a plan of compromise and arrangement was devised. The plan was overwhelmingly supported by the creditors. The plan came before the court to be sanctioned. For a plan to be sanctioned, the applicant must meet the following three tests: (i) there has been strict compliance with all statutory requirements and adherence to previous orders of the court; (ii) nothing has been done or purported to be done that is not authorized by the CCAA; and (iii) the plan is fair and reasonable. (See Re Sammi Atlas Inc. (1998), 1998 CarswellOnt 1145, 3 C.B.R. (4th) 171 (Ont. Gen. Div. [Commercial List]).) Counsel to the IOO submitted that the circumstances of this case were atypical. Until late 2010, the Applicant was under the direction of Mr. Boutet who, counsel submitted, appeared to have committed a number of wrongful and fraudulent acts. At the sanction hearing, counsel advised that there could be no assurances provided by the IOO or the Monitor that there was strict compliance with the court orders or the CCAA by the Applicant prior to the appointment of the IOO. Counsel submitted that in a case where the control of the debtor company is changed in the course of the CCAA proceedings, the tests of compliance must be applied with reference to the conduct of the persons who are directing the debtor company and the persons who will benefit from the exercise of the court s discretion at the time of the application for sanctioning.

5 In the circumstances of this case, Morawetz J. accepted this submission and considered it appropriate to apply the test as set out in Sammi Atlas, supra, in respect of compliance with statutory requirements and orders of the court, for the period subsequent to the appointment of the IOO. Justice Morawetz also determined that the plan was fair and reasonable and in the result, the plan of arrangement received court approval. See Houlden & Morawetz, Bankruptcy and Insolvency Law of Canada: N 45 Sanctioning of the Plan [Canada (Revenue Agency) v. TNG Acquisitions Inc. (Trustee of)] Canada (Revenue Agency) v. TNG Acquisitions Inc. (Trustee of) (2011), 2011 ONSC 3129 (Ont. S.C.J. [Commercial List]) Canada Revenue Agency ( CRA ) appealed under section 81(2) of the Bankruptcy and Insolvency Act ( BIA ) from the disallowance by the trustee of its claim to an interest in property of the bankrupt made under section 81(1) of the BIA. The appeal arose from GST refunds claimed and received by the bankrupt ( Nex ) from CRA prior to its bankruptcy. It also involved refund claims made by Nex to the Ministry of Revenue in Québec ( MRQ ) for QST refunds. Nex, a GST registrant, filed GST returns with CRA on a monthly basis. Nex also carried on business in Québec and was required to file QST returns. Nex filed monthly GST returns for January through July Included in the input tax credits for that period claimed by Nex was the amount of $1.5 million, said to have been GST paid by Nex to its suppliers. That turned out to be wrong. CRA accepted the returns and paid the GST refunds claimed by Nex for that period, totalling $2.7 million, which included the claim for 1.5 million. Nex also filed a claim with MRQ requesting refunds due to having paid QST to its suppliers. In October 2007, MRQ contacted CRA in connection with Nex s claim for a QST refund and advised CRA that during an audit it discovered that Nex had recorded $1.5 million on its books as GST having been paid to its suppliers. That was incorrect as the $1.5 million was QST that had been paid by Nex to its suppliers and MRQ realized that Nex had incorrectly claimed that amount as an input tax credit on the GST returns that had been made by Nex. MRQ determined that Nex was entitled to a refund of QST based on these input tax refunds of $1.5 million. The result was that Nex had improperly received a GST refund of $1.5 million. CRA issued an assessment to reduce the GST refund claimed by Nex and Nex did not object. Nex filed an amended GST return. Nex obtained protection under the Companies Creditors Arrangement Act ( CCAA ) on October 2, Shortly after that date, MRQ informed CRA of the mistaken GST claim by Nex. On January 17, 2008, Nex brought a motion for an order approving the distribution of sales proceeds to creditors, including CRA. The portion dealing with this payment to CRA was adjourned. On May 20, 2008, CRA issued a notice of application naming Nex and MRQ as respondents in which a declaration was sought that the QST refund owed by MRQ to Nex in the amount of $1.5 million was CRA s property, and it requested a mandatory order requiring MRQ to pay that amount directly to CRA on the grounds that MRQ held the QST refund owing to Nex as constructive trustee for CRA. On April 8, 2008, the CCAA proceedings were terminated and Nex was adjudged a bankrupt. On June 6, 2008, CRA was advised by MRQ that MRQ had offset the entire QST refund with the result that Nex was said to have owed MRQ $207,000. On October 31, 2008, the trustee s counsel advised CRA that a QST refund in the amount of $90,000 was payable to Nex but that MRQ was reluctant to pay it in light of the outstanding application against it.

6 By agreement, MRQ later paid the outstanding amount owing to Nex to the trustee in trust pending the determination of this appeal. The amount paid was a little in excess of $1 million and it was this amount in which CRA claimed to have a property interest. The trustee took the position that there could no claim by CRA under section 81 of the BIA because section 81 permits a claim of property that was in the possession of the bankrupt at the time of the bankruptcy. Newbould J. did not accept this position. MRQ made its determination that Nex was entitled to the QST refund of $1.5 million prior to the bankruptcy of Nex. Nex had an account receivable from MRQ. The property to which CRA made a claim was the account receivable of Nex that was in existence prior to the bankruptcy. CRA s claim was based on a claim for unjust enrichment and the imposition of a constructive trust as a remedy for the unjust enrichment. If successful, the MRQ refund payment would go to CRA rather than to the unsecured creditors of Nex. The position of the trustee was that there was no basis for the imposition of a constructive trust and that it would be inequitable and contrary to the scheme of distribution under the BIA for CRA to be paid in priority. Justice Newbould set out the test for unjust enrichment. The cause of action has three elements: (i) an enrichment of the defendant; (ii) a corresponding deprivation of the plaintiff; (iii) an absence of juristic reason for the enrichment. See Garland v. Consumers Gas Co. (2004), 2004 CarswellOnt 1558, 2004 CarswellOnt 1559, 72 O.R. (3d) 80 (note), 237 D.L.R. (4th) 385, 319 N.R. 38, 43 B.L.R. (3d) 163, 9 E.T.R. (3d) 163, 42 Alta. L. Rev. 399, 186 O.A.C. 128, [2004] 1 S.C.R. 629 (S.C.C.). Newbould J. stated that there was little doubt that the three tests had been met. A constructive trust is a remedy that may be ordered in appropriate cases for compensating an unjust enrichment. It is a proprietary concept. See Peter v. Beblow (1993), [1993] 3 W.W.R. 337, 23 B.C.A.C. 81, 39 W.A.C. 81, 101 D.L.R. (4th) 621, [1993] 1 S.C.R. 980, 150 N.R. 1, 48 E.T.R. 1, 77 B.C.L.R. (2d) 1, 44 R.F.L. (3d) 329, 1993 CarswellBC 44, 1993 CarswellBC 1258 (S.C.C.). Justice Newbould stated that it did not appear to be a bright line test as to whether the link between the contribution of the plaintiff and the disputed asset is sufficient to permit the imposition of a constructive trust. The critical issue is whether there is a direct link between the plaintiff s contribution and the subject of the trust being claimed. In this case, the asset being claimed by CRA to be subject to a constructive trust was the account receivable of Nex from MRQ that existed prior to the bankruptcy. CRA asserted that because the same expenditures were used to claim GST and QST refunds, albeit incorrectly, there was a direct link between the payment by CRA of the GST refund and the payment by MRQ of the QST refund. CRA relied upon the decision of the Registrar in Bankruptcy in Re Ascent Ltd. (2006), 2006 CarswellOnt 116, 9 P.P.S.A.C. (3d) 176, 18 C.B.R. (5th) 269 (Ont. S.C.J.); and Re Credifinance Securities Ltd., Re (2010), 2010 CarswellOnt 830, 63 C.B.R. (5th) 250 (Ont. S.C.J. [Commercial List]), reversed in part (2011), 2011 CarswellOnt 1218 (Ont. C.A.). Newbould J. was of the view that these cases did not assist CRA and he did not think it could be said that there was a sufficient link between the overpayment made by CRA to Nex and the receivable owing by MRQ to Nex that would permit the imposition of a constructive trust on the MRQ payable. There was nothing improper that led to the MRQ payable. It was the result of a proper claim by Nex for a QST refund. Unlike Ascent or Credifinance Securities, there was nothing improper at all on the part of Nex that gave rise to the QST refund payable by MRQ. The wrongdoing was in Nex making an incorrect claim on CRA. Justice Newbould went on to note that there was no connection to those funds received by Nex from CRA and the funds owing by MRQ and thus no basis to impose a constructive trust over the MRQ refund. What CRA sought was to obtain a constructive trust over assets of Nex to which it had provided no contribution. This appeared to be precisely the situation that the Ontario Court of Appeal held in Barnabe v. Touhey (1995), 1995 CarswellOnt 1167, 10 E.T.R. (2d) 68, 37 C.B.R. (3d) 73, 26 O.R. (3d) 477 (Ont. C.A.) to be improper. In that

7 case it was stated that the constructive trust imposed by the motion judge over all the property the bankrupt was contrary to clear law which required that a constructive trust be imposed over a specific property in which the person claiming the trust has a reasonable expectation of obtaining a property interest. While the order sought in this case by CRA was not to have a constructive trust over all the property of the bankrupt, but only over the amount ultimately paid by MRQ, Newbould J. did not see how CRA could ever have expected to have obtained a property interest in that MRQ rebate. In the circumstances, the appeal from the disallowance of the property claim by the trustee was dismissed. CRA was limited to its unsecured claim. See Houlden & Morawetz, Bankruptcy and Insolvency Law of Canada: F 5 Trust Property F 181 Claims to Property in Possession of Bankrupt