SHAREHOLDERS AND CORPORATE INSOLVENCY
By
Luc Morin
May 2006
/2
TABLE OF CONTENTS
I.
Introduction
page 3
II.
Relevant legislation
page 7
A.
Annulling irregularly or invalidly initiated bankruptcy
or reorganization proceedings
page 8
B.
Shareholder opposition to the proposed restructuring
plan
page 9
C.
Summary
III.
IV.
V.
Shareholders and initiation of bankruptcy
reorganization proceedings under the BIA and CCAA
page 12
or
page 16
A.
Proponents of the formalist approach
page 17
B.
Proponents of the factual approach
page 21
C.
Summary and trend
page 25
The shareholder’s role in the drafting and implementation
of the restructuring plan
page 27
A.
Jurisprudence
page 29
B.
Summary and trend
page 36
Conclusion
page 40
/3
I-
Introduction
“Equitable treatment is not necessarily equal treatment. Equal treatment may be
contrary to equitable treatment.”1 This convoluted statement was made by the colourful
former Chief Justice of the Commercial Court of the Superior Court of Justice of Ontario,
James Farley, in his recent decision sanctioning the plan of arrangement of Stelco Inc.2 to
justify the hierarchy of interests that should prevail in reorganization proceedings begun
under the Companies’ Creditors Arrangement Act (hereinafter “CCAA”),3 a hierarchy
that relegates shareholders to the status of “super unsecured.”
This decision is one of many confirming a strong trend aimed at excluding shareholders
from the entire bankruptcy or reorganization proceedings of an insolvent company. The
underlying reasoning for this trend is essentially that the shareholders’ capitalization in an
insolvent company has no value; any loss suffered by the company has a corresponding
effect on shareholders’ equity. Given that their investment security has no value, it would
therefore be unfair to give shareholders a say in the direction the insolvent company
should take to effectively restructure its business and to allow them to take part in its
turnaround.
This trend is supported by certain sacrosanct principles of business law that draw a
distinction between a creditor and a shareholder, the first being the holder of a repayable
debt security based on negotiated terms and conditions and with a predetermined return,
whereas the latter only holds a speculative investment security with no predetermined
repayment terms or return.4
1
2
3
4
In the Matter of the Companies’ Creditors Arrangement Act, R.C.S. 1985, c. C-36, as amended & In the
Matter of a proposed Plan of Compromise or Arrangement with respect to Stelco Inc. and the Other
Applicants listed in Schedule “A”, O.S.C.J. (commercial list), Justice James Farley, decision rendered
on January 20, 2006 (04-CL-5306)
Stelco, supra note 1, p. 4 citing In Re Sammi Atlas Inc., (1998) 3 C.B.R. 171, decision also rendered by
Justice Farley.
R.S.C. (1985) ch. C-36
MARTEL, P., MARTEL, M., Les aspects juridiques de la compagnie au Québec, Les Éditions Wilson
& Lafleur Martel Ltée, Montréal, 2006, p. 12-8 ss. and pp. 32-15 and 32-16.
/4
In a context of insolvency, this fundamental distinction is further amplified by divergent
shareholder and creditor expectations that are difficult to reconcile, particularly when
reorganization is involved. Given their inherently precarious equity in the insolvent
company, shareholders will naturally lean toward high-risk options since their investment
is now worthless and they have nothing more to lose. In contrast, creditors will choose
the option that offers the greatest odds of getting paid.5 Therefore, giving shareholders of
an insolvent company a say invariably works against the creditor.
This paper analyzes the guidelines and imperatives established by Canadian insolvency
legislation as regards the shareholder’s role and place in a company that becomes
insolvent and must resort to the Bankruptcy and Insolvency Act6 (hereinafter “BIA”) or
the CCAA in order to restructure its business or to simply liquidate its assets in an orderly
fashion. So as to clearly identify the scope of these guidelines and imperatives, this
analysis is divided into two parts, based on the two points at which the shareholder may
be called on to play a role, either when the company plans to initiate the bankruptcy or
reorganization proceedings, or when the company prepares and implements a
restructuring plan.
Emphasis will be placed on some of the most frequently raised problems at each point:
5
6
See also: PRENTICE, L.W., “The position of Equity in a Restructuring,” (2003) Annual Review of
Insolvency Law, Thomson & Carswell, p. 259, p. 267: “There is a fundamental distinction between the
nature of the position of shareholders and that of creditors: shareholders have knowingly placed their
capital at risk on the basis of their belief in the future prospects of the corporation, whereas creditors
have entered into short-term commercial transactions that have no reference to an uncertain economic
return.”
LIGHT, D.B., “Involuntary Subordination of Security Interests to Charges for DIP Financing under the
Companies’ Creditors Arrangement Act,” (2002), 30 C.B.R. (4th ) 245, p. 284: “The more insolvent
the firm, the more shareholders will be attracted to high risk options. Since their equity is deeply
under water, only very high return options will be attractive to them, but those options are likely to have
negative expected returns for the firm as a whole. (…) one of the problems that restructuring law must
address is how to restrain or neutralize distorted shareholder incentives until the problem of the
firm’s insolvency is corrected or the assets are transferred to a solvent entity.” [Our underlining]
R.S.C. (1985) ch. B-3
/5
ƒ
When an insolvent company initiates bankruptcy or reorganization proceedings:7
o Can shareholders prevent the initiation of such proceedings or is this
prerogative strictly reserved for the Board of Directors?
o Must shareholders be consulted in the decision-making process leading to
the initiation of such proceedings?
o What is the impact of a unanimous shareholders’ agreement preventing
the initiation of such proceedings without the consent of certain
shareholders?
o What recourses do shareholders have, if any, to block bankruptcy or
reorganization proceedings initiated without their consent?
ƒ
When the insolvent company prepares and implements a restructuring plan:8
o Must shareholders be consulted when preparing a restructuring plan? Do
they have a say, i.e., a right to vote on the plan?
o Can a restructuring plan call for changing the insolvent company’s capital
structure without requiring the consent of the shareholders affected by
such change?
o What is the impact of a unanimous shareholders’ agreement preventing
any change to the company’s capital structure without the consent of
certain shareholders?
7
8
When the Initial Order is issued within the framework of a reorganization under the CCAA (Section 11),
i.e., the filing of a notice of intent or notice of proposal or a voluntary assignment under the BIA
(Sections 49, 50 and 50.4)
The plan of arrangement under the CCAA or the proposal under the BIA.
/6
o Can shareholders of an insolvent company that prepares a proposal or a
plan of arrangement calling for a change to shareholder rights plead
oppression?
o Do shareholders have sufficient interests to oppose approval of a
restructuring plan?
These questions,9 which will form the backdrop of this analysis, will be preceded by a
review of relevant legislation in light, notably, of amendments to the BIA and CCAA,
following the passage of Bill C-55 in November 2005.10 Indeed, it is interesting to note,
that just as the resulting law is about to come into force, i.e., An Act to establish the Wage
Earners Protection Program, to amend the Bankruptcy and Insolvency Act and the
Companies’ Creditors Arrangement Act and to make consequential amendments to other
Acts,11 (hereinafter “Bill C-47”), that Canadian insolvency legislation is undergoing one
of its most profound reforms, certainly the most extensive since the 1992 revision, and
the shareholder’s role does not seem to have escaped the myriad analyses that
characterize all legislative reforms.
It remains to be seen how the principles of fairness, accessibility, predictability,
responsibility, cooperation, efficiency and effectiveness advanced by the Standing Senate
Committee on Banking, Trade and Commerce (hereinafter the “Committee”) have been
coupled with shareholders’ interests and their role in the insolvent company.12
9
10
11
12
It should be noted that the questions raised in this analysis are not exhaustive. However, a number of
questions directly or indirectly pertaining to shareholders’ rights in a context of insolvency are
unquestionably relevant. This analysis is limited to the shareholder’s role at two critical points of the
bankruptcy or reorganization process: when it is initiated and when the restructuring plan is prepared
and implemented.
The Bill was adopted under the Senate’s express condition that proposed amendments would be subject
to a study by the Standing Senate Committee on Banking, Trade and Commerce.
S.C. 2005, c. C-47
“Debtors and Creditors Sharing the Burden: A Review of the Bankruptcy and Insolvency Act,” Report
of the Standing Senate Committee on Banking, Trade and Commerce, November 2003, p.7 (hereinafter
the “Report”): “As the Committee began this study, we focused on what we believed should be the
fundamental principles guiding the design of insolvency laws in this country. Certain prerequisites for a
well functioning insolvency system continually struck us as important: fairness, accessibility,
/7
II-
Relevant legislation
Enacted in November 2005, amid the parliamentary commotion caused by threats of
bringing down the minority Canadian government, Bill C-47 resulted in a comprehensive
reform of Canadian bankruptcy and insolvency legislation.
However, because there was no specific amendment as regards the shareholder’s role in
the initiation of bankruptcy or reorganization proceedings, our analysis must rely on
current legislation and the principles established by case law to date.
In contrast, the shareholder’s role in preparing and implementing a reorganization process
has been addressed, and for the first time, the notions of subordinating the shareholders’
interests and not giving them a right to vote on the restructuring plan proposed by the
insolvent company to its creditors have been introduced. In this regard, Bill C-47 is
remarkably similar to U.S. legislation where the “Absolute Priority Rule”13 reigns when
analyzing the shareholder’s role in a context of corporate insolvency reorganization.
13
predictability, responsibility, cooperation, efficiency and effectiveness. These are all critical hallmarks
to remember as legislative changes are proposed.” [Our underlining]
Bankruptcy Code, United States Code, Title 11, chapter 11, subsection 1129 (b) (2) (B) (ii), available at
http://www.doney.net/code_text.htm. This subsection states that in order for plan of arrangement to be
just and reasonable, and therefore be sanctioned by the Court, it must show that the creditors will not be
affected by the payment of shareholders’ claims.
See also: TOWRISS, S., “Through the Lens of Insolvency: Shareholder Equity in CCAA
Reorganization,” (2005) Annual Review of Insolvency Law, Thomson & Carswell, p. 527, p. 534-535:
“The American approach to the problem of shareholder equity in corporate insolvency reorganizations
is much more clear and unequivocal than the Canadian position. Plans of reorganization under
Chapter 11 must accord with the Absolute Priority Rule which requires not only “that the legal and
contractual priorities existing among claims and ownership interests in the absence of reorganization
must be preserved under the plan” but also that pursuant to this requirement senior creditors must
“receive the full value of their claims in cash or equity before the claims of any junior creditors or
interests are satisfied under the restructuring plan”. [Our underlining]
See also: SARRA, J.P., “Creditor Right and the Public Interest: Restructuring Insolvent
Corporations,” University of Toronto Press, 2003, p. 12
/8
A-
Annulling irregularly or invalidly initiated bankruptcy or reorganization
proceedings
The shareholder’s role in the bankruptcy initiation process, if any, as will be subsequently
analyzed,14 is guided by section 81 BIA, which stipulates:
“181. (1) [Power of court to annul bankruptcy] If, in the opinion of the
court, a bankruptcy order ought not to have been made or an assignment
ought not to have been filed, the court may by order annul the bankruptcy.”
This provision grants the court considerable discretion, allowing it to annul bankruptcy
proceedings that were initiated irregularly or for reasons contrary to the BIA. That said, as
will be discussed later, while there are two case law trends on the scope of these powers,
the current trend favours the status quo, i.e., maintaining the irregularly initiated
bankruptcy proceedings unless it can be demonstrated that the company was not insolvent
on the day it was initiated and that it is still not insolvent on the day of application for
annulment.15
Amazingly, little jurisprudence exists as regards the irregular initiation of reorganization
proceedings, whether under the BIA, by filing a notice of intent or notice of proposal, or
under the CCAA, by issuing an Initial Order. However, in light of section 66 BIA,16 it
would be surprising if the powers granted the court under section 181 BIA did not extend
to a context of reorganization as well. Also, under the CCAA, which contains no specific
provision for annulling an initial order, we can reasonably presume that the inherently
broad powers reserved for the courts are sufficient to allow them to annul an initial order
obtained under irregular conditions or false premises. Still, such a situation is unlikely to
occur in the case of restructuring under the CCAA since this Act is reserved for complex
reorganizations involving major bank and institutional creditors, which presumes that
14
15
16
Infra, section III
Infra, section III-C
Section 66. BIA: “All the provisions of this Act, except Division II, of this part, insofar as they are
applicable, apply, with such modifications as the circumstances require, to proposals made under this
Division.”
/9
considerable rigour and prudence precede the initiation of any such reorganization
proceedings.
As such, at first glance, as regards the irregular initiation of bankruptcy or reorganization
proceedings, current legislation offers very little protection to shareholders, whose fate is
left to the court’s discretion. Moreover, current jurisprudence does not appear to favour
shareholders of an insolvent company who, despite the company’s articles of
incorporation or a shareholders agreement clearly stipulating that their approval is
required prior to initiating bankruptcy or reorganization proceedings, allow such
proceedings to be initiated without due consideration to their interests.17
Given that Bill C-47 contains no amendment in this regard, we can reasonably conclude
that the legislator is ratifying the current case law trend that gives precedence to the
socio-economic function of Canadian insolvency legislation over private interests and
over the governance rules of insolvent companies, preferring to maintain an irregular
situation in order to support the imperatives of economic stability that are supposed to
guide all insolvency legislation.18
B-
Shareholder opposition to the proposed restructuring plan
Heavily criticized, primarily by the banking and institutional establishments, Canadian
insolvency legislation is being extensively amended as regards the shareholder’s role
when a restructuring plan is being drafted and implemented. While current legislation is
silent on how shareholders should be treated during a reorganization, Bill C-47
17
Infra, section III-B, Hovey c. Whiting, (1886) 13 R.C.S. 515, Re London, New York & Paris Assn. of
Fashions Ltd., (1982) 40 C.B.R. (N.S.) 127, Re 609940 Ontario Inc., (1985) 57 C.B.R. 137, Gouin v.
Gestion Routière L.G.F. inc. (Syndic de), [1995] A.Q. no 2409 (C.S.)
18
In this regard, see the Seventeenth Report of the Standing Senate Committee on Banking, Trade, and
Commerce submitted on November 24 and 25 and available at the following address:
www.parl.gc.ca/38/1/parlbus/commbus/senate/Com-f/rep-f/rep17nov05-e.htm: “The Committee
continues to believe that the Bankruptcy and Insolvency Act and the Companies’ Creditors Arrangement
Act constitute critical framework legislation that affect, in a very fundamental manner, the Canadian
economy and all Canadians who participate in it. The Committee understands that the appropriate
government legislative initiatives will be taken to ensure the foregoing.
/ 10
introduces two concepts drawn directly from U.S. legislation: subrogation of shareholder
interests to those of the creditors, and no voting right on any restructuring plan.
First, at the drafting stage, Bill C-47 stipulates that shareholders do not need to be
consulted on the restructuring plan proposed by the insolvent company. Subsection 54 (2)
a) BIA, as amended,19 and its corollary under the CCAA, i.e., Section (3), as amended,20
state that henceforth shareholders will not have the right to vote on a proposal or a plan of
arrangement submitted by the insolvent company to its creditors:
“54. (2) a) All unsecured creditors – other than the creditor having a claim
against the debtor arising from the rescission of a purchase or sale of a
share or unit of the debtor or a claim for damages arising from the
purchase or sale of share or unit of the debtor, and those secured creditors
in respect of whose secured claims the proposal was made are entitled
provided they have proven their claims.”
“22. (3) Creditors having a claim against a debtor arising from the rescission
of a purchase or sale of a share or unit of the company or a claim for
damages arising from the purchase or sale of a share or unit of the
company must be in the same class of creditors in relation to those claims
and may not, as members of that class, vote at a meeting to be held under
section 4 in respect of a compromise or an arrangement relating to the
company.”
[Our underlining]
Then, subsection 140.1 BIA, as amended,21 which appears to be the necessary corollary to
subsections 54 (2) (a) BIA and 22 (3) CCAA in order to justify the absence of voting
rights in reorganization cases, expressly confirms the “super” unsecured nature of
shareholder claims as well as the subordination of the shareholder’s interests:
“140.1 A creditor is not entitled to claim a dividend in respect of a claim
arising from the rescission of a purchase or sale of a share or unit of the
bankrupt or in respect of a claim for damages arising from the purchase or
sale of a share or unit of the bankrupt until all claims of the other creditors
have been satisfied.”
[Our underlining]
19
20
21
Bill C-47, supra note 11, section 37 (1)
Ibid, section 131
Ibid, section 90
/ 11
Given that shareholders are “super unsecured” creditors whose interests are subordinated
to the creditors’ until all their interests have been satisfied, it would not make sense to
allow them to vote on a restructuring plan that, compared to the alternative of outright
bankruptcy, can only be more beneficial to them.
In any event, it seems strange that the legislator has relegated the shareholder to the status
of creditor and routinely interchanges one for the other when the reasoning of case law,
and to a certain extent, of the Committee, to justify subordinating shareholder interests to
those of the creditors, was content to rely on the fundamental distinction between the two
in a company’s capitalization.22
Moreover, some would claim that by incorporating into Canadian insolvency legislation
the concepts of subordination of shareholder interests and of no voting right on
restructuring plans, the legislator wanted to put an end to what many considered a lottery
based on divergence between the provinces’ corporate laws and the Canada Business
Corporations Act23 (hereinafter “CBCA”) by ultimately favouring uniform application of
any reorganization proceeding that calls for a restructuring of the insolvent company’s
capital, regardless of its incorporating act.
In fact, any reorganization calling for a change to the company’s capital structure is
subject to the capital structure provisions in its incorporating act, which typically state
that consent must be obtained from various classes of shareholders when changes to
22
23
Committee Report, supra note 12, p. 177: “In our view, the law must recognize the facts in insolvency
proceedings: since holders of equity have necessarily accepted – through their acceptance of equity
rather than debt – that their claims will have a lower priority than claims for debt, they must step aside
in a bankruptcy proceeding. Consequently, their claims should be afforded lower ranking than secured
and unsecured creditors and the law – in the interests of fairness and predictability - should reflect
both this lower priority for holders of equity and the notion that they will not participate in a
restructuring or recover anything until all other creditors have been paid in full.” [Our underlining]
See also: Re Central Capital Corp., 38 C.B.R. (3d) 1, where the Ontario Court of Appeal, in a split
decision with one dissenting opinion, concludes that a shareholder who holds the option to force
redemption of his shares by the firm is not a creditor in the bankruptcy and remains a shareholder whose
interests are subordinated to that of the creditor.
See also: MARTEL, supra note 4
R.S.C. (1985) c. C-44
/ 12
capital structure are involved. A reorganization involving such a change must therefore
respect the provisions of the insolvent company’s incorporating act.24
Following the example of the CBCA, some provincial corporate legislation has opted for
an exception regime when a company is insolvent and looking to restructure its business
under Canadian insolvency legislation. The goal of this exception regime is to encourage
reorganization by taking away the shareholders’ right to vote on changes to capital
structure and by extension, their veto right in insolvency situations.
Accordingly, some of these corporate laws, including the CBCA,25 clearly stipulate that
insolvent companies may make changes to their capital structure without the shareholder
consent that would otherwise be required under normal circumstances.
In fact, section 42 CCAA26 as amended, expressly provides for the possibility of linking a
reorganization launched under the CCAA with a restructuring of the insolvent company’s
capital structure made in accordance with its incorporating act. While abundant case law
confirms that such a capital reorganization can also be made jointly with the BIA,27 Bill
C-47 unfortunately has not introduced a similar provision to section 42 CCAA, as
amended, thereby leaving some doubt as to whether an insolvent company can reorganize
its capital as part of a restructuring launched under the proposal regime.
C-
Summary
Although it is difficult to accurately determine the scope of the amendments in Bill C-47
since they are still not in force and since their enactment is conditional on the outcome of
24
25
26
27
See: ABITAN, S., TARDIF-LATOURELLE, D., “Les restructurations effectuées conjointement au
terme des lois sur l’insolvabilité et des lois corporatives,” Canadian Bar Association, Québec Division,
Bankruptcy Insolvency Section November 29, 2005.
Subsection 191 (3) CBCA
Bill C-47, supra note 11, section 131
ABITAN, TARDIF-LATOURELLE, supra note 24, pp. 4-5
/ 13
the Committee’s study, which began in early 2006,28 we can still make out some trends
and principles.
First, as regards the initiation of bankruptcy or reorganization proceedings, despite broad
discretion, the legislator is not making any changes to section 181 BIA and seems to
uphold the interpretation of the courts to date. Consequently, as will be analyzed later, the
shareholder’s role at this initial is largely dependent on the economic reality of the
company.
It seems clear that the legislator sought to be more in line with U.S. legislation, where the
interests of shareholders are subordinated and where they play a lesser role in the
decision-making process that leads to the restructuring plan.29 That said, the amendments
proposed by Bill C-47 do not seem to be quite as drastic as regards the interests of
shareholders of an insolvent company in that while they cannot be consulted on the
restructuring plan, their interests are not entirely extinguished.
Actually, the legislator did not adopt the American “Absolute Priority Rule” under which
a restructuring plan cannot provide for settling shareholder claims until all the creditors
have been paid in full. In fact, the plan will not be approved by the court unless it adheres
to this principle. The legislator also seems to have set aside the Americans’ “Crammed
Down Rule,” which tempers the Absolute Priority Rule by allowing a restructuring plan
to, exceptionally, protect shareholder interests before certain creditors are paid in full,
provided that these creditors do not receive less than what they would have been entitled
to if the insolvent company’s assets were liquidated and provided that this solution is fair
and reasonable. The combination of these two rules create a principle whereby a
28
29
The Office of the Superintendent of Bankruptcy Canada states on its site: “The exact scope of possible
amendments is as yet unknown. It is clear, however, that any additional review by the Senate may
impact
on
the
timing
of
the
coming
into
force
of
the
legislation.”
(http://strategis.ic.gc.ca/epic/internet/inbsf-osb.nsf/en/br01561e.html).
For its part, the Canadian Association of Insolvency and Restructuring Professionals in its latest
bulletin (BUL06-2F- April 2006) states that “It is highly unlikely that C-47 will be proclaimed prior to
2007.” This bulletin available at www.cairp.ca/english/enpdf/Bul06-2-F%20(3).doc
See also the Committee’s seventeenth report, supra note 18.
Bankruptcy Code, United States Code, Title 11, chapter 11, supra note 13.
/ 14
restructuring plan that calls for even the slightest protection of shareholders’ interests
must ipso facto be considered unfair and unjust, by making this principle a condition for
the plan’s judicial approval. Moreover, such a solution makes it much harder for the
courts to determine when it might be fair and just for a restructuring plan to protect the
shareholders’ interests, deeming it an exceptional situation and limiting the benefits
shareholders can derive to any amount remaining after the creditors’ claims have been
settled.30
Rather than integrate the entire twofold American solution, the legislator has established
the principle of subordinating shareholder interests to those of the creditor; however, the
legislator has not established a rigorous framework for this principle, leaving it up to the
courts to decide when and to what extent shareholder interests should be considered in
order to comply with the principles of justice and fairness when sanctioning a
restructuring plan.
Thus, it appears that the legislator decided to deprive shareholders of any involvement in
the decision-making process leading to the restructuring plan but not from any
participation in its implementation. In this way, the risk of shareholders derailing the
process is greatly reduced since they are given the opportunity to contest the plan once it
has been prepared and accepted, at the sanctioning stage, on the grounds that it is not fair
or just.
It will also be interesting to see how the courts interpret subsection 140.1 BIA, as
amended, which calls for subordinating shareholder interests in a case of reorganization.
It seems reasonable to conclude that since this provision was not included in the
conditions for sanctioning a restructuring plan, neither under the BIA nor the CCAA, as
U.S. legislation has done, the legislator has chosen to limit the application of this
principle to bankruptcy cases, allowing the courts some leeway to decide when
shareholders’ interests should be considered while not limiting the benefits they could
derive from a reorganization.
30
TOWRISS, supra note 13, p. 535
/ 15
In any case, at first glance, it appears that the amendments proposed by Bill C-47 address
many of the Committee’s concerns. First, the much decried exodus of Canadian
companies that preferred to restructure on American soil and that had ramifications on
both sides of the border will certainly diminish now that shareholder interests will be
subordinated to those of creditors and particularly since shareholders will not be able vote
on restructuring plans.31
The fact that shareholders will not have a say in restructuring plans should also resolve
the Committee’s concerns about the diverging treatment of restructurings that involve
capital reorganization, and about the fact that the courts have no power to approve such a
restructuring without shareholder consent in Canadian insolvency cases.32
It will, however, be interesting to see how case law evolves on this topic, particularly as
regards the scope of these amendments. Will these amendments really prevent
shareholders from availing themselves of the insolvency provisions in the company’s
incorporating act stipulating that shareholder consent is required before changes can be
made to the capital structure? It could certainly be argued that this provision only applies
to a vote on the proposed restructuring plan and not to changes to the capital structure
that the plan may contain. Furthermore, despite the Committee’s recommendations, while
some believe that this prerogative is part of the Court’s inherent power,33 the legislator, in
Bill C-47, did not seem to think it wise to grant the Court express power to allow an
insolvent company to reorganize its capital without obtaining the consent of the
31
32
33
Committee Report, supra note 12, p. 176: “Canadian insolvency law does not subordinate shareholder
or equity damage claims. It is thought that this treatment has led some Canadian companies to
reorganize in the United States rather than in Canada.”
Ibid, pp. 167-168: “We also feel that, in some cases, the prospect of successful reorganization is
enhanced where the equity of the organization is reorganized. At this time, however, neither Act gives
the Court the authority to reorganize share capital. In our view, this inability limits effectiveness. We
believe that the court should have this ability, and should be able to exercise its authority to
reorganize share capital, with or without consent of shareholders, who could veto an arrangement to
the detriment of creditors.” [Our underlining]
ZIEGEL, J., DUGGAN, A.J., THOMAS, G.W., TELFER, E. Canadian Bankruptcy and Insolvency
Law : Cases, Text and Materials, Emond Montgomery Publications Limited, Toronto, 2003, p.521
See also: TOWRISS, supra note 13, p. 531
/ 16
shareholders affected by the restructuring.34 Consequently, Bill C-47 does not appear to
adequately address this second concern raised by the Committee.
III-
Shareholders and initiation of bankruptcy or reorganization proceedings
under the BIA and CCAA
While in principle it is up to the company’s decision-making body – the Board of
Directors – to make the decision to initiate bankruptcy or reorganization proceedings,
shareholders may, in some circumstances, be asked to take part in this crucial decision.
Under the company’s articles of incorporation or shareholders agreement, it may be
essential to offer the shareholder consideration before going forward. In such mixed
circumstances where the shareholders and the Board of Directors must share the burden
of this decision, it could happen that the Board acts without due regard to the
shareholder’s right to partake in the decision to launch bankruptcy or reorganization
proceedings. In light of the company’s governance rules, what then happens when such a
process is irregularly initiated?
There are two opposing schools of thought on this thorny question.35 On the one hand,
jurisprudence holds that a company’s articles of incorporation, by-laws and incorporating
act must be respected when initiating a bankruptcy proceeding under the BIA or a
reorganization proceeding under the BIA or CCAA.36 Proponents of this approach
recommend penalizing companies for any irregularity in the instrument used or in the
underlying decision-making process used to initiate the bankruptcy or reorganization
proceeding. The reasoning behind this approach is based on the ab initio validity of the
authority from which the decision to initiate such a process emanates: there can be no
irregularity, not even a technical one, in a decision to initiate a process with such drastic
consequences, and consequently, if one does exist, it is sufficient to justify a retroactive
34
35
36
Committee Report, supra note 32
HOULDEN, L.W., MORAWETZ, G.B., The 2006 Annotated Bankruptcy and Insolvency Act,
Thompson-Carswell, Toronto, 2005, par. D-26.
Infra, section III-A, Re Trail Building Supply Ltd., (1957) 36 C.B.R. 100, Re Associated Color
Laboratories Ltd., (1970) 14 C.B.R. (N.S.) 35, Re Prince Albert Beef Producers Ltd., (1979) 32 C.B.R.
(N.S.) 301, Re Global Pollution Control Co. (1975), (1979) 32 C.B.R. (N.S.) 204.
/ 17
annulment37 of the bankruptcy or reorganization proceedings launched by invoking either
subsection 181 BIA or the inherently broad powers the court enjoys under the CCAA. For
the purposes of this analysis, we refer to this approach as formalist.
On the other hand, there are the proponents of an approach based on the doctrine of
“indoor management, which states that a decision cannot be invalidated because of an
irregularity. In the context of insolvency, this means that an internal irregularity in the
decision-making process that led to the initiation of the bankruptcy or reorganization
proceedings cannot be used to justify the retroactive annulment of the resulting
consequences.38 Advocates of this approach assert that any other reasoning would deprive
Canadian bankruptcy and insolvency legislation of its socio-economic importance by
making it unnecessarily fragile and unpredictable,39 and consequently, they are against
the notion of authorizing a retroactive annulment of bankruptcy or reorganization
proceedings on the mere ground of internal irregularities affecting the underlying
decision to initiate said proceedings unless it can be shown that the company that resorted
to this legislation was not insolvent at the time the proceedings were launched and is still
not insolvent on the day the application for annulment is filed. For the purposes of this
analysis, we will refer to this approach as factual.
A-
Proponents of the formalist approach
One case law trend adopts a formalist approach in order to determine the validity of the
initiation of the bankruptcy or reorganization proceeding. This approach is based on
respecting the company’s corporate standards, and consequently, the proponents of this
approach penalize any failure or irregularity in the process leading to the decision to
initiate such proceedings. Consequently, when it can be shown that the decision that gave
rise to a notice of intent, a notice of proposal, a voluntary assignment or an initial order
37
The annulment is retroactive only for the status of the bankrupt and not for the actions taken between
commencement of the bankruptcy and the judgment annulling said bankruptcy: sub-section 181 (2)
BIA.
38
Ibid
39
Infra, section III-B, Hovey v. Whiting, Re London, New York & Paris Assn. of Fashions Ltd., Re 609940
Ontario Inc., Gouin v. Gestion Routière L.G.F. Inc. (Syndic de), supra note 17
/ 18
contravenes the company’s articles of incorporation or shareholders agreement, the
proponents of this approach advocate simply annulling the initiated proceeding.
The case law behind this approach essentially holds that a voluntary assignment is
annulled on the grounds that it contravenes the governance rules of the insolvent
company. However, there is no legal precedent on annulling a reorganization proceeding
launched in contravention of these same governance rules. In any case, we can apply
jurisprudence on the annulment of bankruptcy proceedings to reorganization given that
what is objected to is not so much the consequences of launching this process but rather
the ab initio validity of such a decision.
The decision behind this formalist approach was rendered by the Supreme Court of
British Columbia in Re Trail Building Supply.40 The facts of this case can be summarized
as follows. Under the company’s articles of incorporation, the decision to initiate
bankruptcy proceeding had to be made unanimously by the two directors. Given that the
company was experiencing serious financial difficulties, the two directors and the
company’s shareholders arrived at the conclusion that it was time to liquidate the
business’s assets, collect the accounts receivables and distribute the proceeds equitably
among the creditors. Thus, the two directors agreed to a resolution stating their decision
to liquidate the company and even providing that a certain accounting firm be appointed
to assist them with the process. On the basis of this resolution one of the two directors
contacted the selected accounting firm and authorized the voluntary assignment of the
company’s assets in accordance with the BIA, naming said firm as the trustee of the
company’s assets. The other director asked that this voluntary assignment be annulled on
the grounds that although the resolution he had signed authorized the asset liquidation
with the help of an accounting firm and the distribution of the proceeds of the sale among
the creditors, it did not authorize resorting to the BIA and was certainly not intended to be
an authorization to a voluntary assignment.
40
Re Trail Building Supply Ltd, supra note 36
/ 19
Justice Clyne agreed with this second director and after reading the resolution at issue
ruled that his intention was not to authorize the initiation of a bankruptcy proceeding.
Given that the company’s articles of incorporation stipulated that the decision to initiate
such a proceeding had to be unanimously approved by the Board and since one of the
directors had not given his approval, Justice Clyne concluded that the assignment had
been authorized without the requisite authority, which is more than a formal defect that
can be cured by the court.41 Consequently, the judge authorized annulment of the
voluntary assignment due to the irregularity of the decision leading up to it.
In a second decision handed down by the Supreme Court of British Columbia in Re
Associated Color Laboratories,42 Justice MacDonald, based on the ruling of Justice
Clyne in Re Trail Building Supply,43 arrived at a similar conclusion, granting the
application for annulment of an irregularly authorized voluntary assignment. In this case,
one of the company’s large creditors, presumably unsecured, contested the voluntary
assignment of his debtor on the grounds that the directors’ resolution authorizing the
assignment was not made at a duly convened Board meeting. In effect, some directors
had not been convened to the meeting and some directors had given their consent by
phone.
Justice MacDonald concluded, first, that the company’s articles of incorporation did not
allow directors to make decisions outside Board meetings, and second, that all the
directors had to be convened in order for a resolution made during the meeting to be
binding.44 Of interest is the judge’s comment in passing that the consent of the
41
42
43
44
Ibid, par. 6: “It is regrettable that it should be necessary at this stage of the proceedings to annul the
assignment but I think it would be extremely dangerous to hold that a resolution such as the one before
me was sufficient to authorize the execution of an assignment in bankruptcy. The absence of authority
to execute is more than a formal defect or irregularity which can be cured by the Court; it destroys
the validity of the assignment. The execution of the assignment was not the act of the company”
[Our underlying]
Re Associated Color Laboratories Ltd., supra note 36
Re Trail Building Supply Ltd, supra note 36
See also: Re Prince Albert Beef Producers Ltd., supra note 36: “It is trite law that, prima facie, due
notice must be given of convening a meeting of directors, and in default the meeting is irregular, and
when notice has to be given and is not given a reasonable time before a meeting, the proceedings at the
/ 20
shareholders holding all of the company’s share capital could have compensated for these
corporate shortcomings and hence, the outcome could have been different.45
One more decision merits attention. While Justice Clyne in Re Trail Building Supply46
based his decision to allow the application for annulment of the bankruptcy proceeding
on the content of the resolution authorizing the proceeding, and while Justice MacDonald
in Re Associated Color Laboratories47 based his on the fact that the directors’ meeting
was irregularly convened, the Saskatchewan Court of Appeal, in Re Global Pollution,48
based its decision on the failure of the directors to fulfill their basic obligations to the
company’s shareholders:
“The learned chambers judge found that the directors had failed to carry out
some of their duties. He found that no financial statement had been prepared
or delivered to the shareholders and that no annual meeting had been called
for the election of directors. Under s. 151, the court has a wide discretion.
The learned chambers judge in no way exceeded the limits of that discretion
here, so this court should not interfere.” 49
[Our underlining]
As such, in light of the directors’ failure to provide the shareholders with the financial
information to which they were entitled and given that no annual meeting had been called
to elect directors, the Saskatchewan Court of Appeal concluded that the chambers judge
had not overstepped the discretion granted to him under section 181 BIA by annulling the
company’s otherwise valid voluntary assignment.
45
46
47
48
49
meeting will be invalid unless all the directors are present. As no actual meeting was held (…) the
resolution authorizing the assignment in bankruptcy is invalid and of no effect.” [Our underlying]
Re Associated Color Laboratories Ltd., supra note 36, par 28: “After reviewing a number of authorities,
Spence J., who gave the judgment of the Court, stated that he had been led to the conclusion that a
corporation, when a matter is intra vires of the corporation, cannot be heard to deny a transaction to
which all the shareholders have given their assent even when such assent be given in an informal
manner or by conduct as distinguished from a formal resolution at a duly convened meeting. But this
law is of no assistance in upholding the validity of the assignment here in question because there is no
evidence that Shannon and Kemp were the holders of all the issued shares of the Company.” [Our
underlying]
Re Trail Building Supply Ltd, supra note 36
Re Associated Color Laboratories Ltd., supra note 36
Re Global Pollution Control Co. (1975), supra note 36
Ibid, par. 5
/ 21
B-
Proponents of the factual approach
Another case law trend prefers to temper the broad discretion granted the court to annul a
reorganization or bankruptcy proceeding by limiting this solution to cases where the
company fails to meet the criterion of insolvency. For the proponents of this more factual
approach, the importance of the consequences of initiating a bankruptcy or reorganization
proceeding must have precedence over the internal irregularities that could have tainted
the decision-making process leading to the decision to initiate the proceeding. The indoor
management rule, according to which a third party acting in good faith should not see his
transaction with the company nullified due to an internal irregularity,50 must guide the
courts when deciding whether to annul a reorganization or bankruptcy proceeding. The
proponents of this approach hold that economic stability and predictability are the
guiding principles on which all insolvency legislation should be based.51
The Supreme Court Hovey52 decision is often cited as the origin of this factual approach.
In this matter, certain creditors had contested the company’s voluntary assignment on the
grounds that the directors’ resolution authorizing such assignment was irregular in that it
had been authorized by a director of an affiliated company and that the shareholders had
not approved the assignment. First, Justice Ritchie stated that the directors of an insolvent
company have the duty to allow a voluntary assignment of assets when the company is
insolvent without seeking shareholder approval.53 As for the creditors’ objections, Justice
Gwynne confirmed that shareholder consent is not necessary to validate the Board’s
decision to allow the bankruptcy process and that a director has the de facto authority
50
51
52
53
MARTEL, supra note 4, p. 24-7
Committee Report, supra note 12
Hovey, supra note 17
Ibid, p. 519-520: “ I am clearly of the opinion that they not only had the right to do it, but that,
whenever they found the company were unable to meet their engagements and were in
unquestionably insolvent condition, (…) not only they had the right, but it was their bounden duty, in
honesty and justice, to take such steps in their management of the affairs of the company entrusted to
them by law, (…) and this without any special statutory provision, upon general principles of justice
and equity and without the formal sanction of the whole body of shareholders. The board of directors,
in my opinion, has unlimited powers over the property of the corporation so to deal with it as to pay the
just debts of the corporation.” [Our underlining]
See also: In the matter of the bankruptcy of Menuiserie de Granby Inc., [1980] C.S. 108, p. 117
/ 22
required to authorize the initiation of such a process.54 That said, it bears mentioning that
Justice Gwynne appears to base his reasoning for excluding shareholders from the
decision-making process, at least partially, on the absence of any challenge from the
shareholders.55
While the convoluted reasoning of the Supreme Court in the Hovey56 decision made it a
multi-issue decision, the case was not recognized as a landmark ruling. It was not until
1982 that a case established the principles that should guide courts in their decision
whether to annul an initiated bankruptcy or reorganization proceeding. In Re London,57
Justice Goodridge of the Supreme Court of Newfoundland based his decision on a
comprehensive review of the jurisprudence and echoed, for the first time, the connotation
of public order stemming from the application of the BIA. The facts in this case can be
summarized as follows. Some of the company’s creditors asked that the voluntary
assignment of the company be annulled on the grounds that there were many
irregularities in the decision-making process that led to the directors’ resolution
authorizing the initiation of the bankruptcy proceeding, including the absence of a notice
of directors’ meeting as well as the absence of some members at the meeting during
which other members agreed to a resolution authorizing the initiation of the bankruptcy
proceeding.
Justice Goodridge refused to consider these irregularities, particularly since the
company’s insolvency was not questioned. Incidentally, Justice Goodridge pointed out
that the indoor management rule must be applied and as such, the internal irregularities of
a company cannot justify annulment of a bankruptcy proceeding, especially when the
54
55
56
57
See the question of directors’ de facto authority to initiate a bankruptcy proceeding: Re Deziel, (1962) 4
C.B.R. (N.S.) 215 where the Superior Court of Québec, citing the Hovey decision, arrives at the same
conclusion and Re Tru-Value Investments Limited, (1970) 15 C.B.R. 6
Hovey, supra note 17, p. 528
Ibid
Re London, supra note 17
/ 23
company is clearly insolvent.58 He also pointed out that allowing the annulment would do
nothing to change the insolvency of the company except perhaps to expose the directors
to greater liability. It is interesting to note that Justice Goodridge, albeit in obiter,
mentioned that the directors who were involved in the resolution were also majority
shareholders of the company and that according to the company’s articles of
incorporation, that was sufficient to form a quorum at the directors’ meeting and that this
therefore remedied the irregularity in the decision-making process that led to the
assignment.59
The Supreme Court of Ontario used similar reasoning in Re 609940 Ontario Inc.,60 with
an additional detail, i.e., the presence of a unanimous shareholders agreement. The facts
in this case can be summarized as follows. One of the company’s two directors, who was
an equal shareholder with the second director, resigned from his duties. As the company
was experiencing serious financial difficulties, the remaining director approved a
resolution authorizing the initiation of a bankruptcy proceeding. The former director and
still a shareholder contested the initiation of the process on the grounds that under the
unanimous shareholders agreement, his consent was required.
Justice Henry concluded that the unanimous shareholders agreement was not enforceable
against the trustee and associated the problems stemming from such an agreement to an
irregularity in the decision-making process leading to the initiation of the bankruptcy
proceeding. Consequently, the agreement was not sufficient to justify annulment of the
process, particularly since the company was insolvent.61 In an interesting argument,
58
59
60
61
Ibid, par. 20 and 21: “The indoor management rule precludes it. If the instrument is apparently properly
executed and delivered, the company cannot subsequently deny its authenticity on the grounds that the
regulations prerequisite to its execution were not complied.”
Ibid, par. 23: “There is also the practical consideration (although this is not of legal consequence and
does form part of my findings herein) that the directors who voted in favour of the assignment were
majority shareholders. The articles provide that two directors holding between them a majority of the
shares of the company constitute a quorum. The two directors who voted represented voting control of
the company.” [Our underlining]
Re 609940 Ontario Inc., supra note 17
Ibid, p. 141: “The effect of the unanimous shareholder agreement is to limit his authority but in my
opinion that is an entirely internal matter between the director and the shareholders. He may be
accountable to them for failure to comply with the agreement and the statute but that does not render
/ 24
Justice Henry notes that the unanimous shareholders agreement, as we know it today, i.e.,
an agreement that gives shareholders certain prerogatives typically reserved for
directors,62 was introduced in Ontario business law in 1982. The decisions on which the
proponents of the formalist approach rely (Re Trail Building Supply,63 Re Associated
Color Laboratories64 and Re Global Pollution65) were all rendered before this date.
One final decision that merits attention is Gouin,66 handed down by the Superior Court of
Québec. In this matter, two shareholders of a company who had made a voluntary
assignment of its assets contested the validity of the directors’ resolution leading to the
initiation of the bankruptcy proceeding on the grounds that it had not been adopted during
a duly convened directors’ meeting, which ran counter to the company’s articles of
incorporation, which stipulated that shareholders must be consulted before initiating such
a process.
Justice Alain refused to consider the objections raised by the shareholders on the grounds
that the directors who approved the resolution were also majority shareholders of the
company.67 Incidentally, Justice Alain based his decision on public order considerations
in the BIA and on the fact that it is preferable to allow the liquidation of an insolvent
company within the well-defined context of the Act.68 It is interesting to note that the
indoor management rule does not seem to be the basis of this decision. Instead, respect of
62
63
64
65
66
67
68
the assignment void or disentitle the trustee to rely on the assignment and supporting resolution.”
[Our underlining]
SARNA, L., Corporate Structure, Finance and Operations – Essays on the Law and Business Practice,
vol. 8, Carswell, Toronto, 1995, pp. 119-120
See also: LAFORTUNE, D., Droit spécialisé des contrats – Les contrats relatifs à l’entreprise, “La
Convention d’actionnaires,” volume 2, Les Éditions Yvon Blais Inc., Cowansville, 2003
Re Trail Building Supply Ltd., supra note 36
Re Associated Color Laboratories Ltd., supra note 36
Re Global Pollution Control Co. (1975), supra note 36
Gouin c. Gestion Routière L.G.F. Inc. (Syndic de), supra note 17
Ibid, par 29: “Even if resolution R-1 did not satisfy all the requirements provided for in the Companies
Act, the Court concluded that this shareholders’ resolution, adopted by the two shareholders who
held 60% of the voting shares issued and outstanding, was sufficient to allow them to file the
assignment of assets (...)” [Our underlining]
Ibid, par 30: “Both testimonial and documentary proof shows that it is in the interest of the creditors in
general and of the public that the debtor be liquidated within the framework of the provisions stipulated
in the Bankruptcy Insolvency Act.”
/ 25
the rule of the majority was applied to remedy the corporate irregularities of the decisionmaking process that led to the initiation of the bankruptcy proceeding. Rather than simply
set aside these corporate irregularities, Justice Alain remedied them in order to give them
some legitimacy.
C-
Summary and trend
It appears that case law primarily leans toward the factual approach. Indeed, recent
jurisprudence shows that the courts are relying on the indoor management rule,
reiterating that the latter must prevail and hence relegating the internal irregularities that
could taint the decision to initiate such a process to second rank, to the benefit of the
strategic role that bankruptcy and insolvency legislation is called upon to play in the
Canadian economic system.
Although much of case law concentrates on administrative irregularities stemming from
the board of directors, some decisions have assimilated the failure to respect a
shareholders agreement or articles of incorporation expressly providing for various
degrees of shareholder consent as regards initiating a bankruptcy proceeding, into the
company’s internal irregularities. In fact, most of the irregularities raised by case law can
be classified into two categories: one, the irregularities affecting the decision-making
process that led to the initiation of the bankruptcy proceeding, whether in terms of the
authority typically required for such a decision to be valid or in terms of the failure to
consult the relevant and required levels of authority, and two, the irregularities in the
interpretation of the decision-making instrument at the source of the decision to initiate
the bankruptcy proceeding.
That being the case, it seems that the real nuance in distinguishing the analysis between
the two approaches resides in the consideration, or absence thereof, of the context in
which the company finds itself when the application to annul the proceeding is made. In
order to justify their reasoning, the proponents of the formalist approach seem to have
separated the notion of insolvency from the context in which the decision to initiate a
/ 26
reorganization proceeding is made. It is on this point that the proponents of the factual
approach rely to justify some of their reasoning, although it is essentially grounded in the
indoor management rule.
The advocates of the formalist approach appear to have analyzed the validity of a
decision only from a corporate perspective, without taking into account the nature of the
decision and the context in which it was made. While an argument can be made for the
fact that well-informed business people specifically stipulated that a decision to initiate a
bankruptcy or reorganization proceeding requires varying degrees of approval from
members supporting or managing the company, this argument does not hold sway when
the company is insolvent. The admission of insolvency that generally leads to the
initiation of bankruptcy or reorganization proceedings makes this company vulnerable
and places it in a situation of no return. Validating the inevitable on the grounds of form
would be contradictory and counterproductive.
For this reason, the proponents of the factual approach must be commended since their
analysis, in addition to relegating all irregularities that could taint the decision-making
process leading to the initiation of bankruptcy or reorganization proceedings to internal
irregularities that are unenforceable against third parties acting in good faith, including
the trustee,69 made sure to point out that such a proceeding must not be annulled because
of failure to respect a rule of form and that the merit of the decision should prevail. Merit
means financial difficulties that cannot be resolved and obvious insolvency. In such
circumstances, the creditors, shareholders or directors would be ill perceived if they were
unable to demonstrate the company’s solvency when making an application to annul a
bankruptcy or a reorganization proceeding already underway.
This solution appears to be the most appropriate to preserve the socio-economic
importance and economic regulation functions of Canadian legislation. Any other attitude
means that bankruptcy or reorganization proceedings could be tainted by an ab initio
design defect, rendering the insolvency system unnecessarily fragile and unpredictable
69
Re 609940, supra note 60, pp. 141-142
/ 27
with the parties involved always questioning the validity of the proceeding already
underway.
While this approach now appears to be mainstream, it is unfortunate that the legislator, in
Bill C-47, did not see fit to limit the judicial discretion granted by section 181 BIA to
annul bankruptcy or reorganization proceedings, reserving this discretion solely to cases
where the company was not and is still not insolvent.
It is also unfortunate that the legislator did not see fit to adopt a similar provision in the
section pertaining to the proposal70 or in the CCAA. That said, the reasoning behind the
case law on the annulment of a bankruptcy proceeding must be applied mutatis mutandis,
particularly since section 66 BIA certainly does not hinder application of the judicial
discretion provided under section 181 BIA as regards a notice of intent or a proposal filed
in contravention of the company’s governance rules. As for the issuance of an initial
order subject to the same irregularities, it would be surprising that the inherently broad
powers granted to the court under the CCAA were insufficient to give the court similar
discretion.
In any event, unless the parties seeking annulment of an already initiated bankruptcy or
reorganization proceeding can demonstrate that the company, at the time such proceeding
was initiated, was not and is still not insolvent on the day of the annulment application,
the courts will be inclined, justifiably, to refuse the annulment solely on the grounds of an
internal irregularity in the decision-making process leading up to the initiation.
IV-
The shareholder’s role in the drafting and implementation of the
restructuring plan
While the roles of a shareholder and a creditor are similar in the initiation of bankruptcy
or reorganization proceedings in that both are essentially powerless in this regard when
the company is insolvent, although shareholders can have a say in the initiation of such a
70
Part III of the BIA
/ 28
proceeding, their role in drafting and implementing a restructuring plan initiated under
regular circumstances is decidedly different from that of creditors.
According to case law, shareholders play second fiddle to creditors who supplant them in
the hierarchy of interests to be considered in a reorganization proceeding. This approach
is based on the fact that the shares of an insolvent company have no value whatsoever
and therefore the shareholders must step aside in favour of the creditors who hold a debt
security that could still be realized.
The position adopted by the legislator in Bill C-47 seems to have been directly inspired
by the concerns raised by the Committee. As discussed earlier, in its Report, the
Committee was concerned by the exodus of Canadian companies to restructure on U.S.
soil, attributing this situation, at least partially, to the unpredictability of Canadian
insolvency legislation, particularly as regards the subordination of shareholder interests
and the elimination of their right to vote on restructuring plans.71
There is some question as to whether the amendments proposed by Bill C-47 will
permanently alleviate these concerns. The fact is that the legislator seems to have opted
for an ambiguous solution, subordinating shareholder interests to those of creditors in a
bankruptcy proceeding, thus expressly denying shareholders any right to vote on the
restructuring plans proposed by the insolvent company. Some would contend that by not
making full settlement of creditors’ claims a condition for a restructuring plan’s judicial
approval, as is required under the U.S. Absolute Priority Rule, the legislator has left the
door wide open to consideration of shareholder interests in a restructuring plan, which
will have to be fair and just in order for the plan to be sanctioned. Moreover, by not
setting a limit as to this potential consideration of shareholder interests in the
restructuring plan, after the fashion of the U.S. “Crammed Down Rule,” some would
argue that the legislator has left the courts with broad discretion to decide when and to
what extent to include shareholders interests in the restructuring plan.
71
Committee Report, supra notes 31 and 32
/ 29
In any event, the amendments proposed by Bill C-47 seem to codify an approach that has
already been mainstream for a few years although Canadian courts have sometimes
clearly established that it would be unjust and unfair to not protect some of the
shareholders’ interests, particularly when the restructuring plan depends on keeping the
corporate structure in place. Some would argue that the shareholder’s role should be
analyzed differently in a reorganization proceeding than in a bankruptcy proceeding; the
analysis of shareholder interests in the case of a reorganization should consider the extent
to which the shareholders are dependent on the continuity of the insolvent company’s
operations and to what extent they will contribute to the company’s turnaround.72
A-
Jurisprudence
Justice Farley’s recent decision in Stelco73 merits attention in that it reviewed applicable
jurisprudence and came out strongly in favour of eliminating shareholder interests in a
reorganization proceeding unless the shareholders of the insolvent company can prove
that their shares have some value. In this matter, the insolvent company, Stelco Inc., and
some of its affiliates asked that the plan of arrangement overwhelmingly approved by the
creditors but not submitted to the shareholders who, under this plan, saw their interests in
the company’s share capital extinguished in favour of new capital, did not have the right
to vote on this arrangement, be sanctioned in accordance with section 6 of the CCAA. The
shareholders opposed that this plan of arrangement be sanctioned, claiming that their
interests had been extinguished although the value of their shares was still allegedly
positive, thus rendering this plan unjust and unfair.
Justice Farley, recalling the long jurisprudential tradition of relegating shareholder
interests to the bottom of the hierarchy of interests when an insolvent company is in the
72
73
PRENTICE, L.W., supra note 4 p. 266: “The argument that the shareholders should receive nothing
unless creditors are paid in full is premised on the order of distribution in a liquidation proceeding.
(…) Clearly, this is the correct view of priorities when the assets of the corporation are being
liquidated. However, while many restructuring have an air of liquidation about them, when the
corporate entity is being preserved for whatever purpose it is no longer simply liquidation. It is
therefore a misplaced concept that what applies in one kind of proceeding should apply automatically
to every other.” [Our underlining]
Stelco, supra note 1
For an analysis of the impact of Mr. Justice Farley’s decision in the Stelco restructuring, see: MARLIN,
B., “Reconstructing Stelco,” Canadian Lawyer, vol. 30, issue 4, 2006, p. 14 (April 2006 edition)
/ 30
process of restructuring and subordinating these interests to those of the creditor, refused
to consider the shareholders’ claims and sanctioned the plan of arrangement. Justice
Farley’s reasoning was based entirely on the shareholders’ inability to demonstrate that
their shares had a certain value and that this value was not under water, without any
possibility of these shares having any value whatsoever in the foreseeable future.
Justice Farley stated that the hierarchy of interests does not ipso facto deprive
shareholders of any interests in the insolvent company’s turnaround as a result of the plan
of arrangement. Therefore, there will be circumstances when not considering shareholder
interests in a proposed restructuring plan would contravene the principles of justice and
fairness and thus impede the sanctioning of such a plan.74 For Justice Farley, these
circumstances all depend on being able to show, at the time the application for sanction is
filed, that the shareholders’ interests in the insolvent company have a positive value.75
The judge concluded that the shares held by the shareholders opposed to the sanction,
based on any reasonable and realistic analysis, had no value and the accounting submitted
by these shareholders was at best optimistic.76 Consequently, not only was the plan just
and fair, any solution to the contrary would be unjust, inequitable and unreasonable for
the creditors of the insolvent company.77
74
75
76
77
TOWRISS, supra note 13, p. 10: “In cases where shareholder’s interests can be said to be under water
and without economic value, the courts have been fairly consistent in refusing to give these
shareholders the opportunity to vote and potentially obstruct a plan, even if corporate legislation in the
relevant jurisdiction authorizes such a vote. However, there may still be situations where shareholders
should have a “seat at the table” in restructuring.” [Our underlining]
Stelco, supra note 1, par. 16: “The question then is does the equity presently existing in “S” have true
value at the present time independent of the Plan and what the Plan brings to the table? If it does then
the interests of the Equity Holder and the other existing shareholders must be considered
appropriately in the Plan.” [Our underlining]
See also: MCELCHERAN, K.P., “Commercial Insolvency in Canada,, Lexis Nexis Canada Inc.,
Toronto, 2005, p. 290: “If at the time of the sanction hearing, the business and assets of the debtor have
a value greater than the claims of the creditors, a plan of arrangement would not be fair and
reasonable if it did not offer fair consideration to the shareholders.”
Stelco, supra note 1, par. 18: “That approach was accurately described in court by counsel as a
desperation Hail Mary pass and the willingness of someone, without any of his own chips, in the poker
game willing to bet the farm of someone else who does have an economic interest in Stelco.”
Ibid, par. 37: “Therefore, I conclude that the existing shareholders cannot lay claim to there being any
existing equity value. Given that conclusion, it would be inappropriate to justify cutting in these existing
shareholders for any piece of the emergent restructured Stelco. If that were to happen, especially given
the relative values and the depth of submersion of existing equity, then it would be unfair,
unreasonable and inequitable for the affected creditors.” [Our underlining]
/ 31
Another recent decision of the Superior Court of Justice of Ontario merits attention:
Fiber Connections.78 This decision is now under appeal in the Ontario Court of Appeal.79
In this matter, one of the shareholders of the insolvent company is contesting the
sanctioning of a proposal made under the BIA on the grounds that the proposed capital
reorganization is affecting his rights. The uniqueness of this case resides in the fact that
the shareholders of the insolvent company were parties to a unanimous shareholders
agreement specifically stipulating that any change to the company’s capital structure
required the consent of certain shareholders. The shareholder contesting the sanctioning
of the proposal claims that changing the capital structure provided for in the proposal
would breach his rights as stipulated in the unanimous shareholders agreement.
Justice Campbell concluded that a shareholder whose interests have no economic value
cannot block a reorganization proceeding and consequently allowed the insolvent
company to proceed with its capital reorganization pursuant to provisions of the Ontario
Business Corporation Act80 (hereinafter the “OBCA”), which allows the court to sanction
a change in the capital structure of an insolvent company without the consent otherwise
required of the shareholders. In order to set aside the unanimous shareholders agreement,
Justice Campbell authorized an amendment to the latter with a view to removing any
possibility of a veto right provided under the circumstances, the whole pursuant to the
inherent powers granted to the court by the BIA.81 Any other solution would have been, in
his view, unjust and inequitable.82 Moreover, it is interesting to note that Justice
Campbell based his decision, at least partially, on the allegation of oppression raised by
the insolvent company, stating that the attitude of the shareholder contesting the
78
79
80
81
82
Fiber Connections Inc. v. SVCM Capital Ltd., (2005) 10 C.B.R. (5th) 192
Fiber Connections Inc. v. SVCM Capital Ltd., (2005) 10 C.B.R. (5th) 201, appeal upheld.
Business Corporation Act, R.S.O., c. B-16
Fiber Connections Inc., supra note 78, par. 39, 40 and 42
Ibid, par. 41: “Where the corporation is insolvent and the shareholders would, upon liquidation, get
nothing, it would be unfair to creditors and other stakeholders to permit one shareholder with no
economic interest to block a reorganization. The alternative would be bankruptcy and nothing for most
of the creditors and all shareholders.” [Our underlining]
/ 32
sanctioning of the proposal was oppressive83 within the meaning of the OBCA. It will be
interesting to hear the opinion of the Ontario Court of Appeal, particularly on the pure
and simple annulment of rights stemming from a unanimous shareholders agreement
solely on the basis of the inherent powers granted to the courts.
These recent cases stem from landmark decisions such as Re Canadian Airlines84 and Re
T. Eaton & Co,85 both of which lay the foundation of the hierarchy of stakeholder
interests in a reorganization proceeding, relegating the interests of shareholders after
those of the creditor.
In Re Canadian Airlines,86 the minority shareholders of the insolvent company contested
the sanctioning of the plan of arrangement that called for a complete reorganization of the
company’s share capital, and even eliminated some classes of shareholders, the whole in
accordance with the provisions of the Alberta Business Corporation Act87 (hereinafter
“ABCA”) allowing such a reorganization without shareholder consent when the company
is insolvent. The shareholders reproached the insolvent company for not having consulted
them in preparing the restructuring plan and maintained that the support and interests of
Air Canada Inc. during the reorganization proceeding had resulted in an increase in the
value of the company and by extension, of their shares. They also maintained that the
company’s conduct, through the proposed restructuring plan, was oppressive in their
regard.
83
84
85
86
87
Ibid, par 27: where the judge assigns the insolvent company the status of “complainant” pursuant to the
OBCA, thus entitling it to raise the issue of oppression. See par. 33: “I conclude that the purported
exercise of a veto of the amendments to the share structure proposal is oppressive of the Corporation,
its shareholders and directors.”
On this topic see: MARTEL, supra note 4, p. 19-88: “Not only are shareholders not called upon to
vote on the reorganization, but in addition, they do not benefit from the right to dissent. The
reasoning behind this violation of shareholders’ statutory protection is that, because the firm is
insolvent, their shares are not worth anything and it is not up to them to block a proposal or
arrangement with creditors that would benefit the company and eventually, if the company manages to
survive and restart its operations thanks to this procedure, their advantage.” [Our underlining]
Re Canadian Airlines Corp., (2000) 20 C.B.R. (4th) 1
Re T. Eaton Co., (1999) 15 C.B.R. (4th) 311
Re Canadian Airlines Corp., supra note 84
Business Corporation Act, R.S.A. (2000), c. B-9
/ 33
Justice Paperny of the Court of Queen’s Bench of Alberta, in a comprehensive ruling,
refused to consider the three claims of the shareholders, recalling first that the
reorganization of an insolvent company’s share capital, when the incorporating act so
permits, can be made without their consent. The judge underscored, in passing, that this
was exactly the type of situation to which the Dickenson Report, based on which the
CBCA was revised and from which the ABCA appears to be inspired, wanted to respond
by providing that Canadian corporate legislation should allow the courts to approve an
insolvent company’s capital reorganization without the consent otherwise required of
shareholders.88
As for demonstrating that the value of these minority shareholders’ equity was not under
water, it appears that the proof submitted in this regard was not convincing, with Justice
Paperny simply saying that the shares had absolutely no value and that in these
circumstances, it was not unjust and inequitable to not consult the shareholders on the
proposed restructuring plan.89 Lastly, as regards the allegations of oppression, Justice
Paperny pointed out that oppression must be analyzed through the lens of the company’s
insolvency and that in this situation, the shareholders cannot claim to have great
expectations as to the protection of their interests.90 In light of these considerations,
Justice Paperny sanctioned the plan of arrangement.
88
89
90
DICKENSON, R., GETZ, L., HOWARD, J.L., “Proposal for a New Business Corporation Law for
Canada,” Vol.1: Commentary, Information Canada, Ottawa, 1971, par. 374: “For example, the
reorganization of an insolvent corporation may require the following steps: first, reduction or even
elimination of the interest of the common shareholders; second, relegation of the preferred
shareholders to the status of common shareholders (…)” [Our underlining]
Re Canadian Airlines Corp., supra note 84, par. 76: “Indeed, it would be unfair to the creditors and
other stakeholders to permit the shareholders (whose interest has the lowest priority) to have any ability
to block a reorganization.”
See also: Cable Satisfaction International Inc. v. Richter & Associés Inc., (2004) 48 C.B.R. (4th) 205
where Justice Chaput comes to a similar conclusion, based on, however, an additional consideration,
namely, that the shareholders did not have to bear the burning costs: “As the company is insolvent, the
shareholders have no economic interest to protect. More so when, as in the present case, the
shareholders are not contributing to any of the funding required by the Plan. Accordingly, they have
no standing to claim a right under the proposed arrangement.” [Our underlining].
See also: Re Beatrice Foods Inc., (1996) 43 C.B.R. (4th) 10
Re Canadian Airlines Corp., supra note 84, par. 143: “The expectations of creditors and shareholders
must be viewed and measured against an altered financial and legal landscape. Shareholders cannot
reasonably expect to maintain a financial interest in an insolvent company where creditors’ claims are
not being paid in full. It is through the lens of insolvency that the court must consider whether the
/ 34
While not contested, it is interesting to note the quasi-legislative nature of Justice
Farley’s obiter in Re T. Eaton & Co.91 which, while approving a plan of arrangement that
called for the protection of the shareholders’ interests and on which the shareholders had
been asked to express an opinion, issues a warning that probably stems from the
narrowing of the place reserved to shareholders in most of the decisions analyzed earlier:
“What is of concern is the question of the size of the pot going to the
shareholders. That was a bone contention amongst the various creditors – but
as I have observed, no one advanced a competing plan. I would also like to
make it clear that I have no doubt that many of the shareholders have suffered
significant losses as a result of the demise of Eaton’s and I know that it is
painful for them. It is not my intention to increase that pain but I do think that
it is important for at least future situations that in devising and considering
plans persons recognize that there is a natural and legal “hierarchy of
interest to receive value in a liquidation or liquidation related transaction”
and that in that hierarchy the shareholders are at the bottom. (…) I trust that
a forward analysis of these views will be of assistance to those involved in
future cases.”92
The plan of arrangement called for changing Eaton’s capital structure in that it provided
for the company’s merger with a company affiliated with Sears Canada Inc., which was
interested in recovering the substantial remaining tax losses. Eaton shareholders were
asked to express an opinion on the plan of arrangement and also managed to save a
substantial part of their interest. The plan of arrangement was sanctioned by Justice
Farley. However, in light of the judge’s obiter, some creditors are certainly kicking
themselves to this day for not having challenged the place reserved for shareholders
throughout Eaton’s reorganization proceeding.
One final decision merits attention in that it is a typical example of when the courts
conclude that it would be unjust and inequitable to not consider the interests of
91
92
acts of the company are in fact oppressive, unfairly prejudicial or unfairly disregarded. (…) The
reduction or elimination of rights of both groups is a function of the insolvency and not of oppressive
conduct in the operation of the CCAA.” [Our underlining]
See also on the topic of oppression in the context of insolvency: Re Uniforêt, 43 C.B.R. (4th) 254,
upheld by the Québec Court of Appeal: J.E. 2003-1595
Re T. Eaton Co., (1999) 15 C.B.R. (4th) 311
Ibid, par. 9
/ 35
shareholders in a restructuring plan. As such, in Woodward’s,93 the proposed plan of
arrangement called for a dividend to be paid to the shareholders while the creditors had to
take a loss on their debt. Moreover, the shareholders of the insolvent company were
consulted on the restructuring plan, albeit only those of a certain voting class.
Justice Tysoe of the Supreme Court of British Columbia concluded that despite the
opposition of certain creditors, the proposed plan of arrangement was fair and equitable
given that the insolvent company had been stripped of all its assets and that the remaining
tax losses were related directly to the insolvent company and consequently, to the shares
that make up its share capital. Hudson’s Bay Company wanted to acquire the share
capital of the insolvent company in order to take advantage of its accrued tax losses, and
since the only way to complete this transaction was to merge the insolvent company with
a company affiliated with Hudson’s Bay Company, Justice Tysoe concluded that it was
fair and equitable that the shareholders, whose consent was required under British
Columbia corporate legislation, be compensated for this specific transaction.
It is interesting to note that British Columbia corporate legislation, after the fashion of
Québec business legislation,94 does not have provisions similar to subsection 191 (3) of
the CBCA authorizing the court to sanction the reorganization of the capital structure of
an insolvent company without shareholder consent.95 Consequently, it would have been
interesting to see if this decision would have been the same had the insolvent company’s
incorporating act been from another province, or under the CBCA, which specifically
states that an insolvent company does not require shareholder consent to make changes to
its capital structure.
B-
93
94
95
Summary and trend
Re Woodward’s, (1993) 20 C.B.R. (3d) 74
Companies Act of Québec, R.S.Q, c. C-38
Re Woodward’s, supra note 93: “However, there was no other method by which The Bay could have
accessed the tax losses, except by having the shareholders consent to a merger with The Bay entity. The
law required their consent, and it followed that their consent required compensation.” [Our
underlining]
/ 36
At first glance, the role of the shareholder in the drafting and implementation of a
reorganization proceeding is very limited. It appears well established that shareholder
interests must be set aside in order to preserve all the interests of the creditor.
First, as regards the shareholders’ right to be consulted on the proposed restructuring
plan, while jurisprudence offers examples where they were indeed consulted, it appears
that the legislator has definitely eliminated any ambiguity in this regard by specifically
stipulating that shareholders do not have any right to vote on any proposal or plan of
arrangement.96 These amendments will clarify the approach to take as regards the
shareholder’s role in preparing the restructuring plan. Indeed, it is interesting to note that
in two of the decisions analyzed earlier, Stelco97 and Fiber Connections,98 the
shareholder’s role was treated quite differently when it came time to prepare the
restructuring plan in that Stelco’s shareholders had no say on the plan of arrangement
whereas Fiber Connections’ shareholders were consulted on the proposal.
Then, as regards the right of the shareholder to be considered in a restructuring plan, a
slight, albeit uncertain trend can be observed in jurisprudence. This trend is expressed by
Justice Farley in Stelco99 which takes up a series of prior100 decisions that can be
summarized by the following dichotomy. The principle seems to be that shareholders,
given that they have no interest or value in the insolvent company since losses impact
shareholder equity, they cannot hope to recover anything whatsoever in a restructuring
plan. Consequently, in principle, the interests of the shareholder must give way to
preserving all of the creditor’s interests. The exception is when it can be shown that the
shareholder’s interest is not without value and must be considered in the restructuring
plan. In such a case, jurisprudence holds that it would be unjust and inequitable to not
consider the shareholder’s interests in a restructuring plan.
96
97
98
99
100
Bill C-47, supra note 11, subsection 37 (1) and section 131
Stelco, supra note 1
Fiber Connections, supra note 78
Stelco, supra note 1
See: Re Cadillac Fairview, [1995] O.J. No. 707 and Re Laidlaw Inc., (2002) 34 C.B.R. (4th) 72
/ 37
The onus is therefore on the shareholders to demonstrate that their interest in the
insolvent company has some value, justifying that it not be extinguished by the
company’s projected turnaround as a result of the restructuring plan. Determining the
value of shareholders’ interests in an insolvent company is no small feat as Stelco’s
shareholders unfortunately learned.101 In his ruling, Justice Farley rejected the accounting
submitted into evidence by the shareholders, stating that the conclusion of such
accounting could not be reasonably considered. It should be noted, however, that the
judge analyzed the value of the interests only from the book value of shareholders equity.
Consequently, it must still be determined from which angle this alleged value of
shareholder interest in an insolvent company should be analyzed, and in this regard, the
burden of proof falls on the shareholder.
It makes sense to determine this value from the perspective of business continuity rather
than asset liquidation, which is a last resort.102 It cannot be limited to a context of
liquidation when creditor interests are not jeopardized by the business continuity
alternative. The business continuity angle, found in most restructuring scenarios, would
obviously benefit all the parties involved. Yet must this benefit be reserved solely for the
creditors on the grounds that if the insolvent company were to become bankrupt, the
interests of the shareholders would be completely subordinated to those of the creditors?
This rationale seems oddly incomplete since if the company were to go bankrupt, the
interests of the creditors would also change sharply.
101
102
Indeed, it is interesting to note in this regard that Stelco’s recapitalization raised a considerable amount
of money. The shareholders who fell prey to this new capitalization still maintain that this clearly shows
that the value of their equity was not under water and that from a reasonable perspective, their equity
had some value. See the article in this regard by The Canadian Press, which appeared in the daily La
Presse on April 10, 2006 entitled: “Les anciens actionnaires de Stelco se sentent trahis,” available at
http://argent.canoe.com/lca/infos/canada/archives/2006/04/20060410-071858.html
PRENTICE, supra note 72
See also ABITAN & TARDIF-LATOURELLE, supra note, p. 16: “Added to this problem is the fact
that it is difficult if not impossible to accurately determine the value of a business in the context of
continuity except by selling it. This, in our opinion, is the difference between a reorganization and a
liquidation. It is easy to apply the rules of subordination when you have proceeds from a sale and a
schedule of distribution. This exercise is not as easy when you have a debt compromise whose just and
reasonable character is compared to an estimated realized value in a context of a theoretical
liquidation.”
/ 38
Consequently, it would be more fair and equitable to distribute the benefits resulting from
the continuity of the company’s operations and from the restructuring plan based on the
contribution of each party involved. While there may be situations where the
shareholders of an insolvent company have interests with absolutely no value,
specifically, when business continuity is not contemplated in the restructuring plan,
which instead focuses on liquidating and parcelling out the operations to other
companies, there are many situations where the restructuring plan focuses solely on
maintaining the company as a going concern: for example, the insolvent company holds a
permit that is difficult to transfer, owns exclusive licenses, has large contracts that ensure
its survival, has a large network and distribution structure, or possesses a registered
trademark.103
In short, evaluating shareholder interest is a function of the value of the insolvent
company. And just as in any business valuation, determining its value cannot be limited
to an accounting analysis of its shareholder equity. Jurisprudence seems to adopt a
different approach when it comes to establishing the value of the company, because this
is what a restructuring plan usually does; it establishes the value of the company and not
just the value of its assets just because it is insolvent. However, insolvent companies
often find themselves in this situation as a result of questionable management and that
definitely affects its value as a company but certainly not to the point of limiting its value
to the liquidation value of its assets. Determining the value of an insolvent company
based solely on its liquidation value appears unjust and inequitable, especially when the
only reason this is being done is because of the hierarchy of interests that only applies to
liquidation cases.
While it is difficult to assign a value to all these intangible elements that are difficult to
identify in the financial statements of the insolvent company but that nonetheless clearly
help its value, their value must be determined in light of the interest expressed by
investors in the insolvent company’s turnaround. Once this analysis is completed, then
103
PRENTICE, supra note 4, p. 270
/ 39
the burden of the reorganization can be spread justly and equitably between the creditors
and shareholders as well as the resulting fruits of the turnaround.
By not adopting the American Absolute Priority and Crammed Down Rules in their
entirety, the legislator appears to be uncomfortable imposing a rigid framework for
respecting the principle of subordinating shareholder interests in the case of a
reorganization.104 As explained earlier,105 the combination of these rules is such that
subordination of shareholder interests becomes a condition for judicial approval of a
restructuring plan although exceptionally, a plan can circumvent this condition by
providing a certain treatment in favour of the shareholders provided, however, that it
shows that this solution is fair and equitable and that the interests of the creditors are not
affected to the point that they would realize less than in a bankruptcy proceeding.106
In this regard, it is interesting to note that the legislator has limited the rule of
subordinating shareholder interests solely to bankruptcy situations as set out in amended
subsection 140.1 BIA, not seeing fit to replicate a similar provision in the section on the
proposal or in the CCAA, or to make this rule a condition for approving a proposal or a
plan of arrangement. It therefore seems that the legislator preferred to eliminate the
irritants that could arise from shareholder intervention in the preparation of a
restructuring plan, which could be explained by their tendency to favour high-risk options
given that their equity is deeply under water.107 In so doing, the legislator, however,
preferred to preserve the discretion of the courts as to when to consider the interests of
shareholders in a restructuring plan and as to the extent to which these interests should be
reflected in the plan at the sanctioning stage. It is interesting to note that this approach
runs completely counter to the Committee’s recommendations.108
104
As such, certain decisions based, at least in part, on the American approach should be reviewed in light
of the amendments proposed in Bill C-47: Re Loewen Group Inc., (2001) 32 C.B.R. (4th) 54
105
Supra, section II-C
106
Bankruptcy Code, United States Code, supra, note 29
107
LIGHT, supra note 5
108
Committee Report, supra note 12, p. 177: “Consequently, their claims [of shareholders] should be
afforded lower ranking than secured and unsecured creditors and the law that in the interest of fairness
and predictability – should reflect both this lower priority for holders of equity and the notion that they
/ 40
It will be interesting to see how jurisprudence evolves now that it has been clearly
established that shareholder interest in an insolvent company depends on the ability of
shareholders to demonstrate that this interest has worth, particularly as regards the notion
of value and how it is measured.
V-
Conclusion
Bill C-47, in its current version, proposes a major reform of Canadian insolvency
legislation. While it is still difficult to assess the impact of the adopted amendments, it
seems that the legislator followed the fundamental principles raised by the Committee as
being the basis of all insolvency legislation, namely, fairness, accessibility, predictability,
responsibility, cooperation, efficiency and effectiveness.109 What do these principles
mean when applied to the shareholder role?
Initially, when bankruptcy or reorganization proceedings are initiated, jurisprudence now
seems well entrenched in the indoor management rule, such that it is difficult for
shareholders deprived of their rights to be consulted as regards the initiation of such
proceedings, either pursuant to the company’s articles of incorporation or to a unanimous
shareholders agreement, to have these proceedings annulled on the grounds that internal
irregularities tainted the validity of the decision leading to the proceedings. In fact, unless
the aggrieved shareholder can prove that on the day the bankruptcy or reorganization
proceedings were initiated the company was not insolvent and is still not insolvent on the
date of the annulment application, the courts will usually refuse to annul the proceeding,
preferring to decide on the merits of the company’s insolvency situation. Jurisprudence
must be commended in that it is consistent with the socioeconomic function of Canadian
insolvency legislation. Provided the company is insolvent, whether or not the decision to
initiate bankruptcy or reorganization proceedings was validly made should not be used to
obfuscate the fact that the company is insolvent. Annulling such a proceeding when the
109
will not participate in a restructuring or recover anything until all other creditors have been paid in
full.” [Our underlining]
See also TOWRISS, supra note 13, p. 8
Committee Report, supra note 12
/ 41
company is plainly insolvent would only delay the inevitable since the company has
made a clear admission of insolvency. Thus, allowing the annulment of such a
proceeding for questions of form when the company’s actual situation is not contested
would be inconsistent with the economic regulation function of insolvency legislation
and moreover, would unnecessarily weaken the underlying economic system.
The legislator does not appear to have considered it necessary to intervene in the issue of
irregularly initiated bankruptcy or reorganization proceedings. While this is
understandable given the clear uniformity of jurisprudence and the merits of the accepted
solution, one would advance that a specific limit to the broad discretion granted to the
courts under section 181 of the BIA limiting their discretion to annul irregularly initiated
proceedings solely to cases where the company was not and is still not insolvent would
have established a legislative solution favoured by jurisprudence while eliminating the
chance factors associated with discretionary powers. Moreover, by not including a
provision similar to section 181 of the BIA in the CCAA, it seems that the legislator was
once again relying on the inherent powers granted the courts under the CCAA and whose
nature and scope depend on numerous jurisprudential factors.
Second, as regards the shareholder’s role in the drafting and implementation of a
restructuring plan, the legislator did not simply rely on jurisprudence. As such, Bill C-47
makes major changes to Canadian insolvency legislation when reorganization
proceedings are properly initiated. By introducing the concept of subordination of
shareholder interests in favour of the full protection of creditor interests and by
eliminating the option of consulting the shareholder on a proposed restructuring plan, the
legislator clearly drew inspiration from the American solution founded on the Absolute
Priority Rule, with the result that shareholders will henceforth play second fiddle.
However, this change will not likely bring an end to the controversy on the shareholder’s
place in insolvency situations.
When the restructuring plan is being drafted, subsections (2) (a) BIA and 22 (3) CCAA do
not seem to have the scope required by the Committee, which implored the legislator to
/ 42
allow the courts to approve changes to an insolvent company’s capital structure without
shareholder consent.110 While the CBCA and some provincial corporate laws grant the
court such powers in insolvency situations, this is not the case for the other provinces
where, as in Québec, the court cannot bypass the shareholder consent required to approve
a capital reorganization affecting them. It is doubtful whether the amendments proposed
by Bill C-47 have sufficiently broad scope to not only exclude shareholders’ right to vote
on restructuring plans but also to allow the court to approve a capital reorganization
without the shareholders’ consent. It seems that in this regard, the legislator relied on
corporate legislation specific to each insolvent company. It is unfortunate that the
legislator did not put a definitive end to this problem by promoting a cross-Canada
solution whose main advantage would have been to prevent Canadian companies from
having different reorganization options based on their incorporating act.
Finally, as regards implementing a restructuring plan, it is also unlikely that the new
legislation will resolve the problem of determining when shareholder interests should be
considered in a restructuring plan and, if they are taken into account, to what extent so
that the plan is fair and equitable. Despite some vacillation, it seems that jurisprudence
now holds that shareholder interests must be taken into account in a restructuring plan
when it can be shown that these interests have a value. The issue seems to be more on
how to determine the value of these interests. Whereas some favour a purely accounting
analysis of shareholders equity, others maintain that the value of the shareholder’s
interests is directly related to the nature of the proposed restructuring plan. As such, the
more the plan focuses on maintaining the insolvent company as a going concern, the
more the shareholder’s interests should be considered. This last approach is the best
course of action. Provided that the value of the company is significant, notwithstanding
its insolvency, which may be due to cyclical events and poor management, it would be
unfair and inequitable to determine and treat the shareholder’s interests solely on the
basis of a bankruptcy scenario, which in all likelihood will not materialize. It would be
unfair and inequitable to overlook the business continuity projected by the restructuring
110
Committee Report, supra note 32
/ 43
plan since in a bankruptcy scenario, the interests of the creditors are likely to suffer the
same fate.
It bears pointing out that the legislator, by introducing the concept of subordinated
shareholder interests, seems to have limited it to bankruptcy situations given that this rule
was not carried over to the BIA section on proposals or in the CCAA. We can therefore
conclude that in reorganizations, the interests of the shareholder must be considered by
the courts. While the extent to which these interests must be considered is largely up to
the court, the latter must ensure the benefits resulting from the projected continuation of
the insolvent company’s operations is distributed fairly between the shareholders and
creditors. Only then can a restructuring plan be called fair and equitable and be
sanctioned by the court.