THE REORGANIZATIONOF INSOLVENTBUSINESSES:

A FUNCTIONALCOMPARISONOF THE CANADIANAND AMERICANMODELS

by

KEITH DENNISYAMAUCHI

B.A., The Universityof Calgary, 1977 LL.B., The Universityof Saskatchewan,1981

A THESISSUBMIEfED IN PARTIALFULFILLMENTOF

THE REQUIREMENTSFOR THE DEGREEOF

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THE FACULTYOF GRADUATESTUDIES

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THE UNPIERSITY OF BRITISHCOLUMBIA

September 1994

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it 11 ABSUACE

The businessreorganizationsystemsavailableto fmancially-distressedbusinessesin Canada are evolvinginto a systemsimilarto that employedin the United StatesunderBankruptcyReformAct of 1978(Code). Business reorganizationshave been an integralpart of Americancommercialculture for almosta century. In Canada,businessdebtorsmay resortto the Companies’Ceditoi

Anwgemeni’Act (CCAA)or the Bankruptcyand InsolvencyAct (BIA),when seekingto reorganize their affairs. However,Canadiandebtorsuse thosesystemssparingly.

A primaryobjectiveof a businessreorganizationsystemis to balancethe debtor’srehabilitation effortswith the rights of creditors. Thispaper examinesthe Codeand conductsa functional comparativeanalysisof certainaspectsof the Canadianand Americansystems. The purposeof this examinationis to detemiinewhetherthe systemsaccomplishthat objectiveand whetherthe Canadian systemscould accomplishthat objectivemoreeffectivelyby examiningand incorporatingaspectsof other systems.

This paper arguesthat the BL&neitherencouragesthe debtor’srehabilitationeffortsnor treats creditorsequitably. The primaryreasonfor this shortcomingwas the failureof the policymakersto considerthe objectivesof a businessreorganizationsystem. Thesepolicyobjectivesformedthe foundationof the Code. As a result,the Codecontainsconceptsthat attemptto balancethe interests of debtorsand creditorsand givesthe courtsthe necessaryflexibilityto mouldthe concepts toachieve that balance. The CCAAprovideslittleproceduralor substantiveguidanceconcerningits policy objectives. Accordingly,the courtshave significantflexibilityin applyingits provisions. However, that flexibilityalso resultsin a lackpredictability.

The proposalprovisionsof the BIA must undergosignificantchangesbefore it becomesa workablebusinessreorganizationmodel. Furthereffortsat bankruptcyreformmust includea thorough studyof legislativeand doctrinalaspectsof systemsotherthan those used domestically. Thispaper 111 arguesthat Canadianpolicymakerscould create a fair and equitablebusinessreorganizationsystemby usingthe conceptsin the Codeand those developedunder the CCAA and by attemptingto resolve shortcomingsof those systems identifiedby the courtsand commentators. v

TABLE OF CONTENTS

ABSTRACT ii

TABLE OF CONTENTS iv

GLOSSARY vii

CHAPTER I INTRODUCTION 1

A. CONCEPTUAL FRAMEWORK AM) ISSUES 1

B. LITERATURE REVIEW 6

C. METHODOLOGY 9

D. “BUSII.1ESSREORGANIZATION” 14

CHAPTER II LEGISLATIVE HISTORY 16

A. BIA 16

B. CCAA 21

C. CODE 22

CHAPTER ifi ELIGIBILITY TO REORGANIZE 29

A. DEFINITIONAL DIFFERENCES 29

B. TECHNICAL REQUIREMENTS UNDER THE CCAA 36

C. GOOD FAITH IN COMMENCING REORGANIZATION PROCEEDINGS 39

1. The Concept of Good Faith in a Business Reorganization 40

2. Legislative History and Evolution of the Concept of Good Faith in Reorganization Proceedings 42

3. Should Good Faith Be a Consideration? 51

D. CONCLUSION 53 V

CHAPTER 1V CUSTODY OF THE ESTATE OF THE DEBTOR 55

A. DEBTOR IN POSSESSION (DIP) 56

1. Legislative History and Conceptual Basis 56

2. Fiduciary Duty of the DIP 61

3. External Control of the DIP 63

4. Appointment of a Trustee or Examiner 66

B. THE CANADIAN APPROACH 69

C. FULFILMENT OF OBJECTIVES AND PROPOSALS FOR REFORM 72

CHAPTER V CERTAIN ADMINISTRATiVE POWERS 76

A. ADEQUATE PROTECTION DURING THE STAY OF PROCEEDINGS 77

1. Terminology 80 (a) Secured Creditor 80 (b) Adequate Protection 84

2. Nature of the Stay of Proceedings 95

3. Scope of the Stay of Proceedings 103

4. Lifting the Stay / Dismissing the Case 114 (a) CCAA 116 (b) Code 121 (c) BIA 127

5. Analysis of the BIA and Proposals for Reform 132

B. REPUDIATION OR REJECTION OF REAL PROPERTY LEASES 140

1. Legislative History 140 vi

2. Repudiation / Rejection 145

3. Rejection or Repudiation of Unexpired Leases to Facilitate Reorganization 152 (a) The Necessity for the Existence of a Lease 153 (b) Ipso Facto or Bankruptcy Clauses 155 (c) Time Limitfor Election to Reject or Repudiate 159 (d) Performance of Obligations During the Stay of Proceedings 162 (e) The Landlords Claim or Compensation for Breach 168 (f) Standards for Rejection or Repudiation 171

4. Considerations for Reform 173

C. FINANCING THE PROCEEDING 175

1. Use of Cash Collateral 177

2. Obtaining Credit 186

3. Conclusion 200

CHAPTER VI MOVING TOWARD CONFIRMATION OF A PLAN OF REORGANIZATION 201

A. STEPS PRECEDING CONFIRMATION 202

B. TIME WITHIN WHICH THE PLAN MUST BE FILED 210

C. CLASSIFICATION AN]) VOTING ON THE PLAN 223

1. Voting on the Plan and Required Majorities 225

2. Classification of Claims and Interests 234

D. CRAM DOWN 254

CHAPTER VII CONCLUSION 270 Vu

GLOSSARY

77B: Act of June 7, 1934, ch. 424, 48 Stat. 911 at 912 (1934).

1898U.S. Act: Banknq,tcy Act of 1898, ch. 541, 30 Stat 544 (1898).

1984Amendments: BankruptcyAmendmentsand FedeiviJudgesh4’Act of 1984,Pub. L. No. 98-353, 98 Stat. 333 (1984).

BIA: Bankruptcyand InsolvencyAct, R.S.C. 1985,c. B-3, as am. by S.C. 1992,c. 27.

Bkr-L Ed: J. Lee, Consultant, BankruptcyService LawyersEdition (Deerfield:Clark Boardman Callaghan, 1993).

CCAA: Companies’CreditorsArrangementAct, RS.C. 1985,c. C-36.

ChandlerAct: ChandlerAct of 1938, ch. 575, 52 Stat. 840 (1938).

Chapter 11: Code, ss. 1101-1174.

Chapter X Chandler Act, ss. 101-276.

ChapterXI: Chandler Act, ss. 301-399.

Code: BankruptcyRefonn Act of 1978,Pub. L. No. 95-598,92 Stat. 2549 (codifiedas amended at11 U.S.C. ss. 101-1329(1988)).

Colter Committee Report: AdvisoryCommitteeon Bankruptcyand Insolvency,Repoil (Ottawa: Consumerand CorporateAffairs Canada, 1986)(Chair: G. Colter). former CanadianAct: BankruptcyAct, RS.C. 1985,c. B-3, as am. up to but not includingS.C. 1992, c. 27.

House Report: House Repon’,HR No. 95-595,95th Cong., 1st Sess (1977), reprinted in 1978 U.S.C.C.A.N.(598 Stat.)5963.

Norton BankruptcyLaw & Practice: W.L. Norton, Jr., Non’onBankruptcyLaw and Prc4tice,2d ed. (Deerfield:Clark BoardmanCallaghan, 1994).

SenateReport: Senate Repon’,S.R No. 95-989,95th Cong., 2d Sess. (1978), reprinted in 1978 U.S.C.C.A.N.(598 Stat.) 5787.

Tassé Report: Study Committeeon Bankruptcyand InsolvencyLegislation,Repon’(Ottawa: InforniationCanada, 1970)(Chair: R Tassé). 1 EERICHAI IN1RODUCHON7

A. CONCEPTUALHAMEM)RK AND ISSUES

Tn1947,in the seminalarticleon the CCAA, StanleyE. Edwardswrotethe following,when

speakingabout the developmentof businessreorganizationlaw in Canath:

Canadiansare fortunatelyin a positionto adoptthe portions they choosefromthe solutions, both statutory andjudicial, whichhave been workedout in the United Statesand Great Britain. The wisdomof the procedures and rulesworkedout there will be examinedin the lightof Canadian conditionsin an effortto devisethe fairest and most feasibleschemepossiblefor applicationof the 1C.C.A.A. Fromthe time of Edwards’articleto the early 1980s,there were few business reorganizationsin

Canada. There were two reasons for this. First, there was the notion that the CCAAwas intendedfor

largecompanieswith complexcapitalstructures. Few companiesmet these criteria. The second

reasonwas that theformerCanadianAct2 didnot allowthe debtorto bind securedcreditorsto the

proposalprovisionsor the ancillaryprovisionsof the act that were enactedto facilitateproposals.

Debtorsstartedusingthe CCAAin the early1980sand since then,it has becomethe “remedy of 3choice” of debtorsseeking to reorganizetheir fmancialaffairs. However,the structureof the CCAArequiresthe debtorto make numerouscourt applicationsto accomplishthe objectivesof the

act. Thus,companies thatuse the CCAAmust havethe necessaryfmancialbackingto withstandthe

significantcosts attendant onsucha proceeding. The formerCanadianAct continuedto be of little

use to debtorswith significantsecureddebt. Bill 4C-22, whichreceivedRoyalAssent onJune 23, 1992,resultedin significantamendments

1 S.E.Edwards,“ReorganizationsUnder theCompanies’CreditorsArrangementAct” (1947),25 Caii Bar Rev. 587 at 592.

2 For a discussionof this issue, seechapterffl(B), below.

F.J.C.Newbould,Q.C. “TheCompanies’CreditorsArrangementAct” (1992)7 B.F.L.R 51.

‘ Bill C-22,An Act to Amend the BankmptcyAct and to Amend the Income TcccAct in consequencethereof, 3d Sess.,34thParl., 1991(assentedto 23 June 1992). 2

to the formerCanadianAct. The amendments changedthe nameof the former Canadian Actto the

Bankruptcyand InsvlvencyA5ct and they were proclaimedin forceon November30, 1992.6 The BIA

completely changedsubstantiveand proceduralaspectsof the proposal provisionsof the former

CanadianAct. The most significantchangewas to the rights and dutiesof securedcreditors. The

debtornow has the abilityto stayproceedingsof secured creditors andto bind a minorityof secured

creditorsshoulda majorityacceptthe proposal. TheBIA did not repealthe CCAAand, as a result,

debtorsin Canadapresentlyhave a choiceof reorganizationregimesunderwhich toproceed.

By its terms,the provisions andthe operationof the BIAare to be reviewedby a parliamentary committeeestablished forthat 7purpose. Parliamenthas formed thecommittee andits purposeis to:

providea forumto discussand determine prioritiesfor insolvencyreformfor the next severalyears andto allowfor the developmentof a consensuson policyrecommendations in various areasof 8concern. Theparliamentarycommitteehas establisheda numberof workinggroups. The objectof each workinggroupis to focus on a specificarea of 9concern. WorkingGroup#2 is to focuson, inter alia, commercialreorganizationissues. The Superintendentof Bankruptcyviewsthe provisionrequiringthe

S.C. 1992,c. 27, s. 2.

6 P.C. 1992-2180,ST192-194,C. Gaz. 1992.11.4079.Certain administrative provisionswere proclaimedin forceprior to that time [P.C. 1992-1665,SJJ92-135,C. Gaz. 1992.11.3300].Those provisionswill not be addressedin this paper.

S.C. 1992,c. 27, s. 92 provides:

“Afterthe expirationof three years after thissectioncomesinto force,this Act shall stand referredto such committeeof the Houseof Commons,of the Senateor of both Housesof Parliamentas may be designatedor establishedfor that purposeand the committeeshall,as soonas practicablethereafter,undertakea comprehensivereviewof the provisionsand operationof this Act and shall,withinone year afterthe reviewis undertakenor withinsuch furthertime as the Houseof Commonsauthorize,submita reportto Parliamentthereon.”

8 S.J.Kershman, “WorkingGroupsof the Bankruptcyand InsolvencyCommittee”(1993) 13:3 Insolv.Bulletin342 at 343. 9lbid 3

review by the parliamentarycommitteeas continuingthe momentumstarted by the enactmentof the

He goes on to state:

The opportunitypresented by that review will only be meaningfulif interested partieskeep the process alive by makingthe Government awareof the need for ongoingreform. The [parliamentarycommittee]provides a unique forum through whichto set the agenda for research and reform and to shapethe futuredirectionof the insolvencyprocess.”

Thispaper is intendedto contributeto that discourse.

During thatreview, the parliamentarycommitteemust examine whether theamendmentsmeet

the broader objectivesof a businessreorganizationregime. This paper will show that the committee

cannotundertakethis task without takingadvantageof the methodologysuggestedby StanleyE.

Edwards,over four decades ago.

In consideringthe CCAA, a numberof courts and writers use Americancase law in their

argumentsand discussionand they have alluded tothe fact that the CCAAis evolvingin a waythat providesthe parties to the proceedingwith rightssimilarto those containedexpresslyin the 2Code.’ The few cases that have considered theBIA appear to be taking an approach similar tothat taken

under the CCAA.

The Colter CommitteeReport specificallyrejected the wholesaleadoptionof the reorganization

provisionscontained in Chapter 11 and the administrativeprovisions containedin chapter3 of the 13Code. Parliamentappearedto have taken this advice, although theremay be sufficientflexibilityin the BIA to allow some of the Code’smore desirable concepts tobe used in a Canadian business

10 G.F. Redling, “The First Year of the Bankruptcyand InsolvencyAct: The Policy and RegulatoryPerspective” (1993)13:4Insolv. Bulletin 381 at 391.

‘ Ibid

12 See e.g., Quintette Coal Ltd v. Nippon Steel Corp. (1990), 80 C.B.R. (N.S.) 98 (B.C.S.C.); MeridianDevelopmentsInc. v. TorontoDominionBank (1984), 52 C.B.R. (N.S.) 109 (Alta. Q.B.); Re UnitedMaritime Mshennen Co-op. (1988), 69 C.B.R. (N.S.) 161 at 169 (N.B.C.A.); RePerkins Holdings(1991), 6 C.B.R. (3d) 299 at 301 (Ont. Gen. Div.); Edwards,supra note 1; L.J. Crozier, “GoodFaith and the Companies’CreditorsArrangementAct” (1989) 15 Can. Bus. L.J. 89.

13 Colter Committee Reportat 53-54. 4

reorganization. It is not clear wi’ythe Colter CommitteeReport and Parliamentwere determinedto

reject all aspects of the Americanmodel. There are aspects of the Americanmodel that are lessthan

desirable,such as the time necessaryto completemost proceedingsunderChapter 11 and the fact that few debtors emerge from the proceedingsas viable 4entities.’ However,this should not have discouragedParliamentfrom incorporatingsome of the Code’smore equitableprovisionsand the

notions developedby the American courts that balancethe interestsof debtors and their creditors.

Parliamentshouldnot have rejected the Americanmodel without a thoroughexaminationof the and

the practical effects flowing from it.

This paper will illustratethe utility of conductingsuch an examination,to show that certain

conceptsdevelopedin the United States could more effectivelydeal with Canadianbusiness

reorganizations.While it is acknowledgedthat Parliamentincorporatedcertainmechanismssimilarto

those used in the Code, considerablelitigationwill be necessaryto resolve the uncertaintiescreatedby

such piecemealincorporation. This shortcomingcould have been avoided in the originaldraftingof

the BIA.

A further concern is the suggestion’ that Parliamentwill repealthe CCAA sometime followingthe presentationof the5parliamentarycommittee6report.’ The CCAA is a flexible reorganizationtool that the courts have generallyathpted to fit the circumstancesof the particular

case. ShouldParliamentrepeal the CCAA, without incorporatingsome of the principles developed

under it into the BIA, a debtor seekingrelief must reestablishthose principlesto obtain equivalent

relief. This is not an efficientway of proceeding,giventhat the CCAA and the American statutory

andjudicial solutions are at the disposalof the policymakers.

‘ See generally, D.G. Baird “TheDark Side Of Chapter11: A Commenton ProfessorTriantis’ Article”(1992), 20 Can. Bus. L.J. 261.

‘ S.L. RobinsonBurns, “TheNew Bankruptcyand InsolvencyAct: CommercialReorganizations” in TheNew Bankriq,tcyand InsolvencyAct (Toronto:CanadianInstitute, 1992)at 42.

16 Supra note 7. 5

With respect,the BIA is not a useful reorganizationtool. A reasonfor this shortcomingis that

the legislatorsfailedto determinethe “spiritand intent”of the legislationand, in particular,they failed

to considerthe broaderobjectivesof the legislationor how the legislationwouldactually workin 7practice.’ A primary objectiveof a businessreorganizationstatuteis to provide thedebtorwith a structurewithinwhich to rehabilitate, whileensuringthe equitabletreatmentof creditors. This paper

will examinewhetherthe structureof the proposalprovisionsof the BIA servesto accomplishthat

objective orwhetherthe American model orthe modelestablished underthe CCAAis moreconducive

to accomplishingthat objective.

In exploringthese issues,this paper will pay specialattentionto the rightsand dutiesof

securedcreditors. In the United States,the Code tendsto restrictthe rightsof securedcreditorsin to

facilitatethe objectof achievingequityand fairnessin the distributionof the assetscomprisingthe estateand affordingthe debtora fresh 8start.’ However,in restrictingthose rights,the Codeattempts to preservethe relativepositionsof secured creditorsby providingcertainprotectivemeasures.

The former Canadian Act placedfew restrictionson the rightsof securedcreditors. The Tassé

Reportsuggestedthat, whenParliamentpassedthe first Canadianbankruptcystatute,securedcreditors held such a smallproportionof the total debt that givingthem specialtreatmentwas not9justified.’ Thatreportand the ColterCommitteeReport suggestedthat any bankruptcyreformshouldinclude

provisions forat leastmonitoringand perhapsplacingrestrictionson the rightsof securedcreditors?°

The BIA includescertain restrictionson the rightsof securedcreditors andplacescertaindutieson

them. One of the purposesof this paperis to explorewhetherthe amendmentsare conceptually

effectiveto alleviatethe inefficiencies andinadequaciesperceivedby the TasséReportandthe Colter

17 G.C. Thornton,LegislativeDrq/ting,2d ed. (London:Butterworth, 1979)at 106.

18 F.R Kennedy,“SecuredCreditorsUnder the BankruptcyReformAct” (1982) 15 Ind. L. Rev. 477 at 482.

19 TasséReportat 56.

20 ColterCommitteeReportat 56-58;TasséReportat 96-98. 6

CommitteeReport.

B. LITERATUREREVIEW

Most of the articlesand treatises written on businessreorganizations havedealt with issues

arising out of domestic legislation,with very little attention beingpaid to the legislationor case law of

otherjurisdictions. Several excellentarticles have been written that describeand synthesizethe case law decided underthe 21CCAA and there are numerousAmericantextbooksand servicesthat describe in detail the policiesand proceduresinvolvedin a Chapter 1122proceeding. The reader may obtain background informationfrom those works, as it is not the intent of this paper to describethe

proceduresand case law, other than to assist in resolving theissues at hand.

The BIA has received little scholarly attentionto date. Most of the articles have beenprepared

for continuinglegal educationpanels that, for the most part, describethe amendments,with possible 23ramifications. Three articles have taken a more generalapproachto the policy issues arising out of a business reorganizationsystem by lookingto Canadianand American legislation andcase law. 24ELward& article is importantand frequently-cited,as it sets forth the policy objectivesof a business

21 See e.g., J.D. Honsberger,Debt Restructuring(Aurora:CanadaLaw Book, 1994);Newbould supra note 3; A. Zimmermanand D. Knowles, “Developmentsand Trends in the Companies’ CreditorsArrangementAct” in InsolvencyInstitute of Canada SecondAnnual Meeting and Conference Materials,October 20-22, 1991at 40; D.H Goldman,D.E. Baird, Q.C. and MA. Weinczok, “ArrangementsUnder the Companies’CreditorsArrangementAct” (1990),1 C.B.R. (3d) 135; FR. Foran andT.M Warner, “Reorganizingthe InsolventOil and Gas Corporation” (1990)28 Alta. L.R. 132.

22 See e.g. Norton BankruptcyLaw & Practice, vol. 4; MJ. Bienenstock, Bankruptcy Reorganization(New York: PracticingLaw Institute, 1987).

23 One exceptionis RA. Klotz, “Protectionof Unpaid SuppliersUnder theNew Bankruptcyand InsolvencyAct” (1993) 21 Can. Bus. L.J. 161,where the author undertakesan examinationand a comparativeanalysis of the right of repossession under theBIA and refersto similar rightsunder the Quebec CivilCode, the American UniformCommercialCode and the Code. This issue will notbe examined inthis paper. See also Honsberger,supra note 21.

24 Edwards,supra note 1. 7

reorganizationsystem. Whilerecognizingthe “greatpotentialimportance”of the CCAA, Edwards

expressed thelimitationof his work bystatingthat the CCAA“hasreceived littleattentionin either Canadianlegal literature or thedecisionsof the 25courts.” He proposeda methodologyfor the studyof Canadianreorganizationlaw byrecommendingthat the studentconsiderthe reorganizationlawsof other26countries. Edwardsabidesby that advice and illustrateshis pointsby referenceto American and Englishcases. In reviewinghis article,one mustrememberthat he was consideringa previous

versionof the Americanreorganizationregimeand therefore,its presentuse for interpretingparticular

provisionsmay be limited. However,the valuableinsightthat Edwardsprovidedinto the policyof

businessreorganizationsystemsis as valid todayas in 1947andtherefore,this paper will referto his

work,fromtime to time.

An articleby ProfessorGeorgeTriantis27 examined theeffectivenessof the draft BIA in

quellingthe desire of creditorsin a reorganizationproceedingto hold out for a greater proportionof

the “goingconcernsurplus.” Professor Triantisseesthe objectiveof bankruptcy reorganization lawas

a solutionto this “collectiveactionproblem”whichresults inthe liquidationof a debtorthat is worth

moreas a goingconcernthan the aggregate liquidationvalue of its assets. He discussesthe stayof

proceedingsand the voting andacceptanceof proposals andconcludesthat neithermechanism

addressesthe collective actionproblem. He proposesa simpler,albeithypothetical, modelthat

addressesthe problemand incorporatescertainfeaturesof the Code,suchas the cram downand the

prepackagedplan. He does not conducta comparative doctrinalanalysisof these conceptsbut merely

uses them for illustrativepurposes. ProfessorTriantisalso points tocertain difficultiesarisingout of

the wholesaleadoptionof the extensively regulatedsystemof Chapter11.

25 Ibid at 587.

26 Supranote 1 and accompanyingtext.

27 G.G.Triantis,“Mitigatingthe CollectiveActionProblemof Debt EnforcementThrough BankruptcyLaw: Bill C-22and its Shadow”(1992),20 Can.Bus. L.J. 242.This article, although publishedin 1992,was writtenin 1991,prior to the passageof the BIA. 8

ProfessorDouglasG. Baird questionedthe wisdomof ProfessorTriantis’suggestion that Canadamovealong thereorganizationspectrumtowarda Chapter1128model. ProfessorBaird’s articledoesnot analyzethe doctrinalor normativebasesof the Canadianand Americanbusiness

reorganizationprovisions. Rather,he providesa critiqueor, more accurately,a criticismof Chapter

11. We musttemperany suggestionof adoptingcertainfeaturesof anothersystemwith the concerns

raisedby those livingunderthe system. Accordingly,this paperwill refer to ProfessorBaird’sthesis

throughoutthe discussionthat follows.

Thispaper will expanduponthe notion put forthby Triantis and Edwardsthat certainfeatures

of the Codebe incorporatedinto the Canadianbusinessreorganizationregime. However,ratherthan

lookingat a businessreorganizationsystemas a rationale forthe mitigationof the collectiveaction

problem,this paper will treat thedistributionalobjectiveof balancing debtorand creditorrights,along

with the objectiveof rehabilitationof the debtor,as the primaryobjectivesof a businessreorganization 29system. Theseobjectivesprovidethe normativeplatformupon whichto build a business reorganizationsystem. One may take the positionthat businessreorganizationsare desirableandthat

the rightsof the debtor(and hence,the reorganizationitself)should takeprecedenceover the rightsof

the creditors. However,one can hardlymakean argumentthat businessreorganizationsare desirable

in everysituation. Conversely,it is equallyeoneous to suggestthat business reorganizationsshould

not be a part of a commercialsystem,as certainbusinesses should havethe opportunityto adaptto the

changing circumstancesin the marketplace. To that extent,the systemmay modifythe strictrightsof

creditors. A systemthat favoursneitherthe debtornor its creditorsbut attempts to balancethe

interestsof each is one that we should seekto attain. In attemptingto strikesuch a balance,the

respectivepositionsof the partiesthat havethe leastto gain shouldnot be sacrificed. Conversely,

28 Baird,supra note 14. This articlewas preparedand publishedat the sametime as the foregoingarticleby ProfessorTriantis.

29 Professor Triantisconsidersbankruptcy lawas attemptingto achieveefficiency ratherthan balancing therightsof debtorand creditor, giventhat the partiesconsiderthe distributionalimpactof bankruptcyrules long beforethe rules becomeoperative. 9

thosethat may prosper from asuccessfulreorganizationshouldbe made to incurthe risks of the reorganization°3proceeding. C MKIIIODOLOGY

This work willuse, in a very general way,the methodologysuggestedby Edwards, althoughit

will notstressthe publicpolicyobjectivesupon whichEdwardsbasedhis work. Since hisarticle,the

Canadianand Americansystemshave developedsufficiently tojustify a doctrinalanalysisof the

conceptsthat have evolved. Thistype of analysis willallowus to determinewhetherwe haverealized

the “greatpotentialimportance”of the CCAAand businessreorganizationlaws, foreshadowedby 31Edwards. It wouldhowever,be naive tothinkthat one could studya topic dealingwith business

reorganizations,insolventbusinessdebtorsand potentialloss ofjobs, througha purelydoctrinal

analysis,withoutsometype of policyanalysis. The normative valuesunderlyinga business

reorganizationsystemwill significantlyaffectthe natureof this analysis. This will be an important

aspectof this discussion,as it appearsthat the Parliamentof Canadaleft the developmentof a

businessreorganization systemto the courts. With respect,the courtsshouldnot be requiredto bear

this burden. The legislationshould havereflectedthe broadpolicies soughtto be accomplished.

Courtsface only the very narrowissuesthat come beforethem and mustresolvethose issueswithout

beingrequiredor permittedto establishbroad,seemingly unrelatedpolicies. Furthermore,the courts

have limitedsourcesof informationfromwhichto draw,comparedto the vast resourcesavailableto the 32policymakers. Without clearly articulatedpolicies,as reflectedin the legislation,it maytake

° SeeD.G. Baird and T.H Jackson,“CorporateReorganizations andthe Treatmentof Diverse OwnershipInterests: A Commenton AdequateProtectionof SecuredCreditors inBankruptcy”(1984) 51 U. Chi. L. Rev. 97.

31 Edwards,supra note 1 at 587.

32 RA. Heineman,ed., The Worldof the Policy Analyst (Chatham:ChathamHouse, 1990)at 141-169. 10

yearsto realize those policiesor they may neverbe realized, shouldthe preciseissuenot comebefore the 33courts. The specificmethodologyto be undertakenwill be one of comparativeanalysisof the proposal

provisionsof the BIA, the reorganizationand certain administrativeprovisionsof the Codeand the

CCAA. This methodologyraises severalissuesthat must be dealtwith beforeembarkingon the

examination. Given thedifferences inthe structuresof the respectiveregimesit is difficult tooverlay

one systemon another. Therefore,this paperwill undertake functional comparisonsof similar

mechanismsto illustratethe necessityof conductinga comprehensivereviewof the Canadiansystem.

A purelydescriptiveapproachwill be avoided,althoughsomedescriptionwill be necessary.Rather, an “appliedcomparative34law” approachwill be undertaken.Suchan approachdoesnot merely describethe laws being consideredor their differences,but is a functionalcomparisonof the mechanismsand conceptsused in each 35system. As part of this examination,a brief reviewof the legislativehistoriesof the statutesunder considerationwill be made. This may giveus someinsight

as to the legaland social causes underlying thedifferencesin the reorganizationregimes.

There areseveral reasons for employingthis methodology, atthis time. First,the provisions

of the Code have been operativefor over fifteenyears,whichhas resultedin a body of case law.

This case law may assist us indeterminingwhetherthe objectivesof the Americanpolicymakersin

enacting Chapter11have been realizedin practice. Furthermore, thisapproachmay point to positive

and negative aspectsof the Code and may assistus in formulating proposalsfor reformthat are lucid and accomplishthe desired36objectives. As well, becauseof the perceptionthat the Canadian

E.L.Rubin, “TheConceptof Law and the New PublicLaw Scholarship”(1991)89 MIch.L. Rev. 792 at 804-805.

I{C. Gutteridge,Comparative Law(Cambridge:CambridgeUniversityPress, 1946)at 9.

Ibid

36 It has been said of this type of methodologythat:

“Tostudythe way other systemsat comparablestages of developmentdeal with problemsthat 11 reorganization regimesare evolvinginto a systemsimilar to the American 37model, examiningthe Americanmodelmay assistus in interpretingand understandingthe current Canadiansystems.

Finally,the United Statescontinues tobe the majortrading partnerof Canadaand the levelof trade will undoubtedly continueor escalate underthe Canada-U.S.Free Trade38Agreement and theNorth AmericanFree Trade39Agreement. If both countriesreexaminetheir respectivebusiness reorganization regimeswith aview to harmonizingthe provisions,the expectationsof creditors

involvedin cross-borderinsolvencyproceedingsmay be more expeditiouslyand equitablyrealized.

Whileeach of the statutesthat will be consideredin this paper may be tracedbackto English statutesand case °4law, this paper willmake onlypassingreference tothose laws. Alan Watson described theimportationof rules or systemsof law fromone countryto anotheras a “legal 41transplant” and developedan analogyto describethe levelof acceptanceof the transplant: A successfullegaltransplant- like that of a human organ - will growin its new body,and becomepart of that bodyjust as the rule or institutionwouldhave continuedto developin its parent system. Subsequentdevelopmentin the host systemshouldnot be confusedwith 42rejection. An interestingquestionis why businessreorganizationlaw continuedto developin the UnitedStates

our own systemeitherdoes not handle very well or to whichwe have not yet workedout satisfactorysolutions,is often extremelyenlightening. Comparatistsdo not ordinarilyview this sort of studyas preliminaryto wholesaletransplantationof a foreigninstitution,but rather as a sourceof inspiration,and an indicationof the problems,as well as the benefits,to be anticipatedwith usingalternativemodels.[MA. Glendon,MW. Gordonand C. Osakwe, ComparativeLegd Trcditions(St. Paul: West, 1985)at 14].

Supra note 12.

38 Ottawa:Departmentof ExternalAffairsCanada,1987.

Ottawa:Minister of Supply andServicesCanada,1992.

° See generallyJ.A. MacL.achlan,Law of Bankniptcy(St. Paul:West, 1956)at 20-21;L.W. Houldenand C.H Morawetz, Bankruptcyand Insolvency Lawof Canixla,3d ed. (Toronto: Carswell, 1993)at 1OA-l.

41 A. Watson,Legal Transplants(Charlottesville:UniversityPress of Virginia, 1974).

42 Ibid at 27. 12

whereasin Canada,neitherthe formerCanadianAct nor the CCAAwere usedto any greatextent

prior tothe early 1980s. Tn1947,Edwardsattributedthe lack of Canadianreorganization lawto Canada’srelativelyimmature economic43development. This however,does not explainwhy, since that time, businessreorganizationsin Canadacontinued tolie dormantwhileAmericanreorganizationlaw

was flourishing.Certainly, it did nottake Canadato the early 1980sto reachthe economic

developmentof the UnitedStatesin the 1940s.

A comparativeanalysisapproachis also fraughtwith the dangerof ethnocentricityor a

suggestionthat one law is a superioror exemplaryregime. Hopefully,a paper whichsuggeststhat

noneof the systemsis entirelysatisfactorymay not be accusedof either.

This brings us to perhapsthe mostvexingproblem inundertakinga comparativeanalysis

involvingforeignlegislation. In the first instance,one must familiarizeoneselfwith the legislation.

This requiresnot onlya reviewof the legislation,but also a reviewof certaincases and commentaries

interpretingthat legislation. It is dangerousto assumethat theapproachestakenby scholarsandthe

judiciaryare completelyobjectiveand as such,there is somedifficultyin exercisingautonomy inthe

interpretationof the legislation. In combattingthis difficultyhowever,the readermust rememberthat

the objectof this paper is not to providea critiqueof the American system,but to use American

materialsas a benchmark fromwhichto determinewhetherthe Canadiancourtsand legislatorswould

benefitfrom adopting asimilar approach. In this manner,the commentarieson the American

legislationwill be invaluable. This paperwill also refer to the SenateReportand the HouseReport,

where appropriate,in an attemptto determinethe legislativeintentof the Code. This not onlywill

assistin interpretingthe provisionbeingconsidered,but also may be useful in givingus insightinto

the socialobjectivesthat the legislationsoughtto accomplish. Theaim in reviewingthe Americanlaw

is not todeterminewhetherthe systemis inherentlygood or bad, but whetheraspectsof it helpto

accomplishthe broaderobjectivesof a businessreorganizationsystem.

“Therewas little reorganization lawin Americawhen its economicdevelopmentwas ata stage comparableto Canada’spresentcondition.”[Edwards,supra note 1 at 592). 13

This approach is not meant to suggestthat a uniformityof business reorganizationlaws is

possible oradvisable. To make such a suggestion,it would be necessaryto examine broader

nonbankruptcymatters such as regimes involvingreal and personal propertysecurityand

macroeconomicfactors. This broader examinationis beyondthe scope of this paper.

One final issue concerningthe approachto be taken in conductingresearch ona topic that

affects a broad range of individualsand entities inthe businessconmiunitymust be addressed. As

mentionedabove, one purposeof insolvencylegislationis to attempt to balance theinterestsof the

variousparties involved in the proceeding. An attempthas been madeto attain scholarly objectivity

in conductingthe research. However,dependingon the position of the reader, the resultsof the

researchmay be seen as biased in favourof one or more parties. For example, in discussingthe

conceptof adequateprotectionunder the Code, it has been said that:

In resolvingthe conflict,manybankruptcycourtsappear to give unduedeferenceto the securedcreditor’srights, leadingthem to impose standardsof adequateprotectionthat seriously impedeand often arrestthe debtor’45reorganization. On the otherhand, some ‘witers see the concept of adequateprotection as one which favoursthe

debtor such that “the balanceis usually in favour of the debtor so as to effectuate theunderlying

bankruptcypolicy of rehabi1itation.”

This merely illustratesthe danger in assumingthat the research will be seen as objective,

despitethe lofty aim of objectivity. In fact, the legislationitself may be value-ladenas it may not

truly reflect the best interests of the business communityas a wiole. The committeethat preparedthe Tassé Report statedthat it was not a committeeof inquiryor 47investigation, although it solicited

Supra note 29 and accompanyingtext.

Comment,“AdequateProtection and the AutomaticStay Underthe BankruptcyCode: Easing Retraintson Debtor Reorganization”(1982) U. Pa. L. Rev. 423 at 426.

D. Price, “AdequateProtectionUnder the Bankruptcy Actof 1978”(1982-83)71 Ky. L.J. 727 at 742.

TasséReportat xi. 14

informationfrom registrars and official receiversand interviewedjudges, registrars, official receivers,

trustees, lawyers and law teachers. In addition, a number of parties, a partial list of which appearedas

an appendixto the Tassé Report, made written submissions. Only one party specificallyrepresented 48debtors. One must questionwhetherthe Tassé Report fairly representedthe position of debtor and accordingly,whether the legislationthat resulted serves the needs of society as a whole.

C ‘BUSINESSREORGAMZATION”

This paper is concernedwith business reorganizationsunder Chapter11, compromisesand

arrangementsunder the CCAA and proposalsunderdivision I of part ifi of the BIA.. The term

“reorganization”or “businessreorganization”will be used to designatethese procedures. This paper

specificallyavoids use of the term “corporatereorganization,”as the Code and the BIA also applyto

individualsand parthershipsthat are carrying on business. Excludedfrom the term are consumer proposalsor 49arrangements, arrangements involvingfarmers and farm corporations, plans for adjustmentof a municipality and raifroad reorganizationsor schemes°5of arrangement.52 Although5 one may define a businessreorganizationin terms of the objectivesthat it seeks to accomplish,it may’ be more appropriateto defme it by its intiinsic nature. For the purposes of this

paper, “reorganization”or “businessreorganization”means a judicially-supervised settlementbetween

a debtor and its creditors andamongthe debtor’screditorsconcerning53 thefmancial affairs of the

48 It is acknowledgedthat submissionswere made by organizationssuch as the CanadianBar Associationand La Chambre de Commercedu District de Montréal,wiuichmay have addressed the interestsof debtors butoverwhelmingly,the written submissionswere from interest groups representingcreditors.

DivisionII of part ifi of the BIA and chapter 13 of the Code.

50 Fann Debt ReviewAct, RS.C. 1985,c. 25 (2d Supp.)and chapter 12 of the Code.

51 Chapter 9 of the Code.

52 RailwayAct, R.S.C. 1985,c. R-3, ss. 99-103 and subchapterIV of chapter 11 of the Code.

Honsberger,supra note 21 at 1-21. 15 debtor. The reorganizationseeksto solvethe problemof how to make a debtorin failing circumstanceseconomicallysound,whileat the sametime preservingor modifyingthe legalrightsof its creditorsand shareholders.M

Collieron Bcinkniptcy,vol. 1, 14thed. (NewYork:MatthewBender, 1974)s. 0.01. 16

CHAPTERII

LEGISIATWE HISTORY

This chapterwill providea brief legislativehistoryof each systembeing consideredin this paper.’ Placingthe provisionswithin ahistoricalcontextmay providean indicationof the interests soughtto be protectedat the time of their enactment. It may also assist a contemporarylawreformer in determiningwhetherthose interestscontinueto require protectionor alternatively,whethercurrent valuesrequire protectionof differentinterests.

A. BIA The first bankruptcy legislationenactedby the Parliamentof 2Canada was the InsolventAct of This chapterwill deal with the legislativehistoryof businessreorganizationlegislation generally. Throughoutthis paper,referencewill be madeto the legislativehistoryof the particular provisionsunderconsideration.

2 Bankruptcylaws and specifically,businessreorganizationlaws,are promulgatedpursuantto the respectivejurisdictionsgrantedto the federalgovernmentsof the United Statesand Canadaundertheir constitutions. Subsection91(21)of ConstitutionAct, 1867, (U.K.),30 & 31 Vict., c. 3 [hereinafter the CanadianConstitution],delegatesto the Parliamentof Canada legislativeauthority over bankruptcy and insolvency. Similarly,the Constitutionof the UnitedStates of America, 1 Stat. 10 (1845) [hereinafterthe U.S. Constitution],grantsCongressthe powerto establish“uniform Lawsin the subjectof Bankruptcies throughout theUnited States”[art. I, s. 8, cl. 3]. The courtshave placedfew limitson the extentof the bankruptcypower. The DistrictCourt of Missouristated:

“I hold it extendsto all caseswhere thelaw causes tobe distributed thepropertyof the debtor amonghis creditors; this is its least limit. Its greatestis a dischargeof the debtorfromhis contracts. And all intermediatelegislation,affectingsubstanceand form,but tendingto further the greatend of the subject - distributionand discharge- are in the competencyand discretion of congress.”[In re Klein, [1843]Fed. Cas.716 at 718 (D. Mo.)].

If there are inconsistentor conflictingfederaland provincialor state laws,the federallaws will prevail orpre-emptthe provincialor state law. This is based,in Canada,on the federal paramountcy doctrine [Tennantv. UnionBank, [1804]A.C. 31 (P.C.)] and, in the United States,on the “supremacy clause”in the U.S. Constitution,that provides:

“ThisConstitution,and the Laws of the United Stateswhich shallbe madein Pursuance thereof ... shallbe the supremeLaw of the Land;and the Judgesin everyState shallbe bound thereby,any Thingin the Constitutionor Lawsof any Stateto the Contrary notwithstanding.” [art. VI, s. 2] 17 1869. That act containedprovisionsallowingan insolventdebtorto make a 4compositionwith its These doctrinesare applicablewhenthe federallaw and the provincialor state law are validand enactedwithin eachgovernment’sdelegatedor residualauthority,but they yieldinconsistentor conflicting results[P.W. Hogg, ConstitutionalLaw of Canada,3d ed. (Toronto:Carswell,1992)at 418]. A recent challengeto the commercialtenancyprovisionsin Part ifi of the BIA was undertaken in Re Janpar Inc. (1993),20 C.B.R (3d) 8 (C.S.Qué.),where the court upheldthoseprovisions onthe basis of the federalparamountcydoctrine. The Canadian and Americancourts haveupheldthejurisdictionsof the Parliamentof Canada and Congressto enact legislation providingfor compositions,extensions andreorganizationsunder their respectivebankruptcypowers. Theconstitutionalityof a provisionpermittingthe debtorto effect a compromiseof its debtswith its creditorswas upheldon the basis that thebankruptcypowerwas nothingless than “thesubjectof the relationsbetweenan insolventor non-paying orfraudulentdebtor and his creditors,extendingto his andtheir relief.”[In re Reiman, 20 Fed. Cas. 490 at 496-497(No. 11,673) (S.D.N.Y.1874)].The constitutionalvalidityof the rehabilitativemethodsfrom composition of unsecuredclaimsto reorganizationand adjustmentof secured claimshas alsobeen upheld. The CCAA was upheldin a referencecaseto determineits constitutionalvalidity. In Re Companies’CreditorsArrangement Act, [1934]S.C.R 659 [hereinaflerCCAAReference],Duff C.J. statedthat:

“Thehistoryof the law seemsto show clearly enoughthat legislationin respectof compositions and arrangementsis a naturaland ordinarycomponentof a systemof bankruptcy and insolvencylaw.” [at660]

The AlbertaCourtof Queen’sBenchrecentlyhad occasionto considerthe constitutionalityof the CCAAin Norcen EnergyResourcesLtd v. OakwoodPetroleumsLtd (1988)72 C.B.R.(N.S.) 1 (Alta.Q.B.). The court madecertaincommentsthat may forecloseany challengesto the constitutionalityof reorganizationstatutesgenerally. In discussingthe CCAAReference case,Forsyth J. said:

“TheC.C.A.A.is an Act designedto continue,ratherthan liquidate,companies. In upholding the C.C.A.A.,the SupremeCourtof Canadamust be takenas havingextendedthe meaningof the term “insolvency”to includedealingwith insolvent companies outsideof a liquidation setting. The criticalpart of the decisionis that federallegislationpertainingto assisting inthe continuingoperationof companiesis constitutionallyvalid. In effectthe SupremeCourtof Canadahas giventhe term “insolvency”a broadmeaningin the constitutionalsenseby bringingwithinthat term an Act designedto promote the continuationof an insolvent company.”[at 15-16].

S.C. 1869,c. 16.

Althoughthe term businessreorganizations,as used in this paper,includescompositions, extensionsand schemesor plansof arrangement,early legislationreferredonlyto compositions.A compositionis an arrangementbetweenthe debtorand its creditorswhere the creditorsagreewith the debtorand among themselvesto take less than the full amountof their respectiveclaimson apro rata basis in full satisfactionof the debtsdue or accruingdue to them fromthe debtor[Blxk’s Law Dictionaiy, 6th ed. (St. Paul: West, 1990)at 286]. It is importantto note the differencebetween commonlaw compositionsand compositionscreatedby statute. In the case of a statutory composition,the statute allowsthe majorityto bind theminorityto the composition. For example, section94 of the InsolventAct of 1869, ibid, provided: 18 5creditors. The InsolventAct of 18756repealedthe InsolventAct of 1869. The InsolventAct of 1875contained provisionssimilarto those8repealed. These actsappliedonlyto insolvent9traders. Becauseof the numbercommercialfailuresresulting fromthe depressionin Canadabetween1874and

“A deed of compositionand discharge,executedby the majorityin numberof thoseof the creditorsof an Insolvent whoare respectivelycreditors forthe sumsof one hundreddollars and upwards,and who representat leastthree fourthsin value of the liabilitiesof the Insolvent subjectto be computedin ascertainingsuchproportion,shallhavethe same effect withregard to the remainderof his creditors,and be bindingto the same extentupon him and uponthem, as if they were also partiesto it;”

Conversely,in a commonlaw composition,a non-assentingcreditorneed not be boundby the agreementof others. In the contextof a business reorganization,an extensionis an agreementbetweenthe debtor and its creditorswhere,in considerationof the creditorsagreeingnot to enforcetheir rightsto collect the debtsowingby the debtorfor a periodof time after the debtsare due, the debtoragreesto pay the debtsin full withinthat period [TasséReportat 93]. Finally,a schemeof arrangement,in strictterms, includesany arrangementwherethe property or incomeof a debtoris proportionatelyappliedto its debts {R.Bird, Osboum’s ConciseLaw Dictionary,7th ed. (London:Sweet& Maxwell,1983)at 297]. The assetsof the debtorare transferredor assignedto a trusteewho administersthe scheme[M Crystaland B. Nicholson, Baiikmpteyand Deeds of AirangementLaw aridPrtice (London: Oyez,1978)at 59; L. Duncanand J.D. Honsberger,Bankntptcy in Canada, 3d ed. (Toronto:CanadaLaw Book, 1961)at 261]. Other than the distinguishingfeatureof the third partyintermediary,it appearsthat a schemeof arrangement could havethe substantive featuresof an extension orcomposition. Althoughthe definitionof “proposal”in the BIA includesa proposal“fora composition, foran extensionof time or for a schemeof arrangement”[BIA s. 2 “proposal”]and the CCAAallowsthe debtorcompanyto make a “compromiseor anarrangement”[CCAAss. 4 and 5] with its creditors, these termsare of historicalsignificanceonly, as “in actualpracticethe court is not greatly concerned whether the proposalfalls into oneof these. .. headingsor is a combinationof them” [L.W. Houlden and C.H Morawetz,Bankruptcyand InsolvencyLaw of Canada, 3d ed. (Toronto:Carswell,1994)at 2-74]. This paperhas chosento use the words “businessreorganization”to denoteone or all of these types of arrangements.This term is broaderthan the three termsused in the BIA, as it encompasses the potentialof there beingfundamentalchangesto both thedebt and the equity structuresof the debtor,includingthe eliminationof someinterests. The currentpracticeof the courtsappearsto treat proceedingsunderall of the legislativeschemesbeingexamined inthis broadmanner. However, whenthe terms composition,extensionand schemeof arrangementare used in this chapter,they shall havethe strict,narrowmeaningsdescribedabove.

InsolventAct of 1869, supra note 3 ss. 94-108.

6 S.C. 1875,c. 16.

‘‘ Ibid ss. 149and 151.

8 Ibid ss. 49-66.

Section 1 of both acts. 19

1878,public discontentwith legislationthat permitted “dishonestand designingdebtors”to escape their 10liabilities, led to the passage of An Act to repeal the Acts RespectingInsolvencynow inforce in Canzki.’ A further reason for the repeal was the “constantirritation caused by ill-considered legislativetinkeringwith so importanta piece of legislation.” Canadawas withoutbankruptcy legislationuntil 1919,when the Bankruptcy3Act’ 2was passed. The 1919Act enlargedthe scopeof proposalsthat an insolvent debtor could maketo its creditorsto include,not only compositions,but also extensionsand schemesof 14arrangement. In 1923,ParliamentpassedTheBankruptcyAct AmenthnentAct, 1923.’ Section 15 of that act repealed section 13 of the 1919Act and replacedit with a provisionallowing only a bankrupt tomake a proposal. This amendmentresulted from allegationsthat debtors were avoidingbankruptcyby securingcreditor consentto a proposalthrough bribesand other fraudulent6means.’ Parliamentrepealed the 1919Act in 1949’ and replaced it with the 19498Act.’ It appearsthat Parliamentintendedto clarifybankruptcylegislationby the passage of the 1949Act. When the bill was introducedto the Senate,the HonourableJ. Gordon Fogo said “[t]hebill provides a more orderly arrangementof subjects and the languagein many sectionsof the Act has been 9simplified.” For our

10 House of CommonsDebates (19 February 1880)at 102.

“ S.C. 1880,c. 1.

12 Duncanand Honsberger,supra note 4 at 17.

13 S.C. 1919,c. 36 [hereinafterthe 1919Act].

14 1919Act s. 13(1).

15 S.C. 1923,c. 31.

16 Tassé Report at 19.

‘ BankruptcyAct, 1949, S.C. 1949,c. 7 [hereinafterthe 1949Act], s. 173.

18 Ibid

‘ Debates of the Senate [6 October 1949]at 98. 20 purposes,the most notable change was the reinstatementof the provisionallowing an insolventperson to makea proposal,withoutbeingbankrupt. The 1949Act was criticizedas inefficient,obsoleteand incapableof dealing with fraudulentbankruptcies?° Thus, in 1966,Parliamentmade significant amendmentsto the 1949Act by the Act to amendthe Bankniptcy’2Act. Among other things,the amendmentsgave the court the right to appointan interim22receiver and providedthat the insolvent person would be consideredbankmpt on the refusal of the creditorsor the court to accept or approve the proposal?

In 1966,steps werealso taken towardthe processof amendingCanada’sbankruptcyregime, with the formationof the Study Committeeon Bankruptcyand InsolvencyLegislation. The committee presentedthe TasséReport to the Ministerof Consumerand CorporateAffairsin June of 1970and recommendedthe adoption of a new bankruptcyand insolvency24statute. Since the presentationof the Tassé Report, Parliamentmade no fewer than six attemptsto repeal and replace the former Canadian

Act prior to the passage of the amendmentsthat resultedin the BIA.

In 1984,followingthe sixth failure of Parliamentto adopt a new bankruptcystatute,the

Ministerof Consumerand CorporateAffairsat that time, suggestedthat it may be more expedientto amendthe former Canadian25Act. The Minister struckthe Committeeon Bankruptcyand Insolvency that presentedthe Colter CommitteeReport in 1986. The TasséReport and the Colter Committee

Report recommendedthe retention of a system allowingfor the reorganizationand rehabilitationof

20 Colter CommitteeReport at 18.

21 S.C. 1966-67,c. 32.

22 Ibid s. 5.

23 Ibid ss.7and8

24 Tassé Report at 81.

ColterCommitteeReport at 18. 22 statements to inducethem to acceptthe proposal being put 3forth. As a result, Parliamentenacted 195332 ’ amendmentsto the CCAA in that requiredthe debtor companyto have issuedbonds, debenturesor other evidencesof indebtednessunder a trust deedor other instrumentrunningin favour of a 3trustee? However, in recentyears, the courtshave allowedless than complex debtorsto use the CCAA,by permittingthem to gain accessto its provisionsby issuing “instanttrust deeds.” Therefore, the the CCAAis not meetingthe legislativeintent, althoughcourt supervisionof proceedings underit may serve to quell any abuses of the 34legislation.

C CODE

The debtor’sright to makea compositionwith its creditorsfirst appearedin the 1874 35amendments to the BankruptcyAct of 1867.36A debtor could effecta compositionwithout being adjudicateda 37bankrupt. Tn1878,Congressrepealed theBankruptcyAct of 186738becauseof abuses on the part of the courts andexcessive39fees. The United Stateswas without bankruptcylegislation for twenty years until the passage of the 1898U.S. °4Act. The compositionprovisionsof the 1898

‘ Ibid

32 An Act to amend The Companies’CreditoicArrangementAct, 1933, S.C. 1952-53,c. 3.

This provision is now CCAA s. 3(a). The types of debtors to whom the CCAA was intended to have application were“companiesthat have complexfinancial structures,and a large numberof investorcreditors.” [House of CommonsDebates (23 January1953)at 12691.

“ For a discussionof this issue, see chapter ffl(B), below.

Ch. 390, 18 Stat. 178 (1874).

36 Ch. 176, 14 Stat. 517 (1867) (repealed 1878).

Collier onBankruptcy,vol. 1, 14th ed.(New York: MatthewBender, 1974),s. 0.05.

38 Ch. 160,20 Stat. 99 (1878).

Collier onBankruptcy,supra note 37.

4° The 1898U.S. Act was repealedby Pub. L. 95-598,92 Stat. 2549 (1978),s. 401(a). 23

U.S. Act were similar to those includedin the amendmentsto the BankruptcyAct of 1867. A debtor could only make a compositionwith its unsecuredcreditors. This limitation curtailedthe use of the composition provisions. 1898 4 However,the U.S. Act’ did not require the debtor to be insolventto be eligibleto make a 42composition. Provided thecomposition metthe necessaryprerequisites,it could be confirmedby the court’ and the debtor would be dischargedfrom its debts, followingits compliancewith the provisions of the composition.

Congressenacted minoramendmentsto the composition provisionsof the 1898U.S. Act in

l910 and 1922.46 However, major amendmentswere not madeuntil the onset of the depressionthat took place in the 1930s. The depression resultedin a significantincrease in the numberof 47bankruptcies. As a result, Congresssaw a need to amendthe provisionsof the bankruptcyregimeto protect the integrity of the system and allow honest but unfortunatedebtors easier access to the system

41 Collieron Bankruptcy,supra note 37, vol. 6, s. 0.03.

42 1898U.S. Act s. 4 provided that “[amyperson who owes debts. .. shall be entitled tothe benefits of this Act as a voluntarybankrupt”,cf First National Bankof Cincinnativ. Flershem,290 U.S. 504 (1934), where the court foundthat insolvencywas neither presentnor imminentand, althoughthe court acknowledgedthat the plan was formulatedto provide futurebenefit to the business,it found that the course of action proposedby the debtor wasin “deliberatedisregard”of the rights of the affected creditors [at 517]. The court went further however,and found that the purpose soughtto be effected by the debtor was “fraudulentin law.” [at 519].

1898U.S. Act ss. 12 and 13.

1898U.S. Act s. 14.

‘ Cli.412, 36 Stat. 838 (1910),which amendedthe time at which an offer of compositioncould be made.

Ch. 22, 42 Stat. 354 (1922),which added thenecessity of an indemnityfor any losses suffered as a result of the delay in adjudicationresulting fromthe presentationof a composition.

In his address to Congressin 1932,President Hooveroutlinedthe following staggering statistics:

“Thenumber of cases in bankruptcyhas steadily increasedfrom 23,000 in the fiscal year 1921 to 53,000 in 1928and to 65,000 in 1931. The liabilitiesinvolvedhave increasedfrom $171,000,000in 1921to $830,000,000in 1929and to $1,008,000,000in 1931,and the losses to creditors haveincreasedfrom $144,000,000in 1921to $740,000,000in 1928andto $911,000,000in 1931.”[reprintedin, Collieron Bankruptcy,supra note 48 at s. 0.06] 24 and more expeditious48relief. Unfortunately,the time requiredto studythe existingsystemand make recommendations necessitated thepassageof “emergency”legislationin the mid-1930s.

The legislationthat precededthe enactmentof the emergencylegislation,permittedonly compositions. Itdid not permita comprehensivereorganizationof the debtand capitalstructuresof the debtorto facilitateits ongoing49operation. Amongother things,the emergencylegislation attemptedto accomplishthis. For ourpurposes,the additionof section7713was the most significant amendmenteffectedby the emergencylegislation, asit was the first comprehensivecode for the reorganizationof corporatedebtors.

Section7Th laid the groundworkfor the reorganizationprovisionsthat evolvedinto Chapter

11. It providedthat on acceptanceof a plan by specialmajoritiesof creditors andstockholders,the

48 Ibid

W.J. Blum and S.A.Kaplan,CorporateRe4ustments and Reoigazizations(Mineola: FoundationPress, 1976)at 185. Prior to the enactmentof section7713,corporatereorganizationswere accomplishedthrougha deviceknownas the equityreceivership. An equityreceivershipwas commencedby a creditorwhose executionhad beenreturnedunsatisfied. Thecreditorwouldseek the court’sassistancein havinga receiver appointedto take controlof and, ostensibly,sell the debtor’s assets to satisfythe creditors. However,once a receiverwas appointed,the debtorand the creditors couldformulatea plan that wouldsee the debtor’sassetssold andthe rightsand obligationsof the partiesadjustedwith a viewto havingthe former businessof the debtorcontinue,as reorganized[fora full discussionof equityreceiverships,see Collier on Bankruptcy,supra note 37, vol. 6, s. 0.04]. Although equityreceivershipwas an adequate device forreorganization,it possessedmany inadequaciesthat section7Th attemptedto rectify. The inadequacieswere summedup by the United StatesSupreme Court,whereGoldbergJ. said:

“Beforepassage, in1934,of s. 7Th of the BankruptcyAct, 48 Stat. 912,bankruptcy procedures offeredno facilitiesfor corporate rehabilitation,which,therefore,was left to equity receiverships,with their attendantparaphernaliaof creditors’and securityholders’committees, and of rival plansof reorganization.Lack ofjudicial controlof the conditions attending formulationof the plans, inadequateprotectionof widely scattered securityholders, frequent adoptionof plans whichfavouredmanagementat the expenseof other interests andwhich affordedthe corporation onlytemporaryrespitefromfmancialcollapse,so oftencharacteristic of equity receivershipreorganizations,led to the enactmentof s. 7Th. ... As doesthe present ChapterX, s. 7Th perniittedthe adjustmentof all interestsin the debtor, secured creditors,unsecuredcreditors,and stockholders.”[Securitiesand Exchange Commissionv. American TrailerRentals Co., 379U.S. 594 at603-604(1965)[hereinafterAmerican Trailer Rentals]]. 25 plan wouldbe bindingon the dissenting50minority. It alsoprovidedfor the classificationof 5claims, the stay of 52proceedings, the continuationof the debtor inpossessionin the absenceof the ’ appointmentof a 53trustee and allowedthe courtto makean independentdetenninationconcerningthe fairnessof the 54plan. However,section7Th lackedprovisionsfor the protectionof creditorsand investors and supervisionof the businessof the debtorduringthe reorganization55procedure. Accordingly,Congress passedthe ChandlerAct in 1938. Section7Th essentiallybecame ChapterX whichgoverned corporatereorganizations.The theoryunderlying ChapterX was that theactual parties ininterest, beingthe creditorsand the stockholders,wouldcontrolthe reorganization56process. It also provided for the mandatoryappointmentof an independenttrusteeto monitorthe affairsof a largedebtor during the 57reorganization and a more comprehensivemeansof controlby the courtsduring the reorganization58process. One of ChapterXs strengths wasin permittingthe debtor to reorganizeand compromisethe interestsof unsecuredand secured creditors,and stockholders.However,the

° 77B(e).

51 77B(c)(6).

52 7Th(c)(10)

77B(c)(1).

77B(f)(1).

SenateRepon’No. 1916 on House Report 8046, 75th Cong.,3d Sess.(1938)21-22.

56 J.I. Weinstein,TheBankniptcyLaw of 1938(NewYork:NationalAssociationof Credit Men 1938)at 192.

ChandlerAct s. 156provided:

“Wherethe liquidatedand non-contingentindebtednessof a debtoris $250,000or over,the judge shall,uponthe approvalof the petition,appoint oneor more disinterestedtrustees, who shallbe qualified, exceptas to residence andlocationof office,as prescribedin section45 of the Act. Where such indebtednessis less than $250,000,the judge may appointone or more trusteesor may continuethe debtor inpossession.”

58 American TrailerRentals, supra note 49 at604. 26 provisions wereintendedfor largepublicly-heldcorporationsthat neededreadjustmentof secured 59debt. The ChandlerAct also created a new procedureunder Chapter XI, knownas an “arrangement.”

ChapterXEwas designedfor use by individualsand corporationsotherthan those to whomthe provisionsof ChapterX 60applied. As ChapterXI permitteda debtor toreorganizeits affairs only with its unsecured61creditors, it sufferedthe same weaknessas the formerCanadianAct. Theplan could not affectsecured62creditors. One commentatorexplained the rationalefor excludingsecured creditorsfromthe provisionsof ChapterXEas follows:

The policyof dealingwith secureddebtswas unsound;it was soonrecognizedthat the interferencewith the free exerciseby secured creditorsof their remedieswas bound ultimately to impair the liberalextensionof creditupon collateral. Besides,its provisionswere ineffective;in the majority of cases ... the securedindebtednesswss a singledebt heldby a singlepersonand in an amount sufficient to constitutea substantial,if not the major,part of the indebtedness. Sucha securedcreditorheld and frequentlyexerciseda virtualvetopower over the 63proceeding.

Collieron Bankruptcy,supra note 37 at s. 0.09. Tnthis manner,the focusof ChapterX was the sameas the intended focusof the CCAA. UnderChapterX, public investorswere protectedby the interventionof the Securitiesand ExchangeCommission. See e.g., ChandlerAct s. 172which provided:

“Afterhearing andbeforeapprovalof any plan, thejudge may, in cases inwhichthe scheduled indebtednessdoes not exceed$3,000,000and shall,in cases in whichthe scheduled indebtednessexceeds$3,000,000,refer to the Securitiesand ExchangeCommissionfor examination andreportthe planor plans deemedby him worthyof consideration. Suchreport shall be advisoryonly.”

60 ChandlerAct s. 147,provided:

“A petitionimproperlyfiled under thischapter,becauseadequaterelief can be obtainedby the debtor under chapterXE,may uponthe debtor’sapplication,be amendedto complywith the requirementsfor a petitionunderchapterXE,and thereuponshallbe regardedas if originally filed thereunder.”

Seealso ChandlerAct ss. 146(2)and 141whichtogether,providedthat a courtmay dismissa petition that is filed underChapterX if adequaterelief wouldbe obtainableby the debtorunder ChapterXE.

61 Weinstein,supra note 56 at 259.

62 Ibid

63 Ibid at 260. 27 The provisions of Chapter Xl were much less stringentthan those of Chapter X giventhe intereststo be served by Chapter X Despitethe intent of Congress,it appearedthat a corporationhad a choice of regimes underwhich it could attemptto effect a reorganization. The United States

SupremeCourt held that the considerationcontrollingthe choice of regime was not the characterof the debtor, the nature of its capital structureor its size, but the nature of the interests and the needs to be served in the rehabilitationof the debtor.MAlthough generally,Chapter X was intendedfor adjustmentof publicly-held65debt, the courts allowed larger, publicly-heldcorporationsto use Chapter XL However,on applicationof the Securitiesand ExchangeCommission, the court had the discretionto dismissa Chapter XI proceeding,unless the debtor compliedwith the more stringent requirementsof a Chapter X 67proceeding. Despite theseprocedures,fewer that 10percent of all reorganizationswere commencedunder Chapter X Debtors used the the less rigorousprovisionsof Chapter XI more 68frequently. The House 69Report referred extensivelyto the shortcomingsof having two reorganization chaptersand summarizedits position as follows:

In sum,anyjustification that existedin 1938for two reorganizationchaptershas disappeared. Chapter X has becomean unworkableprocedure,and chapter XEis inadequateto fill the void. Chapter X needs to be made moreflexible,both in terms of procedureand fmancial standards

64 GeneralStores Corp. v. Shlenky, 350 U.S. 462 (1956).

65 American TrailerRentals, supra note 49at 613.

See e.g, In re Transvision,Inc., 217 F.2d 243 (2d Cir. 1954),cen’.denied, 348 U.S. 952 (1955).

67 11 U.S.C. 728 (1970). See e.g, In m Lea Fabrics,Inc., 272 F.2d 769 (3d Cir. 1959),where, in describingthe scope of the discretionto be exercisedby the courts in sucha case, GoodrichJ. said:

“Thatdiscretion,it is to be observed,is not one limited greatlyby settled legal niles. ... But the criterionby which the districtjudge’sdiscretionis to be exercisedhas to do with the best arrangementfor all parties concernedunderthe circumstancesconfrontingthe particular corporation.”[at 771].

House Report at 222.

69 Ibid 28

for confirmation. ChapterXI needsto be expandedto pemiit adjustmentof secureddebtand equity,and needsto have addedcertainpublicprotectionsnot now found in chapterXI. As these changesare integratedintothe two chapters,the differencesbetweenthem beginto disappear,and a consolidatedbusinessreorganizationchapterbeginsto appear. [TheCode] adoptsa consolidatedchapterfor all businessreorganizations. Thus,Congressadoptedthe consolidatedversionof the°7 reorganizationchaptersas Chapter11.

Ibid at 223 [citationsomitted]. 29 CHAPTERifi

E[IGIBILHY TO REORGANIZE

At first blush,the eligibilityof an entityto take advantageof a statuteallowingit to reorganizeits fmancial affairsmay seemlike a simplematter. However,the Code,because of its permissiveeligibilitydescription,has been creativelyused in a way thatmay seemunusualto

Canadianinsolvencypractitioners. The CCAAand the BIA use morerestrictivedescriptions.

This chapterwill examinethe definitional requirementsof the legislativeschemeswith a view to determiningwhether thoserequirements encourageor restrict certainentitiesfrom using the reorganization opportunities offeredby the legislation. Shouldthe conclusionresulting fromsuch examination bethat only certaintypes of entitiescan take advantageof the opportunityto reorganize, one is confrontedwith the issueof whetherthat result meetswiththe broaderobjectivesof the legislation.

Any enactmentthat givesone party an advantage over otherpartiesmay be subjectto abuse.

Thus,becausethe Code and the CCAAgive a debtorextensive rightson the commencementof a reorganizationproceeding,such as the stay of proceedings,’the courtsconsiderwhetherthe debtor must actin good faith in commencingthe proceeding. This chapter will examinewhethergood faith shouldbe consideredby the courtsand whether theconceptsupportsthe objectivesof a reorganization proceeding.

A. DEFINiTIONALDIFFERENCFS Subsection109(a)of the Codeallowsa 2person that resides,is domiciled orhas a place of businessor propertyin the United Statesto be a debtor under theCode. Section 109then provides

See discussionin chapterV(A),below.

2 Code s. 101(41) defmes“person”as including anindividual,a partnershipand a corporation. The defmitionexcludesgovernmentalunits,undercertaincircumstances. 30 that all persons, other than stock and commoditybrokersand certaindonstic and foreigninsurance companiesand banking institutionsmay be debtorsunderChapter 11. The exclusionsexist because, in the case of stock and commoditybrokers, Congressviewedcustomeraccounts,whichare the essenceof suchentities,as unprotectedin a Chapter11proceeding. Separatestate and federallaws, that containdetailedprovisionsconcerningthe insolvency4 and liquidationof insurancecompaniesand banking institutions,comprehensivelysuperviseand regulatethose 5entities. The CCAApemiits a “debtorcompany”to proposea compromiseor arrangementwith its creditors. A company,underthe CCAA,includesany federallyor provinciallyincorporatedcompany or any incorporatedcompany havingassetsor doingbusiness inCanada,whereverincorporated. It excludescertain companiessuch as bankinginstitutions,railwaycompaniesand insurance6 companies, as applicable federalor provinciallaw governstheir insolvencyand liquidation. A debtorcompanyis one that is or is deemedto be insolvent,has committedan act of bankruptcy7 underthe BIA or is 8bankrupt. Section3 sets forththe furtherprecondition thatthere be outstandingbonds issuedby the debtorunder a trust deed or other instrumentrunning in favourof a 9trustee. Subsection50(1)of the BIA allows a proposalto be madeby, inter alia, a bankruptor an insolventperson. “Insolventperson”is, in turn, defmedas a °1person who resides orcanies on

Code ss. 109(b)and (d).

House Report at 319.

HouseReportat 318; SenateReport at 31.

6 CCAAs. 2 “company”. 7lbid. 8 CCAAs. 2 “debtorcompany”.

Use by the debtorcompanyof an “instanttrust deed”to permit its use of the CCAAhas been the subjectmatter of a number of casesand commentaries.This issuewill be examinedin chapter ffl(B),below.

‘° BIA s. 2 defmesa “person”as includinga corporation,partnershipor unincorporated association. 31 businessin 1Canada, whose liabilitiesamount toone thousanddollarsand who has ceasedpayingor is unableto’meet its obligationsas they becomedue orwhoseassetswouldnot be sufficientto pay all obligationsthat are due and2accruing) The most strikingdifferencebetweenthe Canadian andAmericanreorganizationregimesis the absenceof a requirementin the Codethat the debtorbe insolventor bankruptat the time the voluntary proceedingis commenced.’ The Code,therefore,permits seemingly solventdebtors to takeadvantage of the protective3 aspectsof the Code. Beforethe enactmentof the Code,eitherthe courtsor the legislationrequiredthe petitioningcreditoror debtor toshowthat the debtorwas insolventat the time of the commencementof the case. The 1898U.S. Act did not require the debtorto be insolvent,only that it owed4debts) However,the United StatesSupremeCourtheld that it wouldbe “fraudulent”for a debtorto attemptto take advantageof provisions permitting reorganizationif the debtorwas solvent

‘ All of the statutoryschemesbeingconsideredpermitan entitythat carrieson businessin the respectivecountryto seekthe reliefbeingofferedby the legislation. The CCAAand Codefurther providethat an entitythat merelyhas assetsin that countrymay use the provisionsof the statute. This broadjurisdictionalbase has caused difficultiesin multinationalinsolvencies. Thesedifficulties will not be consideredin this paperbut the readeris referredto varioustreatisesand commentariesthat considerthis issue suchas the TasséReport at 60-62;J.D. Honsberger,Debt Restructuring(Aurora: CanadaLaw Book, 1994);and the many articleswrittenover a periodof approximatelyfive decades by ProfessorKurt Nadehnann, commencingwith “TheRecognitionof AmericanArrangements Abroad”(1941-42)U. Pa. L. Rev. 780and “Compositions- Reorganizationsand Arrangements- in the Conflictof Laws”(1948)61 Harv.L. Rev. 804.

12 BIA s. 2 “insolventperson”.

‘ A voluntarycase is commencedunder section301 of the Codeby the debtorfiling a petition with the bankruptcycourt. An involuntarycase is commencedunder section303 of the Codeby the requisitenumber of creditorsas providedin subsection303(b). Tnorderto grantthe relief requestedin the involuntary petition, thecourtmust be satisfiedeitherthat the debtoris generallynot payingits debtsas they becomedue or that a trustee,receiveror agentwas appointedto take possessionof all or substantially allof the propertyof the debtor forthe purposeof enforcinga lien againstsuchproperty, within 120days beforethe filingof the petition. Similarly,a creditormay make theinitialapplication underthe CCAAfor an orderthat a meetingof creditorsbe summoned. The BIA however,doesnot permita creditorto commencethe proposalproceedings, otherthan indirectlythrough a bankruptcy trustee,liquidatoror receiver.

14 1898U.S. Act s. 4, providedthat “anypersonwho owes debts. .. shallbe entitledto the benefitsof this Act as a voluntarybankrupt.” 32 or whereinsolvencywas not imminentor 15certain. Section77B,whichwas addedto the 1898U.s. Act in 1934,requiredthat the debtorset forth in its petition“factsshowingthe need for reliefunder this section;and that the corporationis insolventor unable to meetits debts asthey matureandthat it desiresto effecta plan of reorganization.” Insolvencywas alsoa requirementunderChapterX and Chapter)j17 6 The legislativehistoryof the Code doesnot suggestthe reasonfor removal of the insolvency requirement,in the case of a voluntaiypetition. One whter suggestedthat Congressmay havefelt that a solventdebtorthat was facingfmancialdistresscould losethe opportunityto reorganizeif it waited too longto commence18proceedings. Also,the removalof the insolvencyrequirementalleviatesa preliminaryobjectionrequiring a hearingto determinethe financialconditionof the debtor. Unless the debtoris clearly insolvent,a hearingto determinethe debtor’sfmancialconditioncould be a lengthy andcostly procedure,as it wouldrequire the debtorand the objectingpartyto retainthird partiesto provide valuationsof the debtor’sassetsand opinionsconcerningits solvency. Shouldthe debtorbe in a tenuousfmancialcondition,the fmancialand other resourcesexpendedon sucha

15 Plist National Bank of Cincinnativ. Plendiem,290 U.S. 504 (1934)[hereinafterPlerchem]at 517, 519.

16 77B(a);see In re PiccdillyRealty Co., 78 F.2d 257 (7th Cir. 1935),where thecourtheld that, as a resultof the definitionof “claim”in section77B which excludedthe claimsof stockholders,the debtor wassolvent,as the only significant liabilitieswerethose owingto stockholderson accountof dividendsand amountsowingupon maturityof the stock. Accordingly,the court held that the debtor was not permitted touse section77B; cf In re Kelly-SpringfieldTire Co.,10F. Supp.414 (D. Md. 1935),wherethe court alloweda solventdebtorto use the provisionsof section77B to helpthe debtor remainviableand avoid eventualfmancialdemise. In so doing,the court felt that “it is very,very clearthat in applying thesubstanceor intentionof this Act we do not have to wait until a corporation is absolutelyinsolvent.”[at 417].

17 ChandlerAct ss. 106(3)and 306(3),respectively. See e.g, Tuckerv. TexasAmerican Syndicate,170F.2d 939 (5th Cir. 1948),wherethe courtheld that the petitionwas not filed in good faith as the debtor,although“cashpoor” was “assetrich” and madeno effortto borrow moneytoy maturingobligations. In otherwords,the debtor was notinsolventand accordingly,it could not use the provisionsof Chapter X See also In ir SouthwestEnteiprises, Inc.,261 F.Supp. 721 (W.D.Ark. 1966).

18 MS. Bever, “ManvilleCorporationand the ‘GoodFaith’Standardfor Reorganization Underthe BankruptcyCode” (1983) 14U. ToledoL. Rev. 1467at 1495-1497. 33 procedurecouldbe betterallocatedto maintainingoperations.

To temper the possibilityof abuse resulting fromthe removal of the insolvencyrequirement,

Congressprovided the courts with the ability to scrutinizea Chapter11proceedingto determine whetherto permit it to continue. Paragraph305(a)(1)of the Codeallowsthe courtto dismissor suspendthe reorganizationproceedingif the interestsof the debtorand the creditorswouldbe better servedby a dismissalor suspension. The courtalso has theabilityto permita party to commenceor continueany actionthat it has againstthe debtoror debtor’sthe propertyby grantingrelief fromthe automatic9stay.’ Finally, under subsection1112(b)of the Code,a case may be dismissedor converted from areorganizationcase to a liquidationcase,whicheveris in the best interestsof the creditorsand the estate.

In the case of relief fromthe automatic stayand conversionor dismissal,the courtmay grant suchrelief “forcause.” Althoughthe Code doesnot list the debtor’sinsolvencyor good°2faith as a prerequisiteto commencingproceedingsunder Chapter11,severalcourtshave concludedthat the

“causeslistedin those sections arenot exhaustiveand that othercauses,suchas lack of goodfaith or the fmancialconditionof the debtorcould beexamined.” A casethat raised theconcern overthe’2use by solvententitiesof the reorganizationprovisions of the Codeand that established the rightof suchentitiesto use the protectivemeasures containedin the Codewas the case involvingJohns-Manville22Corporation. When it filed its voluntarypetition

‘ Code s. 362(d); seediscussion chapterV(A)(4)(b),below.

20 The issue of whethergoodfaith is a prerequisiteto commencingand maintaininga reorganizationproceedingwill be discussedin chapterffl(C),below.

21 See e.g., In re Pappas, 17B.R. 662 at 666 (Bankr.D. Mass. 1982);In re VictoiyConstruction Co., 9 B.R 549 (Bankr.C.D. Cal. 1981)[hereinafterVictoiy],modified, 9 B.R. 570, vccatedas moot, 37 B.R 222 (9th Cir. 1984),wherethe courtheld that “thedebtor’slack of ‘goodfaith’in filinga case underChapter 11is ‘cause’,independentof the existenceor lack of adequateprotection. . .“ [at 5601

22 Johns-Manville Corporationis hereinafterreferredto as Manville. See,In re Johns-Manville Coiporation,36 B.R. 743 (Bankr. S.D.N.Y.1984);In re Johns-ManvilleCoiporation,36 B.R 727 (Bankr.S.D.N.Y.1984),cppealdenied42 B.R. 651 (S.D.N.Y.1984),reh’gdenied41 B.R 654 (S.D.N.Y.1984). 34 under Chapter11, Manville’snet worthexceeded$1.1 billion and its total sales for the immediately precedingyear were more than $2 23billion. Althoughthere were manyreasonsfor its filing,Manville filed primarilyto control and quantifyexistingand anticipatedtoxic tort liability claims of victims sufferingfrom asbestos-relateddiseases. Although solvent atthe time of the filing, Manville submitted that the time and expenseof litigationand the quantumof the awardswould,in the opinionof companyofficials, leave Manvillewith no alternativebut to liquidateor otherwise disposeof its assets and dismemberits 24business. Commentators havecriticizedand defendedthe Manville25filing. However,it must rememberedthat the court upheld the filing. The BankruptcyCourt specificallyheld that insolvencywas not a preconditionto filing a voluntarypetition underChapter 11•26 Moreover,the court upheld the policy “thata fmanciallybeleaguereddebtor with real debt and real creditorsshould not be requiredto wait until the economicsituation is beyond repair in order to file a reorganization petition.“27

We must contrast theCode’seligibilityrequirementswith the Canadianeligibility requirements. Given the restrictivedescriptions inthe Canadianreorganizationstatutes, it is unlikely

23 L.A. Flyer, “Will FinanciallySound Corporate Debtors Succeedin Using Chapter 11 of the BankruptcyAct as a ShieldAgainst MassiveTort Liability?”(1983) 56 Temple L.Q. 539 at 541-542 (f. 11).

24 JJ,jd (f. 13).

25 See e.g.,Flyer, ibid at 566-567,where the author said “. .. courts should concludethat a financiallyhealthy corporation whichhas filed for reorganizationfor the purpose of escapingtort liabilityhas not filed in goodfaith. ... To allow a stable corporatedebtor to cloak itself in the protectiveprovisions of chapter 11 would render the chapter a sham.”;M Kunlder, “TheManville Corporation Bankruptcy:An Abuse of Judicial Process?”(1983/84) 11 PepperdineL. Rev. 151,where the author arguesthat the filing by Manvillewas an abuse of the federal bankruptcylaw; cf S. Friedman,“Manville:Good Faith Reorganizationor ‘Insulated’Bankruptcy”(1983/84) 12 HofstraL. Rev. 121,where the author argues that becauseof the futureprospect of fmancial distressand the attemptby Manville to accountand provide forthe victims whosehealth problemshad yet to manifest themselves,the filing was indeedwithinthe contemplationof the Code and accords with the spirit and intent of Chapter 11.

26 In re Johns-ManvilleCoiporation,36 B.R. 727 at 732 (Bankr. S.D.N.Y. 1984).

27 Ibid at 736. 35 that a solventdebtor couldseekthe protectionof reorganization.Both statutesrequirethe debtorto be insolventor bankruptand it wouldappear thedebtormust be insolventat the timeit commencesthe proceeding. However,a debtormay be ableto deviseits eligibilityto commenceproceedingsunder the CCAA or the BIA. For example,a debtor companyunder theCCAA is one that, inter alia, “has committedan act of bankruptcywithinthe meaningof the Bankruptcyand Insolvency28Act”. Oneact of bankruptcyunderparagraph42(l)(h) of the BIA is the debtor giving noticeto any of its creditors that it is about to suspendpaymentof its debts. Underthe BIA, a debtor couldfall withinthe definitionof “insolvent person”by merelyceasing topay its current obligationsin the ordinarycourse of businessas they generallybecome29due. The BIA saysnothingconcerningthe inabilityof the debtorto make suchpayments,only that the payments haveceased. Whetherdevisingits eligibilityto proposea compromise or arrangement underthe CCAAor to file a proposal ora noticeof intentionto file a proposal under theBIA breaches anygoodfaithrequirement does not derogatefromthe fact that, on a strictreadingof the statutes,the debtoris qualified°3 to usethe provisions. Althoughone may attempt toarguethat the possibilityof massivetort liabilityin Canadais remote,giventhe size of awardsmadeby Canadiancourtsor the fact that Canadianindustryis simply not as large as that carried onin the United States,the possibilityof such liabilityexistsin Canada.

Furthermore, debtorsare usingthe CCAA forpurposesthat were likelynot contemplatedby the policymakers, suchas the downsizingof operationsby disdaining leasesof unprofitablelocations.

circumstances, other strategicadvantagescouldbe gained CCAA,3 such In appropriate by usingthe ’

28 CCAAs. 2 “debtorcompany”(b).

29 BIA s. 2 “insolventperson”(b).

° See discussioninfra notes 71-89and accompanyingtext.

31 E.g., the case involvingSilcorpLtd. involveda substantialdownsizingwiierethe court pennittedthe debtorto repudiatea substantialnumberof leasesof unprofitablepremises. Theissue concerningrepudiationof real propertyleasesis discussed inchapterV(B), below. 36 disclaimingother oneroustypes of 32contracts. Is an insolvencyrequirementnecessaryor desirable ina businessreorganizationregime? The probabilityor even 33possibility of financialdemiseis within the contemplationof the objectivesof a businessreorganizationsystem. Thus, if an entity is facing financialdistress,it shouldbe able to take advantageof a reorganizationregime, whether or not it is insolvent. However,removal of a requirementof insolvencycouldpresent an opportunityfor abuseof the system. If removed,the courts should be given the powerto scrutinizeall of the circumstancesof the case to detennine whetherthe proceedingmeets objectivesof the legislation. It is arguablethat despite the solvencyof

Manville,its filing fell within the intent and spirit of a businessreorganizationsystem. Had it not filed, the claims of existing victims could havetaken precedenceover those victimswhose damages had yet to manifestthemselves,in the sense that the claims of existingvictimsmay have resultedin

Manville’sliquidationand dismemberment. By allowingthe filingto stand,all of the victims,both existingand future, would be treated equally. However,a debtor that is merely attemptingto gain some strategic advantageover its creditors or is seekingthe protectionof a reorganizationstatutefor somepurpose that does not further the objectivesof the legislationshouldnot be able to take advantageof its provisions. In such a case, the legislationshould be sufficientlyflexible to allow for the dismissal of the case. The Code providesthat flexibility. The Canadian statuteshave yet to be tested in this regard.

B. TEQINICAL REQUIREMFNIS IJNDER ThE CCAA

The CCAA is uniqueamongthe reorganizationstatutesbeing considered,as it sets forth a

32 For example, in the United States,Chapter11 has been used by debtorsto extricatethemselves from obligationsunder collectivebargainingagreements. See e.g., In te ContinentalAirlines Coip., 38 B.R 67 (Bankr. S.D. Tex. 1984).

It was held in In re US.A. Motel Corp., 450 F.2d 499 (9th Cir. 1971),relying on Flerthem, supra note 15, that the debtor’sinabilityto pay its liabilitieshad to be more than a mere possibility; such inability had to be proved imminentand certain. 37 preconditionto its application. When Parliamentfirst enactedthe CCAA, any companyincorporated by or under any federal or provincialact or any companyhavingassets or doing business inCanada could use it.35 The 195336amendment attemptedto limitthe use of the CCAAto widely-held companieswith complex fmancial structures. Whenthe amendmentwas introducedin the Houseof

Commonsfor second readingon January23, 1953,the HonourableStuartS. Garson,providedthe

House with a brief rationale for the amendment.

With the passage of this bill it will leave companiesthat have complex fmancial structures, and a large numberof investor creditors,able to use the Companies’CreditorsArrangement Act for the purposeof reorganization. Moreover,they will be able to use it efficiently; because as a nile, the terms of their o trust deedprovide for a trustee of the creditorswhose business it will be to look aftertheir interestsproperly, a provisionwhich is ahnostinvariably absent in the case of the mercantilecreditors. The mercantilecompanieswill be able to use the provision of part ifi of the new revised BankruptcyAct, which,unlikethe BankruptcyAct in force in 1933,has a provisionwhereby companiesmay apply for an extensionto work out their affairswithout incurringthe stigmaof 37bankruptcy. Companiesmade little use of the CCAAduring the first four decades of its existence. Onemay surmisethat the trust deed requirementhad the intendedeffect of limiting its use to certain typesof companies.

The 1980ssaw a significantincrease in the use of the CCAA, althoughthe trust deed requirementdid not limit its use to entities with complexfmancial structuresor many investor creditors. Debtors met the preconditionby issuingbondsor debenturesunder trust deedscreated immediatelybefore the commencementof the proceeding. Thecourts allow debtors touse these

“instanttrust deeds”to meet the conditionimposedby section 3. TnRe United MaritimeFishennen

Re Ccmiian Bed& Biakfact Reg. Ltd (1986), 65 C.B.R. (N.S.) 115at 116(B.C.S.C.).

S.C. 1933,c. 36, s. 2(b). The defmitionof “company”excludedbanks, raily or telegraph companies,insurancecompanies,trust companiesand loan companies.

An Act to amendthe Companies’Creditoi AirangementAct, 1933, S.c. 1952-53,c. 3, s. 2 [now CCAA s. 3].

House of CommonsDebca’es(23 January 1953)at 1269. 38 38Co-op, the New BrunswickCourt of Queen’sBench specificallyheld that: the words “bonafide” do not appearin section3 of the Act and that the Court, upon hearing such an application,had no obligationand indeedno rightsto raise the issue and determinethe validity of the trust 39deeds. With respect, one must questionthe court’srationale in this case. The New Brunswick Court of Queen’sBench,as a court of °4equity, has the jurisdiction to questionthe bonafides of any matter before it, whether or not the statutespecificallyallows forthat examination. Despite this criticism,the courts have permitted debtors to seek relief under the CCAA followingthe issuance of an instanttrust ’4deed. Thus, section 3 merely constitutesa proceduralhurdle. Althoughother reasonsexist that may dissuadea debtor from seekingthe protectionaffordedby the CCAA, section 3 does not imposea serious impediment. Theeffect of this impedimentis lessenedby the doctrineof reasonabledemand and section 244 of the BIA that requires a securedcreditor to give the debtor notice of the creditor’s

38 (1988), 67 C.B.R.(N.S.) 22 (N.B.Q.B.),rev’don other grounds67 C.B.R. (KS.) 161 (N.B.C.A.)[hereinafter United MaritimeRshennen].

Thid at 54 (N.B.Q.B.).

° JudicatureAct, RS.N.B. 1973,c. J-2, s. 26.

41 See e.g. Elan Corporationv. Cominskey(Trusteeof) (1991), 1 C.B.R. (3d) 101,per Doherty J.A. (dissentingin part); Hongkong Bankof Cancth v. Chef Rec4’ Foods Ltd (1991), 4 C.B.R. (3d) 307 (B.C.S.C.),affd (1991), 4 C.B.R. (3d) 311 (B.C.C.A.),where the British Columbia Court of Appeal affirmedan order of the British ColumbiaSupremeCourt allowingan applicationof the debtor for a stay of proceedingsunder the CCAA notwithstandingthe creation of an instanttrust deed. The Court of Appealspecifically recognizedthat the debtor createdthe trust deed “so as to qualify”under the CCAA [at 313]. Cf Re Nonnc HaulingLtd (1991), 6 C.B.R. (3d) 16 (Sask. Q.B.), wherethe court refusedto follow the courtsof the otherjurisdictions in sanctioning theuse of instanttrust deeds. In so doing, Wimmer J. stated:

“It is the duty of the court to give effect to legislation,not to emasculateit. The plain languageof s. 3 offers no other conclusionthan that it was enactedto exclude certain companiesfrom the benefitsof the Act. No companyis excludedif all that is requiredis an “entrancefee” in the form of a trust deed creatednot to raise capital but simply to gainaccess to a legal remedy not otherwiseavailable. I cannot thinkthat the legislationwas intendedto be interpretedin a way that permitsthis. In my opinion, s. 3 contemplatedthe existenceof securitiescharacterizedby genuinenessin the sense that they were issued to raise capitalor secure existing indebtednessand not, ashere, to achievean obliquepurpose. To hold otherwisewould fail to give effect to the spirit and intent of the legislation.”[at 19] 39

intentionto enforceits security. Thesetime periodsprovidea debtorwith ampleopportunityto create a trust deed and issue bondsor debenturesthereunder. Any reformshouldremovethe requirementof the trust deed. The requirementwas originally intendedto protectinvestorcreditorsby havinga trusteemonitor thedebtor’saffairs. A morecomprehensivereorganizationregimethat requires extensivereportingby a debtorin possessionor the appointmentof a trusteeor interimreceiverwith broadinvestigativepowerscouldprovide thisprotection. Anotheralternativemay be to createa two- tieredreorganizationsystem;one that dealswith morecomplexentities,the otherto deal with the less complexones. Althoughthis was attemptedunder theChandlerAct withChapterX and ChapterXI, it maybe workablein a manner similarto that beingdone in Canadawith the BIA and the CCAA.

Like the Code,the flexibilityof the CCAAspawnslitigationto deal with substantive and procedural matters. Thisflexibilityand the costsattendanton such a proceedingresults inthe CCAA beingused by the larger,morecomplexentities,in any event.

C GOOD FAiTH N COMMENCINGREORGANIZATION PROCEEDINGS

None of the statutoryschemesexpressly requiresthe debtor tobe acting in goodfaith,when commencinga reorganizationproceeding. However,the goodfaith issue arises ina numberof situationsunderthe Code and at least oneCanadian commentatorhas suggested thatgoodfaith should consideredby the courtsunderthe CCAAand the 42BIA. This sectionwill examinethe conceptof goodfaith in a businessreorganizationproceeding.It will then, brieflyexaminethe historyof the conceptunder theAmericanenactmentsand analyze whethera debtorshould beactingin goodfaith in commencinga reorganizationproceeding.

42 J.D. Honsberger,“TheCompanies’CreditorsArrangementAct: Howto Use It and Not Use It and a CriticalComparisonwith Part ifi of the BankruptcyAct, Chapter 11of the U.S. Bankruptcy Codeand AdministrationProceedings inEngland”in CanadianInsolvencyAssociation1991National Semincc (Toronto:CanadianInsolvencyAssociation,1991)Tab 2 at 23. 40

1. The Concept of Good Faith in a BusinessReoiganizafionPoceeding Black’sLaw 43Dictionary defmes“goodfaith”as follows: Goodfaith is an intangibleand abstractqualitywith no technicalmeaningor statutory defmition,and it encompasses,amongotherthings,an honestbelief,the absenceof maliceand the absenceof designto defraud or seekunconscionableadvantage,and an individual’s personalgoodfaith is conceptof his own mindand inner spiritand, therefore, maynot conclusivelybe determinedby his protestationsalone.

Honestyof intentionand freedom fromknowledgeof circumstanceswhichought toput the holderupon inquiry. An honestintentionto abstainfromtaldngan unconscientiousadvantage of another,even throughtechnicalitiesof law, togetherwith absenceof all information,notice, or benefitor beliefof facts whichrendertransactionunconscientious.In commonusagethis term is ordinarilyused to describethat stateof mind denotinghonestyof purpose,freedom from intentionto defraud,and, generallyspeaking,meansbeing faithfulto one’sduty or obligation.

A Canadianlaw dictionary4adds a further elementto the definitionof goodfaith that is relevantto the issue at hand.5 It statesthat goodfaith impliesan “absenceof ulteriormotive.” This elementis crucialto any determinationof goodfaith of the debtorin commencingreorganization proceedings andrequires an examinationof the objectivesor purposesof a business reorganization regimeagainst theactual,subjectivemotivesof the debtor. In otherwords,for the debtorto have an ulteriormotive,the properobjectives mustbe manifest. As goodfaith is a “stateof mind,”a debtor mustbe awareof the policieswhichit is attemptingto circumvent,to find that it is lackinggoodfaith.

As none of the statutes censuresthe commencementof a reorganizationproceeding based onthe absenceof goodfaith, a debtormay examinethe statuteand concludethat it falls withinits jurisdictionalambit. Tofmd that the debtorlacks goodfaith,one must go the extra step and fmdthat, althoughthe debtorfalls withinthejurisdictionalambitof the legislation,it isusing thatlegislationfor

‘ Blcrk’sLaw Dictionary,6th ed. (St. Paul: West 1990)[citationsomitted] [hereinafterBlack’s].

‘‘ Ibid at 693. Black’sgoeson to providea specificdefmitionof goodfaith inthe contextof a reorganizationproceedingof an individual. However,the defmition refersto a provisionof the Code that expressly requiresgoodfaith as part of the confirmationprocessand accordingly,it is inapplicable to the issueat hand.

J.A. Yogis,Q.C., CancdianLaw Dictionary(NewYork:Barron’s,1990). 41 “inappropriatepurposes.” The analysis must focus on the debtor’shonesty, as the concept speaksof honest 47intention. It must not be based on some objectivecriteria that would suggestwhether there is a reasonable possibilityof reorganization The circumstancesmaypoint to factors that wouldallow the courtto

gleanthe subjectiveintention of the debtor despite its “protestations,”but these factors must not derogatefrom the primarythrustof the examination,which is to determinethe debtor’s48motives. A primary purposeof a businessreorganizationstatuteis to allow the debtor toreorganizeits financialaffairsto facilitate its rehabilitation,while treatingcreditors inan evenhanded,fair and equitablemanner. If there is no realistic hope of reorganizationand the debtor commencesthe proceedingmerely to delay, defeat or defraud creditors,then there is an absence of good 49faith. However,one must question whethersuch an analysis truly examinesthe state of mind of the debtor or whether it is an objective examinationof the circumstancesof the case to arrive at a conclusionas to the prospects of reorganizationor the future viability of the debtor. The timing of such an

D.L. GaIThey,“BankruptcyPetitionsFiled in Bad Faith: What ActionsCan Creditor’sCounsel Take?”(1979-80) 12 U.C.C.L.J.205 at 210.

Black’s,supra note 43.

48 But see discussionconcerningthe goodfaith standardunder ChapterX infra notes 54-59and accompanyingtext.

‘ Eg., much has been witten on the single-assetcases in the United States,where a debtor transfersa singleasset, in whichit holds no equity, to an entity that has no other assets, liabilities, employeesor active business. This entity subsequentlyfiles a Chapter 11 petition. Theintent in effectingthe transfer is to shield the debtor’sactive and profitableoperationsand to delay any foreclosureproceedingsthrough the use of Chapter 11, in the hopes that the property will appreciatein value. It is submittedthat a petition filed for this purpose is one that lacks good faith. See e.g.,In re PhoenixPiccdilly, Ltd, 849 F.2d 1393(11th Cir. 1988)[hereinafterPhoenix Piccdilly];In re Little CreekDevelopmentCoip., 779 F.2d 1068(5th Cir. 1986)[hereinafterLittle Creek], in whichthe court characterizedthis type of arrangementas the “newdebtor syndrome”and observedthat it “exemplifies, althoughit does not uniquelycategorizebad faith cases.” [at1073];In re Nancant, Inc., 8 B.R. 1005 (Bankr.D. Mass. 1981),where the court similarly granteda motion to dismissthe petition However, the court refused to hold that all new debtor cases would necessarilybe dismissed onthe groundsof bad faith. [at 1008];cf In re Becrh Club,22 B.R. 597 (Bankr.N.D. Cal. 1982),where the court found no bad faith in the filing of the petition on the groundsthat there was a legitimatebusinesspurposein the debtor effecting a transfer of the assets to the “newdebtor”and the creditors were adequately protectednotwithstandingthe transfer. 42 examinationis crucial. If the court conductsthe examinationvery early in the proceedingsunderthe

CCAA or Code,there may not be sufficientevidencebeforethe court concerningthe future prospects of the debtor,such as the possibilityof securingadditionaldebt fmancingor equitycapital. Underthe

BIA, the policakers have madeprovisionfor the filingof a projected cash-flowstatementwithin 10 days after the filing of a noticeof intentionto makea proposal. This is presumablyintendedto give the creditorssomeidea the debtor’s in filing5 notice of bonajides ° the of intention. However,one must rememberthat the debtorpreparesthe projectedcash-flowstatementand, althougha trusteereviews the statementfor its reasonableness,the trustee’sreport is basedon assumptionsand information providedby managementof the debtorand containslanguagesufficientto exoneratethe trusteefrom any liabilityotherthan errors resulting from grossnegligenceor 51fraud. It may be difficultto arguethat the courtsshould sanctionthe commencementof reorganizationproceedingswhenthere is an absenceof goodfaith by the debtor.However,a plain reading of the statutesdoes not mandatethis type of examination.

We now turn to the issueof whetherthe policymakersdeliberatelyexcludedan express mandateto make a determinationof goodfaith fromthe Code and whetherthe courtshavethe statutoryor inherentauthorityto examinethis issueat the outsetof a reorganizationproceeding.

2. LegislativeIlistoiy and Evolutionof the Conceptof Good Faith in ReoiganizafionPmceedings

The 1898U.S. Act requiredgoodfaith as a conditionof the court approvinga composition following acceptanceby the 52creditors. However,it did not make goodfaith a prerequisiteto the

50 BIA s. 50.4(2).

‘ See BIA Form 42.2.

52 1898U.S. Act s. 12(d)provided:

“Thejudge shall confirm a compositionif satisfiedthat. . . [the compositionhas been offered] and its acceptanceare in goodfaith and have not been madeor procured. . . by any means, promisesor acts hereinforbidden.” 43 commencement’of a compositionproceeding. Tn1933,Congressenacted section 7Th wiuichmade good faith a prerequisiteto the commencementof the proceeding. Subsection77B(a)provided:

Upon the filing of such petition or answerthe judge shall enter an order eitherapprovingit as properly filed underthis section if satisfiedthat such petition or answercomplieswith this section and has beenflied in goodfaith, or 53dismissing. The Chandler Act repealed section 7Thand created Chapter X and Chapter XEto govern businessreorganizations. Onlya petition filed under Chapter X had to be filed in goodfaith.

Chapter X provided the followingnonexclusivedefmitionof “goodfaith”:

146. Without limitingthe generalityof the meaning of ‘goodfaith,’a petition shall be deemed not to be filed in goodfaith if - (1) the petitioningcreditorshave acquiredtheir claims for the purposeof filing the petition; or (2) adequaterelief would be obtainableby a debtor’spetition under chapterXl of the Act; or (3) it is unreasonableto expect that a plan can be effected;or (4) it appearsthat in a prior proceedingpending in any court,the interestsof creditors and stockholderswould be best subservedthereby.”

For our purposes, subsections 146(3)and (4) are of interest. Subsection 146(4)allowedthe court to dismissthe petition in a two-party dispute betweenthe debtor and one of its creditors. Asbankruptcy only dealswith problems involving thecollectiveinterestsof all or substantiallyall of the debtor’s creditors,subsection 146(4)would protect the debtorfrom a petition filed byone of its 55creditors for an improper56purpose, such as collectionproceedingsof the 57creditor. It also protectedthe creditors

Ch. 204, 47 Stat 1467at 1474(1933) [emphasisadded].

ChandlerAct s. 144provided:

“Uponthe filing of a debtor’spetition, thejudge shall enter an approvalorder if satisfiedthat the petition complieswith the requirementsof this chapterand has beenflied in goodfaith; otherwise,he shalldismiss it.” [emphasisadded]

ChandlerAct ss. 106(8)and (9) allowed a petition to be filed against a debtor by a creditoror trustee under a trust deed, indentureor mortgage.

56 See e.g., In re SouthCocchCo., 8 F. Supp. 43 (D. Del. 1934).

A petition under the BIA may similarlybe dismissedif it is filed for some improperpurpose, such as an attempt by the creditor touse the bankruptcysystem as a collectionmechanism. See e.g. Re Wells(1944), 25 C.B.R. 291 (Ont. S.C.). 44 and stockholdersfrom a debtor that was merely attemptingto obtainsome strategicadvantageby seekingprotectionthrough bankruptcylegislationwhen state court proceedingswere 58pending. Subsection 146(3)of the ChandlerAct providedthat a petition was deemednot to be filed in good faith if it was “unreasonableto expectthat a plan can be effected.” This appearedto addressthe situationof a petition being filed when there was little objectivehope that a plan couldbe effected. As mentioned59previously, a court, in attemptingto determinewhether the petitioner commencedthe proceedingin goodfaith, must inquireinto the petitioner’sstate of mind. By usingthe word “expect” in subsection146(3)of the ChandlerAct Congresswas seekingto deal with the state of mind of the petitioner. However, by requiringthe court to determinewhether theexpectationwas “unreasonable,” the court had to examineobjectivecriteria that would leadto conclusionsconcerning,not the state of mind of the petitioner, but the state of mind of a reasonablepetitioner. Althoughthis type of inquiry derogatesfrom the “pure”concept of goodfaith that deals with subjectiveintention,Congressmay have been attemptingto address the unreasonableexpectationsand optimismof entrepreneursin financial difficulty.

Unlike ChapterX Chapter Xl had no goodfaith filingrequirement. It has been argued, however,that the courts implieda requirementof goodfaith for the filing of a petition under Chapter °6X1. Victoiywent further, however, and held that, as the goodfaith filing requirementwas implied into Chapter XI, despite an absence of an expressrequirement,so too should it be impliedinto the ’6Code. Professor Flaccushas recently argued thatthis conclusionis ong on the basis that the cases 58 In re Willicimsport WireRope Co., 10 F.Supp.481 (D. Pa. 1935);In re Phelps Manor Redly Co., 73 F.2d 1010(3d Cir. 1934).

See Chapter ffl(C)(1), above.

60 See e.g., Victoiy,supra note 21 at 557, where thecourt observed “[a]swe have seen, Chapter XI, X[I and XIII containedno ‘goodfaith’filing requirement. This’gap’ was filled by the courts!!”;L. Ponoroffand F.S. Knippenberg,“The Implied Good Faith Filing Requirement:Sentinelof an Evolving BankruptcyPolicy” (1991) 85 Nw. U.L. Rev. 919 at922-923 (ii. 10);RM Cohn, “GoodFaith and the Single-AssetDebtor” (1988) 62 Am. Bankr. L.J. 131at 132.

61 Victoiy,ibid at 557. 45 upon which Victoiyrelied to supportthe conclusion,were basedon faulty62reasoning. She concludes that all of the cases cited by Victoiywere consideringstatutoryprovisionsthat made good faithan express filingrequirement,such as Chapter X, an expressrequirementfor confirmationof the plan, or other factors listed in section 146. Accordingly,she concludesthat a goodfaith filing requirement shouldnot have been impliedas part of Chapter XI in the cases precedingVictoiy. It follows therefore,that if the decision in Victotywas incorrectlygrounded,its conclusionis likely not strong authority. That is, it maybe improperto imply a goodfaith filing requirementinto Chapter Xlor the

Code.

The legislativehistory also refutes any argumentthat there is a goodfaith filing requirement under the Code. The Report of the Commissionon the BankruptcyLaws of the United 63States recommendedthe eliminationof the goodfaith filing TMrequirement. The footnote explainingthis recommendationstated:

The proposed Act ... allows any party in interestto movethe court for an order of dismissalor conversionto liquidationif it is unreasonableto expect that a plan can be effectuated,rather than requiringthe court to determinewhether goodfaith existsat an often prematurestage andwithoutadequate65evidence. In adoptingthis recommendation,Congressintendedto deletea finding of goodfaith as a precondition to the filing of a petition. It also enactedparagraph1112(a)(1)which allows a court to converta

Chapter 11 case to a liquidationor dismissthe Chapter 11 case for cause, including, “continuingloss to or diminutionof the estate and absence of a reasonablelikelihoodof rehabilitation”[emphasis added]. The “state of mind” element has been deleted. That is, the paragraphspeaksof the absence

62 J.A. Flaccus, “HaveEight CircuitsShorted?Good Faith and Chapter 11 BanlcruptcyPetitions” (1993) 67 Ani Bankr. L.J. 401 at 412-413.

63 House Doc. No. 93-137,Part I, 93d Cong., 1st Sess., reprintedin A.N.Resnick and E.M Wypyski,eds., BankntptcyRefonn Act of 1978:A LegislativeHistoiy, vol. 2, doe. 21 (Buffalo: WilliamS. Hem, 1979).

64 Ibid at 183.

65 Ibid at 222-223. 46 of a reasonable “likelihood”of rehabilitationrather than a reasonable “expectation.” It is submitted that the courts, in analyzingthis element,must look at all of the circumstancesto determine, objectively,whether rehabilitationis likely, ratherthan attempt to glean the state of mindof the petitioner. In other words, it appearsthat the Congressionalintent was not to have the courts determinethe goodor bad faith of the petitioner in filing the case. The courts are to makean objectivedeterminationof the likelihoodof a successfulreorganization,quite apart from the motives of the petitioner. Accordingly,goodfaith of the petitioner is not necessaryin the filing of a petition under Chapter 11. The importantissue forthe courts to consideris not whether the petitionerwas acting in goodfaith, but whether the objectivesof the legislationmay be achievedthrough a reorganization. Even if the petitioner had ulterior motives in filing the Chapter 11 case, a reorganizationmay be the most appropriatemeansof treating creditors equitably.

Althoughthe list of “causes”that wouldresult in conversion ordismissalis not exhaustive and the court possesses equitablepowers to carry out the provisionsof the 67Code, the court shouldnot be permittedto base its reasoningon a groundthat was specificallyremovedby Congressin enacting the legislation Such an approach subvertsthe legislativegrantand allowsthe court to go beyond its jurisdiction, which is to decidewhethera reorganization proceedingmay be beneficialfor all concerned,whatever the state of mindof the debtor.

Good faith, as a requirementfor filing a petition under Chapter 11,has also been implied underparagraph362(dXl), which allows the court to grantrelief from the automaticstay of

House Reportat 406, where it was saidthat the court “vill be able to consider other factorsas they arise, and to use its equitablepowersto reach an appropriateresult in individualcases.” See also In r I-JBAEast, Inc., 87 B.R 248 at 258-259(Bankr.E.D.N.Y. 1988);In r G-2 Realty Trust,6 B.R. 549 (D. Mass. 1980),where the court dismissedan involuntarypetition of three “ffiendly”creditorson the basis that the debtor lacked goodfaith in changingits structureto make it eligible for Chapter 11 relief.. A lack of goodfaith in filing the petitionon the part of the debtor has been held to be an equitable groundwhich wouldjustify dismissalof the case [PhoenixPiccdilly,supra note 49].

67 Codes. 105(a). See In re HartfordRunApartmentsof Buford,Ltd, 102BR. 130at 132 (Bankr. S.D. Oh. 1989).

68 Flaccus,supra note 62 at 416. 47 proceedings,“for cause, includingthe lack of adequateprotectionof an interestin property “69

The courts havegrantedcreditorsrelief from the automaticstay of proceedingswhen it appearsthat the debtorlacks goodfaith in filingthe petition. Paragraph362(dXl)does not allow for the dismissal of the case but it provides an effectivemeans of enforcementof the concept of good °7faith, especially in the case of a creditor holding securityon all or a substantialportion of the assets of the debtor.

Unlikethe United States, which has a rich history underlyingthe current statutoryprovisions,

Canadahas little to draw upon with respect to the absenceof the concept of goodfaith in the legislativeschemesbeing considered. As mentionedpreviously,the New Brunswick Court of Queen’s

Bench refusedto read an elementof goodfaith into the provisionsof the CCAAbased on a plain readingof the 71act. The court found,however,that the debtor was not acting in bad faith in creating the instanttrust deeds.

Althoughthe New BrunswickCourt of Queen’sBench rejected the argumentthat the debtor mustbe actingin good faith in commencingproceedingsunder the CCAA. Canadiancourts have since implied a conceptthat appearsto approacha notion of good faith. The approachtaken by the courts in this regardis similarto the approachtaken by some courtsin the United States when considering whether a Chapter 11 case should be convertedto a liquidationor dismissedon the basis that there is

69 See e.g, Victoiy,supra note 21 at 560; cf In re Beach Club, supra note 49, where the court found that the creditorswere adequatelyprotected. See also In re Lotus Investments,Inc., 16B.R 592 (Bankr. S.D. Fla. 1981)where the court said:

“Whiles. 362(d)(1)does not specificallyincorporates. 1112(b),it is reasonableto conclude that a creditor should be grantedrelief from the stay if the case is one which the court should dismiss if a motion to dismissunder s. 1112(b)were presented.”[at 595]

Althoughthis logic makes practical sense, the coiut, with respect,assumesthat goodfaith is an element of s. 1112(b)thatjustified conversionor dismissal. Neither section expressly so provides. For a full discussionof section 362 of the Code, seechapterV(A), below.

70 E. Di Donato, “GoodFaith ReorganizationPetitions:The Back DoorLets the StrangerIn” (1983) 16 Conn. L. Rev. 1 at 7.

71 UnitedMaritime shennen, supra notes 38 and 39 at 54 (N.B.Q.B.). 48 an absenceof a reasonablelikelthoodof rehabilitationunderparagraph1112(b)(1)of the CodeY

Underthe CCAA, a challengeto the debtor’sabilityto successfullyrehabilitateitselfis

generallytaken as a challengeto the stay of proceedings. If a creditorthat holds securityon all or substantiallyall of the propertyof the debtorsucceedsin its challenge,the proceedingwill be effectivelydismissed,as the debtorwill no longerhave assetswith whichto attemptto reorganize.

Tht Treaswy FincincidInc. v. CongoPetroleums74Inc illustratesthe approach. In that case,a secured creditorof the debtorbroughtan applicationfor the appointmentof a receiverand managerpursuant to its debenture. Securedcreditorsholding approximately60 percentof the amountowingto all securedcreditorsand an unsecuredcreditorwhoseclaimconstituted“wellover half of the unsecured claims”of the debtorsupportedthe 75application. The debtorbroughta cross-applicationfor relief underthe CCAA.

The court allowedthe applicationof the securedcreditorand dismissedthe applicationof the debtoron severalbases, includingthe fact that “anyplan Cangocouldput forward woulddmost certainlybe turned downby boththe securedand the unsecured76creditors.” The court didnot discuss the motivesof the debtorin seekingrelief underthe provisionsof the CCAAin terms of its goodor

72 Paragraph1112(b)(l) of the Coderequiresan additionalelement tobe provedwhena court dismissesor convertsa case underthat provision,viz., the “continuinglossto or diminutionof the estate.” Despitethis additionalrequirement,somecourtshave consideredthe likelthoodof a successfulreorganizationas a separateelementand have dismissedor convertedthe case on that basis alone. See e.g., In ie Canion, 129B.R 465 (Bankr.S.D.Tex. 1989);In re Mogul, 17BR. 680 (Bankr.MD. Fla. 1982);In re Dutch FlatInvestmentCo., 6 BR. 470 (Bankr.N.D. Cal. 1980);In re Pappas,supra note 21 wherethe courtappliedboth arms of the test. The diminutionof the estate wouldresult from the fact that the debtorhad no equityin its assetsand the debtswouldcontinueto increaseas a result of accruinginterestand taxes.

This issue willbe fully discussedin Chapter V(A)(4)(a),below.

‘ (1991), 3 C.B.R..(3d) 232 (Ont.Gen.Div.) [hereinafterCongo].

Ibid at 238. In orderto succeed,a compromiseor arrangementmustbe acceptedby a majority in number,representingthree-fourthsin value of the creditors,or class of creditors,votingat the meetingdirectedby the court. [CCAAs. 6].

76 Ibid at 240 [emphasisadded]. 49 bad faith. However,one mightinfer fromthe reasonsfor the decision thatthe courtmay havebeen

influencedby certainfactorsthat pointedto the lack of bonafides of the debtoror its principals. The courtobservedthat:

(a) the debtorhad “deliberatelyqualifieditself’ to seek relief underthe CCAAby issuing an “instantdebenture”so as to bring itselfwithinthe requirementsof section3 of the 77CCAA; (b) the familythat controlledthe debtorhad “enhancedits o positionvis-a-vis[the unsecuredcreditors]by takingsecurityto the extentof $5 million.., fromthe companyto that 78value”; (c) the objectiveof any plan wouldnot be to continuethe businessof the debtorbut to sell it off in whole or in part and that a merchantbankerretainedby the debtorto assistthe debtorwith its fmancialdifficulties“wasconcernedwith the agenda”of the familythat controlledthe 79debtor; and

(d) “. . . Cangois simplyaskingthe Court tostay thehandsof creditorsin the hopethat, in whateverperiod of graceis granted,somethingmorewill happenthan has occurredduring the past9 months,and that somethingwill permitthe companyto be 80salvaged.” We mustcontrastthe approachtakenin Congowith the approachtaken by the samecourtin

Re PerkinsHoldings. In that case,the courtrecognizedthat proceedingsunderthe CCAAshouldbe discontinued’8 if the situationis “totallyhopeless,” sincethe plan wouldhave no hope of succeeding giventhe creditors’strongoppositionto it. However,the court allowed thedebtor’sapplicationunder the CCAAon the basis, inter alia, that the debtor“recognizedits fmancialproblemsand retained outsidehelp in an attemptto resolve83theni” Again,the court didnot alludeto the motivesof the debtorin seekingrelief underthe CCAA. However,the basis on whichthe court allowedthe

Ibid at 235, 236.

78 Ibid at 238.

‘ Ibid at 240.

80 Ibid at 238.

81 (1991),6 C.B.R. (3d)299 (Ont. Gen.Div.) [hereinafterPerkins].

82 Ibid at 303.

83 Ibid at 306. 50 applicationcertainly points to the “stateof mind” of the debtor.

Reportedcases consideringthe BIA have not addressedthe issueof goodfaith incommencing proposalproceedings. However, onecommentatorsuggestedthat goodfaith maybe an issueto be consideredunder subsection50.4(11)in a motionby a trustee,interim receiveror a creditorfor the terminationof the periodduringwhichthe debtormay file a proposal. This doesnot directlyaddress the issue the debtor must 8 of whether be actingin goodfaith in commencing proposalproceedings,as the issueis not consideredat the outsetof the case. It is consideredas part of an applicationthat is heardoncethe court has acceptedjurisdictionof the matter.

An absenceof a requirementor specificexclusionof goodfaith may proveto be beneficialfor

Canadianpractitionersseekingto challengethe commencementof reorganizationproceedingsby a debtoron that ground. Unlikethe Code,whereit is at least arguablethat goodfaith shouldnot be an elementto be consideredas a filingrequirement,givenits specificexclusion,in Canada,the courts havethe rightto consider theconceptundertheir equitable85jurisdiction. Underthe BIA, the courts listedin section 183 “areinvestedwith suchjurisdictionat law and in equity as will enablethemto exerciseoriginal,auxiliaryand ancillaryjurisdictionin bankruptcyand in otherproceedingsauthorized by this Act” [emphasisadded]. The CCAA provides certaincourtswithjurisdictionto hear applicationsand make orders86thereunder. The variouscourtslistedin the CCAA,by their enabling provincialstatutes,are investedwith legaland equitablejurisdictionwithintheir respectivetenitorial jurisdictions. Accordingly,the variouscourtshearingapplicationsunder either theBIA or the CCAA

‘ K Han,, “CorporateRestructuringUnderPart ifi of the Bankruptcyand InsolvencyAct”in CoiporateRestructuring(Toronto:CanadianInstitute,1992)Tab ifi at 32. See chapterVI(B), below, for a generaldiscussionon the time withinwhicha plan proponent mustfile a plan.

85 Honsberger,supranote 42 at 23.

86 CCAAs. 2 “court”.

87 See e.g.,JudicatureAct, R.S.A. 1980,c. J-l, s. 5(l)(a); Supreme CourtAct, R.S.B.C.1979,c. 397, s. 3, Law and EquityAct, R.S.B.C.1979,c. 224, s. 4. 51 may apply the doctrineof goodfaith,apart the holdingin UnitedMaritime 88Fishennen. This is illustratedby the following quotationfrom a leadingtext on equity:

Thesethree maximsmay be viewedas togetherillustratingthat greatdistinctiveand governing principleof equity,that nothingcan call forth a court of equityinto activitybut conscience, goodfaith, and personal89diligence. Having establishedthat thecourtsin Canadamay havethejurisdictionto considerthe “stateof mind”of the debtor in commencing reorganizationproceedings,we now turn our attentionto whether the courtsshould considergoodfaith in determining whetherto allow adebtorto commenceor continuereorganizationproceedings.

3. Should Good FaithBe a Consideiufion?

The commentatorswho suggestthat thereis or shouldbe a goodfaith standardfor commencingreorganizationproceedingsunderthe Codecite the legislativehistoryand general principlesof equity in supportof that 9position. Conversely,those who arguethat there is not or shouldnot be such a standardcite the°legislativehistoryand the plain meaningof the statutein

88 Supra note 38.

89 E.HT. Snell, The Princ4,les of Equity (London:Stevenand Haynes, 1868)at 33. Thethree maximsreferredto by the authorare:

(a) He who seeksequity mustdo equity.

(b) He who comesinto equitymust comewith cleanhands.

(c) Equityaids the vigilant, notthe indolent.

9° See e.g, J. Moss, “ConsecutiveChapter 11Filings:Use or Abuse?” (1991/92)19Fordham UrbanL.J. 111;Cohn,supra note 60; D.B. McColl,“GoodFaith in ChapterElevenReorganizations” (1984)35 S.C.L.Rev. 333;RL. Ordin,“TheGoodFaithPrinciplein the BankruptcyCode:A Case Study”(1983)Bus. Law. 1795;D.M Zavagno,“TortClaimsAgainstBusinessDebtorFilingsFor Reorganizationand a Fresh Start”(1983)52 U. Cin. L. Rev. 791. 52 supportof that 9position. It is difficult’ to arguethat goodfaith shouldnot be presentwhen a debtorcommencesa reorganizationproceeding. Saidanotherway, shoulda businessreorganizationstatuteallowa debtor with improperor fraudulentmotivesthe benefitof its protections? One’svisceralreactionto sucha propositionis to reject it outright. After all, it seemslogicaland properthat to take the benefitof a reorganizationstatute,the debtor should havean honestyof intent touse the legislationto attemptto reorganizeY In addition,the goodfaith standardpreventsthe debtorfrom abusingthe bankruptcy process forillegitimateor reprehensible purposesand maintainsthejurisdictionalintegrityof the bankruptcy93courts. Whilethese argumentsare compelling,the difficultyin requiringgoodfaith as a precondition to allowinga reorganizationproceedingto be commencedor continuedis its abstractand intangible quality,as describedin the definitionset forth 94earlier. To be of assistancein the commercial environment,standards governingconduct must havepredictabilityof result. Withoutsuch predictability,transactioncostswill increase andforumshoppingmay result. One commentator expressedthis concernover lack of predictabilityby notingthat “themajorproblemwith the good faith standard[is that] it is so vaguethat there will alwaysbe conflictingcase 95law.”

91 See e.g., Flaccus,supra note 62; MJ. Bienenstock,BankniptcyReoiganization(NewYork: PractisingLaw Institute, 1987)at 28-34;D.J. Tyukody, “GoodFaithInquiriesUnderthe Bankruptcy Code:Treatingthe Symptom,Not the Cause”(1985)52 U. Chi. L. Rev. 795;Di Donato,supra note 70.

cohn, supra note 60 at 134.

Little Creek,supra note 49 at 1072.

‘ Supra note 44 and accompanyingtext.

Flaccus,supra note 62 at 434-435; see also,PhoenixPiccr]illy,supra note 49, wherethe court said:

there is no particular test fordeterminingwhethera debtor hasfiled a petitionin bad faith. Instead,the courtsmay considerany factorswhich evidencean intent toabusethe judicial processand the purposesof the reorganization provisionsor, in particular,factors whichevidencethat the petitionwas filed to delay or frustratethe legitimateeffortsof secured 53

Whilethere may be reasonsfor attemptingto determinethe motivesof the debtorin

conmiencingthe proceedings,there are adequatestatutoryprotectionsaffordeddisgruntledparties, whichmay be invokedvery early in the proceedings. A party may applyto have theautomaticstay lifted underthe Code for cause,includinga lack of adequateprotection. Under theBIA, the party may apply forrelief fromthe stayif it determinesthat it is beingmateriallyprejudiced? In addition, the niles of court in the variousjurisdictionsin Canath providethat a proceeding6 that is frivolousor vexatiousmay be 97dismissed. if the normativebasis of a businessreorganizationproceedingis evident,the motivesof the debtorshouldbe irrelevant. That is, the courtwouldmerelybe askedto considerwhetherthe proceedingmeetsthe objectivesof the legislation. One writersuggestedthat dismissinga case based on bad faith may adverselyaffectcreditorsand the publicinterestby thwartinga reorganizationand equitabledistributionof the assetsof the debtorbased onthe “mentalsin of the debtor’sproprietoror corporate98officer.” In otherwords,the courtsshouldnot focuson the “stateof mind”of the debtor. Theyshouldconsiderthe objectivesof the legislationto determinewhetherreorganizationll benefit creditorsthrough an equitabledistribution,whetherthere is a benefitto societyas a wholeby salvagingthe businessand havingit continueas an ongoingentityand whether,througha reorganization,the debtormay be 9rehabilitated? D. CONCLUSION

The character andmotivesof the debtorshouldnot be consideredby the courts indeciding

creditorsto enforcetheir rights.”[at 1394,citationsomitted].

See discussionin chapterV(A)(4Xc),below.

See e.g. AlbertaRules of Court,r. 129(1)(b).

98 Bienenstock,supra note 91 at 30-31.

cf PhoenixPiccdilly,supra note 49 at 1395wherethe court said “[t]hepossibilityof a successfulreorganizationcannottransfera bad faith filinginto one undertakenin goodfaitK” 54 whetherto allow a reorganizationproceedingto be commencedor to continue. The focusof the examinationshouldbe whetherthe proceedingwill accomplishthe objectivesof the legislative scheme. Whetherthe debtoris insolvent,has issuedbondsor debenturesunder a trust deedor is actingin goodfaith in commencingthe proceedingshouldnot be the focusof the court’sinquiry.

Thereare alternatemeansof suppressingan abuseof the bankruptcyprocesswithoutcompromising the interestsof the partiesto the proceeding. The court could,for example,lift the automaticstayof proceedingsor dismissthe proceedingon the groundsthat it is ffivolousor vexatious, If there are legitimatereasons for maintainingthe proceedings,irrespectiveof the character,conductor motivesof the debtor,the proceedingshouldbe maintained. 55

CHAFFERIV

CUSTODYOF ThE FSTAFE OF ThE DEBTOR

Reorganizationproceedingscommencedunder the BIA require the interventionof a trustee,’ inter alia, to nxnitor and investigatethe debtor’sassets, business and financialaffairs and to evaluate the causeof its financial difficulties. Section47.1 of the BIA gives the court discretionto appointan interimreceiver, in addition2 to the trustee appointedunder the proposal or named in the notice of intentionto make a proposal. The court will appointan interim receiver if it is considerednecessary for the protection of the debtor’sestate or the interestsof one or more creditors or the creditors 3generally. Underthe CCAA,,althoughthere is no expressprovisionallowingfor the appointmentof a trusteeor interim receiver,the orderspromulgatedat theoutsetof a proceedingunderthe CCAA

“typicallyincludeprovisionfor the appointmentof a ‘monitor’.”

We must contrastthis virtualautomaticappointment4 of an independententityhaving powers rangingfrom overseeingthe debtor’soperationsand financialaffairs to ousting its management,with the approachtaken under the Code that maintainsthe debtorin possession of the business and its affairs. The ouster of the debtor’smanagementby the appointment5 of a trustee underthe 6Code has

BJA ss. 50(2)and 50.4(1).

2 BIA ss. 50(5) and (10) and 50.4(7).

BIA s. 47.1(3).

D.H Goldman,D.E. Baird and MA Weinczolç “ArrangementsUnder the Companies’Creditors ArrangementAct” (1990), 1 C.B.R.(3d) 135at 200.

Code s. 1101(1)defmes “debtorin possession”as the “debtorexceptwhen a person that has qualifiedunder section322 of this title is servingas trustee in the case”. In this chapter,the acronym DIP will be used to denotethe debtorin possession.

6 Code s. 1104(a). 56 been describedas an “extraordinary7remedy” that will be allowedonly on the basis of clear and convincing8evidence. In other words, the debtor’srightto remain in possession and control its financial and businessaffairs is a strongpresumption. This chapter will examinethe concept9 of the DIP, its rights and duties andthe checksand balances imposedby the Code and the courtswhich ensure that the DIPis fulfilling its duties. It will then examinethe circumstancesunder and standardsby which the courtsdetermine whetherthe appointmentof a trusteeor an examineris 10appropriate. The purpose of this examinationis to determinewhether maintainingthe DIP or, alternatively, whether the virtual automaticappointmentof an independentthird party is more likely to result in the fulfilmentof the objectivesof a businessreorganizationsystem. In so doing, this chapterwill examine the advantagesand disadvantagesof appointinga trusteeor examiner.

A. DEBTORIN POSSFSSION(DIP)

1. legislative Ilistoty and ConceptualBasis

The legislativehistory of the Codeand the structureof Chapter 11 make it clear that the

In re Ionosphere Clubs,Inc., 113B.R. 164at 167(Bankr. S.D.N.Y.1990)[hereinafter Ionosphere];In re Microwave Productsof America, 102B.R. 666 at 670 (Bankr.W.D. Tenn. 1989) [hereinafterMicrowave];In re Sharon Steel Coip., 86 B.R 455 at 457 (Bankr.W.D. Pa. 1988),afJ’d 871 F.2d 1217at 1225(3d Cir. 1989)[hereinafterSharon Steel]; In re Hotel Associates, Inc., 3 B.R. 343 at 345 (Bankr.E.D. Pa. 1980) [hereinafterHotel Assocs.].

8 C.W. Frost, “Runningthe Asylum: GovernanceProblems inBankruptcyReorganizations”(1992) 34 Az. L. Rev. 89 at 121. See also Sharon Steel, ibid at 1226(3d Cir.), ibid. at 457 (Bankr.); Microwave,ibid at 670.

Committeeof Dalkon Shield Claimantsv. A.H Robins Co., 828 F.2d 239 (4th Cir. 1987)where the court affirmedthe fmding that the debtorwas in civilcontempt,but held that such fmdingwas not to be equatedwith fraud or mismanagementsufficient tojustify the appointmentof a trustee [at 240].

10 Code s. 1104(b). The appointmentof an examineris a less drastic remedy. An examinerhas investigative andreporting duties under paragraphs 1106(a)(3)and (4) but it does not have the same managerial andsupervisory rightsand duties as a trustee, such as the rightto carry on the businessof the debtor pursuant to section 1108 [D.W.Given, “Whenand Why Courts Appoint Trusteesin Bankruptcy”(1988) 34:6 Prac. Law.29 at 35]. 57 debtor’sprepetitionmanagementis to remainin possessionand controlof the debtor’sfmancialand business affairsfollowingcommencementof the proceedings. Section1107provides thatthe DIP shallhave all the rightsand powersand shallperformall the dutiesof a trustee,other thancertain obviousexceptions,such as the dutyto investigateitself and reportthereon. Section 1108of the Code allowsa trustee,unlessthe courtorders otherwise,to operatethe debtor’sbusiness. Thus,the DIPis entitled,inter dia, to carryon the debtor’s1business. The conceptof the DIP firstappeared’ insection277B.’ ChapterX retainedthe 3concept,’but only with respectto entitiesthat owedless than a prescribedamount. In all other cases,ChapterX requiredthe appointmentof an independent14trustee. ChapterX includedthe requirementfor the appointmentof an independent trustee,in large cases,at the instanceof the SecuritiesandExchange 15Commission, to protectpublic investorsand the publicinterest. The trustee’srole was notmerelyto investigate or supervise,but to take a very activerole in the reorganizationprocess. Besides investigativeand supervisorypowers,the trustee wouldsupervisethe negotiationsleadingto a reorganizationplan, assistin the formulationof the plan and, ultimately,presentthe planto the 6court)

“ The legislativehistoryreflectsthis intention. The House Reportat 404, stated thatsection1107 “placesthe debtorin possessionin the shoesof a trusteein everyway”andthat section 1108“does not presumethat a trusteewill be appointedto operatethe businessof the debtor. Rather, thepower granted totrusteeunder this sectionis one of the powers thata debtorin possessionacquiresby virtue of proposed[section11071.”

12 77B(c)(1).

13 ChandlerAct s. 156provided,interdia

“Wherethe liquidatedand non-contingent indebtednessof a debtoris $250,000or over,the judge shall,upon theapprovalof the petition, appointone or moredisinterestedtrustees,who shallbe qualified, exceptas to residenceand locationof office,as prescribedin section45 of the Act. Wheresuch indebtednessis less than $250,000,thejudge may appointone or more such trusteesor may continuethe debtorin possession.”

14 Ibid

15 J.I. Weinstein,TheBankriçtcy Law of 1938 - ChandlerAct (NewYork:NationalAssociation of CreditMen, 1938)at 212.

16 RJ. McAfee,“BusinessRehabilitation- Chapter11”(1979)48 U. Cin. L. Rev. 392 at 393. 58

ChapterXI provided,in substance,that thedebtorwas to remain in possessionand authorized the debtor to operate the business, unless a trusteewas appointed.’ This was very similar tothe

Code’sprovisions. This issueof the appointmentof a trustee7 was the subjectof a “substantial 8debate” prior to the Code’spassage. Theresultinglegislationis a compositeof the SenateandHouse versions.

ChapterX requiredthe appointmentof a trusteein cases involvinglarge,widely-held companies. The SenateReportfelt thatit was necessaryto differentiatebetweena case involvinga public companyand one involvinga privatecompanyand soughtto retaina requirementfor appointmentof a trusteein the caseof publiccompanies,whatevertheir 9size.’ The SenateReport expressedthe necessityof this protective mechanismas follows:

In a largepublic company,whoseinterests arediverse andcomplex,the most vulnerabletoday are public investorswho own subordinateddebt or equitysecurities. The bill, like chapter)ç is designedto counteract thenaturaltendencyof a debtorin distressto pacifylarge creditors, with whom thedebtorwouldexpectto do business, atthe expenseof small andscattered public20investors. In otherwords,a trusteewould protectthe interestsof the subordinateddebt holdersand investors

“i’ ChandlerAct ss. 342 and 343 provide:

“342. Where thereis no receiveror trustee,the debtorshall continuein possessionof his property andshall have thetitle and exercisethe powersof a bankruptcytrustee,subject, however,to the controlof the court and tothe limitations,restrictions,terms and conditions whichthe courtmay, fromtime to time,prescribe.

343. The receiveror trusteeor the debtor inpossession,whenauthorizedby the court and subjectto its control,shall havethe powerto operatethe debtor’sbusinessand manageits property during such limitedor indefmiteperiodas the court may, from timeto time,fix, and shallreportthereonto the courtat such intervalsas the courtmay designate.”

‘ Frost,supra note 8 at 113. The extent andnatureof the debateis discussedin RJ. Berdanand B.G.Arnold,“Displacingthe Debtorin Possession:The Requisites for andAdvantagesof the Appointmentof a Trustee in Chapter11Proceedings”(1984)67 MarquetteL. Rev. 457 at 460-469. Illustrativeof the extentof the debate,the writersof the latter articlenoted “. . . very few issuesdealt with by Congressin connectionwith thedraftingof the Codeproduceda greaterdivergenceof views than thestandardsfor the appointmentof trustees.”[at 461].

‘ SenateReportat 9-11.

20 Ibid at 10. 59 whereas,it was the Senate’sperceptionthat a DIP would onlybe concernedwith self-interest.

The HouseReport spurnedthe publicversus private companydistinction. The report specificallyreferred to the fact that the securitieslaws and the vigorous enforcementby the Securities and ExchangeConmiissionprovide sufficientpublic protection. The House Report felt that “[t]he public andthe creditors will not necessarilybe harmed’2 if the debtor is continuedin possessionin a reorganization22case.” The court, in consideringwhether a trustee would be appointed,would consider allfactors and determine,in each case, whether there is a need for a 23trustee. The major divergencebetweenthe recommendationsof the HouseReportand the resulting

Codeprovisionswas in the methodof selectingthe trustee. The HouseReport recommendedthat the United States4truste& make the appointmentof the trustee,followingconsultationwith the partiesin interestand su1ject to approvalof the court,which, in mostcases,wouldbe 25perfunctory. The Code rejectedthis notionand providedthat the court appointthe trustee“onrequest of a party in interestor the United States 26trustee.” The DIP is the prepetitionmanagementof the debtor and practically,there is no change in or

21 HouseReport at 233.

22 Ibid

23 Ibid

24 The United Statestrustee is a governmentofficial appointedthe Attorney General, see 28 U.S.C. 581 (1988). In creatingthe office of the United States trustee, the House Reportexplainedthe duties of the office as follows:

“Someof the servisory functionsremoved from the judge will be transferredto a new system of United States trustees who will act as bankruptcywatchdogs,overseeingthe qualificationsand appointmentsof private trustees in bankruptcycases, servising their performance,monitoringtheir fees, and servingas trustees in cases where a private trustee cannot be found to serve.” [HouseReport at 4]

The United States trustee is not mlike the &qeiintendent of Bankruptcyin Canadi See BIA ss. 5 and 6.

25 House Report at 234.

26 Code s. 1104(a). 60 replacementof the personnelof preexisting27management. However,conceptually,because theDIP has powersand assumesdutiesthat, beforethe filingof the petition,the debtordid not 28have, the DIP doesnot appearto be one and the sameas the debtor. This has resultedin some courtsdescribingthe DIP as a “new29entity.” The analysisof the DIP as a new entityis usefulconceptually. Itis difficult, for example,withoutsuch analysis,to understandhow the law maysanctiona breachof a valid contract. However,if one proceedson the basisthat the DIP is a differententity fromthe debtorand that theDIP is not a party to the contract,such analysisis morepalatable. The courtshave not universallyacceptedthe new entityconcept,°3 31however. For example,the United StatesSupremeCourt inNationalLabor RelationsBoard v. Bildisco and 32Bildisco, heldthat the debtor andthe DIP werethe sameentitybut that theCodeconferredon the DIP certainpowers

27 In re DeLuca DistributingCo., 38 BR. 588 (Bankr.N.D. Oh 1984).

28 The DIP, postpetition,has the power,for example,to recover preferencesor fraudulent transfers pursuantto sections547 and 548 of the Code,respectivelyor it may reject or assumeand assign executorycontracts orunexpiredleasespursuantto section365 of the Code. This latter poweris discussedat chapterV(B),below. Priorto the filing of the petition,the debtor did nothavethese powers. Conversely,the DIP has additionalduties suchas the filingof lists, schedulesand statements requiredby subsection521(1).

29 See e.g., Re Baldwin UnitedCoip., 43 B.R 443 (Bankr.S.D. Oh.1984)[hereinafterBaldwin]; Shopman’sLocal UnionNo. 455 v. Kevin Steel Products,Inc., 519 F.2d 698 (2d Cir. 1975) [hereinafterKevin Steel], where the court said “[a]debtor-in-possessionunder chapterXI orunder chapterX a trusteeunder thelatterchapter,or a trusteein a straightbankruptcyproceedingis not the sameentityas the pre-bankruptcycompany.”[at 704,emphasis original].

° See e.g., Kevin Steel, ibid This type of analysisis also useful for determiningthe priorityof claims. Sections503 and 507 of the Codegive a first priorityto administrativeexpenseswhichare “theactual,necessarycosts and expensesof preserving theestate.”Second inpriorityare allowed unsecuredclaims. If the DIP incurredthe expense,the claimwouldbe givenan administrative expensepriority. On the otherhand,if the expense wasincurredby the debtor,it wouldmerelybe an unsecuredclaim. See Baldwin, ibid. Seealso Re Wil-LowCqfeterios,Inc., 35 F. Supp.965 at 968 (S.D.N.Y.1940).

31 See e.g. Cle-WareIndustries,Inc. v. Sokolsky,493 F.2d 863 (6th Cir. 1974)where,in rejecting the notionof appointingseparatecounselfor the debtorand for the DIP, the court said “[t]hedebtor and the debtor-in-possessionis one and the sameperson,although‘wearingtwo hats’.”[at 870-871].

32 465 U.S. 513 (1984). 61 and duties that the prepetitiondebtor did not 33have. Thistype of analysisis in keeping with the notion that legislation,if it is clear and unambiguous,may effect an object that, atfirst blush, appears to be contraryto our notions of fair play. The Code is clear in providingthe DIP the right, for example,to reject a valid and enforceableexecutorycontract or unexpiredlease incircumstances where the debtor could not do so. The United States SupremeCourt merely interpretedthe plain and unambiguouslanguageof the Code without seeing the necessityof attemptingto draw a conceptual distinctionbetween the DIP and the debtor. One witei characterizesthis distinctionbetweenthe debtor and the DIP as nothing more than a distinctionin roles. That is, the DIP exercises its duties and powers for the benefit of “diverse35constituencies,” includingcreditors and shareholders,whereas the debtor’sduties are limitedto benefittingthe equity 36holders.

2. Hduciaiy Duty of the DIP Althoughthe structureof the Code makes the dutiesof the DIP and the trustee 37coextensive, with certain exceptions,the followingexaminationwill focus on the DIPs fiduciaryduty, as the trustee, usually, will not exercise its duties in a biased 38manner.

Ibid at 528

T.G. Kelch, “ThePhantomFiduciary:A Debtor in Possessionin Chapter 11”(1992)38 Wayne L. Rev. 1323at 1334.

Ibid at 1323.

36 MJ. Bienenstock,“ConflictsBetweenManagementand the Debtor in Possession’sFiduciary Duties”(1992) 61 U. Cm. L. Rev. 543 at 553.

Codes. 1107.

38 Subsection324 of the Code penriits the removal of a trustee “for cause.” The legislative history makes it very clear that removal may be made in a summaryfashion if the trustee is fI.inctioning“improperly,poorly or even illegally”[HouseRepon, HR. No. 99-764,99th Cong.,2d Sess. (1986) at 27, repHntedin 1986U.S.C.C.A.N.(554 Stat.) 52271. 62 The DIP has the duty to act as a fiduciaryof the estate andthe estate’s39creditors. The United StatesSupremeCourtoutlinedthis dutyas follows:

[T]hewillingnessof courtsto leavedebtorsin possessionis premisedupon an assurancethat the officersand managingemployeescan be dependeduponto carry out the fiduciarydutiesof a 4trustee. This duty°does not extendto the debtoritself or the debtor’sprincipalsunless the principalsare also 4creditors. In acting inits fiduciarycapacity,the DIP must maintaina levelof impartialityandtreat ’all partiesfairly and 42equitably. In addition,it must exercisethe care and skillthat a reasonable person wouldexercisein similar 43circumstances and must avoidprofitingat the expense of creditors and the debtor’sshareholders.

With the fiduciaryduty imposedon the DIP comesliabilityfor its breach. Negligencein the performanceof its fiduciaryduty may result in liabilityof the 45estate or personal4°liability. However,

HouseReport at 404;SenateReport at 116. See also In re Johns-ManvilleCoip., 52 B.R 879 (Bankr.S.D.N.Y.1985),wherethe court said:

“Thus,Manville’sdirectors,in negotiatingany plan of reorganization,and indeedfor as long as Manvilleremains in Chapter11,are requiredby the Code to act as fiduciariesof the estate. [Amy directorswouldhaveto act not for the narrowinterestsof shareholders,but as fiduciariesof the estate.”[at 8851

For an extensivediscussionof the fiduciarydutiesof the DIP, see Kelch,supra note 34.

4° CommodityFutures TrcriingCommissionv. Weintrc&b,471 U.S. 343 at 355 (1985) [citations omitted],on remand 776 F.2d 1049(7th Cir. 1986).

‘ In ie L & S Industries,Inc., 122B.R. 987 at 993-994(Bankr.N.D. 111.1991),qtj’d989 F.2d 929 (7th Cir. 1993).

42 Kelcl supra note 34 at 1344. See also In re Cochise CollegePark, Inc., 703 F.2d 1339(9th Cir. 1983)at 1357[hereinafterCochise CollegePatic].

Cochise CollegePark, ibid

Microwave,supra note 7, wherethe courtheld that “anyattemptby the individualboard members[of the DIP] to structuredealsthat wouldbenefitthemprivatelyto the detrimentof other creditorswould contravenethe fiduciaryrelationship.”[at 672].

“i Ford Motor Credit Co. v. Weaver,680 F.2d451 at 461 (6th Cir. 1982)[hereinafterWeaver]. SeealsoIn re Johnson, 518 F.2d 246 at 251 (10th Cir. 1975),cert. denied (sub nom. Clark v. Johnson)423 U.S. 893 (1975). 63 personal liability will certainlyresult from intentionalviolationof the fiduciary 47duty. As there are only finite resourcesavailablefor distributionamongthe debtor’screditors,the DIP must make decisionsconcerningthe allocationof those s.’ Accordingly,what one party sees as a breachof the DIP’sfiduciaryduty, others may see as completelyfair dealing. In clear casesof intentional ‘wongdoing the DIP will be held strictly49accountable. On the otherhand, the courts will uphold decisionsbased on reasonablebusinessjudgment. The DIPmust exercise caution in makingsuch decisionsand be able to justify the basis°5 of its decision,from a practical and documentarypointof view.

The DIP may be put in the unenviableposition of having to makedecisions detrimentalto both the debtorand the prospectsof reorganizationin the interests of “impartiality,”if to do otherwise may be seen as a breachof its fiduciary duty.

3. External Contrnlof the DIP Besides the appointmentof a ’5trustee or 52examiner and the impositionof disclosure

Mosser v. Darrow, 341 U.S. 267 at 272, 274 (1951).

Weaver,supra note 45; In re GeorgeSchumann Tire and Batteiy Co., 145B.R. 104at 108 (Bankr.MD. Fla. 1992),which was a chapter 7 case. In that case a trustee was found to have intentionallybreachedcourt orders requiringthe payment of surplus funds to the debtor. The court grantedpersonaljudgment against the trustee. See also In re Weber,99 B.R. 1001(Bankr.D. Utah 1989),where the court “piercedthe corporateveil” and held the sole shareholderand directorof the DIP personally liable for a breach of fiduciaryduty [at 1011].

48 Microwave,supra note 7 at 671.

See e.g. In re Weber,supra note 47 at 1013.

5° See e.g, In ie Johns-Manville,60 B.R. 612 at615-616(Bankr S.D.N.Y. 1986). In this case, the court approvedthe DIP’sretention of lobbyiststo monitor and express the views of the debtor on all legislativeand regulatorymatters with respect to, interalia, asbestos compensationlegislationon the basis that there was a “reasonablebasis for its businessdecision.”

Code s. 1104(a). See discussioninfranotes 6 1-75and accompanyingtext.

52 Code s. 1104(b). See discussioninfra notes 76-79 and accompanyingtext. 64 53requirements, the Codeprovidesmechanismsfor overseeingthe powersexercisedby the DIP. The legislativehistorysuggeststhat Congress,whilerecognizingthat creditorcontrolin bankruptcycases couldbe beneficialand is “theoreticallysound,Malso recognizedthat most creditorsare simpiynot interestedin pursuingthe debtoror participatingin the bankruptcy55process. This seemslogical whetherone is examininga Canadian proceeding oran Americanone. To continueits pursuitof a debtor oncethe debtorcommencesbankruptcyproceedings,a creditorwill incur expensesthat may result in a judgmentagainsta person fromwhomthe creditor will not recoveranything. Shouldthe creditorchooseto participatein the proceedingdirectlyas eitheran inspector(in a Canadian bankruptcy proceeding) oras a memberof a creditors’committee(in an Americanreorganization proceeding),there may be significanttime commitmentsinvolvedin attendingmeetingsand instructing outsideadvisors. Not surprisingly,Congressobservedthat “[c]reditorcontrolin bankruptcycasesis a 56myth.” Congressdiminishedcertainfunctionsof the creditors’committeein an attemptto makethe creditors’committee procedureless onerouson the 57participants. The creditors’committeemay consultwith the DIP, investigatethe debtor’saffairs,participatein the formulationof the plan and request theappointmentof a trusteeor 58examiner. In realityhowever,creditorsare still reluctantto participatedirectlyin monitoringthe debtor’saffairs.

Creditors’committeeswere appointed inonly a minorityof cases. Theyusuallyfailed to obtain assistancefrom an attorney, accountant,or otherpersonfamiliarwith the reorganization

Referencehas afreadybeen made tothe filingof lists, schedulesand statementsunder subsections1106and 521(1)of the Code [Seediscussionsupra note 281. Other examplesof disclosureduringthe reorganization proceedingis the dutyto disclosethe identityand affiliationsof individualsthat the plan proposesto serveas directorsor officerspostconfirmation[Codes. 1129(a)(5)(A)(i)]and the compensation payableto trusteesduringthe chapter 11case [Codes. 326(a)].

HouseReportat 92.

Ibid

56 Ibid

House Reportat 104.

Codes. 1103. 65

process. They seldom conductedinvestigationsof the cause of business failure or provided serious oppositionto any course the debtor chose to follow. In those cases where they did oppose the debtor, they were 59unsuccessful. Thus, it appearsthat, with the level of creditor apathyin reorganizationproceedings,creditors’ committeesdo not provide an effectivemode of controllingthe debtor. The more powerfulweaponin thearsenal ofacreditor is thecdhocpowertoraiseandbeheardonanyissue inacaseunder

Chapter 11.60 Under subsection 1109(b),a party mayraise issues that affect it directly, thoughit is not involvedin the case in any general supervisorycapacity. The court may also limit the powers of the DIP under subsection1109(b),acting sua sponte. Subsection 105(a)of the Code provides:

The court may issue any order, process, or judgment that is necessary or appropriateto cany out the provisionsof this title. No provisionof this title providingfor the raising of an issue by a party in interest shall be construedto precludethe court from, sua sponte, taking any action ormaking any determinationnecessaryor appropriateto enforceor implementcourt orders or niles, orto prevent an abuse of process.

Under subsection1107(a),the court may circumscribethe powers of the DIP. This right points to the broad power of the court to controlthe operationof the business and the transactions entered into by the debtor, as well as the entire procedurecontemplatedby Chapter 11. The court may exercisethe powers on a transactionalbasis, such as through hearings forrelief from the automatic stay of proceedingsor the rejection or assumptionof executorycontracts or unexpiredleases.

The foregoingillustrates some externalcontrols imposedon a DIP. However, partiestake less than full advantageof these controls because of creditor apathy, which may be the result of the perceptionthat the system is working adequatelyor, conversely,that the system is a completefailure and participatingin it is a waste of time and resources. This paper will not examinethat issuebut

L.M LoPucki, “TheDebtor in Full Control- SystemsFailure Under Chapter 11 of the BankruptcyCode?”(2d Install) (1983) 57 Am. Bankr. L.J. 247 at 272. ProfessorLoPucki’sstudy is one of the few quantitativeanalyses conductedin the field of business reorganizations.

60 Code s. 1109(b). This right must be contrastedwith the section 34 of the BIA which permits only the trustee to apply for directionsand does not permitany other party to apply. Creditorsare givenvery little recourseto the courts andonly in limitedcircumstances,see e.g. the right under section 69.4 of the BIA to apply to the court fora declarationthat the stayof proceedingsno longer operates in respect of that creditor. 66 merely observesthat creditor participationin Chapter 11 cases is minimal. Provided that creditorsare adequatelyprotected and their positions are not eroding during thependencyof the case, one wonders whetherthe mandatoryappointmentof an independentthird party is necessaryor advisable.

4. AppoinUnentof a Tiusteeor Examiner

The appointmentof a trustee is an extraordinaryremedythat the courts use sparingly. One court stated that, absent fraud, a trustee shouldnot displacethe 62debtor. The practical’6 reason for this reluctanceis that the DIP is usually more experienced andmore familiar with the debto?s businessand operationsthan the trustee. As well, the decisionhas financialaspects, as a trustee will uadoubtedly consumethe debtor’sscarce financialresourcesin its attemptto familiarizeitself with the debtor’s businessand the operationof the 63business. Whilecourtsrecognizethat, in most reorganizationcases, some mismanagementor imprudentdecision-makinghas taken place, they are scepticalthat a trustee is in any better position to manage a business,properly and pnidently, with which it has little or no TMfamiliarity. Thus,as complexityof the debtor’sbusiness or industryincreases,the applicant’sonus becomesheavier and there is an increased likelthoodof the application65failing. Generally,the courts requirethe applicantto establish a clear and convincingcase for the appointmentof a trustee,

61 Supra note 7 and accompanyingtext.

62 In re ColumbiaMotor Express,Inc., 33 B.R 389 at 393 (MD. Tenn. 1983).

63 In re Anchorage BoatSdes, Inc., 4 B.R 635 at 644 (Bankr.E.D.N.Y. 1980),where the court felt it appropriateto conduct a cost-benefitanalysisin order to detem,inewhetherthe appointmentof a trustee was appropriatein the circumstances;Microwave,supra note 7 at 676.

64 In re Anchorage Boat Sdes Inc., ibid at 645; In re QueenKon&iratosLines, Ltd, 10B.R 609 (Bankr.D. Me. 1981),wherethe court observedthat “[utis reasonable to expectthat no [sic] every business decision of a reorganizationdebtor will reflect exemplarybusiness acumen. . . it beingthe exceptionalreorganizationcase that doesnot come intothis court at least in part because of some imperfectmanagerialdecisionmaking.”[at 610].

65 D.W. Given, “Whenand Why Courts Appoint Trustees in Bankruptcy” (1988)34:6 Prac. Law. 29 at 31-32.

Supra note 8 and accompanyingtext. 67

although theCode doesnot requiresuch a standard.

Subsection 1104(a)sets out the standardsgoverningthe appointmentof a trustee. It provides:

At any time alter the commencementof the case but before confirmationof a plan, on request of a party in interestor the UnitedStatestrustee, andafter noticeand a hearing,the court shall order the appointmentof a trustee - (1) for cause, includingfraud,dishonesty,incompetence,or gross mismanagementof the affairsof the debtor by current management,either before or alter the commencementof the case, or similarcause,but not includingthe numberof holders of securitiesof the debtor or the amountof assets or liabilitiesof the debtor;or (2) if such appointmentis in the interestsof creditors,any equity securityholders,and other interestsof the estate, without regard to the numberof holders of securitiesof the debtor or the amountof assets orliabilitiesof the debtor.

Althoughthe courts draw a distinctionbetweenthe “for cause” standardin paragraph 1104(a)(1)and the “bestinterests”standard in paragraph671104(a)(2), a “cause”under paragraph(1) that wouldnot justify the appointmentof a trusteeunder that paragraphwould likely be an elementconsideredin an analysisunderparagraph(2).

The causes listed in paragraph(1) are not exclusivebut are merely illustrativeof causesthat mayjustify the appointmentof a trustee, as Congresslisted the factors as 68“included” in the descriptionof “cause.” Also, the applicantneed not prove all of the factors listed in paragraph(1) to have a trusteeappointedbut the listed factors are alternatives. For example, incompetentmanagement is not necessarily69dishonest. Improperconductby prepetitionmanagementinvolving°7fraud or breach of fiduciary ’7duty will justify the appointmentof a trustee. Casesinvolvingprepetition negligence,incompetenceor errors of judgment of managementare less clear. The courts examine

67 Berdan and Arnold,supra note 18 at 472.

68 Code s. 102(3)provides “includes’and ‘including’are not limiting.”

69 In re WarwickPark, Inc., 100B.R 179at 180(Bankr. D. Del. 1989). 7° See e.g. In , New Haven Rcdio, Inc., 23 BR. 762 at 767 (S.D.N.Y. 1982);In ir Bonded Mailings,Inc., 20 BR. 781 at 786 (Bankr.E.D.N.Y. 1982). 71 See e.g, In , Fiesta Homes of Georgic Inc., 125BR. 321 at 325-326(Bankr. S.D. Ga. 1990), where the court displacedthe DIP because of the presence of a conflict of interest that could lead to a breach of fiduciaryduty; In n McCorhillPublishing Inc., 73 B.R 1013at 1017(Bankr. S.D.N.Y.). 68 these caseson a case by case basisto decidewhetherthe conductor omissionis sufficient tojustify the appointmentof a 72trustee. Thesetypes of casesrequirethe applicantto show causeby clearand convincing73evidence. Paragraph 1104(a)(2)provides the secondbasis forthe appointmentof a trustee. In considering the“bestinterests”standard,the court balancesthe respective interestsat stakeand, in particular,it examinesthe advantagesand disadvantagesof appointinga trustee. The courtwill considerthe followingfactors insuch a case:

(a) the trustworthinessof the debtor;

(b) the debtorin possession’spast and presentperformanceand prospectsfor the debtor’s rehabilitation;

(c) the confidence- or lackthereof - of the businesscommunityand of the creditorsin present management;and

(d) the benefits derivedby the appointmentof a trustee,balancedagainstthe cost of the 74appointment. The courtmust considerthe additionalcosts imposedon the estateby the trustee’sappointmentand the availabilityof a trusteethat is capableand willing toact. However,at the heart of the inquiryis whether theDIP or a trusteewill morelikely facilitatea confirmedplan of arrangementexpeditiously.

For example,if the creditors refuseto deal with the DIP underany circumstances,the courtmay be justified in appointinga 75trustee. The courtor the partiesmay considerthe appointmentof an examinerunder subsection

1104(b)if there are concernsregardingthe DIP or the conductof prepetitionmanagementthat are not

SharonSteel, supra note 7 at 1226(3d Cir).

Berdanand Arnold,supra note 18at 472.

Ionosphere,supra note 7 at 168[citationsomitted].

Ibid See also In re ScwinoOil & HeatingCo., 99 B.R 518 at 527 n. 11 (Bankr.E.D.N.Y. 1979);In re AdvancedElectronics,Inc., 99 B.R 249 (Bankr.MD. Pa. 1989). 69 seriousenough to justify the appointmentof a 76trustee. The examiner’sprimary role is to investigate and report to the court and not to managethe debtor’sbusiness and 77affairs. The limited role of the examinerand its report has been describedas follows:

His fmdingsdo not havebinding effect on the court or parties of those of a specialmaster, arbitrator ormagistrate;nor do they have the evidentiarycharacter of an opinion by a court expert ... An Examinerperformsthe investigativeduties of the trustee, and may perform other investigativeduties as the Court directs, but he stands on a different legal footingthan a 78trustee. The examiner’sreduced role results in a correspondingreductionin the onus on the party seekingthe appointment. All that appears necessaryto justify the appointmentof an examineris an allegationand evidenceof mismanagement.

B. ThE CANADIANAPPROACH

The Colter Committee Reportrecommended thatin all cases where a securedcreditorhas not appointeda receiver, the debtor should appoint a trustee to act as interim 80receiver. The role of the

76 Code s. 1104(b)provides:

If the court does not order the appointmentof a trustee under this section,then at any time before the confirmationof a plan, on request of a party in interestor the United Statestrustee, and after notice and a hearing,the court shall order the appointmentof an examinerto conduct such an investigationof the debtor as is appropriate,includingan investigationof any allegationsof fraud, dishonesty,incompetence, misconduct,mismanagement,or irregularityin the managementof the affairs of the debtorof or by current or formermanagementof the debtor, if - (1) such appointmentis in the interestsof creditors, any equitysecurity holders,and other interestsof the estate; or (2) the debtor’sfixed, liquidated,unsecureddebts, other than debts for goods,services, or taxes, or owing to an insider, exceed $5,000,000.

In re Boileau, 736 F.2d 503 at 506 (9th Cir. 1984);In re InternationalDistributionCentei, Inc., 74 B.R 221 at 224 (S.D.N.Y.1987). One court held that it is proper to appoint an examinerfor the expresspurpose of investigatingthe issue of whether a trustee should be appointed [In re Hainiel & Sons, Inc., 20 B.R 830 (Bankr. S.D. Oh.1982)].

78 Bddwin, supra note 29 at 316.

McAfee,supra note 16 at 397.

80 Colter CommitteeReport at 56. 70 trustee orinterimreceiver,as contemplatedby the report,was similarto the role assignedto the proposaltrusteeunderthe BIA, as the trusteeor interim receiverwouldhave been requiredto review the books andrecordsof the debtorand maintaincontroland accountfor the dispositionof the debtor’spropertyduring theinterim 8period. However,the ColterCommittee Reportwent further and providedthe courtthe discretionto grant’ additionalpowersto the trusteeor interimreceiver,including the rightto take possessionand sell all or part of the debtor’spropertyor managethe debtor’s business. The BIA givesthe proposaltrusteerelativelynoninvasiveduties,such as to report on the reasonablenessof the debtor’sprojectedcash-flow83statement, notifythe creditorsof the filingof the noticeof intentionto make a proposal, monitorand reporton the debtor’sbusinessand 85affairs and adviseon and participatein the preparationof the proposal.

The courtmay givean interimreceiverappointedpursuantto section47.1 moreinvasive powers. Subsection47.1(2)givesthe court very broaddiscretion indeterminingthe powersthat may be givento the interimreceiver,including the powersto takecontrolover thedebtor’sbusinessor propertyandto “takesuch other actionas the court considersadvisable.” Althoughcase lawunderthe

BIA has yetto establishthe contoursof the role of an interimreceiver,the legislativegrantappearsto contemplatea broad and potentiallyinvasive87role.

81 Ibid

82 Ibid at 56-57.

83 BIA s. 50.4(2).

BIA s. 50.4(6).

85 BIA s. 50.4(7).

86 BIA s. 50.5.

Onemust becautiousin attemptingto analogizethe interimreceiver’srole on the filingof a petitionfor a receivingorder (a liquidationproceeding). It hasbeen held that the interimreceiver,in those circumstances,is to take only conservatorymeasures toprotectthe debtor’sestateand is not to divestthe debtorof its property[Re Soren (1926), 7 C.B.R 545 (Ont. S.C.); Re Stuan’-Sutterby (1930),12 C.B.R.267 (Ont. C.A.)]. It shouldbe notedhowever,that the BIA specificallystatesthat, in such circumstances,“theinterim receivershallnot undulyinterferewith the debtor in the carrying 71 The recent case of Re NT. W.ManagementGroup88Ltd illustratesthe separationof the roles of the proposaltrustee and an interimreceiver. In that case,the courtappointedan interimreceiveron the basisthat the debtor,after filingthe noticeof intentionto makea proposal,openeda newbank accountand depositedfunds intothat accountthat were subjectto a securityinterest. Ratherthan appointinga separateentityas the interimreceiver,the courtappointed theproposaltrustee,to reduce 89costs. The court further heldthat the proposaltrustee neednot relinquishits dutiesas proposal trusteebut thereafter,it must fuffilthe dutiesof proposaltrusteeand also, complywith the court ordereddutiesof an interim receiver.

The BIA does not providea list of personswho may applyfor the appointmentof an interim receiver. It has been suggestedthat the proposaltrusteeor any creditoror creditorsmay makethe 90application. In such an application,the applicanthas the onusof showing thatthe appointmentof an interimreceiveris necessaryfor the protectionof the estateor the interestsof one or more creditorsor the creditorsgenerally. The courtshave held that theymust act cautiouslyin consideringwhetherto appointan interim’9 receiver. The reasonfor this cautious approachis their desireto avoidprecipitous actionthat couldnot only prejudice thehopesof the debtorfor its recovery,but also the interestsof 92creditors. The applicantmust adduceevidenceof an actualdangerof dissipationof assets;mere

on of his business exceptas may be necessaryfor the conservatory purposesor to comply with the orderof the court.”[BIAs. 46(2)1.

88 (1993), 19 C.B.R (3d) 162(Ont. Gen. Div.).

89 TnDufferin-CustomConcretev. CarlinWMaplehuis’tDevelopmentsInc. (1993),22 C.B.R (3d) 67 (Ont. Gen Div.),the court held that the “crucialconsideration”in the appointmentof an interim receiveris “to reduceor controlcosts as muchas possible.”

9° L.W.Houldenand C.R Morawetz,TheAnnotated Bankniptcyand InsolvencyACt 1993 (Scarborough:Carswell,1992)at 92.

91 BIA s. 47.1(3).

92 156190Cancda Ltd v. Ba,coum DrugsLtd (1993), 19C.B.R.(3d) 129at 135(N.W.T.S.C.). 72 suspectedor feareddissipationwill not be 93sufficient. A monitor appointedin an orderunder the CCAAmust assessand reviewthe debtor’sbusiness and affairson an ongoing94basis. The courthas the discretionto grantpowersin excessof these duties. In CanadianImperial Bank of Commercev. QuintetteCoal Ltd , the courtrefusedto expand the role of the monitorto includethe right to prepare,negotiateand file the plan with the court, coordinatethe approval process andcall and chairall meetings. The court feltthat the objectivesof the CCAA wouldbe best accomplishedthroughthe limitedrole of the monitor,who wouldbe subjectto the court’ssupervision.

C FULFILMENTOF OBJECIIVFS A1NI)PROPOSALSFOR REFORM

Althoughthe primaryobjectiveof a businessreorganizationproceedingis the confirmationof a plan of reorganization,there will be a periodbetweenthe commencementof the proceedingand confirmationof the plan, duringwhichmany interimdecisionsand interlocutoryproceedingswill take place. Thoseinterimstepswill affectthe rightsof the partiesto the proceeding.

The appointmentof an independentthird party,in additionto or in substitutionof former management,will injectelementsof objectivityand impartialityinto the proceedingY This has the advantageof easing the mindsof the creditors, shouldtherebe a suspicion7 of wrongdoingor negligenceon the part of the formermanagementof the debtor. The independentparty will take an objectivelookat the business operationsto determinethe most cost-effectivemannerof proceeding,

Re L.A.T McrcáonddEnteiprises Ltd (1982), 42 C.B.R.(N.S.) 17 (Ont. S.C.);156190Canada Ltd v. Barsoum Dntgs Ltd, ibid.

“ Goldman,Baird and Weinczoksupra note 4 at 199.

(1991), 1 C.B.R. (3d)253 (B.C.S.C.).

The court felt that theobjectivesare “topermita corporation,throughreorganization,to continueits businessand therebypreventits organizationfrombeing disruptedand its goodwilllost.” [ibid at 260, emphasisadded].

Hotel Assocs., supra note 7. See also Berdanand Arnold,supra note 18at 385-386. 73 henceforth,unencumberedby previous loyaltiesand relationshipsthat may have cloudedthe judgment of formermanagement. Followingits review,the independentparty may decideto liquidateor dispose of unproductiveassetsor divisionsof the businessand dismissalof long-termemployees.

More importantly,it can assessthe fmancialviabilityof the debtorto determinewhethera reorganizationis a feasiblealternative. Theindependentparty will also undertakeexaminationsand investigationsthat formermanagementmay be unwillingor unableto undertake,such as the reviewof insider transactions.

Conversely,the appointmentof an independentthird personwill result in additional,often significant,costs that the creditorswill 8bearY In addition,because the trustee or interim receivermay lackthe experienceof formermanagement inthe debtor’sbusinessoperationsand industrypractices, there may be significant delaywhilethe trusteeor interimreceiverfamiliarizesitselfwith these 9mattersY This delaymay result in loss to the debtorin terms of time, customersand suppliers. A morepracticalconcernis that the independentpersonmay not havethe timeor incentive to maintain the businessin a way that will result in a confimed plan of reorganization.This propositionhas two aspects. First, the independentperson may not havethe necessaryhuman resourcesto dedicateto the debtor’sbusiness. In times of severemacroeconomicdifficulty,the independentperson may be workingat full capacity,with no personnelto dedicate tothe debtor’saffairs. Althoughthis may result in a loss to the debtor’sbusiness,the more seriousconsequenceis that the independentthird personmay view the most expeditioussolutionas the best solutionin the circumstances,viz., liquidation. A relatedconcern is the perceptionin the insolvencyconummitythat, if the third party can deal with and concludethe matterexpeditiously,the appointingcreditorsmay be more inclinedto providethe trusteeor monitorwith replacementwork. Althoughthis is a valid considerationfor the free-marketmentalityof the insolvencypractitioners,it hardlyencouragessupportof the debtor’s

98 HouseReportat 233. 99Ibid. 74 reorganizationefforts.

In a broadersense,the virtual automaticappointmentof a trusteeor monitormay providea disincentivefor managementto seek the protectionof a reorganizationstatute,even if a reorganization is the most effectivemeansof solving thedebtor’s10problems. Managementmay feel that a total or partial loss of controlmay spellthe demiseof the business° because of the lack of knowledgeof trustees and monitorsandthe costsresulting from theirappointment. This type of approachdefeats the purposeof a businessreorganizationregime,as it results indebtorswaitinguntil the last possible moment beforeseekingthe protection thatmay have savedthem somemonthspreviously.

To fashionproposalsfor reform,it is necessary,in first instance,to determine whetherthe businesscommunitywantsa businessreorganizationregime. If that inquiryleadsto an affirmative response,we must determinethe best methodof accomplishingthat objective, If we accept Professor LoPucki’sobservationthat creditorstake little activeinterestin the affairsof their 1debtors,’°we must questionthe role of the independentpersonappointedto protectthe creditor’sinterests.

The virtualautomaticappointmentof a proposaltrusteeto investigatethe debtor’saffairs or a monitor tosupervisethe debtor’sbusinessmay not encouragea debtorto seekthe protectionof a businessreorganization regimeand may not servethe interestsof all those concernedwith the process, not the least of whichare the creditors. Becausethe reorganizationprocessis generallya “zero

102sum” game, wherethere is a limitedamount for distribution among theparties,with someparties gainingand otherslosing,the effectivedeploymentof assetsis of primary concernto the parties. The appointmentof an independentthird personwill erodethe resources availablefor the creditors and equity holdersand accordingly,the decisionto appointan independentperson toprotectthose interests shouldbe leftto the partiesthat will be payingfor the benefitof that person’sadvice. Shouldthe

100 HouseReportat 233-234;see also Frost,supra note 8 at 136.

101 LoPucki,supra note 59 and accompanyingtext.

102 Frost,supra note 8 at 119. 75 partieshave confidencein existingmanagementor see no need in “throwinggoodmoneyafterbad,” they shouldnot be forcedto pay for a resourcethat they do not want in the firstplace. Thus,in all cases,the presumptionshouldbe that thedebtor remains inpossessionand controlof the businessand operations,but that the creditorsbe permittedto apply summarilyto the court forthe appointmentof a trusteeor monitor. The partiesor the court, if the partiesare unableto agree,will be determinethe rights and dutiesof the trusteeor monitor. In this manner,the stakeholdersare makingthe decision concerningthe dispositionof “their”money.

In analyzing thecreditorswho are supporting theapplication,the court must be cognizantof the actualcreditorsthat will bear the costs of the trusteeor monitor. An undersecuredcreditorwith securityon all or substantiallyall of the debtor’sassetswill bear those costs,as any further expenditureswill furthererode itssecurity, if the secured creditoris frillysecured,the unsecured assetswill bear the costs. In such a situation,the court mustpay specialattentionto the interestsof preferredand unsecuredcreditors.

if the policymakersput this typeof systeminto place, sufficientchecksand balancesmust exist for the courtsand creditors tomonitorand controlthe debtor’saffairs. The debtormay seethis as a smallprice to pay for the opportunityto attempta reorganization. Thelegislationcould implementprovisionsfor adequatedisclosure requirements,the possibilityof havingthe reorganization proceedingconvertedto a liquidation,requirement for court approval andeasy access tothe courtsby the DIP and otherpartiesin interestfor advice anddirection.

Theseproposalsdo not derogatefromthe objectiveof a businessreorganizationsystembut enhanceit. If the checksand balancesand the debtorremainingin possessionare satisfactoryto the parties,there is no reasonwhy thedebtorshould notremainin possession. The systemshouldserve the constituentswhose interestsit seeksto protect. Providing flexibilityto allowthe partiesto structurethe proceedingin a waythat servestheir respectiveneeds,while alwaysprovidingthe courts the opportunityto supervisethe proceedings,attainsthis objective. 76

CHAPTERV CEREAN ADIIMSThAT1VE PORS

The title of Chapter 11 is “Reorganization”whichmay leadthe readerto concludethat the focusof this paper wouldbe on that chapter. However,chapters 1, 3 and 51 are generalprovisions applicableto all proceedingsunder theCode. The “administrativepowers”in subchapterIV of chapter

3 of the Codeare the essenceof a businessreorganizationproceeding,as those powerswill determine whetherthe debtorwill have an opportunityto attemptto formulatea planof reorganization.

SubchapterIV of chapter3 of the Codeconsistsof six relativelyshortand, facially,simple sections. However,there is a very richhistoryunderlyingeach sectionand they have eachengendered a significantbody of case law. This chapterwill examinewhether the administrativepowersassistthe

Americancourts indefmingand attainingthe objectivesof a businessreorganizationsystem.

The CCAA,throughits loosely-worded provisionsor throughcase law, has developed administrativepowerssimilarto those outlined insubchapterIV of chapter3 of the Code. This chapter willexamine thedevelopmentof those powersunderthe CCAAto determine whetherthey have enhancedor hinderedthe debtorin its reorganizationefforts.

The BIA also hasincorporatedmechanismssimilar to mostof the administrativepowers contained inthe Code. However,the differenceshave a significantimpacton whetherthe insolvent personwill be able to put forth an acceptableproposal. This chapterwill contrast theadministrative powerscontainedin the Code with the mechanismscontainedin the BIA to determine whichsystem will betterattain theobjectivesof the legislation.

This chapterwill examine theconceptof adequateprotectionand the automaticstay of proceedingsthat the Code imposesat the outsetof a case. It will also reviewthe discretionarystayof proceedingsunderthe CCAAand the automatic stayof proceedingsunder theBIA and will consider

1 Theyare, respectively,entitled“GeneralProvisions”,“CaseAdministration”and “Creditors, Debtor and Estate”. 77 whether importationof the concept of adequateprotectionduring the stay would assist a Canadian debtor inits attempts toreorganizeits fmancialaffairs.

We willthen examineof the issueof repudiationof real propertyleases. The Codeand the

BJA specificallygivethe debtor the rightto repudiate,rejector disclaimreal propertyleases. In certaincircumstances,the courtsallowdebtorsa similarrightunder theCCAA. Again,this chapter will examinethis powerto determinewhichsystemfostersthe objectivesof the legislation.

The fmal sectionof this chapter willreviewthe statutoryschemesavailableto the debtorto fmancethe proceedingand its operationsduringthe proceeding. The Code has a comprehensiveand complexscheme forfmancingduringthe proceeding. Neitherof the Canadianlegislativeschemes appearsto have addressedthis specificissue,althoughout of necessity,creditorswho allegematerial prejudiceto theirinterestsby the absenceof such provisions haveraisedthe issue.

These issueshave very practicaland seriousramifications forthe parties in interest. Fromthe debtor’sperspective,a determinationadverseto its interests onany of these issuesmay destroythe possibilityof its effectinga reorganizationof its fmancialaffairs. A creditormay find itself fmanciallyunableto copewith the consequencesof the exerciseof an administrative powerand may facethe possibilityof its own insolvency.

A. ADEQUATEPROTECHON DURING THE STAY OF PROCEEDINGS

This sectionwill examinecertain changesto the rights and dutiesof secured creditorsthat resultedfromthe passageof the 2BIA. Tnparticular,this section willexaminethe stayof proceedings

2 The relationshipbetween a debtorand its securedcreditorsand the validityand enforceabilityof securityare generallygovernedby lawpromulgatedby the provincespursuantto subsection92(13)of the Canadianconstitution. That subsectiondelegatesauthorityto the provinciallegislaturesto enact legislationgoverning“propertyand civilrights in the provinces.” However,when bankruptcy intervenes,the federalbankruptcyand insolvencylaws governthe relationshipsbetweenthe debtorand its creditorsand amongthe creditors. In the case of Cushingv. Dtpuy (1880),5 App. Cas.409 (P.C.),the JudicialCommitteeof the Privy Councilprovided therationalefor this shift as follows:

“Itwouldbe impossible to advancea step in the constructionof a schemefor the 78

administrationof insolventestateswithout interferingwith and modifyingsome of the ordinary rightsof property,and other civil rights,or withoutprovidingsome modeof special procedurefor vesting, realization,and distributionof the estate,and the settlementof the liabilitiesof the insolvent. . . It is thereforeto be presumed,indeedit is a necessary implication,that the ImperialStatute,in assigningto the DominionParliamentthe subjectsof bankruptcy andinsolvency,intended toconferon it legislativepowerto interferewith property, civilrights,and procedurewithinthe Provinces,so far as a generallaw relating to those subjects mightaffectthem” [at 416].

The courtsin the United Stateshave cometo a similarconclusion. ChiefJustice Fullerof the United StateSupremeCourt expresslyrecognizedthis right of Congressin Hanover NationalBank of the City of New Yorkv. Moyses, 186U.S. 181(1902):

“Thesubjectof ‘bankruptcies’includesthe powerto dischargethe debtorfromhis contracts and legal liabilities,as wellas to distributehis property. The grantto Congressinvolvesthe powerto impair theobligationof contracts,and this thestateswere forbiddento do.”[at188].

Notwithstandingthe right of Congressand the Parliamentof Canada to abrogatethe rightsof secured creditorspursuantto theirjurisdictionover bankruptcyand insolvency,the courtsjealouslyguardthe propertyrights of securedcreditors. In the United States,constitutional challengesto federal bankruptcylaws take place primarilyunder the“dueprocess”and the “unlawful taking”clausesof the FifthAmendment. The relevantprovisionsof the FifthAmendmentprovidethat “[nb personshallbe deprivedof life, libertyor property,withoutdue processof law, nor shallprivatepropertybe taken for publicuse, withoutjust compensation.” The conceptof “dueprocessof law,”as that term is used in the FifthAmendment,requires that a particularlaw not be unreasonable,arbitraryor capriciousand that the law and its meansof enforcementshallhave a reasonable andsubstantialrelationto the resultsbeing sought[US. v. Smith, 249 F.Supp515 at 516 (S.D.Iowa 1966)]. Alongwith this generalrequirement,the courtsrequire “substantivedue process”and “proceduraldue process”in any case to whichthe Fifth Amendment applies. Substantivedue processis the doctrinethat a personshallnot be deprivedof life, libertyor propertyarbitrarily,and legislationthat resultsin suchdeprivationmusthave a rationalbasis [Jeffries v. TurkeyRun ConsolidatedSchoolDistrict,492 F.2d 1 (7th Cir. 1974)]. Proceduraldue process,on the otherhand,requiresprocedural fairnessprior to deprivinga personof life, libertyor property. At a minimum,the applicantmustprovidenotificationof the proceedingsto the party being deprived, who mustbe givenan opportunityto be heardat the proceeding. Theproceedingmust be held ata meaningfultime and in a meaningfulmanner[Fuentesv. Shevin,Attorney-Generalof Florida,407 U.S. 67 (1972)]. The 1935United StatesSupremeCourtdecisionin LouisvilleJoint Stock Land Bankv. Rcdford, 295 U.S. 555 (1935)[hereinafterRcdfordjis seen by manycommentators andcourtsas the decisionthat entrenchedthe FifthAmendmentprinciplesintothe bankruptcypower [Seee.g., L.S. Jayson,ed., The Constitutionof the UnitedStates of America - Analysisand Inteipretation (Washington:United StatesGovernmentPrintingOffice, 1973); In re Gfford, 669 F.2d 468 (7th Cir. 1982); US. v. Security IndustrialBank, 459 U.S. 70(1982)]. The court inRcdfordwas considering certainamendmentsto the 1898U.S. Act thataddedprovisionsdesignedto save family-ownedfarms fromforeclosure. The courtheld theamendmentsto be unconstitutionalas a violationof the principlescontained in the FifthAmendmentand statedthat “Thebankruptcypower,like the othergreat substantive powers of Congress,is subjectto the FifthAmendment.”[Rc4’ord,supra at 589]. The courtnoted thatdespite 79 imposedon securedcreditorsat the outsetof a reorganizationproceedingand the protectionafforded to secured creditorsas a result of the impositionof the stayof proceedings. The fmalpart of this

sectionwill considerthe issue of whether stayprovisionsfurtherthe objectivesof a business reorganizationproceeding.

The Colter Committee Report advisedthe policymakersthat “[amy proposedchangeto our bankruptcylegislationshouldbe assessedin terms of how well it contributes tomeetingthe basic

the dire economic conditions andthe importanceof agricultureto the economyof the UnitedStates “. privatepropertyshallnot be thus taken even for a whollypublicuse withoutjust compensation.”[Rcdford,supra at 602]. Rcdford uses the wordingof the unconstitutional“taking”provisionof the FifthAmendment and notthe deprivationof life, libertyor propertywithoutdue processof law. However,subsequent decisionscite Rcdford as authorityfor the dueprocessproposition[Wrightv. VintonBranch of the MountainTrustBank of Roanoke, 300 U.S. 440 at 457 (1937)],as well as for the unconstitutional takingproposition. Althoughthere is somedisputeamongcommentatorsand courtsas to the natureof the Rc4dforddecision,it is clearthat both concepts havebeen appliedand followedin subsequent decisions[Fora discussionof the debate,see In re Gfford, supra]. Thus, it can be saidgenerally,that the bankruptcypower is limitedby the FifthAmendment. In Canada,there is a commonlaw limitationon the legislativepowerto take propertywithout compensation.The lack of constitutionalprotectionplacesthe interestsof securedcreditorsin jeopardyshould theParliamentof Canada choose toexerciseits broad legislativepowers todeprive securedcreditorsof their interestsin the bankrupt’sproperty[J.M Ferron,“TheConstitutional Impairmentof the Rights of SecuredCreditorsin Canadaand the United States” (1986),60 C.B.R (N.S.) 146]. To date however,the Anglo-Canadiancourtshave consistentlyheld that, in the absenceof a clear intentionto the contrary,legislationwhichtakesprivatepropertyor impairsa vestedinterestin privatepropertyfor publicuse or the use of third parties mustprovide compensationfor that whichis taken. The courtshave goneso far as to require notjust reasonablecompensationfor the property taken butfull compensation[Belfast Coip. v. O.D. Cai Ltd, [1960]A.C. 490 (HL.)]. The general principlewas recentlyappliedin the case of Lloyds Bank Ccinalav. International WairantyCo. (1990), 76C.B.R (KS.) 54 (Aita.C.A.),leaveto appealto the SupremeCourtof Canada refused (1990),76 C.B.R.(KS.) xxix [hereinafterInternationd Watronty]. In that casethe AlbertaCourtof Appeal held:

“ForRevenueCanadato succeed,the plain and unambiguousmeaningof the section mustbe that it deprivesa properlysecuredcreditor. . . of all or part of its securitywithout compensation,for the purposeof payinganotherdebt entirely unrelatedto the security. It is surelyequivalentto thetransferof proprietaryrightswithoutcompensation.”[at 58]

Practically,the rights of secured creditorsin Canadaare similarto those of their Americancounterparts,notwithstanding thelack of constitutionalprotectionof propertyrights. This functionalsimilarityhowever,may be shatteredby Parliamentat any time by the utilizationof “plain and unambiguous”[InternationalWanvnty, supra]language. 80 goals or objectives of the 3law.” Laws facilitatingbusinessreorganizationsmust attemptto strikea delicate balance between“the desireto achieveequity and fairnessin the distributionof the bankrupt’s 4funds” and assets, on the one hand,and the contractualrights of securedcreditors,on the other hand. The Codeand the CCAA tend to restrict the rightsof securedcreditors in a businessreorganization proceedingto facilitate the object of achievingequity and fairnessin the distributionof the assets comprisingthe estate and affordingthe debtor a fresh 5start. The former CanadianAct placed few restrictionson the rights of securedcreditors. The Tassé Reportrecognizedthe significantincreasein securedcredit in Canada and the inadequacyof the former CanadianAct to adjust,efficientlyand fairly, the relationshipbetweendebtors and 6creditors. It recommendedchangesto the legislationthat would monitor and place certainrestrictionson the rights of securedcreditors. This chapterwill considerwhetherthe BIA is conceptuallyeffectiveto resolve the inefficienciesand inadequacies perceivedby the TasséReport.

1. Temnnology

(a) SecuredCreditor

The Code does not defme “securedcreditor.” Rather, it describesthe claimant accordingto the natureof its allowed claim. Thus, whereasthe 1898U.S. Act referredto a creditor holdinga securityinterest in the assets of the debtor as a “securedcreditor,”the Code now describesit as a “creditorsecuredby a lien on property in which the estate has an 7interest.” That is, it classifies

Colter CommitteeReport at 20.

4 Bankof Mann v.Englond, 385 U.S. 99 at 103(1966).

F.R. Kennedy, “SecuredCreditorsUnder the BanlcruptcyReformAct” (1982) 15 md. L. Rev. 477 at 482.

6 Tassé Report at 62.

Codes. 506(a). 81

claims,not creditors,as securedor unsecured. The Code madethis changeto obviatethe vagueness

of the 1898U.S. Act, where it was8necessaryto determinewhethera creditorwith a securityinterest

in collateralof a value less than the amountsecuredwas tobe treated as a securedcreditoror as a creditorthat was partly secured andpartlyunsecured. Subsection506(a) resolvesthis apparent problemby bifurcatingthe claimof the creditor9 into a securedportionand an unsecuredportion.’°

The claimis securedto the extentof the valueof the collateral andis unsecuredfor the balance. This is a very importantconcept,as certainprovisionsof the Codedefinethe interestor limitthe claimsof suchcreditorson basis of the amountof the securedclaimand not by the full amount owedto the 1creditor. ’ As mentionedabove,the creditor’sclaimis secured tothe extentthat the creditorhas a “lien on propertyin whichthe estatehas an interest.” TheCodeprovidesa very broaddefmitionof 2“lien,” whichincludesinchoate3liens.’ The Codethen defmesthree categoriesof liensbeingjudicial liens, securityinterestsand statutory 4liens.’ This sectionshall concernitself only with liens createdby way of securityagreementand notwith nonconsensuallienscreatedby statute or judicialprocess. Liens

8 SeeBarash v. Public Finance Coiporation,658 F.2d 504 (7th Cir. 1981); In re Glenn,796 F.2d 1144(9th Cir. 1986).

Bkr-LEd, CodeCommentaryand Analysiss. 21:251. Underthe Code,such a creditoris commonlyknownas an “undersecuredcreditor”. The distinctionbetweenoversecuredcreditors and undersecuredcreditorsis importantfor determiningthe extentof their entitlementto “adequate protection”. See discussion,infra notes 49-77and accompanyingtext.

10 SeeIn re Glenn,supra note 8.

‘ A plan of reorganizationunder Chapter11will be consideredfair andequitablewithrespectto a classof creditorssecuredby liens on propertyin whichthe estatehas an interest,only if the plan to provides,inter dia, that the claimantsretaintheir liens on the collateraland that theyreceivedeferred cashpayments,each totallingthe allowedamountof the securedclaims and notthe full amountof suchcreditors’claims [Codes. 1129(b)(2)(A),emphasisadded].

12 Codes. 101(37) “lien”meanscharge againstor interestin propertyto securepaymentof a debtor performanceof an obligation;

13 HouseReportat 312.

14 Code ss. 101(36), 101(51)and 101(52),respectively. 82

createdby wayof securityagreementincludereal propertymortgagesand liens on personalproperty

or fixturescreated pursuantto appropriatestate law. Generally,nonbankruptcystate law detemiinesthe validityof the 5lien.’ However,eventhough validunder state law, the trusteeor the debtormay avoid orsubordinatethe lien pursuantto the Code.

The BIA and the CCAA eachdefme “secured creditor,”but only the CCAAdefmes “unsecured16creditor.” Most of the caselaw consideringthese defmitions involvesdeterminationsof whethera particular typeof claimor interestmakesthe claimanta securedcreditor. The vaguenessof an inpersonain defmitionof the temi has not yet caused anydifficultyin practice. However,the BIA oscillatesbetweenreferencesto secured creditorsand “securedclaims,”which is an undefmedterm.

For example,subsection50(1.2)of the BIA provides:

A proposalmust be made tothe creditorsgenerally,eitheras a mass or separatedinto classes as providedin the proposal,and may also bemadeto securedcreditorsin respectof any class

15 Butnerv. US., 440 U.S. 48 (1979).

16 BIAs. 2:

“secured creditor” meansa personholdinga mortgage, hypothec, pledge,charge,lien or privilegeon or againstthe propertyof the debtor orany part thereofas security for a debt due or accruingdue tohim fromthe debtor,or a personwhoseclaim is basedon, or securedby, a negotiableinstrumentheld as collateralsecurityand on whichthe debtoris only indirectlyor secondarilyliable;

CCAAs.2:

“securedcreditor”meansa holderof a mortgage, hypothec, pledge, charge,lien or privilegeon or against, orany assignment,cessionor transferof, all or any propertyof a debtorcompany as security for indebtednessof the debtorcompany,or a holderof any bond of a debtor company securedby a mortgage, hypothec, pledge,charge,lien or privilegeon or against,or any assignment,cessionor transferof, or a trust in respect of, all or any propertyof the debtor company,whetherthe holder orbeneficiaryis resident or domiciledwithinor outsideCanada, and a trusteeunderany trust deed or otherinstrumentsecuringany of those bondsshallbe deemedto be a secured creditorfor all purposesof this Act exceptfor the purposeof votingat a creditor’smeetingin respectof any of thosebonds;

“unsecuredcreditor”meansany creditorof a company whois not a securedcreditor,whether residentor domiciledwithinor outsideCanada,and a trusteefor the holdersof any unsecured bonds issueundera trust deed or other instrumentrunningin favourof the trusteeshallbe deemedto be an unsecured creditorfor all purposesof this Act exceptfor the purposeof votingat a creditors’meetingin respectof any of thosebonds. 83

or classesof securedclaim,subjectto subsection(1.3). [Emphasisadded]

This subsection,if read in isolation,exhibitsthe vaguenessof the 1898U.S. Act. As the BIA does not defme“securedclaim,”we must assumethat it is a claimby a personwhosesecurityhas been provedand appropriately validatedby the trustee. Thissubsection,furthenriore,does not recognizethe possiblybifurcated natureof a securedcreditor’sclaimand specificallydoesnot place the unsecured portionof the creditor’sclaim withinthe bodyof generalcreditors. Theseproblemsare, to a certain extent,addressedin subsection50.1(3)of the BIA that states:

Wherethe proposedassessed valueis less than theamountof the securedcreditor’sclaim,the secured creditormay file with the trusteea proof of claim in the prescribedform,and may vote as an unsecuredcreditoron all questionsrelatingto the proposalin respectof an amount equalto the differencebetweenthe amountof the claimand the proposed assessedvalue.

That subsectionstatesthat the securedcreditor“mayvote as an unsecuredcreditor,”whereasthe sectionprescribingthe votingprocedurespecifiesthat “allunsecuredclaimsconstituteone class”and that the proposalwill be acceptedonly if “allclassesof unsecuredcreditors”vote for its acceptance.’ The BIA providesthat the securedcreditorsmay vote as unsecuredcreditors(the inperonam7 description)for the shortfallamount butdoes notstatethat theirshortfallclaimwouldrank as an unsecuredclaim (the in remdescription). Althoughone may arguethat this is merelysemantic discussionthat has no practicalconsequence,in a propercase, it may proveto be problematic. For example,must unsecuredcreditors,simpliciter,or unsecuredcreditors and secured creditorsvotingas unsecuredcreditorsaccept the proposal?

This problemis magnifiedby the CCAAwhich neithersets forththe detailedprocedureof the

BIA nor provides specificallyfor the bifurcationof an undersecuredcredito?sclaim. In fact,the decision inRe Northland Properties8Ltd’ questionedthe notionof bifurcationunderthe CCAA,by holdingthat the samedebt cannotgiverise to separateclasses.

Despitethe foregoingdiscussion,“secured creditor,”in this section,refersto a creditorhaving

17 Emphasis,in both cases,added.

18 (1988),73 C.B.R.(N.S.) 166(B.C.S.C.). 84

a valid securityinterest in an asset or assets of the debtor. This defmitionapplies to referencesunder

the Americanor Canadianlegislation.

(b) AdequateProtection

The Codedoes not defme adequateprotectionalthoughit refers to the concept in the sections

describingan applicationfor relief from an automatic19stay, use, sale or lease of propertyof the estate when such property is subjectto a lien in favourof a secured°2party and the obtainingof 21credit. We may garneran understandingof the concept from its objective,which is to ensure that the creditor receives “essentiallywhat he bargained22for” unless of course, receipt of that benefit frustratesor seriouslyinterfereswith the purposes of the Code’sreorganizationprovisions. In the latter event,the creditorswill receive the benefitof the bargainby alternate23means. Section361 sets forth the three meansof providingadequateprotectionas follo:

Whenadequateprotection is requiredunder section 362, 363, or 364 of this title of an interest of an entity in property, such adequateprotectionmay be providedby -

(1) requiringthe trustee to makea cashpayment or periodiccash paymentsto such entity, to the extentthat the stayunder section 362 of this title, use, sale, or lease under section 363 of this title, or any grantof a lien under section 364 of this title results in a decrease in the value of such entity’sinterest in such property;

(2) providingto such entity an additionalor replacementlien to the extentthat such stay, use, sale, lease or grantresultsin a decrease in the value of such entity’s interest in such property; or

(3) grantingsuch other relief, otherthan entitling such entity to compensation allowableunder section 503(b)(1) of this title as an administrativeexpense,as will result in the realizationby such entity of the indubitableequivalentof such entity’s interest in such property.

19 Code s. 362(d).

20 Code s. 363(e).

21 Code s. 364(d).

22 House Reportat 339. 23Ibid. 85 These means are neitherexclusivenor 24exhaustive. However,they are all intendedto protectthe creditor’sinterestin the property. With respectto securedcreditors,the protectionappliesonlyto the

“interestof an entity in property”and notto the amount of the debt or the valueof the property,both

of whichmay be more or less than the interestin the property. This appearsto be reasonable. For

example,in the absenceof the stay,the securedcreditorcouldrecoveronly theamount of the debt or the valueof the collateral,whicheveris 26less. It followsthen, that if the interestof the secured creditorhas novalue,there is nothingto 27protect. The Fifth Amendmentthat protectsa creditorfrom beingdeprivedof its property withoutdue processof law orjust 28compensation is the source of the concept of adequateprotection. Adequate protectionseeksto addressboth of the issuesraisedby the FifthAmendment. While acknowledging the constitutionalbasis of the concept,the legislativehistoryindicatesthat publicpolicyplayeda significantrole in the developmentof the conceptand the draftingof section361? The constitutional basisprotects therights of the creditors. Publicpolicy,on the otherhand,focusesprimarilyon debtor rehabilitationor reorganizationby the preservationof businessesand employment,the continuationof

24 HouseReportat 339.

25 In re AlyucanInterstateCorp., 12B.R 803 (Bankr.Utah 1981);In re Pine LakeVillage ApartmentCo., 19B.R 819 (Bankr.S.D.N.Y.1982).

26 As to whethera componentof the securedcreditor’sbargain is compensationfor lost opportunitycost has been the subject-matterof muchdebate. This topic will be examinedinfranotes 49-77and the accompanyingtext.

27 Seee.g. In re 620 ChurchStreetBuildingCorp.,299 U.S. 24 (1936),which held that, if a parcelof land on whichthere are a numberof mortgageshas an appraisedvalueof less than the amountof the first mortgage,the subordinatemortgageeshave no interestin that propertywhich requiresadequateprotection.

28 ContinentalIllinoisNationalBank & TrustCo. v. Chicago,RockIsland& Pcrjfic RailwayCo., 294 U.S. 648 (1935);Radford,supra note 2.

29 HouseReportat 339. 86 °3credit and the protectionof investment. It also protectsmacroeconomicinterestsby preserving essentialand viableindustries. The conceptof adequateprotectionrequiresthe courtsin the United Statesto attemptto balancethose 3interests. Negotiationand agreement’on a method andprocedurefor providingadequateprotectionare the most economicalways of dealingwith it.32 One writer suggestedthat the requirementof adequate protectionshouldfostercooperationbetweenthe debtor andits 33creditors. Oncethe creditor requestsadequateprotectionof its interest,the onus is on the debtoror the trusteeto proposea methodof adequatelyprotectingthe creditor. The debtorwill proposea method of adequateprotectionthat will be acceptable tothe creditorwhile minimizingthe effecton its efforts to 34reorganize. If the securedcreditorobjectsto the methodof protection,the court detenninesthe adequacyof the protection. The courtwill not, in the first instance,suggestthe methodof protection, as this wouldplace the court in an administrative35role.

30 J.L. Smaha,“AutomaticStayUnder the1978BankruptcyCode:An EquitableRoadblockto SecuredCreditorRelief’ (1980) 17 San DiegoL. Rev. 1113at 1123.

31 See e.g., Radford supra note 2.

32 U.S. BankruptcyRules s. 4001(d)prescribesa procedurefor the approvalby the courtof a settlementagreementbetweenthe debtorand its creditorsconcerningadequateprotection. Although the U.S. BankruptcyRules do not mandatea priori approval,it has been heldto be the preferred approach[In re Blehm Land & Cattle Co., 859F.2d 137at 140(10thCir. 1988)1.Otherwise,the creditoris at risk that the court willrefuseto sanctionthe agreementpost fcrto, as beinginequitableor contrary tothe intentand purposeof the Code. U.S. BankruptcyRules s. 4001(d)seeksto preserve the dueprocessrights of third party creditorswho are entitledto noticeof an applicationfor approval of suchan agreement.

A.N. Karlen,AdequateProtectionUnder theBankruptcyCode, ItsRole in Business Reorganizations”(1982)2 Pace L. Rev. 1 at 33 wherehe states:

“Adequateprotectionmay encouragea spiritof cooperationand negotiationbetweenthe debtor and its securedcreditor, sinceit is to both parts advantage toconfirma plan to revitalize the debtor’sbusiness,and to provideadequateprotectionin the interim.”

H R Miller andMR Bienenstock“AdequateProtection forPropertyin Bankruptcy”(1983) 8:1 ALl-ABACourseMaterialsJ. 31.

HouseReportat 338. 87

Subsection361(1),allowingperiodiccash payments,and subsection361(2),allowing additionalor replacementliens,compensatethe creditorfor the “decreasein the vdue of such entityc interestin such property”[emphasisadded],not an interestin specificcollateral. Consequently,if therewill be no decreasein the valueof the interest,there is no entitlementto adequateprotection.

For example,periodiccash paymentsmay be appropriateto compensatefor depreciationof propertyat a relativelyfixedrate.

Similarly,an additionalor replacementlien protectsthe creditor’svalue in the original property,shouldit declineduring the pendencyof the case. The additionalor replacementlien gives the securedcreditoralternateor additionalpropertyupon whichto realizethe decreasedvalueof the 37collateral. Most of the case law attemptingto defmethe conceptof adequateprotectiondealswiththe extentof the protectionnecessaryto result in the creditorrealizing the “indubitableequivalent”of its interestin the collateral. Congressborrowedthe conceptof “indubitableequivalent”fromthe frequently-quotedstatementof JudgeLearnedHand in In re Murel Holding 38Coiporation where,in discussing thepower givento a judge to providea creditorwith adequateprotection,he stated:

li construingso vaguea grant,we are to remembernot only theunderlyingpurposesof the section,but the constitutionallimitationsto whichit must conform. It is plainthat “adequate protection”must be completelycompensatory;and that paymentten years henceis not generallythe equivalentof paymentnow. Interestis indeedthe common measure of the difference,but a creditorwho fearsthe safety of his principalwill scarcely becontentwith that; he wishesto get his moneyor at leastthe property. We see no reasonto supposethat the statute was intendedto deprivehim of that in the interestof junior holders,unlessby a

36 HouseReport at 339. See e.g, In e Bermec Coiporation,445 F.2d 369 (2d Cir. 1971),which originatedthe periodiccash payment method[Bkr-LEd, CodeCommentaryand Analysiss. 15:5]. In that case,the debtorwas in the businessof leasing trucksand tractor-trailers.A numberof secured creditorsprovidedfmancing onsecurityof the vehiclesand opposedthe reorganizationpetition. The courtfoundthat the securedcreditorswere adequatelyprotectedby the trustee’sproposal to pay the” ‘economicdepreciation’on thesecuredcreditor’sequipmentso as approximatelyto preservetheir status quo”[at 3691.

Ibid

75 F.2d 941 (2d Cir. 1935) [hereinafterMwel]. 88 substituteof the niost indubitable39equivalence. The legislativehistory indicatesthat the conceptof indubitableequivalencewas a generalcategory intendedto providethe courts with the necessaryflexibilityto fashion “newmethodsof fmancing.” However,with a few exceptions,the protectionawardedconformsto traditional methods°4of fmancing such as governmentmortgage guaranties, a combinationof equity in the property, currentpayments and insurance42coverage or curing’4 defaults under a securityagreementor lease and undertakingto meet payments as they fall dueor providing thecreditor with a security43deposit. More novel however, is the use by the courtsof an “equity”or “value”cushion as adequate protection. As a secured creditor must be adequatelyprotected for the value of its interest in the collateraland not for the amountof the debt, when the amountof the debt is greaterthan the value of its interestin the collateral,the securedcreditor is “undersecured.” The amountof the debt that exceedsthe value of the secured creditor’sinterestin the collateralshould not be adequatelyprotected.

The debtor, in other words, has no “equity”in the collateral.

Conversely,when the amountof the debt is less than the securedcreditor’sinterest in the collateral,the securedcreditor is “oversecured.” Accordingly,the full value of its interest in the collateralshould be adequatelyprotectedand the courts hold, in some cases, that the “equitycushion” provides sufficientadequateprotection.”’

Ibid at 942. 40Ibid 41 PennsylvaniaState Employee’sRetirementFund v. Roane, 14 B.R. 542 (Bankr.E.D. Pa. 1981); contmRe Heath, 9 B.R. 665 (Bankr.E.D. Pa. 1981).

42 Re Rose, 21 B.R 272 (Bankr.D.C.N.J. 1982).

Re Wdker, 3 B.R. 213 (Bankr.WE. Va. 1980).

The first case to incorporatethis conceptwas In re Blazon Flexible Flyer, Inc., 407 F.Supp. 861 (D.C.N.D.Ohio 1976) [hereinafterBlazon]. In that case, debtor owed the securedcreditor approximately$1,340,000for which it held securityvalued at $5,731,000. The securedcreditor’s concernwas that by allowingthe debtor touse the accountsreceivableand inventory,which were valued in aggregateat $3,700,000,its Fifth Amendmentrightswere being violated. The court held 89 Severalwriters are critical of the evolutionof the equity cushion 45concept where the “collateralcusHon” is erodingthroughdepreciation,accruinginterest and costs, such as when the court holds the equity cushionin real estate tobe adequateprotection,without 47more. Thesewriters do not dismissthe notion of an equity cushion as a componentof adequateprotection in a proper case, so long as the debtor providesthe creditorwith additionalforms of adequateprotection,suchas periodic paymentsor replacementliens. One form of adequateprotectionthat they suggestis

that in view of the value of the assets of the debtor andthe amountowed to the securedcreditor,the securedcreditor’sinterestswere adequately protected[at 864-865]. There were four factorsthat must be noted with respectto this case: 1. the amountowed to the securedcreditor s approximately23% of the valueof the collateral;

2. there would be no detrimentaleffect on the security of the secured creditor as long as the accountsreceivableand inventorywere maintainedat a level sufficientlyin excess of the secured interest of the secured creditor;

3. the court orderedthe debtor toprovide fmancialreportingto it and to the securedcreditor on a regular basis; and

4. the court allowedrevision of its orders to be made on short notice in light of any changes in circumstancewhich would be detrimentalto the securedcreditor [Ibid1.

In other words, the court required, in additionto the equity cushion,regular reportingand maintenance of the equity cushion.

J. McCafferty, “‘Value Cushion’Reexamined:A Critical Review of Value Cushionas Adequate Protectionin Chapter 11 Real Estate Cases”(1984) 89 Comm.L.J. 31; E.D. Flaschen,“Adequate Protectionfor OversecuredCreditors”(1987)61 Am. Bankr.L.J. 341; J.L. Fellows,“Inre Alyucan InterstateCorporation:DeterminingAdequateProtectionin Actionsfor Relief Fromthe Automatic Stay”(1982)Utah L. Rev. 393.

Flaschen,ibid at 348 defines“collateralcushion”as the amount by whichthe valueof the collateralexceedsthe amountloanedby an asset-basedlender. ‘ McCafferty,note 45 at 33. See e.g in i Mellor,734 F.2d 1396(9th Cir. 1984)wherethe court held that an equity cushionof approximately2O%was sufficientadequateprotection. These typesof cases promptedMcCaffertyto state:

“[theequity cushionas adequateprotection]has now been appliedto frustratecompletelythe rights of creditorssecuredby sluggishlyilliquid realpropertyin the handsof speculators, wherethe marginsof value in excessof lienshavebeen so narrowedas to makethe Blazon financingarrangementlook like the best loan Citicorpever made!” [at 32]. 90 providing the oversecuredcreditorwith compensationfor iost opportunity48cost. Althoughsuch compensationusually concernsundersecured49creditors, securedcreditorsthat are providedadequate protectionby the equity cushion alone, with no current interest beingpaid, will alsoseek that compensation.

Opportunitycost is defmed as the loss incuiTedby a secured creditor by not beingpermittedto forecloseits lien, sell the collateral and reinvest the proceeds. Subsection506(b)of the Code provides: °5 To the extent that an allowed securedclaim is securedby propertythe value of which,after any recoveryunder subsection(c) of this section, is greaterthan the cimowitof such claim, there shall be allowed to the holderof such claim, intereston such claim,and any reasonable fees, costs, or chargesprovidedfor underthe agreementunderwhich such claim arose. [Emphasisadded]

Whilesubsection506(b)allowsan oversecuredcreditor torecoverpostpetitioninterest,fees and costs to the extentof the valueof the collateralexceedingthe amountof its securedclaim,it still losesthe time valueof those amountsand therebysuffersa loss. An awardof periodicpaymentsto coverits opportunity51cost wouldfully compensatethe securedcreditorin such circumstances.However,while it maybe arguablethat compensationfor opportunity52cost, should be awarded toan oversecured creditor,there is no statutoryauthorityfor awardingit to an undersecured53creditor. Compensationfor opportunitycost has moreimportanceto undersecuredcreditors. Unlikean oversecuredcreditorwhich mayrecoverpostpetitioninterest,fees and costs fromthe valueof the

48 Flaschen,supra note 45 at 353; McCafferty,supra note 45 at 35.

Defmed,supra note 9 and accompanyingtext.

° In re Timberyof Inwood Forest AssociatesLtd. 793 F.2d 1380at 1382(5th Cir. 1986),afi’d 484 U.S. 365, 98 L Ed 740 [hereinafterTimbers,citedto L Ed].

51 Flaschen,supra note 45 at 354.

52 A securedcreditorwouldbe well-advisedto includea provisionin its securityagreementfor lost opportunitycost to at leastallowthe argumentto be madethat such costwas contemplatedby the agreement.

Timbers,supra note 50. 91 collateralthat exceedsits claim,the Code has no provisionentitlingan undersecuredcreditorto such amounts. Beforethe decisionin Timbers,there was someuncertaintyas to an undersecuredcreditor’s entitlementto compensationfor its opportunity54cost. To understandthe uncertainty,we mustrefer to JudgeLearnedHand’snotionthat adequate protectionshould be“completelycompensatory”and that “paymentten yearshence is not generaliy the equivalentof payment55now.” ManyBankruptcyand DistrictCourtsin the early1980sheldthat the rightof a secured creditorto repossess,sell and reinvestthe proceedsis a valuablerightworthyof protectionand, followingJudgeHand’sopinionin Murel,awardedcompensationfor the present value of that 56right. Tn1984,the court in In re American Mc,inerIndustries 57Inc. upheldthis position. The courtheld that the central issue in the case was not todeterminehow to provideadequate protectionbut 58whether the valueof the collateralor the present value of the interestof the undersecuredcreditorin the collateralis an interestthat mustbe protected. It was then necessaryto determinethe natureof that interest.Whilethe court acknowledgedthat neitherthe legislativehistory nor the Code expresslymentionedprotectionof the securedcreditor’sright to foreclose,sell and reinvestthe proceedsof sale of the collateral,it heldthat, “[u]nquestionably,however, theseare valuablerights of secured creditors,and nothingin the reportssuggeststhat they are not amongthose

Immediatelyfollowingthe decisionin Timbers’,numerouslaw reviewarticlespraisedthe SupremeCourt’sdecisionas being strictlyin accordancewith statutory interpretationand provided undersecuredcreditorswith strategies toassistthem in coping orcircumventingthe Timbers’decision. Thesearticlespointed to the possiblenarrownessof the decisionand criticized previousdecisionsthat werecontraryto the approachin the Timbers’case as beingill-conceived. If the Timbers’decisionwas so obviouslycorrect, onewonderswhy there was any uncertaintyin the first place.

See supra note 39 and accompanyingtext.

In re AnchorageBoat Sales, Inc., 4 B.R. 635 (Bankr.E.D.N.Y.1980);In ir ViiginiaFounthy Co. Inc., 9 B.R493 (D.C.W.D.Va. 1981);MetmpolitanLife Insurance Co. v. MonmePark, 17B.R 934 (D.C.D.Del. 1982).

734 F.2d 426 (9thCir. 1984)[hereinafterAmericanMariner].

58 Ibid at 430. 92 equitableand legal interestsentitledto 59protection.” The courtthereforeconcludedthat opportunity cost was an interestthat requiredprotectionfor the securedcreditorto realize the benefitof its 60bargain. The court acknowledgedthat it was being “guidedby equitable61principles.” It heldthat the awardwas consistentwith JudgeHand’swordingthat Congressadoptedin enactingsection 361(3),62 which “at least encouragesif not requiresa present value63analysis.” The court acknowledgedseveral timesthat it was standingon less than firm ground.However,from a pure publicpolicyperspective,the decisionis defensible.MThe policyunderlyingthe decisionis obvious fromthe following:

To the extent that thedebtor inbankruptcycan preventthe securedcreditorfrom enforcingits rights against collateralwhilethe debtor benefitsfromthe creditor’smoney,the debtor andhis unsecuredcreditors receivea windfallat the expense of the secured65creditor. Meanwhile,BankruptcyCourts in a numberof other circuits concludedthat neitherMurel nor

Ibid at431.

60 House Reportat 339.

61 American Mcriner, supra note 57 at 432.

62 Ibid at 434.

63 Ibid at 432.

64 See, infra notes 69-76and accompanyingtext.

65 AmericanMariner, supra note 57 at 435. The FourthCircuitCourtof Appealsfollowedthe AmericanMariner reasoningin Gnmdy National Bankv. TandemMining Corporation,754 F.2d 1436 (4th Cir. 1985). The EighthCircuitCourtof Appealsin In re Briggs TransportationCo., 780F.2d 1339(8th Cir. 1985),also accepted thatin an appropriatecase, interestpaymentsfor the delayin foreclosing,liquithtingand reinvestingthe proceedsmay be awarded butrefused to “holdas a matter of law that a creditoris alwaysentitledto ‘suchcompensation’.“ [at 13501.The result of this case, whilerecognizingcompensationfor lost opportunitycost, was to require each courtto examineon a case by case basis whethersuch interestis worthyof such protection.This approachwouldhave resultedin considerable litigationand lackof predictabilityand accordingly,it was widelycriticized. See e.g, Note, “AdequateProtection’and the Availabilityof Postpetition Interestto Undersecured Creditorsin Bankruptcy”(1987) 100Harv.L. Rev. 1106at 1120. 93 the Code intendedto protectthe foreclosure,liquidationand reinvestmentinterest and therefore refusedto requirecompensationfor loss of that “right.” This position ultimatelyprevailed. In a carefullyreasoneddecision,Mr. JusticeScalia,who wrote fora unanimouscourt in Timbers,denied the undersecuredcreditorcompensationfor its opportunitycost. The decisionis an exercisein statutoryinterpretationand is thereforeof limitedvaluefor our 67purposes. The courtdid not acceptany of the equitable argumentsput forthby the creditor. It is submittedthat it couldnot acceptthose argumentsas the Code,when read as a whole,presentedthe courtwith no 68ambiguity. Giventhe care that Justice Scaliaused indraftinghis decisionand his logicalapproach,it is difficultto challengethe soundnessof the decisionand the law reviewarticlesbear witnessto that fact. However,the articlesdo not give creditto the soundnessof the publicpolicy concernsthat

American Mariner and subsequentdecisionsadoptingthat approachwere attemptingto address. In discussingan opinionthat supportedthe publicpolicyof AmericanMariner and was “notablefor its misconceptions,” oneauthorwrotethat thejudge”... was apparentlyunawareor choseto ignorethe fact that the bankruptcylaws are designedspecificallyto help debtors “69 Anotherauthor, referringto the factthat awardingcompensationfor opportunitycost wouldhave adverseconsequences

See e.g.,In re Pine Lake VillageApartment Co., supra note 25; In re Alyucan Interstate Coip., supra note 25; In re South Village,Inc. 25 B.R. 987(Bankr.D. Utah 1982).As the conclusions reachedby these courtsaccordwith the decisionof the United StatesSupremeCourtin Timbers,a discussionof the reasoningin these caseswill not be undertaken..

67 For example,the court held that section506(b)allows postpetitioninterestto oversecured creditorsonly and not to undersecuredcreditors. As to oversecuredcreditors,they are only entitledto postpetitioninterest tothe extentof the valueof the collateral.Undersecuredcreditorsas to the unsecuredportionsof their claims,must share the benefitsand lossesof a businessreorganizationwith otherunsecuredcreditors. They shouldnot be giventhe benefitof intereston theirsecuredclaims before unsecuredcreditorsreceiveany principalpayments. Furthermore,section 502(b)of the Code prohibitsthe paymentof unmaturedinterest.

Timbers,siqIv note 50.

T.T. Shepardifi “ThePlight of SecuredCreditorsAfter In re Timbers of Inwood Forest Associates,Ltd.” (1989) Comm. L.J. 26 at 39. 94

on corporatereorganizationsand wouldresult in more liquidationssaid “accordingly,granting undersecuredcreditorslost opportunitycostswouldbe poor public70policy.” Whiledecisionin Timbercis sound,basedon the wordingof the Code,awarding compensationfor opportunitycost is not necessarilypoor publicpolicy,for the reasonsset forthby the courtin American 71Mariner. Bankruptcylaw is not designedexclusivelyfor debtorsor unsecured creditors. It seeksto balancethe interestsof all partiesin interest. Is it poor public policyto allowa securedcreditorthe benefitof its bargain,which is finite (ie. a securedcreditorcan only recover,at most; itsprincipal,interest andcosts)while allowingthe parties thathavethe most to gainfroma reorganizationand the leastto lose from its failure,to use part of the assetsupon whichthe secured creditorbased its bargain? Severalauthorseqressed the concernthat Timberswouldresult in secured creditorsrequiringincreasedmarglns or alternatively,higherborrowingcosts whichcould resultin fewerout of court settlementsand increasedbankruptcies7 Onewondersif this is soundpublic policy.

As the courtsare moving awayfrom fully compensatoryadequateprotection,several writers have suggestedthat creditorswill be movingmore quicklyto seek relief from the automaticstayof proceedings andrequiringthe debtor to show that it has a reasonablepossibilityof successfully reorganizingwithin a reasonable73time. The result will be dismissalof the case or conversionto liquidationcases at an earlier stage in the 74proceedings. It appears,therefore,that American

° C.J. Cuevas“Lost CompensationCosts and the UndersecuredCreditor: A Journey Into the InwoodForest” (1988) 33 N.Y.L. SchoolRev. 1 at 40.

71 Supra note 57.

P. Mable “The Resolution:United States v. Timbers of JnwoodForest Associates”(1989-90)41 Ala. L. Rev. 503 at 522; J.U. Schorer “TheRightof the UndersecuredCreditorto PostpetitionInterest in Bankruptcyon the Valueof its Collateral: Implicationsof Recent Cases”(1988) 21 U.C.C.L.J.61 at 70.

Timbe,, supra note 50 at 751.

P.R Scanlon “AdequateProtectionand SecuredCreditors’StrategiesAfter Timbers”(1989-90) Miss. Coll. L. Rev. 59 at 76. 95 jurisprudenceis moving toward the CCAA approachof questioningthe feasibilityof reorganizationat the outset of the proceedingand forcingthe courtto look at the debtor’schancesof successrather than the creditor’sright to protection Unfortunately,there have been few reportedcases that test this 75hypothesis. As one writer noted, “[flew undersecuredcreditorswaste timefiling early motionsfor stay relief, and few bankruptcycourts are willing to write extensiveopinions on a matterthat has been clearly decidedagainstthe creditor’s76position” To avoid the risk of leavingthe readerwiththe ideathat the conceptof adequateprotectionis illusory,it may be usefulto summarizethe concept. The court must grantadequateprotectionto a creditor on the creditor’srequestor when the Coderequiresit. Adequateprotectionprotectsthe creditorfrom a decreasein the value of its collateraland it may assurethe creditor that it will ultimatelyreceive the value of its collateralat the dismissalor conclusionof the case. It also requires the debtorto maintainthe property and not to exposethe propertyto noncompensableloss througha lack of insurance. Finally, it is arguablethat adequateprotectionwould protect the “collateral cushion”or lending margin of an oversecuredcreditor.

However, it does not protect an undersecured creditorfor its opportunitycost and, to that extent, it is not completelycompensatory,as it deprivesthe undersecuredcreditor of the rightto foreclose,sell and reinvest the proceeds,which is the “essenceof secured lending.”

2. Natme of the Stay of Pioceedings

The BIA and the Codeimpose an automaticstay of proceedingsupon the commencementof

The reportedcasesto date merelyconfirmTimbei. See e.g., In r Reddington/Swaiww LimitedPciflne,s’h4,119B.R. 809 (Bankr.D.NM 1990).

76 Shepard,supra note 69 at 43.

L.R Molbert “AdequateProtectionfor the UndersecuredCreditor in a Chapter 11 Reorganization: Compensationfor the Delay in EnforcingForeclosureRights” (1984) 60 N. DakotaL. Rev. 515 at 517. 96 businessreorganization78proceedings. The BIA imposesthe stay uponthe filing of the noticeof intention tofile a proposal or the proposalitself. Under theCode, the filing of a petition under

Chapter 11 results in the commencementof the stay. Unlike theBIA and the Code, a stay of proceedingsunder the CCAA is not automatic. It is a discretionary79remedy grantedby the court on 80application. In keeping with the philosophythat a businessreorganizationwill be beneficialto all creditors,the CCAA allows “anyperson interestedin the matter’to make the application,although usually it will be the debtor who seeksthe stay. In consideringwhether to granta stay of proceedings under the CCAA, the current trend is for the courts to examinethe bonafides exhibitedby the debtor and the feasibilityof a successfulreorganization,from the perspectiveof the creditors and froman economicperspective. The analysis conductedby the courts in these cases is not unlikethe analysis conducted8by United States courtswhen consideringwhetherto granta secured creditor relief from the ’stay imposed automatic by the Code.

The former CanadianAct containedno provision for automatically stayingthe rights of securedcreditorsupon the filing of a proposal. This severelyrestricted theuse of the proposal provisionscontained in the fonner CanadianAct. Until the revitalizationof use of the CCAA inthe early 1980s,this limitationresulted in there being no effectivemethod under which to structurea businessreorganizationin Canada. The impositionof the automaticstay under the BIA is perhaps the most serious intrusionof the amendmentsinto the rights of securedcreditors.

78 Code s. 362(a);BIA s. 69 and 69.1.

Non’hlarzdPmpertiesLimitedv. GuardianT,ust Co. (1989), 73 C.B.R. (N.S.) 163(B.C.C.A.).

80 CCAAs. 11.

e.g., Re Philip’sManufacturingLtd (1992), 9 C.B.R. (3d) 25 (B.C.C.A.), leaveto appeal denied (1993), 15 C.B.R. (3d) 57 (S.C.C.) [hereinafterPhilzp’s];Ba,gain Haivid’sDiscountLtd v. ParibasBank of Canada(1992), 10 C.B.R (3d) 23 (Ont. Gen. Div.) [hereinafterBargainHarold’s].

82 See discussion,chapter V(A)(4)(b),below.

83 BIA ss. 69(b) and 69.1(b). 97

The specificpolicies addressedby the stayof proceedingsare commonto the statutesbeing

analyzed. However,the broader purposesof the legislation are reflected in the Americanversionof the automaticstay, which seeksto attainthe public policy objectiveof balancingthe interestsof debtors and 85creditors. This broaderperspectiverequiresthe Americancourts to determinewhether the stay is beneficial to all those concerned.

The Canadiancourts, in consideringthe stayprovisionsof the CCAA, focuson the rights of the debtoronly and the public policiesinvolved ina reorganizationproceeding,which usuallyresults in the balancetipping in favour of the debtor. Furthermore,neitherthe CCAA nor the BIA contain the significantprovisions of the Codethat seekto protect creditorsduring thebusinessreorganization proceeding. In the CCAAcases,this has led to an impositionof the stay with no provisionfor interim protectionotherthan in somecases,the appointmentof a monitor,or a completedismissalof the 87case.

Smaha,siq’ranote 30 at 1116.

85 MA. Frey, W.L. McConnicoand P.R Frey,An Introductionto Bankruptcy Law (St. Paul: West, 1990)at 16.

86 It is acknowledgedthat this generalizedpropositiondoes not take into account a numberof other factorsthat the judiciary considersin an applicationby a securedcreditor for relief from the stay. One such factor may be the relative shortnessof time to completea CCAA proceedingas comparedto a Chapter 11 proceeding. However,in the case involvingQuintette Coal Limited,the court grantedthe debtor a period of six months withinwhich to effect a plan of arrangement. While the stay period may not appear inordinate,it must be rememberedthat the companiesseekingrelief from the staywere owed in excess of $36,000,000. It is submittedthat a six month stay with no protectionof the claims of the creditorscouldhardlybe consideredequitablefrom the creditors’point of view.

87 The QuebecSuperior Court hinted at the possibilityof “carvingout” a secured creditor which consideredits securityto be in jeopardy. M le juge Gervais in the case of Tcrhé ConstructionLtée. v. BanqueLloyds du Canada (1991), 5 C.B.R (3d) 151at 162,stated:

“L’intervenanten’adémontréala Cour que ladite machinerieétait plus en dangermaintenant qti’auparavantet, tout comme lea garantiesde l’intervenante,la Banque Lloyds, celles de la Banque nationale du Canada doivent demeureuren suspens durantle moratoire.”

[headnotetranslation, at 152: “As for the creditor who held securitieson the machinery,it did not establish that the machinerywas now in greaterdangerthan it had been before. Its securities,like that of the 98 The ColterCommittee88Report suggesteda means of stayingproceedingsby securedcreditors that recognizedtheir needto be adequatelyprotectedwhile thedebtorconsideredwhethera reorganizationwas feasible. Therecommendationsallowedthe securedcreditorto collectaccounts receivable,sell rapidlydepreciatingor perishableproperty,cany on the businessof the debtor,solicit but notacceptoffers topurchase thecollateraland takepossessionof but not removeproperty. In addition,the recommendationsgavethe courtsa wide discretionto determinewhetherto lift the stay againstthe applicantsecuredcreditor,basedon whetherthe creditorwas “adequatelysecured.”

Althoughthe BIA incorporatedthe recommendationof imposingthe stay againstsecuredcreditors,it gavesecuredcreditorsnone of the rights,otherthan to applyto the courtto seek relief fromthe stay on the groundsthat the securedcreditoris “materiallyprejudiced”or on other 9grounds. Priorto the enactmentof the Code,the policymakersrecognizedthat the° stayprovisionsunder the 1898U.S. Act and the rules promulgatedthereunderwere inadequatefrom the perspectivesof the debtor,who requiredthe protectionof the stay,and the creditoragainstwhomthe stay appliedand who neededrelief from the staywhenthe collateralwas deterioratingin 9value. The following frequently-citedexcerptfromthe HouseReport reflectsthe rationaleand’objectivesof the automatic stayprovisionsof the Code:

The automaticstay is one of the fundamentaldebtorprotectionsprovidedby the bankruptcy laws. It givesthe debtora breathingspell fromhis creditors. It stopsall collectionefforts,all harassment,and all foreclosureactions. It permitsthe debtorto attempta repaymentor reorganizationplan, or simplyto be relievedof the fmancialpressuresthat drovehim into

principalcreditor,shouldremain on holdduringthe moratorium.”]

Had the securedcreditorbeen in a positionto showthat it was in greaterdanger,the courtmayhave beenwillingto allowthe creditorto havethe stayliftedagainst it aloneand allow it to realizeon the machinery.

Colter CommitteeReportat 56.

Ibid at 57.

9° BIA s. 69.4.

9° HouseReport at 174. 99

bankruptcy.

The automaticstay alsoprovides creditorprotection. Withoutit, certaincreditorscouldpursue their ownremediesagainst thedebtor’sproperty. Thosewho actedfirst wouldobtainpayment of the claims in preferenceto and tothe detrimentof othercreditors. Bankruptcyis designed to providean orderlyliquidationprocedureunderwhichall creditorsare treatedequally. A race of diligenceby creditors forthe debtor’sassetsprevents92that. The foregoingpolicy statement reflectsthe culminationof the evolutionof the conceptof the stay of 93proceedings sincethe passageof section77B. Canadiancourts, indescribing the purposeof the stayprovisionsin the CCAA,use similar language. The courtsdescribethe purposeas beingto maintainthe statusquo for a periodwhile the debtorattemptsto gain theapprovalof its creditorsfor a proposedarrangementthat will enablethe debtorto remain inoperationfor the futurebenefitand well-beingof the debtorand its 94creditors. The courtssee the stay as a mechanismfor “holdingthe creditorsat 95bay” until the compromiseor arrangementis approvedby the courtand the creditorsor it is obviousthat the attemptis “doomedto failure.” For policy reasonsthat tend to favourthe debtor,the courts areinclinedto allowthe debtor the opportunityto attempta reorganization,even in circumstanceswhere secured creditorshavemade it clearthat they will notsanctiona plan underany circumstances.The basis on whichthe courtshold that the stay should remainin place is that it is possiblethat the debtorcouldformulatesometype of plan that would see the secured creditorpaid out in full. The creditor wouldclearlyaccept thistype

HouseReport at 340.

See e.g. In re Maler Brewing Co., 38 F.Supp.806 at 817 (S.D. Cal. 1941).

Meridian DevelopmentsInc. v. TorontoDominion Bank(1984),52 C.B.R (N.S.) 109(Alta. Q.B.) [hereinafterMeridian]; Re Non’hla.ndPmpertiesLtd (1988),73 C.B.R.(N.S.) 146(B.C.S.C.).

HongkongBank of Canadav. Chef RecidyFoods Ltd (1991),4 C.B.R (3d) 311 at 315 (B.C.C.A.)[hereinafterChef Ready]. Ibid. 100 of 97plan. That is, the courtsseem to grantthe stay basedon the “interestof the public in the continuationof the 98enterprise,” such as by the numberof people that the business employsor the natureor necessity of the commoditiesor servicessuppliedby the enterprise.

This structureof the CCAArequiresthe courtsto take thistype of approach. The initial applicationunder the CCAA must seekan order for a meetingof creditors,shareholdersor both.’°° It does not give any directionconcerningthe proceedingsor substanceof the meetingbut we may assumethat the purpose of the meetingis to considerthe plan of compromiseor arrangement. Section

11allowsthe court to granta stay of proceedings“wheneveran applicationhas been madeunder”the

CCAA. The only applicationthat the debtorcan makeis the initial applicationseeldngan order for a meeting. In this manner,the court must considersome of the merits of the case when agreeing to grantthe ’10stay. Given the limitedinformationprovidedto the court at that stageby the applicant,the fact that most initial applicationsare ex porte and facedwith the general objectivesof the CCAA, the courts seem to rely on the generalpolicy and objectivesof the CCAA in grantingthe stay. The courts have beenreluctant to “carveout” certaincreditorsand allow them to realizeon their 02security.’ This

See e.g., TimberLodge Ltd v. TimberLodge Ltd (Creditorsof) (1992), 15 C.B.R. (3d)244 at 252 (P.E.I.S.C.)[hereinafterTimberLodge]; Icor Oil & GasLtd v. CancdiaiiImperialBank of Commerce(No. 1) (1990), 102A.R. 161 (Alta. Q.B.) [hereinafterIcon; contra;Elan Coiporationv. Cominskey(Trusteeof) (1990), 1 C.B.R. (3d) 101(Ont.C.A.) [hereinafterElan]; Baigain Harold’s, supra note 81.

98 S.E. Edwards,“ReorganizationsUnder the Companies’CreditorsArrangementAct” (1947)25 Can. Bar Rev. 587at 593.

Ibid However, one case denied an applicationfor a stay on the basis that the public didnot have an interest in the continuationof the enterprise [Re UnselInvestmentsLtd (1991), 2 C.B.R. (3d) 260 at 279 (Sask. Q.B.), rev’don other grounds(1992), 10 C.B.R. (3d) 61 (Sask.C.A.)J. This case appearsto be an anomalyhowever,and is not indicativeof the general trend. 100 CCAAss.4and5.

101 It is therefore more appropriate todiscussthe exerciseof the court’sdiscretionin the context of a creditor seeking relief from the stay. See discussion,chapterV(AX4)(b),below.

102 Quintette Coal Ltd v. Nzpon Steel Coip. (1991), 2 C.B.R. (3d) 291 at 297 (B.C.S.C.) [hereinafterQuintette]. 101 has resulted in applicationsto lift the stay entirely and to have the CCAAproceedingsvacated. This approachclearly favours the debtor, as the only alternativeto reorganizationis liquidation,which is contraryto the intent of the legislation. This situationhas prompted one writerto note, “[tjhiscreates a heavy onus on the creditor seekingto vary stay orders oropposethe reorganizationand technical argumentsare rarely likely to succeed inthe face of ‘economicreality’- the ends will invariablyjustify the 3nans.”° In the United States, on the otherhand, the stay is automatic,which obviatesthe necessityof justifying the stay. The courtsfirst face the issue of the necessityof the automatic stay on an applicationby a disgruntledcreditor to have the stay lifted. The Code gives the court some direction concerningalternate remediesthat it may granton such an application. Specifically,the court may

“carveout” a creditor’sintereston proof of certainfacts or may provide “adequateprotection”° to a creditor. As the court need not deprivethe debtorof the opportunityto reorganize4and as the secured creditorwill be entitled to have its interest “adequatelyprotected,”the court balancesthe interestsof the debtor and the securedcreditor indeterminingwhetherto lift or continuethe stay. Adequate protection may take a numberof 5fomis.’° Canadianlegislationdoes not give the courts authorityto grant adequateprotectionand accordingly,they have simply deniedsecured creditorsthe ability to realize on their security,withoutproviding any interimprotection or compensationfor loss during the stay06period.’ In summary,althoughthe specific objectivesof the stay of proceedingsare commonto all of

103 MA. Fitch, “TheReorganizationof QuintetteCoal Limited: An Unsecured Creditor’s Perspective”in Insolvency Instituteof CancdaSecond AnnualMeetingand ConferenceMaterials, October20-22, 1991,HorseshoeValley Inn, Orillia, Ontario99 at 107.

104 Code s. 362(d)-(g).

‘° See discussion,chapter V(A)(1)(b),below.

106 e.g., Re Phil4is Manufirturing Ltd (1992), 12 C.B.R (3d) 133at 138 (B.C.S.C.),where the court deniedpaymentto a securedcreditorof interest duringthe periodof the stay as it would be “unfair”to “prefer”the bankas to interestwhen no other creditor will receive it. 102 the statutoryschemes,the statutoryschemeshave detennined,to a greatextent,the way in whichthe

staywill operate. The courts,in consideringthe CCAA,with its “allor nothing”approachto the stay

lookfavourablyat allowingthe debtorthe opportunityto reorganize. Unlessthe plan is “doomedto failure,”the courtsallowthe debtortime withinwhichto formulatethe plan. The creditorhas the onusof showingwhy the court shouldnot grant the 7order.’° The courts in the United States,on the other hand,look at whetherthe creditor’sinterestsare protected..’° Otherthan with respectto the issue as to whetherthe debtorhas any equityin the property,8 the debtorhas the burdenof proof on all other 109issues.

Althoughthe structureof the BIA allowsthe courts to considerrelief fromthe stay on a creditorby creditorbasis,the wordingof section69.4110 appearsto place the burdenof proofon the creditorseekingrelief. That sectionprovides:

A creditorwho is affectedby the operationof sections69 and 69.3may applyto the court for a declarationthat those sectionsno longeroperatein respectof that creditor,andthe court may make such declaration,subjectto any qualificationsthat the courtconsidersproper,if it is satisfied (a) that the creditoris likelyto be materiallyprejudicedby the continuedoperation of those sections;or (b) that is is equitableon other groundsto makesuch declaration.

Withno statutorymechanismfor providingsecuredcreditorswith interimprotection,this section placesa burdensomeonus on the creditors. The courts,in consideringcasesunderthe CCAA,choose not to exercisetheir equitablejurisdictionto allowsuch interimrelief or protectionand, in fact,refuse to allowit.” It is open tothe courts,in consideringcasesunderthe BIA, to exercisetheir specific

107 Baigain Harold’s,supra note 81 at 30.

108 Code s. 362(d).

‘ Code s. 362(g).

‘o BIA s. 69.4.

111 Quintette,supra note 102. See also Re Alberta-Pxflc TenninalsLtd (1991), 8 C.B.R.(3d) 99 (B.C.S.C.),wherethe court deniedpaents to a creditorpursuantto operatingagreements notwithstanding continueduse of the securedproperty by the debtor. 103 equitable2jurisdiction” and grant interimprotectionto securedcreditors. 3. Scopeof the Stay of Pmceedings Section362(a)of the Code defmesthe scopeof the automatic13stay.’ The legislativehistory intendedthe scopeof the stayto be broadand to encompass notonlyjudicial proceedings,but also arbitration,licenserevocationand administrativeproceedingsagainstthe debtor,as well as civil

112 BIA ss. 183(1)and (2); Re Gold (1927),8 C.B.R.39 (Ont. S.C.); Re Heron (1933),15 C.B.R. 39(Ont. S.C.).

113 Code,s. 362 (a):

(a) Exceptas providedin subsection(b) of this section,a petitionfiled under section301, 302, or 303 of this title, or an application filedunder section5(a)(3) of the Securities Investor Protection Actof 1070(15 USC 78eee(a)(3)0, operatesas a stay, applicableto all entities,of -

(1) the commencementor continuation,including theissuanceor emploent of process,of a judicial,administrative,or otheraction orproceedingagainstthe debtor that was or could havebeen commencedbefore the commencementof the caseunder this title, or to recovera claimagainstthe debtorthat arosebeforethe commencement of the case under thistitle;

(2) the enforcement, againstthe debtoror againstpropertyof the estate,of a judgmentobtained before thecommencementof the caseunder thistitle;

(3) any act to obtain possessionof propertyof the estateor of propertyfromthe estate orto exercisecontroloverpropertyof the estate;

(4) any act to create,perfect, orenforce anylien againstpropertyof the estate;

(5) any act to create,perfect,or enforce againstpropertyof the debtorany lien to the extentthat such lien securesa claimthat arosebefore thecommencementof the case under thistitle;

(6) any act to collect, assess,or recovera claimagainstthe debtor thatarose beforethe commencementof the case under thistitle;

(7) the setoffof any debt owingto the debtor thatarosebefore thecommencement of the case under thistitle against anyclaimagainstthe debtor;and

(8) the commencementor continuationof a proceeding beforethe UnitedStates Tax Courtconcerning thedebtor. 104 actions and all proceedingseven if they are not before governmental14tribunals.’ The stay also enjoins a securedcreditor holding a securityinterest under article 9 of the UniformCommercialCode from repossessingits collateral by self-helpor judicial 115process. To appreciatethe extentof the stay, one only needreview the definitionof the term “entities,” to which the automaticstay is applicable. An entity includes, inter dia a governmentalunit6 and a person, which in turn, is 7defined” as including an individual,partnership and corporation. Althoughneither section 362(a) nor the definitionsof

“entity”or “person,”refer to creditorsand specifically,secured creditors, section 362(a) is clearly applicableto secured creditors. We shouldalso note that a “claimagainst the debtor” includesa claim againstthe debtor’sproperty” and section 541 comprehensivelydefines “propertyof the estate.”

The 8 11 scope of the stayof proceedingsthat a courtmay order pursuantto section of the

CCAA is not as comprehensiveas section 362(a) of the Code. Section 11provides:

Notwithstandinganythingin the Bankniptcyand InsolvencyAct or the Winding-upAct wheneveran applicationhas beenmade under this Act in respect of any company,the court, on the applicationof any person interestedin the matter, may, on notice to any other person or without notice as it may see fit,

(a) make an order staying,until such time as the court mayprescribe or until any further order, all proceedingstaken or that mightbe taken in respect of the company under the Bankniptcy and InsolvencyAct and the Winding-upAct or either of them;

(b) restrain furtherproceedingsin any action, suit or proceedingagainstthe companyon such terms as the court sees fit; and

(c) make an order that no suit, action or other proceedingshall be proceededwith or commencedagainst the companyexcept with the leave of the court and subjectto such terms as the court imposes.

Shoulda court choose not to makea comprehensiveorder incorporatingsubsections(a), (b) and (c),

114 House Reportat 340.

115 RL. Jordan and W.D. Warren,Bankruptcy(Mineola:Founthtion Press, 1985)at 754; Codes. 362(aX3).

116 Codes. 101(15).

117 Codes. 101(41).

118 Codes. 102(2). 105 the extentof the staywill be limitedaccordingly. Two early CCAAcases serveto illustrate this proposition. In Re Arthur Flint CompanyLimited,” the courtconsidereda provisionin an orderthat stayedall actionsby unsecuredcreditorsand9 furtherorder a that stayedproceedingsfor the recovery of debts. The court held that proceedingsunderthe formerCanadianAct were not proceedingsfor the recoveryof debts. In allowinga petitionunder theformer CanadianAct to stand, the courtnotedthat the stay orderdid not correspondto the wordingof the CCAAthat allowedthe stayingof proceedings under theformerCanadianAct Gray v. WentworthCanning Company2Limited’ furtherillustratesthe strict interpretationof a provisionin a stay order. In that case, the court° held that a provisionin an orderrestraining proceedingsthat may “betaken”againstthe debtorprohibited onlyfuture actions,suits or proceedings againstthe debtorand that preexistingproceedingsmay 12continue. Becauseof Arthur Flint and WeniworthCanning,ordersunder theCCAAincorporate’ the languageof section 11,enjoiningthe commencementor continuationof all presentand future suits,actionsand proceedingsagainstthe debtor,includingproceedingsunderthe BIA and the Winding-upA22ct.’ The courts haveupheld these broad23provisions.’

119 (1944),25 C.B.R 156 (Ont. S.C.) [hereinafterArthur Flint].

120 (1950), 31 C.B.R. 182(Man.KB.) [hereinafterWeniworthCanning].

121 Ibid at 185.

122 FR. Foranand T.M Warner, ‘Reorganizingthe hisolventOil and Gas Corporation: The Courts and Fairness”(1990)28 Alta. L. Rev. 132at 143. See e.g., the stay order in the QuintetteCoal Limitedcase whichread as follows:

AND THIS COURT ORDERSthat all proceedingstaken or that mightbe taken in respectof the Petitioner underthe Bankruptcy Actand the Winding-upAct or either of thembe stayed;

AND THIS COURTORDERSthat any furtherproceedingin any action,suit or proceeding againstthe Petitionerbe restrained;

AND IF11SCOURTORDERSthat no suit, actionor otherproceedingshallbe proceeded with or commencedagainst thePetitioner;

123 See e.g., Quintette Cod Limited v. Nippon Steel Corp. (1991),2 C.B.R.(3d) 303 (B.C.C.A.). 106

The term “proceeding”determinesthe breadth of the stay. While it may be difficultto argue that an“action”or “suit”contemplatessomethingotherthan a judicial proceeding,the term

“proceeding”was the subject-matterof discussionin some of the earliercases. The court in

Wentwon’hCanning, gave the term a very narrow meaning. Using ejusdemgeneris, Kelly J. held that the word “suit”governsthe word “proceeding”and accordingly,the stayenjoins only proceedings institutedin a 24court) Such a narrowinterpretationwouldnot prevent extra-judicialproceedingssuch as self-helpremedies (where they are availableunder provinciallaw) or realizing on assignedor pledgedproperty.

An early case that saw the revitalizationof the CCAArejected this narrow approach. In 25Meridian,’ WachowichJ. gave section 11 a wide interpretationto accommodatethe purposesof the CCAA. Specifically,His Lordshiprefusedto restrict the term “proceedings”to those involvinga court or a court official. The courts have embracedthis broad approach to abrogatethe rightsof secured creditors,for example,to forecloseon a real property 26mortgage,’ realizeon securitygrantedpursuant to section427 (formerly section 178)of the Bank A27ct’ and notify third party lesseespursuant toan assignmentof rents givento the secured28creditor.’ The overridingprinciple, it seems,is that if realizationon the security,regardlessof its nature,prejudicesthe opportunityof the debtor to attempt a reorganizationof its fmancial or businessaffairs, the court will enjoin the secured creditor from realizingon its security.

The stay provisions of the BIA are broad and appear to encompassmost realization proceedingsthat a securedcreditor couldtake. For example,subsection69(1) provides:

124 WentworthCanning supranote 120at 185.

125 Meridian,supra note 94.

126 Re Non’hlandPropeiliesLimited (1989), 73 C.B.R. (N.S.) 141(B.C.S.C.).

127 S.C. 1991,c. 46 [hereinafterBank Act]; Chef Recdy, supra note 95.

128 TimberLodge, siqra note 97. 107

Subjectto subsections(2) and (3) and sections69.4 and 69.5 on the filing of a noticeof intentionunder section50.4 by an insolventperson,

(a) no creditorhas any remedyagainstthe insolventpersonor the insolvent person’sproperty, orshallcommenceor continueany action,executionor other proceedings,for the recoveryof a claimprovable inbankruptcy,

(b) no provisionof a securityagreementbetweenthe insolventpersonand a securedcreditorthat provides,in substance,that on

(i) the insolventperson’sinsolvency, (ii) the defaultby the insolventpersonof an obligationunderthe security agreement,or (iii) the filingby the insolventpersonof a noticeof intentionunder section 50.4,

the insolventpersonceasesto have suchrights touse or dealwith assetssecuredunder the agreementas he wouldotherwisehave,has any force or effect,and

(c) Her Majestyin right of Canadamay not exerciseher rights undersubsection 224(1.2)of the Income TavAct in respectof the insolventpersonwherethe insolvent person is a tax debtor underthat subsection,and Her Majesty inright of a province may not exerciseher rights underprovinciallegislationsubstantiallysimilarto that subsectionin respectof the insolventpersonwherethe insolventpersonis a tax debtor under provinciallegislation

until the filing of a proposalunder subsection62(1)in respectof the insolventpersonor the bankruptcyof the insolventperson.

Paragraph(a) of the stay provisionsimposesa stay against creditorsthat, by defmition,includes secured129creditors. The terminologyappears,at first blush, to be straightforwardand self- explanatory.However,on closerexamination,the stayprovisionsof the BIA leaveone with the feelingthat the policymakerswere unaware of the concernsraisedin the cases underthe CCAA. The terms “action”and “execution”shouldnot be the subject-matterof debate. However, weagain,must facethe term “otherproceedings.”Althoughone wouldthink that the courts willlookto the decisions under the CCAAas a statute inpai materiato determinethe scopeof “otherproceedings,” Parliament could haveclarifiedthat term at the outset.

129 BIA s. 2:

“creditor”meansa personhavinga claim,preferred,securedor unsecured, provableas a claim underthis Act; 108

In the eventthat the courtsgive “otherproceedings”a broadinterpretation,as underthe

CCAA,then the openingwordsof paragraph(a) may be superfluous,as the word “remedy,”likely includesbothjudicial and self-helpremedies. Shouldthe courtsgive “otherproceedings”a narrow interpretation,then the term “remedy”is limitedto self-help remedies,and “other proceedings” contemplatesa limiteddefmition thatcasesas earlyas eightyearsprior to the BIiVsenactmentappear to have settled.

The stay of actions,executions orotherproceedingsin paragraph(a) concerns“therecoveryof a claimprovablein bankruptcy.”A securedcreditormay realizeits securityand prove thebalance due after deductingthe realizedamountor, surrenderthe securityto the trustee, andprovefor the entire°13claini Assuming,as oftenhappens,that the securedcreditorchooses torealizeits security andprove for the balance,the stayprovisionarguably onlystaysthe securedcreditorwith respectto the provableportionand notthe securedportion. In that case,the first portionof paragraph(a) operatesto enjointhe securedcreditorfrom resortingto any remedyagainst the“insolventpersonor the insolventperson’sproperty.” This would, logically,applyto a mortgagee undera real property mortgageor a securedparty holdinga securityinterestin the debtor’sequipment. However,does it preventa secured creditor from realizingon propertythat thedebtorabsolutely assignedto it or propertyin which thesecuredcreditorhas an interst thatis tantamountto ownership? Forexample, a properlyframedassignmentof bookdebtsconveysall of the right,title and interestin the bookdebts to the assigneesuch that the book debts “werenevermorethe propertyof the assignor.” In sucha case, it is arguablethat the securedcreditoris not seekinga remedy againsteither’3 the insolventperson or the insolventperson’spropertyby requestingpaymentfromthe third partydebtor. Similarly, securityunder section427 of the BankAct132 givesthe bankthe samerights and powersas if the

130 BIA s. 127.

‘‘ Royd Bank of Caiicdav. R. (1985),52 C.B.R (N.S.) 198(F.C.C.).

132 Siqra note 127. 109 bankhad acquireda warehousereceipt orbill of lading inthe secured propertyand consequently,all the right and title to those documentsand the goods,waresand merchandisesecured33thereby.’ It is thereforearguablethat the bank is realizingon what it alreadyowns and it is seekingno remedy againstthe insolventpersonor the insolventperson’sproperty.

While onemay raise argumentsto counterthe foregoingpositions,they illustrateproblemsthat the courtsmay face underthe stay provisions. Thepolicymakerscould alleviatethese argumentsby clarifyingthe stay provisionsto addressthe concernsof secured creditorsand debtors.

Paragraph(b) allowsthe debtorto “useor deal”with the collateral. From a securedcreditor’s point of view, this provisionmay be moretroublingthan the actualstay of proceedings,as the BIA providesno protection tothe secured creditorfor the debtor’suse of “liquid”collateralsuchas inventory oraccounts receivable (assumingthat the staypreventsthe securedcreditorfromrealizing on those assets).A debtorcould continuecollectingaccountsreceivable orconsuminginventory withouthavingto protector compensatethe securedcreditor. While the securedcreditormay apply for relieffrom the stay, in such circumstances,suchan applicationwill forcethe courtsto choose betweenthe interestsof the secured creditorand those of the debtor ormore broadly,the public policy interestsof allowingthe debtoran opportunityto reorganizeits affairs. The courts are placedin the difficultpositionof determining theobjectivesof the legislation,with the wordingof the BIA providing little orno 134guidance. This provisionis of even greaterconcernwhen one considersthat the BIA deemssuchprovisionin a securityagreement tobe of no “forceor effect.” This mayprovide legislativesanctionto the debtor divertingfundsfromthe creditorthat previously heldsecurityon suchfunds,with no compensationbeing paidto suchcreditor. It is suggestedthat, in sucha case,the judiciaryexercisingits equitablejurisdiction,couldinjectthe conceptof adequate35protection’ in

133 Ibid s. 435.

134 See discussion,chapterV(5),below.

135 See discussion,chapterV(A)(1)(b),below. 110 favourof a secured creditor withoutfrustratingthe businessreorganizationprovisionsof the BIA.

The foregoingshowsthat the courts,underthe statutesbeingconsidered,have very broad powersto stay proceedingsagainstthe debtor. However, theinherentpowerof the court further augmentsthese powers. Underthe Code,the courtsuse subsection105(a)to issue injunctionsagainst partiesor proceedingsnot otherwisestayedby subsection362(a)or that subsection362(b)specifically exceptsfrom thescopeof the stay. Subsection105(a)of the Codeprovides:

The courtmay issueany order,process,orjudgmentthat is necessaryor appropriateto cany out the provisionsof this title. No provisionof this title providingfor the raisingof an issue by a party in interestshallbe construedto precludethe court from, sua sponte,talcingany actionor makingany determinationnecessaryor appropriateto enforceor implementcourt ordersor rules, or to prevent anabuseof process. In In , Otem Mills, Inc.,‘ the creditorbroughtan actionagainstthe guarantorof obligationsof Otero Mills,Inc. that was subjectto protectionunder subsection362(a)of the Code. The debtorasserted that the guarantorwas goingto contribute personalassetsto it to effectthe reorganizationplan. The court,pursuantto subsection105(a),prohibitedthe creditorfrom enforcingitsjudgmentagainstthe guarantor. Enforcementagainstthe guarantorwouldaffectthe debtor’sestate andadverselyinfluence and pressurethe debtorthroughthe 37guarantor.’ The importanceof this case lies in the formulation by the BankruptcyCourtof the test to determinewiietherthe courtwould grantan injunctionto enjoin a creditorfrom pursuinga co-debtoror guarantor. In sucha case, the debtormust show:

1. irreparableharmto the debtor’sestateif the injunctiondoes not issue;

2. stronglikelihoodof a successfulplan of reorganization;and 3. no harm or minimalharmto the otherparty or 38parties.’ To this, the DistrictCourtaddeda fourthfactor,whichappeared tobe the overridingand most influentialfactor. The courtheld that “in the bankruptcysetting,the public interestlies in promoting

136 25 B.R. 1018(D.N.M 1982)[hereinafterOtero Mills].

137 Ibid at 1019-1020.

138 Ibid at 1021,quotingthe BankruptcyCourt. 111 successful39reorganizationtl The courtreinforcedthis factorby stating: At the beginningof the reorganizationprocess,a court must workwith less evidencethan mightbe desirable and should resolveissuesin favourof reorganization. . Although reorganizationby any bankruptmay be speculativeearly in the proceedings,[the creditor] is protectedin that if a reorganizationplan is not approved,it may applyto the bankruptcycourt to lift the injunction.‘4° Subsequentcase law and legal 4scholars’ have criticizedthe approachin Otero Mills as it”... woulddistortcongressionalpurposeto ’hold thata third party solventco-defendant shouldbe shielded againsthis creditorsby a device intendedfor the protectionof the insolventdebtorand creditors 142thereof.” Despite thecriticism,othercourtshave followedit in different143contexts. Therefore,the stayprovisionsmay applyto the secured creditoreventhoughthe creditorseeksa remedyfor which the stay provisions appearinapplicable.

The Canadiancourtshave recentlybegunexplicitlyrecognizingtheir inherentjurisdictionin casesunderthe CCAA.’’ The courts, however,do not require theincreasedburdenof showing irreparableharmto the debtor’sestate ora strong likelthoodof a successfulplan of reorganization.In

139 Ibid at 1021.

“° Ibid.

141 See e.g., Lynch v. Johns - ManvilleSdes Coip., 710 F.2d 1194(6th Cir. 1983)[hereinafter Lynch]; D.R Kuney, “TheBank GuarantyAgreement: TheEmergingThreatof the BankruptcyStay” (1985-86)Bus. Law. 77.

142 Lynch, ibid at 1197.

143 E.g., In re A.H Robins Co., Inc., 828F.2d 1023at 1026(4th Cit 1987)[hereinafterA.H Robins],wherethe court enjoined theplaintiffsfrompursuingproductsliabilityinsurersof the manufacturerof the DalkonShieldon the groundsthat such an actionwould requirethe insurerto involvethe debtor andsuch involvementwouldcauseirreparableharmto the bankruptcyestateby placinga burden onthe officers,directorsand employeesof the debtor“whichwouldexhausttheir energiesand thus interferewith the debtor’sreorganization”;In re Fussell,928 F.2d 712 (5th Cir. 1991),where thecourtheld thatit couldenjoinstate criminalproceedingspremised ona debt owedby the debtor. But see In re TheRussellCoiporation,156B.R. 347 (Barikr.N.D. Ga. 1993),where the courtheld that the automatic stay“wasnot designedto benefitthird parties, except tothe extentthat third partiesbenefit generallyfrom the preservationof assetsof the debtor.”(at 349). ‘ See e.g. Re WestarMining Ltd (1992), 14C.B.R.(3d) 88 (B.C.S.C.),where thecourt granted a “super-priority”to supplierswho were preparedto keepthe debtoroperating. 112 Ccanpeauv. Olympia& York45Ltd,’ the court exercisedits inherentjurisdiction to restrain the plaintifffrom continuingan action againsta co-defendantof the debtor. Implicit in the decisionis a recognitionthat section 11 of the CCAA did not providethe court withjurisdiction to restrainactions, suits or proceedingsagainstentities other than the debtor company. Using languagethat echoesthe reasoningin similarcases in the United States) the courtstated,”... the restrainingpower extends as well to conduct which could seriouslyimpair the debtor’sability to focusand concentrateits efforts on the businesspurposeof negotiatingthe compromiseor 47arrangement.” The courtthen makesthe very curiousstatementthat “[tlhebalanceof conveniencemust weighsignificantlyin favourof grantingthe stay, as a party’sright to have accessto the courtsmust not be lightlyinterfered48with.” The curiosityof this statementlies not in the propositionitselfbut the court’sfailureto justify interferencewith the plaintiffs right of accessto the courts. More recently,Mr. JusticeFarleyin Re Lehndoff GeneralPailner 49Ltd,’ held that thecourt’s inherentpowerto grantstays “canbe used to supplements. 11 of the CCAA when it isjust and reasonableto do so.”° In this manner,His Lordship stayedproceedings,not only againstthe debtor companiesbut also againstthe individualinterestsof limitedpartners,as the businessof the debtor companiess significantlyintertwinedwith that of the limited15partnerships. Althoughthe BritishColumbiaSupremeCourt,in the caseinvolvingQuintetteCoalLimited enjoinedcreditorsfromdemandingpaymentfromthe guarantors’of the obligationsof the debtor,it

145 (1992), 14 C.B.R.(3d) 303 (Ont. Gen. Div.) [hereinafterCainpeau]. ‘ See e.g. A.H Robins, supra note 43. 147 Campeau,supra note 145at 309.

Ibid at 309-310.

149 (1993), 17 C.B.R. (3d) 24 (Ont. Gen. Div.) [hereinafterLehndorfj].

‘° Ibid at 38.

151 Ibid at 35. 113

appearsfromthe reportedcasesthat that provision wentunchallengedby the creditors.However,other courtsrefuseto stay actionsagainstguarantors,directors and52officers.’ In 53Philzp’s,’ the debtor obtainedthe stay by an exparte application. The stay preventedcreditorsfrom takingproceedings

against directors,officers,employees,agents orconsultantsof the debtor. The court refusedto exerciseits inherentjurisdictionto maintainthe stay. It distinguishedthe Americancasesupholding sucha stay on the basis that “thereis a specificprovisionunder theUnited StatesBankruptcyCode,

11U.S.C.S.(s. 105(a)),whichempowersthe court toissue ‘anyorder.., necessaryor appropriate’to carryout the provisionsof the 54Code.” However,the court grantedliberty toreapplyin the event that the lack of the stay significantlyinterferedwith the preparationof the reorganization55plan.’ The stay provisions under theBIA are limitedto proceedings againstthe insolventpersonor the insolventperson’sproperty. As mentionedabove,56however,’ the BIA givesthe the courts equitablejurisdiction. In addition,the court hasinherentjurisdictionwith respectto all mattersunder the BIA.’ This givesthe courta broaddiscretionto stay variousactionsthat arein somey related to the insolvent person,the insolventperson’spropertyor, more generally,the broadpurposesof the

152 See e.g. GuardianTiust Co. v. Gaglardi(1990),64 D.L.R (4th) 351 (B.C.S.C.);Re Keddy Motor Inns Ltd (1991), 290 A.P.R.419 (N.S.S.C.);Re Faüview IndustriesLtd (1991), 11C.B.R (3d) 37 (N.S.S.C.)

Philip’s,supra note 81.

154 Ibid. at 9.

Ibid

156 See discussion,supra notes 110-112and accompanyingtext.

In Re LoxtaveBuildings of Cancth Ltd (1943), 25 C.B.R 22 at 25 (Sask. KB.), the court said:

“1realizethat the bankruptcylaw is statutorymainly anda Court shouldnot go beyond the provisionsof the statuteapplicable. But,if the subject-matteris within thestatute,the Court may draw on its inherentpowersto giveeffectto the provisionsof the statute.” 114 legislation. However,the stay of proceedingsis in the natureof an 58injunction’ and governedby the same59principles.’ In particular,the threefactorscited inOteroMills reflectthe generalprinciplesin a bankruptcycase160 and the publicpolicyof promotingbusinessreorganizationsshouldnot significantlyinfluencethe courts,unlessall other factors are61equal.’ The oveniding consideration should notbe thepolicy of encouraglngbusinessreorganizationsbut the very specialand extraordinary natureof the exerciseof inherentjurisdiction. As statedby the SupremeCourtof Canada,“[i]nherent jurisdictioncannot,of course, beexercisedso as to conflictwith a statuteor Rule. Moreover,because it is a specialand extraordinarypower,it shouldbe exercisedonly sparinglyand in a clear ii162

4. lifting the Stay!Dismissingthe Case A challengeto the grantingor continuationof the stayis “oneof the major63battlegrounds” of

158 A.-G. Man. v. MetropolitanStores (MTS)Ltd, [198711 S.C.R. 110at 127 [hereinafterMTS].

159 Ibid at 127-29,whereBeetz J. set forthtests employedby the court inconsideringwhetheran injunction shouldbe granted,being:

1. a preliminaryand tentativeassessmentof whether thereis a seriousquestionto be tried, 2. whetherthe litigantwho seeksthe interlocutoryinjunctionwould,unless theinjunctionis granted,sufferirreparableharm,that is harmnot susceptibleor difficultto be compensatedin damages;and 3. a determinationof whichof the two partieswill sufferthe greaterharm fromthe granting or refusalof the interlocutoryinjunction,pendinga decisionon the merits.

160 Supranote 138and accompanyingtext.

161 MTS, supranote 158at 129-30.While the SupremeCourtof Canadafelt that the public interest shouldbe a factorto be consideredunderits third test, it did so in the contextof a challenge to the constitutionalityof a statutepromulgatedby the Manitobalegislature. Althougha business reorganizationaffectscertainsectorsof the publicand the economy,it is suggested,with respect,that the SupremeCourtof Canadas contemplatingpublicrights in the contextof laws whichare passed “forthe commongood” [at135]. The courtthen cites numerousexamples,none of whichappearto fall withinthe purviewof what the courtreferredto as “theinterestsof privatelitigants’whichin most cases,will be the typesof interestssoughtto be protectedunderthe inherentor equitablejurisdiction of the courtunderthe BIA.

162 BaxterStudent HousingLtd v. CollegeCo—opercdiveLtd, [1976] 2S.C.R.475 at 480.

163 F.J.C.Newbould,Q.C. “The CompaniesCreditorsArrangementAct” (1992), 7 B.F.L.R 51. 115 businessreorganizationproceedings. OneAmericanwriter stated that “stayrelief is the mainevent in manychapter 11 cases.lM

The difference in structureof the Codeand the CCAAresults inthe parties seekingto challengethe stay taking different approaches. The courts in Canadafocus on aspects of the case or stages in the proceedingthat differ from their Americancounterparts. A strict comparativeanalysisof the approachestaken is difficultto conduct,althoughthe approachesintersectperiodically. This section willanalyze each scheme separatelyand then, considerthose schemesin light of the BIA.

Before embarkingon the analysishowever,we must addresstwo matters. First, we cannot overstatethe importanceof the conceptof adequateprotectionin an Americanproceeding. Thetheory underlyingAmerican stay litigationis that, so long as the securedcreditoris provided with adequate protectionor hasan opportunityto repossessthe collateral,there is no need for that creditorto questionthe rightof the debtorto attemptto reorganize. Thereorganization processis not harming the creditor. In this way,the debtormay continueoperatingthe businesswhile formulatinga plan.

Conversely,the Canadiancourtshave not used the conceptof adequateprotectionin dealing with casesunderthe CCAA. Accordingly, securedcreditors haveno alternativebut to challengethe entireproceedingbased on the lack of bonajIdes of the debtoror the feasibilityof a successful reorganization. The burdenplacedon a secured creditorin takingsuch an approachis veryheavy, giventhe inclinationof the courtsto affordthe debtoran opportunityof exploringthe reorganization alternative. In other words,the courtsmust choosebetweenthe secured creditor,whoseinterestsare compromised,or the debtor,whichis seekingto reorganizeits affairs. Without theconceptof adequateprotection,there is no mechanismfor the courtsto use to strikea compromise;oneparty wins,the other loses.

A secondmatter that we must note is that, throughoutthe discussionthat follo, passing

164 MJ. Bienenstock,BankmptcyReorganization(NewYork:PractisingLaw Institute,1987)at 132. 116

referencewill be madeto the conductof the parties. Although,generally,the courts do not expressly

statethat their decisionsare heavilyinfluencedby the conductof the parties,such conductappearsto have someinfluence. One ‘.witernoted:

while economicor financialfactorsare significantin automatic-staylitigation,these factors arenot the only considerationthat courtsapply. Instead,litigationby creditorsto lift the stay is oftenreachedin light of the creditor’sand debtor’sbehaviorbeforeand duringthe bankruptcycase. The result is a generalbalancingof equitablefactors,especiallyin business cases,that is significantlymore complexthan the pure economicevaluationoften suggestedin the 65literature.’ Withthe limitednumberof casesunderthe CCAA,the factthat few cases specificallyreferto the conductof the partiesand, most importantly,the fact that this aspectof the decision-maldng processis generallycovert,it is difficultto gamerany generalprinciplesfrom the decisions.

Hovever, the reader must be cognizantof this factorwhenreviewingthe following.

(a) CCAA

A challengeto the stay generallytakesplace at the initialhearing,if the debtorapplieson noticeto otherparties,or soon after the creditorsreceiveor become awareof the stay order,if the debtor’sapplicationwas expan’e. As the courtis reluctantto carveout certaincreditors,it is forcedto considerthe viabilityof the plan at a veryearly stage of the proceedings.’

In the eventthat a single-class creditoror a groupof creditorsof a class sufficientto defeat the compromiseor arrangementadvises thecourtthat no compromiseor arrangementwill be 67acceptable,’ the court mustfacethe issueof whetherthe compromiseor arrangementis doomedto

165 RT. Nimmer,“RealEstateCreditorsand the AutomaticStay:A Studyin Behavioral Economics”(1983) Ariz.St. L.J. 281 at 281. ‘ The issueconcerningthe dismissalof a proceeding basedon the inabilityof the debtorto securethe requisitestatutorymajoritiesis more appropriatelydiscussedin the contextof the creditors’ votingon the plan. SeediscussionchapterVI(C),below. Hoever, as the challengeto the stayputs the entireproceedinginto question,therewill necessarilybe someoverlapin the discussions.

167 Tnorderto succeed,a compromiseor arrangementmustbe acceptedby a majorityin number, representingthree-fourthsin valueof the creditors,or class of creditors,votingat the meetingdirected by the court [CCAAs. 6]. Thereis no provisionin the CCAAwhichallowsthe court to “cramdown” 117 failure. In such a case, the court will dismissthe application forthe stay of proceedingsor lift the stay, if the courtgrantedthe stay orderon the exparte applicationof the debtor. The OntarioCourtof Appealfacedthis issue68Elan.’ The majorityof the courtheld that the appellantbank shouldbe placedin its own class and, as that class wouldrejecta planof arrangement,the plancouldnot 69succeed.’ As a result,the court lifted thestay of proceedingsand dismissedthe proceeding. In Diemc’sterToolInc. v. Skvotsoff(Trusteeoj),17o the courtreacheda similar conclusiondespite testimonythat the planof compromiseand arrangementwouldresult in paymentin full to the secured ’7creditor.’ the plan on a class of creditorsthat has rejectedthe plan as contemplatedby section 1129 (b)of the Code. A rejectionof the plan by a class of creditorsmerelyresults ina failureof the plan with respectto the rejectingclassor, if a plan so provides,a failureof the plan in its entirety[CCAAs. 6; J.D. Honsberger,Debt Restructuring(Toronto:CanadaLaw Book, 1993)at 9-40].

168 Elan, supra note 97.

169 Ibid at 115.In reviewingthe decisionof the majority,one wonderswhetherthe erosionof the collateral wasthe majorfactorbeing consideredby the court,ie. the lack of adequateprotection.One of the primarysecuritiesheld by the appellant wasa first registered chargeon accountsreceivable. The court specifically referredto a previousorderin the proceedingswhich stayed theappellantbank from actingon its securityand allowingthe debtorto spendup to $321,000from accountsreceivable collectedby it [at 109].

170 (1991),3 C.B.R (3d) 133(Ont. Gen. Div.) [hereinafterDiemaster].

171 The debtor requiredthe stayperiod toseek new debt orequityfmancing. The courtappeared concernedwith the fact that the debtorhad been in fmancialdifficultyand had beenseekingdebt or equityfmancingfor almosttwo yearsprior to the applicationunderthe CCAA. Althoughnot expressed,it appears thatthe court hadlittle confidence inthe debtorfindingsufficientdebt or equity fmancingto pay the securedcreditorin fill. This conclusionis implicitin the followingstatement:

“Thebank would hardlyvote for a resultthat wouldgo againstits own interests. Sinceit opposesany proposalsor arrangementsnow, the bank would be expectedto vote againstit, therebyassuringrejectionof any proposalby that classof securedcreditor.”[at 149]

Seealso First Treaswy Pinancid Inc. v. Cango PetroleumsInc. (1991),3 C.B.R.(3d) 232 at 238(Ont. Gen.Div.) [hereinafterCajigo]whereAustinJ., in dismissing anapplicationfor a stay orderunder section 11,said:

“Inthe presentcase, Cangois simplyasking theCourtto staythe handsof creditorsin the hopethat, in whateverperiodof graceis granted,somethingmore will happenthan has occurredin the past9 months,and that thatsomethingwill permitthe companyto be salvaged.” 118 The OntarioCourtof Justicerefmedthe test morerecentlyin Ba,gain 72Ha,vld’s.’ While acceptingthe general propositionthat the court will refusean applicationfor a stay if it is clear that no plan will be acceptableto the requiredpercentagesof creditors,the court held that the advice of

certain secured creditors that they would not approveany plan put forth by the debtor doesnot put an

end to the inquiry. The court felt that it must consider“allaffected constituencies” includingsecured, preferredand unsecuredcreditors,shareholders,landlords,employeesand the public generally.’ The court ultimatelyheld that there was no reasonableprospectthat the debtor coulddevise a plan that would satisfy those voting constituenciesunder section6 and therefore,refused to imposethe 74stay.’ We must distinguishthe foregoingcases from the cases that allow the debtor an opportunityto reorganizein the face of advice that a single-classsecured creditoror a sufficientmajorityof a class will rejectany plan put forth by the debtor. All of the cases, save one, emanatefromjurisdictions outside Ontario. The BritishColumbiaCourt of Appeal in 175Phi4ps and the Alberta Court of Queen’s

172 Baigain Ha,old’s,supnrnote 81.

‘ Ibid at 30.

174 Ibid at 32. This case is a clear exampleof the court’sconcern with the conduct of the debtor. Austin J. referred to a number of “importantelements”which wereused in reaching the decision, including: 1. the debtor didnot know the precisenatureof the problemwhich resulted in its fmancial difficultiesand that its auditors advisedthat the cause may never be known 2. the debtor hadno idea how to salvagethe operation,other than to “dosize”; 3. the debtor lacked operatingcapital and certain shareholderswho were in a positionto assist in refmancinghad made no offer to so assist; 4. the debtor failedor abandonedan attempt toraise equity to fmance expansionon the basis of its fmancial and accountingproblems;and 5. the debtor’sadmissionsof mismanagement,with no proposed solution.

Cf Re Perkins (1991), 6 C.B.R. (3d) 299 (Ont.Gen. Div.) [hereinafterPerkins], where thecourt distinguishedCango,supra note 171,on the basis of the conductof the debtor andthe supportof the unsecured creditors,the latterof whichwas absentin Cango. In Perkins, the debtoritself “had recognizedits fmancialproblemsand had retainedoutsidehelp in an attemptto resolveit [sic]”[at 306].

175 Phil4,’s,siq,n7note 81. 119

Benchin 1761cor imposeda stay of proceedingsto allowthe debtoran opportunityto negotiateand fonriulatea plan of reorganizationand compromise. Eachcourt further heldthat adviceconcerning the unequivocalrejectionof any plan at any stageof the proceedingswas not a sufficientbasisupon whichto dismissthe case, asthe plan couldresult in full paymentof the objectingcreditor’sclaimsor someother satisfactory77arrangement.’ Similar considerationsappearedto have influencedthe PrinceEdwardIslandSupremeCourtin

Timber178Lodge. The value in this case goesbeyond theaffirmationof those approaches,as the court suggestedthat there was evidencetenderedwhichnot only showedthe objectingcreditors tobe “adequately79protected” but also intimatesthat thecreditorsmay be able torecovercompensationfor opportunity°8cost.’ The foregoingillustratesthe difficultiesfacedby the courtsin analyzingthe use or continued

176 Icor supra note 97.

W7 The Albertacase is interesting,as the courtbrieflydiscussesthe fmancialpositionof one of the creditors. Althoughthe terminologyused by the courtdoesnot make clear whetherit was using an appraised valueof the collateralor the face valueof the security,it is clearthat the court feltthat the creditorwas “adequately secured”[at164].The debtwas $2.2 million,the accounts receivable$1.4 millionand the creditorheld “debenturesecurityof 1.5milliondollars.”The creditorwas complaining that theaccountsreceivablewere being used for continuingoperationsto whichthe courtreplied“Itis likelyhowever,that the use of someof accountsreceivablefor ongoingoperations willultimately impingeupon unsecuredcreditors,ratherthan the [complaining creditor].”This indicatesthat the debenturesecurity togetherwith someof the accountsreceivablewouldpay out the complaining creditor. The balanceof the accountsreceivable wouldbe distributed among the unsecuredcreditors.

178 TimberLodge, supra note 97. ‘ Ibid at 252, 253,wherethe courtstated: so long as the positionof the rejectingrespondentsis not beingundulyjeopardized,there should bean opportunityfor the applicant tobe put backon a firm foundation.

I do not fmdthat the debt of the objectingcreditorswill be compromisedin the shortterm or that I wouldbe necessarily delayingthe inevitableif the applicationwere granted.”

180 Ibid at 252 where thecourt stated:

“However,the applicantstatesthat whilethe objectingrespondentswouldhave to giveup somethingat the presenttime, it wouldnot be totallylost as they shouldbe ableto regainin the futurewhatthey are now losing.” 120 use of the stay at a very early stageof the reorganizationproceeding. By focusingon the debtor’s rightto posit a planof reorganizationor compromise,ratherthan on the protectionaffordeda secured creditorduringthe stayperiod, the courtsplace themselvesin the unenviablepositionof havingto determinethe likelihoodof the debtorputtingforth a successfulplan of reorganizationat a stageof the proceedingswhenthe partiesthemselvesare still attemptingto grapplewith their respectivepositions.

The debtoris in the panickedstate of attemptingto formulatea planthat will pacify all creditors, wile, at the sametime, attemptingto determinehow the businessdeterioratedto such an insolvent state. The securedcreditors,on the other hand,are attemptingto determinehow the stay affectsthem and how best to protecttheir securedpositionsvis-a-visthe securedcollateral.

The Canadiancourtsuse varioustermsto describethe standardnecessaryfor the creditorto succeedin havingthe stay lifted or the stay applicationdismissed. The courtsrequire theopposing creditorto show thatthe plan is “doomedto 8failure” or that there is no reasonable82“chance,” 83“prospect,” or of acceptance’ of a plan of arrangementor compromise. Althoughit has been suggestedthat these termsimposedifferentstandardsof 85proof,’ it appearsthat the courts rely onfactorssuch as lack of adequateprotectionof the creditor’sinterestsor the conductof the parties. Onlythe clearestcase will allowthe courtto dismissan applicationusing one of the foregoingstandards. In all other cases,the debtor shouldbe giventhe benefitof the opportunityto formulatea planprovided that it adequatelyprotectsthe creditors’positions. In thismanner,the courts couldtailor the remedyto fit the circumstancesand deal with the matter on a creditorby creditor basis. Shouldthe debtorbe unable toprovideinterimprotectionto its creditors,this may be an

181 Chef Recdy, supra note 95.

182 Cango, supra note 171. ‘ BasgainHarold’s,supra note 81. ‘ Fairi’iewIndustriesLtd (No. 2) (1991), 109N.S.R. (2d) 12 at 23 (N.S.S.C.). 185 Alec Zimmerman,“EffectiveImplementation”in Co?porateRestructuring,(Toronto: Canadian Institute,1992)at 32-38. 121 indicationthat the businessis not worth saving.

This approachis the one set forth in the Code,to whichwe willnow turn our attention. We mustnote at the outsethowever,that the Americansystemis not withoutits faults. The sheer volume of the casesconsideringthis issuebears witness tothis fact. However,the approachsatisfiesthe requirementof allowingthe debtorsome “breathingspace”while at the sametime attemptingto protectthe interestsof securedcreditors. If provisionis madeto provideprotectionto creditorsin

Canadawhilethe debtoris formulatinga plan,the only questionis how adequatethe protectionmust be, not whether the debtorshould have theopportunityto formulatea plan.

(b) Code

Subsections(d) through(g) of section362 governrelief fromthe automaticstay underthe 86Code.’ To obtainrelief fromthe automaticstay,the secured creditormusttake a positivestepto

186 Codess. 362(d)-(g):

(d) C)nrequestof a party in interestand after noticeand a hearing,the court shall grant relief fromthe stayprovidedunder subsection(a) of this section,such as by terminating, annulling, modifying,or conditioningsuch stay -

(1) for cause,including thelack of adequateprotectionof an interest inproperty of suchparty in interest;or

(2) with respectto a stay of an act againstpropertyunder subsection(a) of this section,if -

(A) the debtordoesnot havean equityin suchproperty;and

(B) suchpropertyis not necessaryto an effectivereorganization.

(e) Thirtydays after a requestundersubsection(d) of this sectionfor relief fromthe stay of any act againstpropertyof the estateundersubsection(a) of this section,such stay is terminatedwith respectto the party in interestmakingsuchrequest,unlessthe court,after noticeand a hearing,orders such stay continuedin effectpendingthe conclusionof, or as a result of, a final hearingand determination undersubsection(d) of this section A hearing underthis subsectionmay be a preliminaryhearing,or may be consolidatedwith the fmal hearingunder subsection(d) of this section. The court shall order such stay continuedin effectpendingthe conclusionof the fmalhearingunder subsection(d) of this sectionif there is a reasonablelikelihoodthat the partyopposingrelief from such stay will prevailat the 122 seek suchrelief. A courtmay not act sua sponi’e.’87 Shouldthe securedparty do nothing, thestayof an act againstpropertyof estatecontinuesuntil the propertyis no longerpropertyof the estateandthe stay of an act againstthe debtor continuesuntil the case is closedor dismissedor thecourt grantsor deniesthe debtor’sapplicationfor a discharge,whicheveris 88earliest.’ Shouldthe securedcreditorwish to seekrelief fromthe stay, it must requestsuchreliefby way of motionon reasonablenoticeto the debtor’ and other interested9parties,’ althoughthe court may allowthe creditorto makethe applicationon an ex parte basis in appropriate° 91circumstances.’ After noticeand 1hearing, the court shall grantrelieffrom thestay “forcause,includinglackof conclusionof such fmal hearing.If the hearing underthis subsectionis a preliminaryhearing, then such fmal hearingshallbe commencednot laterthan thirtythys after the conclusionof such preliminaryhearing.

(f) Upon requestof a party in interest,the court,with or withouta hearing,shall grant suchrelief fromthe stay providedunder subsection(a) of this sectionas is necessaryto preventirreparabledamageto the interestof an entity in property,if such interestwill suffer such damage beforethere is an opportunityfor noticeand a hearingunder subsection(d) or (e) of this section.

(g) In any hearingunder subsection(d) or (e) of this sectionconcerningrelief fromthe stay of any act under subsection(a) of this section -

(1) the party requestingsuchrelief has the burdenof proof on the issueof the debtor’sequityin property; and

(2) the party opposingsuchrelief has the burdenof proof on all otherissues.

187 R.M Martin “CreditorAlternativesto ObtainReliefFromAutomaticStaysin Bankruptcy” (1981)98 BankingL.J. 525 at 536.

188 Code s. 362(c).

189 U.S. BankruptcyRules ss. 4001(a)(1), 9014.

190 U.S. BankruptcyRules ss. 1007(d),4001(a)(1);Code s. 1102.

191 U.S. BankruptcyRules s. 4001(a)(2).

192 This phrase is defmedin subsection102(1)of the Code:

(1) “afternotice andhearing”,or a similarphrase-

(A) meansafter suchnoticeas is appropriatein the particularcircumstances,and 123 adequateprotectionof an interestin propertyof’ the secured93creditor.’ A lack of adequateprotection is merelyone “cause”that may result in the court grantingrelief fromthe stayand “cause”is onlyone alternativeon which the securedcreditormay rely inseekingrelief from the stay. On a hearingfor relief fromthe stay, the only issueto be consideredis whetherthe courtwill grantthe requested

194relief. Unlikethe CCAA,the grantingof relief fromthe stay may or may not disposeof the reorganizationproceeding. It merelydealswith the interestof the applicantparty and no other interests.

The courtsin the United States,like those in Canada,are reluctantto grantrelief fromthe automaticstay in the early weeksof the 95proceeding.’ This givesall partiesan opportunityto assess the situationand determinewhetherthe creditor’ssecurityis valid,whetheradequateprotectionis necessaryand in what form and whetherthe possibilityof formulatinga successfulreorganizationplan is feasible.

Section362(d)of the Codeprescribesfour modesof relief fromthe automaticstay,whichare nonexclusive.The courtmay:’

1. terminatethe stay with respectto the applicantcreditoror generally. Terminationallows

such opportunityfor a hearingas is appropriatein the particularcircumstances;but

(B) authorizesan act withoutan actualhearingif suchnotice is givenproperlyand if -

(i) such hearing is not requestedtimelyby a party in interest;or

(ii) there is insufficienttime for a hearingto be commencedbeforesuch act must bedone,and thecourt authorizessuch act;

Code s. 362(d)(l).

194 HouseReportat 344.

195 Jordan andWarren,supra note 115at 786.

‘ F.R Kennedy, “TheAutomatic Stay in Bankruptcy”(1978) 11 Mich.J.L. Ref. 177at 253- 254. 124 the creditorto pursueits remediesto their full 97extent;’ 2. annulthe staywhichterminatesit ab initio. Annulmentgenerallyoperatesretroactivelyto the date of the filingof the 98petition;’ 3. modify the stayto allowone act or one creditor topursuea remedy,such as allowingan actionto continueto judgmentbut disallowingenforcement;’ or

4. place a conditionon the staythat, if breachedor unsatisfied,may automaticallyterminate the °20stay. Relieffromthe stayis mandatory,if the creditorshowscause for the grantingof the relief,or, with respectto property,the debtordoes not have equity inthe propertyand the propertyis not necessary to an effective20reorganization. Cause includesa lack of adequateprotection. It also includesan actionthat lacks any connectionor will not interferewith the bankruptcycase, such as a personal injury action against’ thedebtor andits 202insurer or actionsinvolvingthe debtor’spostpetition

‘ Ibid at 253. 198 In re Albany Partners,Ltd. 749 F.2d 670 (11thCit 1984)[hereinafterAlbanyPartners]. See also Sikes v. Globd Mañne, Inc., 881F.2d 176(9th Cir. 1989). ‘ Kennedy,supra note 196at 254; In re Holtkamp,669 F.2d 505 (7th Cir. 1982). 200 Blazon,supra note 44, where thecourtrequiredthe debtorto continuetransmittingfmancial information toit and tothe securedcreditoron a regularbasis. Althoughthe court did not order automaticterminationof the stay upona failureof the debtorto meetthe condition,it confinnedthe right of the securedcreditorto applyon short notice fora revisionof the order (at 865).

201 One of the more important portionsof the Timbersdecisionis the guidancethat JusticeScalia providesconcerningsection362(d)(2). In particular, HisHonourset forththe burdenthe the debtor must meetto showthat thecollateralis necessaryto an effective reorganization.

“Whatthis requiresis not merelya showingthat if there is conceivablyto be aneffective reorganization,this propertywill be needed for it; but that the propertyis essentialfor an effectivereorganizationthat is inprospect. This means ... that there must be a reasonable possibilityof a successfulreorganizationwithina reasonabletime.” [at 751, emphasisoriginal]

This not only providesan alternativemannerfor undersecuredcreditorsto seek relief fromthe staybut it also opensthe door for American counselto perhapsuse someof the reasoningadoptedby the Canadiancourtsconsideringthe CCAA.

202 In re Holtkainp,supra note 199. 125 203activities. A stay of this type of actionis unnecessary,as it is unrelatedto the purposeof the stay, whichis to protectthe debtorfrom its 204creditors. The debtor’smalafides or misconductis anothercausethat may resultin relief fromthe automatic205stay. Jndiciaof lack of bonafides may be that”... there is no going concernto preserve,there are no employeesto protect,and there is no hope of rehabilitation,exceptaccordingto the debtor’s‘terminaleuphoria’•“206

The creditormay seekthe more drastic remediesof having thecase dismissedin its entiretyor havingthe case convertedto a liquidationcase pursuantto section 1112. A lack of bonafides has beenheldto be groundsfor dismissalof a 207case so that a creditorseekingrelief fromthe staymay fmd the cases consideringthat issueuseful.

An applicationseekingrelief fromthe automaticstay basedon “cause”invitesthe courtto makea broadinquiryinto the facts. The court will examineeconomicfactorsand may examine behavioraland equitable208factors. The factsof each case will determinewhetherrelief is appropriate in the 209circumstances but the courtshavebeen responsive tomanytypes of requests. Althoughthe factsmaynot warranta complete dismissalor conversionof the case, facts evidencing the“causes”

203 HouseReportat 343-344.

204 ibid.

205 See generally,Ordin, “The Good Faith Principle in the Bankn.iptcy Code:A Case Study” (1983)38 Bus. Law. 1795.

206 Ibid at 1073.

207 AlbanyPartnei, supra note 198.

208 Nimmer, supra note 165at 284. A recent exampleof a courtconsideringbehavioralfactorsin reachingits decisionwas in In re Kleinman, 156B.R 131 (Bankr. S.D.N.Y.),wherethe courtgranted the securedcreditorrelief fromthe automaticstay and, in so doing,notedthe fmancialirresponsibility of the debtorsand the fact that one of the debtors“hasundertakena scorchedearthcampaignof litigation,includingmakingnumerousattackson the court’sintegrity.”[at 1321.

209 HouseReport at 344. 126 listedin section 1112(b)of the Codemay be sufficientto obtainrelief from the °21stay. Underparagraph362(d)(2),which is the secondgroundfor seekingrelief from the automatic stay,the secured creditorhas the burdenof proofon the issueof the debtor’sequityin the property and the debtor has the burdenof proof on all other 21issues. The two elementscomprisingparagraph 362(d)(2)are that the “debtor doesnot have an equity’ in suchproperty”and “suchpropertyis not necessaryto an effectivereorganization.”The paragraphrequiresboth elementsto be presentfor the reliefto be granted. If both elementsare not present,the courtwill dismissthe applicationbut the securedcreditormay attempt toshowa lack of adequateprotectionat that hearing,or subsequently,or

210 Code,s. 1112(b):

(b) Exceptas providedin subsection(c) of this section,on requestof a party in interestor the UnitedStatestrustee,and after notice anda hearing,the courtmay converta caseunder this chapterto a case underchapter7 of this title or may dismissa case under thischapter, whicheveris in the best interestof creditors andthe estate,for cause,including-

(1) continuingloss to or diminutionof the estate and absenceof a reasonable likelihoodof rehabilitation;

(2) inabilityto effectuatea plan;

(3) unreasonable delayby the debtorthat is prejudicialto creditors;

(4) failureto proposea plan under section1121of this title withinany time fixed by the court;

(5) denialof confirmationof everyproposedplan and denialof a requestmade for additionaltime for filing anotherplan or a modificationof a plan;

(6) revocationof an orderof confirmation under section1144of this title, and denialof confirmationof anotherplan or a modifiedplan under section 1129of this title;

(7) inabilityto effectuatesubstantialconsummationof a confirmedplan;

(8) material defaultby the debtorwith respectto a confirmedplan;

(9) terminationof a plan by reasonof the occurrenceof a conditionspecifiedin the plan; or

(10) nonpaymentof any fees or chargesrequired underchapter 123of title 28.

211 Code s. 362(g). 127 someother “cause”entitlingit to relief fromthe stay.

In determiningwhether thedebtorhas equity inthe property,the court looksat the difference betweenthe propertyvalue andthe total valueof the liens againstthe property and notjust the value of the lien of the creditorseekingrelief fromthe stayplus all senior212liens. With respectto the secondelement,the courtshave embracedthe requirement establishedby Timbersthat the debtormust showa reasonable prospectfor a successfulreorganizationwithina reasonable213time. It is insufficientfor a single-assetdebtor toarguethat it requiresthe sole asset foran effective 214reorganization or that the propertyis indispensableto the debtor’ssurvivaland ultimate 215rehabilitation.

(c) BIA

Section69.4 governsthe liftingof the automaticstay. It provides:

69.4 A creditorwho is affectedby the operationof sections69 to 69.3 may applyto the court for a declarationthat thosesections no longer operatein respectof that creditor,andthe courtmay make such declaration, subjectto any qualificationthat thecourt considersproper,if it is satisfied (a) that thecreditoris likelyto be materiallyprejudicedby the continuedoperation of those sections;or (b) that it is equitableon other groundsto make such a declaration.

In addition,however,the securedcreditormay effectively terminatethe stay by successfully challengingan extensionof the period withinwhichthe insolventpersonmay file a proposalpursuant to section50.4(9),or by havingthe periodwithinwhichthe insolventpersonmay file a proposal terminatedpursuant50.4(11).

212 Stewartv. Gurley,745 F.2d 1194(9th Cir. 1984).

213 See e.g.,In re CanalPlcs.eLimitedPartnersh4,,921 F.2d 569 (5th Cir. 1991);In re Snapwoods Apartmentsof Dekdb CountyLtd, 153B.R. 524 (Bankr.S.D. Ohio 1993);In re GrandTraverse DevelopmentCo. LimitedPartnership,150B.R. 176(Bankr. W.D. MIcK1993).

214 Bienenstock,supra note 164at 135-136.

215 Norton BankrLaw & Practices. 20.27. 128

Section69.4 givesthe court somediscretionin the remedyit may grant,although theformsof reliefare not as extensiveas those under theCode. For example,whetherthe courthas the jurisdictionto retainthe stay, on the insolventperson providingthe secured creditorwith adequate protection,is questionable. Althoughcourts have equitablejurisdiction,the wordingof section69.4 doesnot appearto supportthe argument that thecourtmay exercisethatjurisdictionin these circumstances.On a strictreadingof the section,the courtmay “makesuch a declaration,”beinga

“declarationthat [the stay provisions]no longeroperatein respectof that creditor.”That is, the court may eitherlift the stay orretain thestay.

However,the court may makethe declaration“subjectto any qualificationthat thecourt considersproper.” Shouldthe court deny theapplication,it cannotimposea conditionon that order.

The staywouldcontinueto unconditionallybind thesecuredcreditor. The courtcould, however,grant leaveto reapply under section69.4, on short notice,shouldcircumstances216change. Shouldthe court grantthe applicationand makethe declarationthat the stay provisionsno longer operate in respectof that creditor,the court couldstay the operationof the orderso long as the insolventpersonmakes periodic payments,providesa replacementor additionallien, or providessomeother typeof adequate protection. This wouldmeet the objectiveof the proposalprovisionsand the stayperiodwouldnot prejudice securedcreditors. If the courtstake an absoluteapproachby lifting or retainingthe stay, withoutqualifications,either thebusinessreorganizationobjectivewill be completelyfrustrated,by leavingthe insolventpersonwithout cashflow,key assetsor any assetswith whichto reorganize, or secured creditors willbe materially prejudicedby allowing theinsolventpersonto continueto use or expendthe collateral,withoutcompensation. The courtsmust devisesomecompromiseposition.

Althoughthe wordingof section69.4 is not as clear in that respectas section362 of the Code,an openingexistswithinwhich toaccommodatesucha position.

Subsection69.4(a)providesthat the courtmay lift the stay in respectof the applicant creditor

216 BIAs. 187(11). 129

if that creditoris likelyto be “materiallyprejudiced”by the continuedoperationof the stay. Denying the securedcreditorits right to realizeon its collateralimmediatelyis prejudicial,to a certainextent.

However,it is difficultto conceiveof whenthe prejudicebecomes“material”and when, evenif the prejudiceis material,the securedcreditor’sinterestsoutweighthe publicpolicyinterestsof encouragingbusinessreorganizations. “Materialprejudice”is beneficialas it attempts tofocuson protectingthe securedcreditorratherthan on the insolventperson’sright to effecta reorganization.

Theterm also provides thecourt with someflexibility,whichis also beneficial,as the decisionswill hopefullyebb andflow with the tides of business. However,the BIA does not givethe courtsany guidanceconcerningthis matterand it is possiblethat a stay of whatever magnitudeand forwhatever periodmay be consideredmateriallyprejudicial. Shouldthe conceptevolvein sucha manner,the amendmentswill have accomplishednothing. On theotherhand,if the courtsinterpretthe standardof proof of materialprejudicenarrowly,they will deny securedcreditorsof the benefitof their respective bargains,whichwill have dire effectson the creditmarket217generally. The materialprejudice standardwill likelyfall betweenthe twoextremes.However,the conceptis soamorphousthat each interpretationwill be fact specific. This will undoubtedlyresult in muchlitigationand very few 218answers. Therehave been no reportedcases todatethat confrontthis issuedirectly,althoughthe few casesdealingwith liftingthe stay or otherremediessoughtby creditorsmay provideus with a preview of how thecourtswill approachthese mattersandthe scopeof the automaticstay. The courtsmay

217 Whethersecuredcreditorsshouldbear any cost in a businessreorganizationat all will be discussed,chapterV(5), below.

218 Not unlikethe litigationattemptingto defmethe doctrineof “reasonablenotice”whichstarted in earnestwith RonaldElwinListerLtd v. DunlopCancdaLtd, [198211 S.C.R 726 and which continues today.Althoughthere have been manycasesconsideringthis issue,the doctrineis so fact specificthat few lawyers,with certainty,will opineon an absoluteminimumamountof notice. 130 place considerable emphasison the conductof the 219parties. For example,the cooperationof the debtor and its principals maytip the balance infavour of requiring the stay to remainin place.°

However,if the debtor commencesa proposalproceedingin bad faith as a shamor delayingtactic,the court may be inclinedto censurethe insolventpersonby lifting the ’22stay. One court stated,as obiter dictum,that it would be materiallyprejudicialto a securedcreditor if the debtorsold the collateralat

“fire sale” pricesto allow the debtor to attemptto stay in businessby generatingcash flow from the 222collateral. One of the groundsjustifying terminationof the period withinwiuichthe insolventpersonmay file a proposal is if “the creditorsas a whole wouldbe materially prejudicedwere the application under this subsection223rejected.” The court, in NT. W.,224 interpretedthat sectionto meanthat all of the creditorsmust be materially prejudicedfor the applicantto succeedon this ground. It held that, althoughthe delay caused the securedcreditorprejudice,the insolventperson was permittedto continueto use securedfunds to operate the companies,while makingno payments tothe secured creditor. This decision makes that groundvery difficult or impossible fora secured creditorto rely on, as any action taken by the court for its benefit would likely have a detrimentaleffect on the

219 See e.g., 156190 CancriaLtd v. Bciiown Drugs Ltd (1993), 19 C.B.R (3d) 129 (N.W.T.S.C.) [hereinafter156190 CanadaLtd 1;Leslie Mcrlnlyre MaritimeAssocktes Inc. v. ZutphanBros. ConstructionLtd (1993), 19 C.B.R. (3d) 94 at 100(N.S.S.C.). See also Nimmer, supra note 165at 298-300.

° Re NT W.ManagementGmiq, Ltd (1993), 19 C.B.R. (3d) 162 (Ont.GeiiDiv.) [hereinafter NT W.J,vkiichwas not an applicationfor relief from the stay but was an applicationpursuant to section 50.4(11)of the BIA for an order terminatingthe notice of intention;Re High Street Construction(1993), 19 C.B.R. (3d) 213 (Ont. Gen.Div.) [hereinafterHigh Street], where the court was dealing with an extensionof time to file a proposalunder section50.4(9) of the BIA. See also Nirnmer,supra note 172 at 301-303.

221 See e.g., Re Malenfant(1993), 19 C.B.R (3d) 295 (Que.S.C.).

156190CanadaLtd. supra note 219.

BIA s. 50.4(11)(d.

224 NT W.,supra note 220. 131 unsecured orjunior securedcreditors. Thedecisionin this case,may have been basedon the protectionaccordedto the securedcreditorduringthe stay. The courtprovideddirectionsto the interim receiver“toprotectthe interest”of the 225creditor. The securedcreditormay have felt that this protectionwas adequateas it adjournedits application undersubsection50.4(11)sine die.

One of the requirementsthat aninsolventpersonmust showto obtainan extensionof the time within whichto file a proposalis that “nocreditorwould bematerially prejudicedif the extension beingappliedfor were 226granted.” In High 227Street, the courtheld that the applicantwas not materially prejudicedby the failureof the debtorto pay the arrearsof intereston the outstanding indebtedness tothe applicantand accruingrealtytaxes. This caseis noteworthy, asthe court suggested thatthe securedcreditorwas adequatelyprotectedbecausethe securedassets “arenon- depreciatingand cannotbe 228dissipated” and the stay did not preventthe secured creditorfrom “issuingits noticeof sale with respectto its 229mortgages.” Althoughthe courtsattemptto avoidusingthe CCAAcasesto arriveat their decisions,° the samethought processesare operating.In High Street, the court cited’3Elar? and (]ltrxare ManagementInc. v. Zevenberger(Trusteeofl232 and held that the securedcreditorcouldnot say that it wouldnot acceptthe insolventperson’sproposalunderany circumstances.The court in NT. W.also

225 Ibid at 164.

226 BIA s. 50.4(9)(c).

227 HighStreet,supranote 220.

228 Ibid at 215.

229 Ibid.

230 In fact, the NT. W. case,supra note 220, explainedsomeof the featureswhichdistinguishthe two acts. ‘ Elan, supra note 97.

232 (1991),3 C.B.R. (3d)151(Ont. Gen.Div.). 132

madethe followingcommentthat is reminiscentof the CCAA cases:

The questionis whetherthey “will not be likelyable to makea viableproposal.” It is difficult to makethis determinationso early in the proceedings. It is clearthat for any proposalto be viableit will have tocontainprovisionsfor a completedischargeof the C.I.B.C.obligation. The evidenceindicatesthe principalsare negotiatingwith otherbanksto arrangenewtake-out financing. The onusis on the applicantto prove on a balanceof probabilitiesthat the insolventcompanieswill likelynot be ableto makea viableproposalbeforethe expiration period. The applicanthas not metthis 233onus.

The secondgroundfor declaringthat the stay is no longer applicableto the applicantgivesthe courtconsiderablediscretionin balancingthe equitiesof the case. That groundis “thatit is equitable on other groundsto make such a 234declaration. NT W. consideredthis groundand retainedthe stay on the basisthat to grantthe applicationwouldeffectivelydefeatthe proposaland accordingly,it was inequitable,as it, wouldprejudiceall other235creditors. Thesesectionshave receivedonly limitedconsiderationto date. Accordingly,it is difficultto drawany convincingconclusions. However,the casesserveto illustratethe difficultiesthe courts must face,withoutlegislationprovidingclear guidance. A furtherconcernis that the natureof the legislationmay not lend itselfto the developmentof generalprinciplesto guidebusinesspeopleand their advisors. It is hopedthat the closingparagraphof High Streetdoes not foreshadowthis concern:

At the conclusionof this applicationcounselfor T.D.notedthat I must be cautiousin granting this extension. I have made my decisionbased on thepan’icularfctts of this applicationand my findingsthat High Streethas satisfiedthe three prerequisitesfor an extensionunders. 50.4(9) of the 236Act. [Emphasisadded]

5. Analysisof the BIA and Pmposalsfor Refonn

The TasséReportrecommendedthat, on the filing of a noticeof intentionto presenta proposal,the debtor wouldreceive” ... a short stay of proceedingsduringwhichthe debtorcould

NT W, supra note 220 at 167-168.

234 BIA s. 69.4(6).

Ibid

236 High Street,supra note 220 at 266. 133 formulatehis proposaland arrangethe necessaryfmancing,guarantiesand other 7details.” The ColterCommitteeReportadopted thisnotionand recommendeda 21-day238period. The BIA actually adopteda 30-dayperiod during whichtime, the insolventperson mustto file a cash-flowstatement and apply forany extensionof the 30-dayperiod. The questionis whetherthese periodsrealistically allowthe debtortime toformulateits proposaland arrangethe necessaryfmancing. We mustalso rememberthat an entity intendingto file a proposalis insolvent,by definition. Is it reasonableto require sucha personto retain a trusteeto certifythe cash-flowstatementand a lawyerto applyfor an extensionof the 30-thy period? As it s the intentof the policymakersthat theBIA dealwith a broadrangeof fact patterns,it mighthave been moreprudentto avoid strictperiodsof time and allow the courtsto deal with the time periodson a case by case basis,as is presentlydone undersection11 of the CCAAand under section362 of the Code. This wouldallowthe court (or the parties)to determine,for example,the time required by the debtorto secure financingfor the proposal or whether fmancingis indeed available. The time periods willvary dependingon the nature and size of the businessto be reorganized. The foregoingillustratesthat perhapsthe policymakersfailedto consider practical realitiesand the difficultiesof attemptingto balance theconflictinginterestsof the parties.

This bringsus back to the originalpurposeof this chapterwhichis, to attemptto detennine the objectivesof a businessreorganizationproceeding. If an objectiveis to balancethe respective interestsof creditorsand debtorswith a view to havingthe debtoremergeas a healthy,viable business,the BIA has failed. The system,as presentlystructured,givesthe debtora limited environmentwithinwhichto reorganizein terms of time and substantiverights. Whilea demandfor repaymentof a loan or a noticeof intentionto realizeon securityusuallycomesas no surpriseto the debtor,it usuallyresultsin a flurryof activityby the debtor,attemptingto stave off the secured creditor,seeking alternatedebt or equity financingand keeping thebusinessoperating. The debtor

TasséReport at 175.

238 Colter CommitteeReportat 56. 134

spendslittle time on formulatinga workableplan whichrequires notonly analyzingexternalmatters

suchas alternatefmancingand marketconditions,but also internalfactorssuch as the historyof the businessthat resultedin the fmancialdifficultiesand how to solvethe problems. Whileone might

arguethat the debtor hadampleopportunityto considerthese mattersbeforethe creditorservedthe

demandor notice,few debtorsactuallyface the realityof the financialdifficulties. Instead they chooseto immersethemselvesin their work in the hopesthat theproblemwill disappearwith

increasedproductivity.

The debtoralso facessubstantive problemscreatedby the BIA that, combinedwith the time limitations,makeformulationof a viableproposalvery difficult. A securedcreditorthat has taken possessionof the collateralprior tothe noticeof intentionto makea proposalbeing filed or has given the debtora noticeof intentionto enforcesecuritymorethan 10days beforethe noticeof intentionto makea proposalis filed, is free to continueits realization39proceedings? A significantsecured creditor,in the formercase,may completely frustrateany possibilityof the debtor makinga proposal.

ShouldParliamentrepealthe CCAA,this wouldleavethe debtorno alternativebut to liquidateor attemptto redeemor purchasethe collateralat the foreclosure,judicial or privatesale. To avertthe runningof the 10-dayperiod in the lattercase,the debtormay be forcedto file a noticeof intentionto makea proposal,simplyto invokethe stayand obtainsome“breathingspace.” If no reorganizationis possible,this delaysthe securedcreditorin its realizationproceedings,for no usefulpurpose.

The structureof the BIA is also unsatisfactoryto securedcreditors. Giventhe stated objectivesof the legislationand the inclinationof courtsin the early stagesof the reorganization proceedingto givethe debtoran opportunityto put forth a plan of reorganization,it is highlyunlikely that the courtwill grantthe securedcreditora declarationthat the stay no longeroperateswith respect to thatcreditor. Therefore,the creditorlosesits bargained-forrights,usuallywithout compensation.

BIA ss. 69(2),69.1(2);SeeMetnpolitan Tiust Co. of Cavzcdav.NovastarDevelopmentCoip. (1993),19 C.B.R (3d) 140 (B.C.S.C.). 135

Priorto suggestingan alternatemannerof proceeding,it is necessaryto set forth the normative

basis of the model.

Bankruptcylaw does not exist ina vacuum,yet one cannotspendmuchtime readingin the field withoutnotingthat fewjudges or scholarshavetaken this observationto heart. Too many seemto thinkthat a bankruptcyproceedingprovides,in the main,an essentially unlimitedopportunityto do what appears atthe momentto be good,just or fair withoutregard to the reasonsfor havinga systemof bankruptcylaws in the first °24place. Theprimaryobjectiveof a businessreorganizationsystemshouldbe to aid businessesthat havethe capacityand capabilityof survivingin the currentmarketplace. Conversely,not all businessesin all circumstancesshouldhave a right to attempta reorganization.Althoughonewriter describedthe Americanbusinessreorganizationsystemas “a rejectionof economic24Darwinism,” it is suggestedthat thesystemis or shouldbe Darwinismin its most pure form. The fittestshouldsurvive andthe imfitshouldperish,unlessthey reorganizein a that will allowthem to’survivein the y changingenvironment

To accomplishthe primaryobjective,it is necessaryto determinewhetherthe debtoris fit or unfit. The automaticstay of proceedingsallowsthe partiesthe timeto makethat determination.

Duringthe stay,the legislationor the courts mustprotectthe rightsof securedcreditors. Thisdoesnot derogatefromthe debtor’srights,as the stayprovidesthe debtorits most valuableresource,time. If the securedcreditoris providedadequateprotection,it shouldhave no difficultyin even a protracted stayperiodas its242“bargain” is 243preserved. In this manner,the reorganizationschemebalancesthe

240 D.G. Baird and Tfl Jackson,“CorporateReorganizationsand the Treatmentof Diverse OwnershipInterests: A Commenton AdequateProtectionof SecuredCreditorsin Bankruptcy”(1984) 51 U. Chi. L. Rev. 97(citationsomitted).

241 Comment,AdequateProtectionand the AutomaticStayUnder theBankruptcyCode: Easing Restraintson DebtorReorganization”(1982) 131U. Pa. L. Rev. 423.

242 The term “bargain”is used not to indicatethe bargainwhichwas negotiatedby the partiesat the commencementof their relationship. Rather,it is the bargainwhich is in effect immediately followingthe debtor seekingthe protectionof the BIA. It is at this momentin time, that for example, valuationof the propertyis made,quantificationof the debtsis made and it is the referencepointfor determiningpre-filingand post-filingconduct. 136

interestsof the debtorand securedcreditor.

The modelalso accountsfor interestsof the subordinatesecuredcreditorsand unsecured

creditorsin that they gainthe samebenefitas the debtor. In the eventof a liquidation,at best,those

creditorswouldreceivea portionof their secureddebts,in the case of subordinatesecuredcreditors,or theirpm rata share of the residualamountafter paent of all securedand preferredclaims,in the

case of unsecuredcreditors. Shouldthe reorganizationbe successful,they wouldreceivethose

amountsplus their respectiveshareof the enhancedvalueof the going-concernenterprise.

Subordinatesecuredcreditorswhosesecurityhas somevaluewouldreceiveadequateprotectionbased on that value.

As reorganizationis a collectiveproceeding,a securedcreditormust not expectto receivethe full value of its bargain. Therefore,adequateprotectionmustbe basedon the value of its interestin the propertyas at the date of the stay,not the value of its debt. Usually,the valuewouldbe the lesser of the amountof the debt and the liquidationor net realizablevalue of the collateral. Liquidationor net realizablevalue is a conceptdistinctfrom a going-concernvalue. The securedcreditorwouldbe entitledto only the reducedvalue,as that is all itwouldrealizein a liquidationor bankruptcyscenario, on the date the proposalproceedingis commenced. However,the legislationshouldgivethe courts considerableflexibility withrespectto valuationissuesto applyproperlythe valuationconceptin light of the facts of the case, the conductof the partiesand other generalequitableprinciples. Any reformsshouldalso givethe courtsflexibilityin establishingmethods2 of adequate protection. Periodicpaents shouldbe the most commonmethodof adequateprotection. While,in manyinstances,the debtor’sproblemsare the result of a lack of cash 245flow, we mustrememberthat

243 ER Jackson,“Bankruptcy,Non-BankruptcyEntitlements,and the Creditors’Bargain”(1982) 91 Yale L.J. 857 at 873.

244 HouseReport at 339.

245 D.C. Gordinier“TheIndubitableEquivalentof Reclamation: Adequate Protectionfor Secured CreditorsUnderthe BankruptcyCode”(1980)54 Am. Bankr.L.J. 299 at 319. 137 the securedcreditoris entitledto only reducedpayments(basedon valuationsusingthe foregoing model)and the stay operatesto preventsecuredcreditorsfrom furthercollectioneffortsduringthat period. Shouldcash still be a problem,the debtormust lookto third partyinvestors,subordinate creditorsor additionalfmancing. This is where “economicDarwinism”is most evidentas, “[am inabilityto persuadeanyone... that the firm shouldstay alive seems goodevidencethat it should ’2not.” Similarly,debtorsmay not haveany unencumberedassetsor assetsthat possessa significant

“collateralcushion”in whichto grantthe secured creditoran additionalor replacement247lien.

However,this should notderogatefromthe utility of an additionalor replacementlien in appropriate circumstances.

Periodiccash paymentsand additionalor replacementliens are merelytwo examplesof methodsof adequateprotection. Shouldthe policymakersaccept theconceptof adequateprotection, then givingcourtsthe necessaryflexibilityto developand adaptthe concept tochangingcircumstances shouldpose little difficulty, If the policymakersgivethe courtsjurisdictionto provideadequate protectionthey consider necessaryor appropriatein the circumstances,this will allowthe required flexibility,withouthaving toaddressthe issueof whetherand towhat extent adequateprotection shouldbe “completely248compensatory” and whetherthe secured creditorshouldreceivethe “mere indubitableequivalent”or the “mostindubitable249equivalent.” We may learnfromthe American experienceby avoidingthe term “indubitableequivalent”and providingthe court a general discretion.

246 Jackson andBaird,supra note 240 at 128.

247 Karlen,supra note 33 at 32; D. Price “AdequateProtection Underthe BankruptcyAct of 1978” (1982-83)71 Ky. L.J. 727 at 739.

248 Murel,supra note 38.

249 W.J. Wahoff,“TheAdequate Protectionof Secured Creditorsin Terminationof StayLitigation Under theBankruptcyCode”(1982)43 Ohio St. L.J. 715at730. Baird and Jackson,supranote 240 have describedthis debateas one that is conductedin a “vacuum”and ignoresthe purposesof businessreorganizationlegislation. 138

An “equitycushion”shouldnot be adequateprotectionin and of itself as it fails to recognize the commercialreality of securedcreditorsgenerallyrequiringa “collateralcushion”to coveraccmed interest,expenses andother costsincurredin realizingon collateral. Of course,a significantequity cushioncould sufficein appropriate25circumstances. However,the courtsmust rely on the commerciallendingcommunityto adviseon the appropriatecollateralcushionrequiredin anygiven circumstance. The underlyingpolicy,° in this situation,shouldbe commercialreasonablenessas that term is used in the UniformCommercialCodeand variouspersonalpropertyregimesused in (251

The reforms shouldrequirethe debtorto proposea methodof adequateprotection,oncethe securedcreditorrequestsit. This is appropriate,as the debtoris best able to determinethe capacityof the businessand the opportunitiesfor third party fmancing. It also givesthe debtoran opportunityto explorenovel methodsof adequateprotection,thout being constrainedby precedent.

The policakers shouldretainthe conceptsincorporatedin section69.4 of the BIA, as those conceptsprovidethe courtwith flexibilityconcerningthe conductof the parties,determiningwhethera successfulreorganizationis likely,whetherthe propertyis necessaryfor a successfulreorganization, whetherthe debtoris makingprogresstowarda successfulreorganizationand generally,other equitablefactorsthat may governin the 252circumstances. The case law underthe CCAAconcerning

250 Suchas in Blazon, supra note 44.

251 E.g. Section66(1)of the AlbertaPersond P’vperty SecurityAct, S.A. 1988,c. P-4.05and section68(2)of the BritishColumbiaPersonal PtvpeHySecurityAct, S.B.C. 1989,c. 36 read, respectively,as follows:

66(1) All rights,dutiesor obligationsarisingundera securityagreementunderthis Act or under any applicablelaw shallbe exercisedor dischargedin goodfaith andin a conmiercially reasonablemanner.

68(2) All rights,dutiesor obligationsarisingundera securityagreement,this Act or any other law applicableto securityagreementsor securityinterestsshallbe exercisedor dischargedin goodfaith and in a commerciallyreasonablemaImer.

252 Kennedy,supra note 196at 238-253. 139

the likelihoodof a successfulreorganizationwill be useful in developingcommonlaw guidelinesin this regard. However,the relief that the courts may grantshould includethe right to modifyor

conditionthe stay. Terminationof the stay is alreadyincludedin the present wording and the courts,

in appropriatecircumstances,grantleave to proceednwicpro tunc under related provisions? Although, assuggestedearlier, the courts have the capacityto make more flexible3 orders undersection 69.4 and then qualifythe declaration,a specificmandateto modify or conditionthe stay is a more appropriatemanner of dealing with this concern.

If adequate protection is providedto securedcreditors,the legislationcouldextend the periods

set forth in the BIA. The cuiTenttime periodsare simply not commerciallyreasonable. In addition, the legislationshould give the courtssufficientflexibilityto determineappropriatetime periods, althoughit should prescribe some guidelinesas to the longestperiod within whichthe debtor must completethe proceeding. The CCAA cases suggestthat the courtsdo not wantto see the reorganizationprocess go on cii infinitum. The period of 6 months inthe case involvingQuintette

Coal Limited seemedto most practitionersto be an extraordinarilylong period, althoughit has been suggestedthat this is the minimalperiod in complex255cases. To be grantedan extensionbeyondthat period orthe initial period grantedby the court, the courts should require the debtorto show extraordinarycircumstances.

The foregoingmodel better addressesthe objectivesof a businessreorganizationstatute.

Althoughit adopts manyconceptsdevelopedunder the Code, it seeksto avoid some of its pitfalls and inequities.

See BIA s. 215; see e.g. Re New Alger Mines Ltd (1986), 59 C.B.R. (N.S.) 113 (Ont. CA).

See discussion,supra note 238 and accompanyingtext.

255 Fitch, supra note 103at 107. 140

B. REPUDIATIONOR RFJECIION OF REAL PROPERlY LEASFS

This sectionwill examinethe issueof whetherthe provisionsof the BIA allowing an insolvent commercialtenantto repudiatea lease of real 256property fostersthe rehabilitationgoalsof the 257debtor, giventheir onerousfmancialburdens. Few tenantswill chooseto reorganizeunder the BIA.

Instead,they will resort to the CCAAwhichpresentsa moreflexibleregimewithinwhichto reorganize.

This sectionwill examinethe right of a tenantto repudiateor reject its leases as part of a reorganizationproceedingunderthe BJA or the CCAAand undertakea functionalcomparisonbetween the Canadianprovisionsand approachesand thosetaken in the United Statespursuantto the Code.

The purposeof this sectionis to determinewhetherCanadianpolicymakersshouldreexaminethe policy underlyingthe BIA and, in particular,whether an effectivereorganizationand rehabilitation systemfor insolventdebtorsshouldform apart of bankruptcyand insolvencysystem. Shouldthe policymakersconcludethat reorganizationand rehabilitationof insolventdebtorsis a laudable objective,they must effectcertain reformsto make the BIA more accessible.

1. Legislativeflistoty

The 1919versionof The Banknq,tcyAct258 containedprovisionsthat attemptedto deal with the interestsof the landlordin having the provisionsof its lease enforcedand those of the trusteewho required the demisedpremisesto conduct an orderlydispositionof the bankrupt’sestate and to dispose of the leaseas an asset of the bankrupt. Subsection52(5) of the 1919Act providedthat, on the

256 This sectionwill deal onlywith the repudiationor rejectionof real propertyleasesby insolvent commercialtenants. Accordingly,whenreferenceis madeto a “tenant”or “debtor”,suchreferenceis to an insolventcommercialtenant or a tenant caffyingon businessin the demisedpremises. Similarly, whenreferenceis madeto a “lease”,suchreferenceshallbe to a lease of real property in whichthe tenantis canying on business.

257 BIA divisionI of part ifi.

258 S.C. 1919,c. 36 [hereinafterthe 1919Act]. 141

bankruptcyof the tenant,the trusteecouldelect to disclaimthe leaseor retainthe premisesfor the unexpiredterm of the leaseor suchperiodas the trusteeconsideredappropriate. If the trusteeelected to retainthe demisedpremises,that provisionrequiredthe trusteeto abideby the terms of the lease.

Subsection52(6) of the 1919Act allowedthe trusteeto assignor subletthe demisedpremises, providedthere was noprovisionin the leaseprohibitingassignmentor subletting. Theserightsdid not arise on an insolventtenanttakingadvantageof the proposalprovisionsof the 191959Act? In that situation,the insolventtenant coulddisclaimthe leaseas part of the proposaland the creditors, includingthe landlord,woulddeterminewhetherto acceptthe proposal. The legislationgavethe landlordadditionalprotection,however,as the courtcouldnot approvea proposalthat did not provide for full paymentof priority°26debts. Subsection52(1) gavethe landlorda priorityclaim for the lesser of the value of the distrainableassetson the demised premisesand three monthsaccruedrent.

The BankruptcyAct AmenthnentAct, 1921261repealedsubsection52(6) and replaced it with a provisionthat expandedthe right of the trusteeto disclaima lease. Followingthe disclaimer,there was noobligationto makeany paymentto the landlord,otherthan the prioritypaymentreferredto 2earlier?5 Tn1923,263Parliamentrepealedsection52 of the 1919Act and replacedit with a provision that, uponthe bankruptcyof the insolventtenant,the laws of the provincein whichthe demised premisesare locatedshalldeterminethe rights andprioritiesof the 264landlord. Provinciallaw

259 1919Act s. 13.

260 1919Act s. 13(16).

261 S.c. 1921,c. 17,s. 42.

262 Supranote 260 and accompanyingtext.

263 L.W.Houldenand CR Morawetz,Bankruptcyand InsolvencyLaw of Canada, 3d ed. (Scarborough:CarswellThomson,1993)at 5-115.

264 TheBankruptcyAmendmentAct, 1923, S.C. 1923,c. 31, s. 31 [emphasisadded]. The constitutionalityof the right to repudiateor rejectreal propertyleasesin a reorganizationproceeding has been upheldin the United Statesand Canada. 142 continuesto deteniiinethe rights of landlordsunder the265BIA.

TheBanknq,teyAct, 1949 maintainedprovisionsconcerninglandlordssimilarto the 1919 Act, as amended. That is, provinciallegislationwould governthe rights of 267landlords in the caseof a tenant’sbankruptcyand, to obtaincourt approvalof a proposal,the proposalhad to providefor payment infull of preferred268claims. The 1949Act containedno specificprovisionfor the disclaimer of leasesin the formulationof proposals.

The Tassé Reportrecommendedthat any reform,shouldallowthe debtor,“with suitable

In the United States, ithas beenheld that the rights of a landlordundera lease “maybe constitutionally alteredby Congressin the exerciseof its bankruptcypowers.”[In re Sweetwater,40 B.R. 733 at 741 (Bankr.D. Utah 1984)[citationsomitted]]. Althoughthe constitutionalityof section365 of the Code has been challenged onthe basisthat it violatesthe due process requirementsof FifthAmendment,a similarprovisionin the 1898U.S. Act was upheldby the UnitedStatesSupremeCourt in Kuehner v. Irving Trust Co., 299 U.S. 445 (1937). The courtstated:

“While,therefore,the FifthAmendmentforbidsthe destructionof a contractit doesnot prohibitbankruptcylegislation affectingthe creditor’sremedy forits enforcementagainstthe debtor’sassets,or the measureof the creditor’sparticipationtherein,if the statutoryprovisions are consonantwith a fair, reasonable,and equitabledistributionof those assets. The lawunder consideration recognizesthe [landlord’s]claimand permitsit to sharein the considerationto be distributedin reorganization.”[at452].

Recently,the Cour Supérieuredu Québecupheldthe constitutionalityof section65.2 ofthe BIA on the basisthat it is legislationpromulgatedpursuantto Parliament’sauthorityto enact legislationin mattersof bankruptcyand insolvency[Re Janpar Produits de Bureau Inc. (1993),20 C.B.R.(3d) 8 (C.S. Que.) [hereinafterJanpar, headnotereferenceonly]].

265 BIA s. 146:

146. Subjectto priorityof rankingas providedby section 136,and subjectto subsection 73(4),the rights of landlordsshallbe determinedaccordingto the laws of the province in whichthe leased premisesare situated.

266 S.C. 1949,c. 7 [hereinafter,in this section,the 1949Act]. The 1949Act, althoughamended fromtime to time, formedthe foundationfor the legislationwhichwas in effect immediatelypreceding the passage of the amendmentswhichresultedin the BIA. The provisionsdiscussedin this section were notsubstantiallyaffectedby any of the pre-1992amendments.

267 formerCanadianAct s. 105.

268 1949Act s. 34(4). 143 safeguards,”to disclaimcontractsor 269leases. The TasséReport also recommendedthat, if the landlordminimizedits losses, itcouldmakea claimfor damagesin the arrangement. It recognized that withoutthis right,the debtor might haveproblemsin comingto an arrangementwith its 27creditors. ° The Colter Committee Report wentfurtherby recommendingthat any refomisshouldallowa debtorwho intendsto or has filed a proposalto apply tothe court foran order allowingthe repudiation orvariationof an executory27contract. To securesuch an order,the reportrecommended that the debtor mustshow,inter alia, that’ the leasewas onerousand that it renderedthe reorganization 272“impractical.” In dealingwith the existingpreferredclaimof landlords,the ColterCommittee Reportrecommended:

in 1985,such additionalprotectionis unwarranted,although provinciallaw does givesuch a priority. A landlord’sclaimshouldbe treatedequallywith the claimsof otherunsecured creditorsand the landlord’sprivilegeshouldbe abolished. Theserecommendations removedany incentive2 fora landlordto reject a proposalsimply on the basisthat, on a liquidation,it wouldreceiveits priority274payment. By retaining thepriority paymentin the BIA, Parliamenthad to makesomeprovisionfor landlordsto makethe proposal

269 TasséReportat 96.

270 Ibid

271 Colter CommitteeReportat 58. The ColterCommitteeReportdid not make specificprovision for leases,which forthe purposesof this portionof the discussion,will be treated as executory contracts.

272 Colter CommitteeReportat 59.

273 Colter Committee Reportat 80.

274 BIA s. 136(1)(f)givesthe landlorda preferredclaimfor:

“. . . arrearsof rent for a periodof three months immediatelyprecedingthe bankruptcyand acceleratedrent for a period notexceedingthree monthsfollowingthe bankruptcyif entitled theretounderthe lease,but the total amountso payableshallnot exceedthe realizationfrom the propertyon the premises under thelease,and any paymentmade on accountof accelerated rent shallbe creditedagainstthe amountpayableby the trusteefor occupationrent;” 144

attractive.

The CCAAcontainsno expressprovisionallowingfor the repudiation,disclaimeror rejection of executorycontractsor unexpiredleases. However,courtsallowthe debtorto disclaimleases pursuantto the generalprovisionsof the 275CCAA. The 1898U.S. Act did not containany provisionsallowingthe debtorto rejectunexpired

leases. Section7Th provided,inter olia, “[a]plan of reorganizationwithin themeaningof this section

mayreject contractsof the debtorwhichare executoryin wholeor in part, includingunexpired leases. .“. It goes on to (a) providethat any personinjuredby the rejectionof an executorycontract or unexpiredlease shall be considereda creditor,(b) limitthe amountof the landlord’sclaimand (c) providethe priorityof that 276claini The ChandlerAct addeda provisionthat the rejectionof an unexpiredlease “shallconstitutea breachof such leaseas of the date of the filing ... of the originalpetition[for 277reorganization]” and provisions: (a) limitingthe time withinwhicha trusteemay rject or assumethe unexpiredlease;

(b) allowingthe court,for cause,to extendor abridge suchtime;

(c) providingthat shouldthe trusteenot assumeor rejectthe unexpiredleasewithinsuch time, the leaseshallbe deemedto be rejected;

(d) prohibitinga generalcovenantagainstassignmentbut allowingan expresscovenantthat an assignmentby operationof law or the bankruptcyof eitherparty shallterminateor givethe otherparty the optionto terminate thelease;and

(e) protectingthe trusteefrom liabilityfor breachesof the lease followingan assignmentof the leaseto a third 278party Theseprovisions,as amendedfromtime to 279time, remainedin forceuntil the enactmentof

CCAAss.4and5.

276 77B(b)(6).

277 ChandlerAct s. 63c.

278 ChandlerAct s. 70b.

279 See generally,V. Countryman,“ExecutoryContractsin Bankruptcy:Part I” (1972/73)57 Mlnn.L. Rev. 439 at448. 145

section365 of the Code. The provisionsof the Coderemainedin effectfor approximately6 years until, in 1984,a stronglobbyby shoppingcentreorganizationsresultedin the 1984Amendmentsthat

effectedsignificantamendmentsto section365.280

2. RepudiafionI Rejection The Code allowsthe 28trustee to reject an unexpiredleaseof the 282debtor. The BJA, on the otherhand,allowsan insolvent’ personto repudiatea 283lease. Is there a functionaldifferencebetween repudiationand rejection? Furthermore,wouldan alternatedescriptionof the effectiveconceptbe preferable? 284Repudiation of a leaseof real propertyby the debtordoes not ipsoftrto terminatethe lease. To accomplishthat object,the landlordmust acceptthe 285repudiatioit This excusesthe landlordfrom furtherperformanceof its obligationsunderthe lease and entitlesthe landlordto commencean action for damagesthat have accruedbecauseof the breach,including damagesresultingfromprerepudiation

280 Ratherthan discussingthe Congressionalhearingsat thisjuncture,referencewill be madein succeedingpagesto germaneportionsof the hearings.

281 Referenceto the term “trustee”in the contextof the Coderefers also to a debtorin possession. SeediscussionchapterIV, above.

282 Code s. 365(a) provides:

“Exceptas providedin sections765 and 766 of this title andin subsections(b), (c), and (d) of this section,the trustee,subjectto the court’sapproval,may assumeor reject any executory contractor unexpiredleaseof the debtor.”

283 BJA s. 65.2(1)provides:

“Atany time betweenthe filing of a noticeof intentionand the filing of a proposal,or onthe filing of a proposal,in respectof an insolventpersonwho is a commercialtenantundera lease of real property,the insolventpersonmay repudiatethe leaseon givingthirty daysnoticeto the landlordin the prescribedmanner,subjectto subsection(2).”

284 The conceptof repudiationhas been held to applyto leasesof real property. SeeHighway PropertiesLtd v. Kelly, Douglas & Co. (1971), 17D.L.R.(3d) 710 at 717(S.C.C.)[hereinafter HighwayProperties].

285 G.ELL.Fridman,The Law of Contrcrt in Canada,2d ed. (Toronto:Carswell, 1986)at 561. 146 286breaches. In other words, acceptanceof the repudiationdoes not destroy the lease. It merely terminatesfuture performanceof the lease obligationsby the landlord andthe debtor, but the liabilities flowingfrom the repudiation287subsist.

Alternatively,the landlordmay disregardthe repudiation,which maintainsthe lease in full force for the benefitof both 2parties. In that case, the landlordmay insist on performanceof the leaseobligationsby the debtor and “sue for rent and damageson the footingthat the leaseremains in full 29force.” Although the landlordneed not mitigate its damagesin this type of case,’ relettingthe premises° wouldbe considereddefcrto mitigation. Shouldthe landlordnot acceptthe repudiation,it wouldalso have the optionof seeldngto enforcethe leasethroughspecificperformance.

In Highway Properties,LaskinJ. (as he then was) summarized theconceptof repudiationas follows:

Although it is correct to say that repudiationby the tenant gives the landlordat that time a choice betweenholding the tenantto the lease or terminatingit, yet at the same time a right of action for damages arises;and the election to insist on the lease or to refuse further performance(and thus bring it to an end) goes simplyto the measure and range of 292damages. Practically,absent a bankruptcyproceeding,the measureof damages and the prospectsof collectingthem determines,at least in part, the issue of whether thelandlordwill accept the

286 Martin v. Stout, [1925]A.C. 359 at 364 (P.C.); Finelliv. Dee, [1968] O.R. 676(Ont S.C.).

287 See Saunders v. Multi BuildersLtd (1981), 30 B.C.L.R.236 at 243 (B.C.S.C.).

288 See Tanenbaumv. Wright-WinstonLtd (1965),49 D.L.R. (2d) 386 at 392 (Ont. C.A.).

289 Harbutt’s“Plasticine”Ltd v. WayneTankand Pump Co.Ltd, [1970] 1 Q.B. 447 at 464-465. (C.A.); Cromwellv. Moms, [1917]2 W.W.R 374 at 377 (Alta.CA). See also HighwayProperties, supranote 284, where the court proposeda further alternative. The landlordcould exercise its option to terminatethe lease and advisethe tenant that it would be seeking damagesbased on the present value of the lease payments for the unexpiredportion of the term [at 570]. ° Highway Properties,supra note 284 at 570. ‘ HighwayProperties,supra note 284 at 572. Thid at 576. 147 repudiation. In a proposalproceeding,the BIA fixesthe quantumof damages. Subsection65.2(3) provides:

Wherea lease is repudiatedpursuantto subsection(1), a proposalfiled by the insolventperson must providefor paymentto the landlord,immediatelyafter court approvalof the proposal,of compensationequalto the lesser of

(a) an amountequalto six monthsrent underthe lease,and (b) the rent for the remainderof the lease,fromthe thte on whichthe repudiation takes effect.

Thereis no questionof mitigationby the landlordor economiccircumstancesthat may entitlethe landlordto damagesexceeding thoseset forth in the BIA. Therefore,if the landlordacceptsthe repudiation,its damagesare fixed and it may immediatelyattemptto reletthe premises.

The BIA, by framing theissueas one of repudiationhowever,appears togivethe landlordthe optionof not acceptingthe repudiationand insistingon the performanceby the debtorof the obligationsin the lease. The dangerin takingthis courseof actionis that the lease alsoremainsin effect forthe benefitof the debtorwho may continueto occupythe demisedpremisesand insiston its rightsunder thelease. Becausethe BIA limitsthe quantumof damagesand givesthe debtorthe right to “unilaterally repudiate”the lease,it seems inconceivablethat a landlordwould notwantto accept the repudiationand, at least,attempt torelet the premisesto gain the “windfall”of two sourcesof rent fromthe premisesfor the same period.

The remedyof specificperformanceshouldnot be availableto a landlord,as it not onlyis contraryto the expresswordingof the BIA, whichallowsthe debtorto “repudiate”the lease,but also, if granted,couldresult in the landlordreceivinga claimin excessof its entitlementunderthe provisionof the BIA.

On the commencementof a proceedingunderthe Code,an unexpirednonresidentialreal propertylease becomespart of the debtor’s93estate? Subsection365(a)of the Code entitlesthe trustee

Unlike the BIA whichdoes not create a separateestate upon the proposalproceedings, subsection541(a)of the Code createsan estate that is independentof the debtoror trustee. Underthe 1898U.S. Act, it was held that an unexpiredleasedid not becomepropertyof the estate upon the 148 to “reject”an unexpiredleaseof the debtor. It provides:

Exceptas providedin. .. subsection(b), (c), and (d) of this section,the trustee,subjectto the court’sapproval,may assume or reject any executorycontractor unexpiredleaseof the debtor. Anglo-Americanlaw has nodefmitionfor the conceptof “rejection”of a 294contract. Accordingly, Americancourts have describedrejectionas a release,repeal, voiding,cancellation,reconsideration, discharge,revocation,repudiation,alterationor avoidanceof the 295lease. The Code describesthe consequencesof rejectionof an unexpiredlease as a breachof the lease “immediatelybeforethe date of the filing of the petition”if the lease “hasnot been assumed”under section365 or underthe plan of 296arrangement. This determinesthe periodduringwhichthe landlordmay claimdamagesfor breach of the lease. Unlikethe conceptof repudiation, noquestionarisesas to the acceptanceor nonacceptanceof the rejection,with the attendant problemsof quantificationof damagesand possibilityof remediessuch as specificperformance. One commentator suggested thatit is improper to characterizerejectionas revocation,repudiationor cancellationof the leasebut simply,rejectionis a

debtor’sbankruptcybut the trusteewas requiredto makean affirmative decisionto assumethe lease to bringthe lease intothe estate. See e.g. In re Lovitt, 757 F.2d 1035(9th Cir. 1985). Althoughthis case was decided afterthe passageof the Code,the decisionwas based onpre-Codelaw as the bankruptcyproceedingwas commencedfive yearsprior tothe passageof the Code. The rationale underlyingthis decisionwas that the estate shouldnot be responsiblefor the liabilitiesof an unexpired leaseuntil suchtime as the trustee has an opportunityto consider whether theestate willbenefitfrom it [at 1041]. Although MT. Andrew, “Executory Contractsin Bankruptcy:Understanding‘Rejection” (1988)U. Cob. L. Rev. 845 at 860-866,suggeststhat thisis the currentpositionin the UnitedStates, the Codemakesthe debtor’sinterestin an unexpired nonresidentiallease,propertyof the estate. Paragraph 541(a)(1)of the Code includes,as propertyof the estate, “alllegalor equitableinterestsof the debtorin propertyas of the commencementof the case.” Specifically excludedfromthe estateis, inter alia, the debtor’sinterestas lesseeundera leaseof nonresidentialreal propertythat has expired by virtueof its own terms. The specificexclusion,suggeststhat a leasewhichhas not expiredby its ownterms is includedas part of the estateand therefore,the casesdecidedunderthe 1898U.S. Act are inapplicableto the Code. Seee.g., Re ConvenientFood Mart No. 144, Inc., 968 F.2d 592 (6th Cir. 1992);Re ArizonaAppetito’s Stores, Inc., 893 F.2d 216 (9th Cir. 1990);cf Turnerv. Aveiy, 947 F.2d 772 at 774 (5th Cir. 1991),wherethe courtheld that “anexecutory contractbecomes partof the banlcruptcyestate when the contrcrt is assumedby the trustee.”.[emphasisadded].

294 Andrew,ibid at 847.

295 Ibid [citationsomitted].

296 Code s. 365(g). 149

decisionnot to assume. Rejection does not affectliabilitiesunder the lease, which continue,but the

Codequantifiesthe landlord’sdamagesand limitsits remedies.

By using “rejection,”which is a conceptunknownto contractlaw, it appears that Congress intendedto provide the courts with an opportunityto fashionremedies, unencumberedby prior jurisprudence,which the courts could seizeuponto frustrateCongressionalintent. However,by analogizingrejectionto concepts such as repudiationor revocation,the Americancourtsallow the

“conceptualbaggage”to follow the previouslyunknownconcept. As it is difficult to resist the temptationto equate “rejection”with familiarconcepts,perhaps the approachtaken in the BIA is preferable,viz., using a familiarconcept havingcertainfundamentalattributes. However,the concept of repudiationmay not be the most appropriate,as it may cause the partiesto inadvertentlyact in a manner detrimentalto their interestsand give the other party rights that were not intended.

Althoughit is not the intentionof this paperto conducta detailedexaminationof modelsother than the BIA, the CCAA and the Code, the InsolvencyAct 1986 298(U.K) may provide a useful model for the purposesof this discussion. Section 315 of the U.K. Act allowsthe trusteeto “disclaimany onerousproperty.” The conceptof disclaimerhas been describedas “a renunciationof, or refusalto claim, rights or property which wouldautomaticallydevolve on or accrueto the person makingthe 299disclaimer” or, more simply, A disclaimer,to be worth anything,must be an act whereby one entitled to an estate immediatelyand before dealing with it renouncesit; whereby, in effect, he says, “I will not be the owner of this 30property.” The U.K Act doesnot require° the trusteeto disclaimthe onerous propertybefore “dealingwiththe

297 Andrew,supra note 293 at 848.

1986,c. 45 [hereinafterthe U.K Act].

299 Lister, [1926] 1 Ch. 149at 165(CA.). See also In ,e Fus’sell;ex p. Allen (1882),20 Ch. D. 341 at 346 (CA.) where the courtdescribedthe trustee’sright to disclaimas a right “to getrid of the property”.

°° Bence v. Gilpin (1868), L.R 3 Ex. 76 at 81. 150 property”but givesthe trusteea periodof time within whichto makethat decision. It also entitlesthe trusteeto disclaimthe onerouspropertyeventhoughthe trusteehas exercisedrights of oership, attemptedto sell or takenpossessionof the 301property The essenceof the concept,however,is that oncedisclaimed,the trusteemaytake none of the benefitsof the leaseand will not be responsiblefor any of its burdens. That is, notiorially,the. leaseneverbecomespart of the bankrupt’sestateand the 302 landlordmay file an unsecuredclaim for 303damages. Unlikerepudiation,the landlordhas no option or obligationto acceptor rejectthe disclaimer. The disclaimer,zpsofato, extinguishesany liabilityof the trusteeand the estateuponthe 304lease.

301 U.K Act ss. 315(1),316 and 317.

302 U.K Act s. 315(3)sets forth the effectof the disclaimerand the respectiverights of the parties as follows:

(3) A disclaimerunderthis section - (a) operatesso as to determine,as fromthe date of the disclaimer,the rights, interestsand liabilitiesof the bankruptand his estatein or in respectof the property disclaimed,and (b) dischargesthe trusteefrom all personalliabilityin respectof that propertyas from the commencementof his trusteeship, but doesnot, exceptso far as is necessaryfor the purposeof releasingthe bankrupt,the bankrupt’sestateand the trusteefromany liability,affectthe rights or liabilitiesof any other person.

303 G.G.S.Takachand E.L. Hayes,“CaseComment:Re Erin Features #1 Ltd” (1993), 15C.B.R (3d) 66 at 70.

Re Salok Hotel Co. Ltd (1968), 11 C.B.R (N.S.) 95 at 101(Man.Q.B.). The U.K Act does not, however,affect therightsor liabilitiesof any otherperson [U.K Act s. 315(3)1and allowsany personsufferinga loss as a result of the disclaimerto provethat loss in the bankruptcyproceeding [U.K Act s. 315(5)]. Aithoughthis would givethe landlordand othersan opportunityto attemptto recovertheir lossesin the bankruptcyproceeding,the primarybenefitis that it does not extinguishthe “rightsor liabilities”of any otherperson. For example,a landlordcouldcontinueany actionagainsta guarantorof the obligationsof the tenant underthe lease. Cf Cummer-YongeInvestmentsLimitedv. Fcot (1966),8 C.B.R (N.S.)62 (Ont.S.C.)wiierethe courtheld that a disclaimerby the trustee extinguishedall of the rightsand obligationsunderthe lease,includingthe covenantto pay rent. Accordingly,the liabilityof the guarantorswas similarlyextinguished. It shouldalso benotedthat determinationof rights and liabilitiesunder theleaseonlytakes effectfromthe date of the disclaimer. Accordingly,it wouldappearthat the trusteewouldbe personallyliablefor occupationrent and other chargesarisingunderthe leaseduringthe periodbetweenthe appointmentof the trusteeandthe effectivedate of the disclaimer. See e.g, In re Lister, supra note 299. 151 The conceptof 305disclaimer moreaccuratelyreflectsthe result intendedby the draftersof section65.2 of the BIA.. Upona “repudiation”of the leaseby the insolventperson,the BIAdoesnot requirethe landlordto acceptor reject therepudiationbut compensationis payableto the landlord becauseof the “repudiation.”The statutorycompensationis not a preestimateof commonlaw damages. It is statutorycompensationand accordingly,it does not requirea doctrinalfoundation,such as damagesresulting froma breachof the lease.

A debtor, following its givingnotice to the landlordadvisingof the repudiation,could not contendthat, as the landlorddid not acceptthe repudiation,the leasethereaftersubsists. Oncethe debtorgivesnoticeto the landlord,it makesan election. Fromthe effectivetime of the noticeof repudiation,the rightof the debtorto remainin occupationof the demised premisesand to claima leaseholdtitle is extinguished. Disclaimeraccomplishesthis result and use of the conceptof repudiationmerelyimpliesthat there are other rights andobligationson the partiesthat the policymakersdid not intend. Accordingly,to avertthe possibilityof a party attemptingto rely on thoserights,the policymakersshouldexpungethe conceptof repudiationand replaceit with the more clearlydelineatedconceptof disclaimer.

Similarly,the Americannotionof rejection,although providingthe courtswith flexibility to attachcertainattributesto it, merelyallowsthe courtsto attemptto equateit with existinglegal 306concepts. Accordingly,Americanpolicymakers shoulddiscontinueany use of this term. Ratherthan attemptingto fashiona new legalconceptor usinga conceptthat derogatesfrom the intendedresult,the policymakersshoulduse “disclaimer”whichis a conceptwith a fixedlegal meaningand accomplishes theintendedobjectives,viz., the terminationof the landlordand tenant relationship,on certainconditions suchas the preservationof certainrightsof the partiesto the lease

305 The draftersof the BIA do not appear tobe averseto the conceptof disclaimeras it is used in relationto a trusteedisclainiinga leaseof propertyof the bankruptin a liquidationscenario[BIAs. 30(l)(k)j.

306 See e.g., supra note 295 and accompanyingtext. 152 and third 307parties. In Canada,the terminationof the landlordand tenant relationshipcould occur withina fixedtime after the givingof the notice, unless the landlordapplies to avert the tennination)° The balance of the section could apply mutatis mutcindis. 8

3. Rejectionor Repudiationof Unexiiitd Leases to FacilitateReoiganizafion

This subsectionwill review the provisionsthat allowa debtorleasing nonresidentialreal propertyto reject or repudiate an unexpiredlease. Rather than simply reviewingthe provisionsof the Code, the BIA and the CCAAin isolation,a more useful methodologywill be to comparecertain features of the proceeding leadingup to, and the consequencesof, a rejection or repudiation. This comparativemethod will assist us in arriving at a useful model for reform or, at least, identifymatters that shouldbe consideredin attemptingto formulatereforms.

The right to assume or reject an unexpired lease is a unique and powerful tool under all of the legislativeschemes. Althoughthis tool is availableto the trusteeor the debtorin possessiononce the reorganizationproceedingis commenced,it was not availableto the debtor before commencementof the proceeding. In this way, the trustee or debtor in possessionis in a strongerposition than that of the debtor prior to the commencementof the proceeding. The right to assumeor reject an unexpired lease is consistentwith the policy of encouragingthe rehabilitationof the °31debtor.

See e.g., W.E. Wmfield, “Rejectionof NonresidentialLeases of Real Property in Bankruptcy: What Happensto the Mortgagee’sInterest?”(1989/90) 17 PepperdineL. Rev. 429, where the author discusseshow the characterizationof rejection as a terminationor breach may result in differing effects on a mortgageof the leaseholdinterest.

308 BIA s. 65.2(2).

Notwithstandingthe discussionin chapter V(B)(2), above,this section will use the statutory terminology. That is, when discussingthe Code, the term “rejection”will be used. When discussing the BIA or the CCAA, the term “repudiation”will be used. However,as it has been arguedthat the term “disclaimer”more accuratelyconveysthe legislativeintent, the terms are referred to in that context.

310 House Report at 174-175,220-221. 153

(a) The Necessity for the Existenceof a Lease

For the provisions allowingthe rejectionor repudiationof a leaseto be operative,there must be a leasein existence. Under the Code, the leasemust be “unexpired”at the time the petition is filed and, if expired,the petition does not resunect the l311 If the term of the lease hasexpiredor if the parties have terminated it before the commencementof the case, there is nothing for the trusteeto reject or 312assume. This is consistentwith subsection541(a)of the Codethat includes,as part of the estate, the debtor’sinterests in property “as of the commencementof the case”and paragraph541(b)(2) which specificallyexcludesthe leaseholdinterest of a debtor whose statedterm has expiredbeforethe commencementof the 313case. State law determineswhetherthe lease expired prior to the filing of the 314petition, andthe courts have used state law to prevent prepetitiontermination. For example,the court may exerciseits equitablepower to relieve againstforfeitureof the interest of the 315debtor, or hold that the landlord has ived or is estoppedfrom relyingon its right to terminatethe 316lease. Havinga leasein existenceat the commencementof the case has some importance. Even if the debtorultimatelyrejects it, the trustee must have an opportunityto determinewhetherthe estate would benefit fromthe lease and, as a practical matter, may requirepremisesfrom which to operatependingformulationof the plan

311 In re TriangleLaboratories,Inc., 663 F.2d 463 at467-468 (3d Cir. 1981).

312 Moodyv. Amoco Oil Company,724 F.2d 1200at 1212(7th Cir. 1984),cen. denied469 U.S. 982, 83 L. Ed. 2d 321 (1984).

313 Supranote 293.

314 Moody v. Amoco Oil Company,siq,ra note 312; In e Southeatem Fann Supply,Inc., 11B.R 89 at 90 (Bankr. MD. Ala. 1981).

315 See e.g, in ie FountainbleanHotel Coiporation,515 F.2d 913 at 914 (5th Cir. 1975);but see Mimi’sofAtlanta Inc., 5 B.R. 623 (Bankr.N.D. Ga. 1980),where the court statedthat”.. . equitable considerations. . . should be drawnupon by bankruptcycourtsonly in rare instances. . .“ [at 628].

316 In re Lcfayette Rcdio ElectronicsCoiporation,7 B.R. 189(Bankr. E.D.N.Y. 1981). 154 of 317arrangement. Assumptionof an unexpiredleasesubjectsthe estate notonly to the benefitsbut alsoto the 318burdens. The converseis also true and is consistentwith the English doctrineof disclaimerwhich holdsthat if the trusteedisclaimsa contract,the trustee maynot disclaimthe detrimentandretainthe

319benefit. if the lease,once assumedby the trusteeunderthe Code,expiresor terminatesby its terms, the expiry orterminationis binding on the trustee,who cannotthereafterseek to amendthe 320lease.

Conversely,once the trustee rejectsthe unexpiredlease,the rejectionis binding on the estateand the rejectionpermanentlydeprivesthe estateof any benefit that maythereafteraccrueunderthe 32lease. Section65.2 of the BIA allowsthe repudiationof “a leaseof real property”whichpresupposes’ the existenceof a lease. In a liquidationproceeding,the court willupholdthe forfeitureof the term beforebankruptcyand the trusteewill thereforehave nothingto retainor 322disclaim. Provinciallaw determineswhethera leaseterm has expiredbeforethe commencementof proposalproceedings. The courtsdo not appearto havedealtwith the issueof whethera lease must3 be in existence at thetime of the initiai application pursuantto the CCAA. However, giventhat thispaper is dealing with the rejection or disclaimer of a lease and that the courts in a CCAAproceedingare not inclined

317 It is acknowledged thatthis is not a cogent reasonfor allowingthe trusteeto remain in possessionof the demised premises and a trusteewould not attemptto use this as the sole basisfor argument. However, it is merely given as an illustrationof the practical considerationswhich may be behind a request for the court to exerciseits equitablejurisdiction to disallow the termination.

318 In re TSWStores of Nanuet, Inc., 34 B.R. 299 at 304-306(Bankr. S.D.N.Y. 1983).

319 In re Fussell,ex p. Allen, supra note 405; and see In re TSWStores of Nanuet, Inc., ibid; In re Pin OaksApartments, 7 B.R 364 at 369-370(Bankr. S.D. Tex. 1980).

320 In re Pin Oaks Apartments, ibid at 372;In re Nashville White Trucks,Inc., 5 B.R 112 at 116-117(Bankr.MD. Tenn. 1980).

321 S.B. Ehrlich, “TheAssumptionand Rejectionof Unexpired RealProperty Leases Under the BankruptcyCode - A New Look” (1983) 32 Buffalo L. Rev. 1 at 6. See also In r Rovine Coip., 6 B.R 661 (Bankr.W.D. Tenn. 1980).

Standard Trusts v. D. Steele Ltd (1922), 2 C.B.R. 183,affd 3 C.B.R. 141 (B.C.C.A.).

Re Custom CmestingLtd (1975), 19 C.B.R (N.S.) 282(Ont. S.C.). 155 to awardsubstantial damagesor compensationfor a rejectedlease,this is an issuewhichis not significant.

(b) Ipso Fcito or BankruptcyClauses

Section 70b of the 1898U.S. Act expresslysanctionedthe operationof “bankruptcyclauses” or “ipsofa.to clauses,”whichallowa landlordto terminatea lease based solelyon the bankruptcyof the 324tenant. These clauses severelyrestrictedthe trustee’sright to assume and assignleases and hamperedthe debtor’scapacityto effecta reorganization7 On the otherhand,by invokingan 4so fcrto clause,a landlordcould avoidinvolvement2 in the debtor’sbankruptcyproceedingsand retain controlover selectionof a tenantthat wouldultimatelyoccupythe premises. The bankruptcycourts, pursuantto theirequitablejurisdiction,had an aversion to forfeitureand accordingly,even in the face of the legislativesanction,the courts grantedrelief fromforfeitureby holdingthat ipso fcrto clauses werepenaltiesor that landlordseitherwaivedor were estoppedfromrelyingon 326theni The courts considerednot onlythe interestsof the tenantand the landlord butalso theinterestsof other 327creditors.

324 1898U.S. Act s. 70b, inter aliq,providedthat “. .. an express covenantthat. . . the bankruptcyof a specified partythereto orof eitherparty shallterminatethe lease or givethe other party an electionto terminatethe same shallbe enforceable.”

325 HouseReportat 348 and SenateReportat 59.

326 See e.g, Geraghtyv. Kia,niFifthAvenue Coip., 210F.2d 95 (2d Cir. 1954).

327 See e.g., Queen’sBoulevard Wine& Liquor v. Blum, 503 F.2d 202 (2d Cir. 1974),whereit appearsthat one of the factorswhichthe court foundparticularlyrepugnantwas the fact that, if the terminationof the leasewere allowedto stand, the landlordwouldreceivea windfallas it would undoubtedlybe in a positionto lease thepremisesat a rental ratehigherthan was beingpaidby the debtor/tenant.However,the converseis also true. That is, if the lease wasadvantageousto the tenant, the trusteecould assumethe lease andtake the benefitof the lease at the reduced rate or seekto assign it for somewherebetweenthe agreed upon rate and the marketrate. While it is acknowledged that thelandlordwouldretainwhat it bargained for(ie. the reducedrate),the court wasmaking a choicebetweenthe interests of the landlordand those of the tenantand simplychose to favourthe interestsof the tenant and those of the othercreditors,who would benefitfromthe assignment. However,the prospectof a windfallis not the sole factormotivatinglandlords. Perhapsmore importantis the nature and characterof the proposedassignee,not only in relationto its fmancial 156 Subsection365(e) of the Codemakesthe effectof zpsofccto clauses328unenforceable. It disallowsthe terminationor modificationof a lease solelybecauseof the insolvencyor fmancial conditionof the debtor,the commencementof a caseunderthe Code or theappointmentof a banlcruptcytrustee or custodian. The legislative historyindicatesthat Congressinsertedthis provision to avertthe detrimentaleffectsof these clauseson the debtor’srehabilitation329efforts. At the same time, the SenateReportand House33Report instructedthe courtsto be sensitiveof the rightsof landlords. ° The automaticstay of 33proceedings also preventsthe landlordfromtaking any proceedingsto conditionbut also in maintaining’ the existingtenantmix. For example,a discountclearancestore couldhardlyfit withinthe plansof the landlordif the intentof the projectwas to only havehigh end fashionstoresas tenants.

328 The courtshave held that this provisiondoesnot violatethe prohibitionagainsttakingproperty withoutdue processof law embodiedin the FifthAmendment. See In re Sapolin Paints, Inc., 5 B.R 412 (E.D.N.Y.1980),wherethe court stated:

“Inrefusingto [allow the landlordto terminatesthe leaseon] the mere filing of a petitionfor reliefunderthe bankruptcylaws,and by layingdownas a rule of law that a landlordwho is otherwisereceiving,and willreceive,full performanceunderhis lease,may not declarea forfeiture,Congress hasnot exceededits constitutionalpowers.”[at 423-424]

Seealso,In re National Shoes,Inc., 20 B.R 55 (Bankr.S.D.N.Y.1982);cf In re LiP, Inc., 22 B.R 556 (Bankr.S.D.Fla. 1982),wherethe court heldthat subsection365(e) of the Code wasnot intended to prohibitterminationof a contractprior to the commencementof the case, solelyon the basisof the insolvencyof the debtor.

329 HouseReportat 348; SenateReportat 59.

330 Ibid

331 Codes. 362. By virtueof the 1984Amendmentshowever,the automaticstay of proceedings doesnot stay:

• . any actof the lessorto the debtorundera leaseof nonresidential real property thathas terminatedby the expirationof the satedterm of the leasebeforethe commencementof or duringa case underthis title to obtain possessionof suchproperty;”[Codes. 362(b)(10)].

The legislativehistoryindicatesthat thisprovisionmerelyattemptedto clarifS’the positionthat as the interestof the debtorhad expiredpriorto the commencementof the case, such interestdid notform a part of the estateand accordingly,the landlordcouldimmediatelytake stepsto repossessand leasethe property[SenateReportNo. 65, 98th Cong., 1st Sess.68 (1983)reprinted in NortonBankruptcyCode Pamphlet1993-1994Edition234] 157 terminatethe lease or recover the demisedpremises. As such,the landlordis at the mercyof the trusteeduringthe initialstagesof the case,notwithstandingthe possible vacancyof the demised premisesand the effectthat the vacancymay have on other332tenants. In Canada,the effectof an ipsofcrto clause appearsto vary fromprovinceto 333province in liquidationproceedings. Priorto the BIA, if a leasecontaineda forfeitureprovisionthat became operativeif the lesseetook advantageof any act forthe benefitof insolventdebtors,the courtsupheld the forfeitureon the filing of a proposal. Section65.1(1)of the BIA, prohibitsterminationor amendmentof the leaseafter the3 lessee commencesproposalproceedings. Terminationor amendment of the leaseprior to the filingremainsenforceable. This is not unlikethe situationunderthe Code wherethe courtsprohibitrelianceon an zpsofa.to clauseafter commencementof the case but allow landlordsto terminateleasesbased onsucha clauseprior to 335commencement. The provisionsprohibiting the enforceabilityof zpsofxto clausesattemptto balancethe interestsof landlordsand debtors. Clearly,landlordssufferprejudiceby not being able to rely on

332 MJ. Gould, “ShoppingCentre TenantBankruptcies:A BetterBalanceof OperatingInterests” (1983)5 CardozoL. Rev. 183at 197.

E.g, the Commercid TenancyAct, RS.B.C. 1979,c. 54 appearsto allowthe effectof zso fato clauses. Subsection32(3)reads, in part as follows:

“(3) If the lesseeis a tenantof premisesthe tenancyof whichis not determinedby the makingof a receivingorder or assignment. .. [thetrusteemay surrenderor assignthe lease].”

However,the OntarioLandlordand TenantAct, R.S.O. 1990,c. L.7, s. 38(2)provides:

“(2) Despiteany provision,stipulation oragreementin any lease or agreementor the legal effectthereof,in the case of an assignmentfor the generalbenefitof creditors,or anorder being made for the windingup of an incorporatedcompany,or wherea receivingorderin bankruptcyor authorizedassignmenthas beenmadeby or againsta tenant,. . . [thetrustee may retain or disclaimthe lease].”

Re McKay (1921),2 C.B.R.59 (Ont. S.C.);cf Drozdzinskiv. Zemel (1953-54)34 C.B.R.59 (Que. S.C.),where thecourtheld that sincea courtapproved proposalis binding onall creditors,“the purposeof the BankruptcyAct would befrustratedif the [landlord]were permittedto exercisethe [ipsofcrto] clausewhichhe now seeksto enforce.”[at 60].

In ir LiP, Inc. supra note 328. 158 these clausesto retain somecontrolover their premises. The effect,however,is less prejudicialto

Canadianlandlords,as the choicesopento the debtorfollowingthe commencementof proposal proceedingsare limited. The debtormay retainthe lease,in which case all of the provisionsare applicable,includingany restrictionon assignability,or it may rejectthe lease,in whichcasethe landlordis free to relet the premisesto a tenantof its choice. In the United States, the landlordfaces a thirdpossibility. A trusteemay assume the leaseand assignit to a third party, despitea restriction on assignmentcontainedin the 3lease. This allowsthe trusteeto take the benefitof a favourable leasefor the estate.

Whether Canadianpolicymakersshouldadoptthe third option,which is available inthe United

States,is not a questionthat we may answerin isolation.The answeris determinedby examining whether the policymakersseek to encouragereorganizations.The American systemallowsthe trustee to assignan advantageousleasethat is unnecessaryto the continuingoperationsof the reorganized debtorand to use the fundsreceivedor to be receivedfor ongoing337operations. This clearly encouragesreorganizations.In the Canadiansystem,a favourablebut unwantedlease is of limited value tothe debtor,becauseof the absenceof the third option. if the debtorrepudiatesthe lease,the landlordwill receive thefmancialbenefitof the buoyantmarket. If, however,the debtorretains the lease,it must continueto abideby the leaseterms,whichmay be a drain on workingcapital. It cannottake advantageof the opportunityto increasecash flow unlessthe leaseitselfpermits assignment.

Code s. 365(hX3).There arecertainconditionson assumptionand assignmentof all leases

[Codes. 365(b)1and additionalconditionsif the demisedpremisesare locatedin a shoppingcentre [Codes. 365((bX3)1.A discussionof these provisionsis beyondthe scopeof this paper.

See e.g.,SapolinPaints,Inc.,supranote 328,wherethe debtorin possessionwas in a position to dispose of its leaseholdinterest for $230,000. 159

(c) TimeLimit for Electionto Rejector Repudiate

In requiringthe courtsto be sensitive tothe rightsof landlords,the SenateReport stated:

If the trusteeis to assumea contractor lease,the court must ensurethat the trustee’s performance underthe contract orlease givesthe other contractingparty the full benefitof his 338bargain. This propositionraises thequestionof whether,if the trusteerejectsthe unexpiredlease,the landlord is entitledto the full benefitof its bargainduringthe periodbetweenthe commencementof the case and the ultimaterejectionof the lease. In otherwords,is the landlordentitledto “adequateprotection” duringthat period? There aretwo aspects tothis problem. The first involvesthe issue of the timing of the election. Thesecondis that, by virtueof a requirementin the Codeor becauseof its obligations to othertenants,the landlord is requiredto provideservicesand suppliesincidentalto the 339lease.

Beforethe enactmentof the 1984Amendments,the Codedid not obligatethe trusteeto make an electionto assumeor reject an unexpiredleasein a reorganizationproceedingwithin a prescribed time. The only requirementwas that the trusteehad to make the electionprior to confirmationof the °34plan. The courts,however, imposeda requirementthat the trusteehad to makethe electionwithina reasonableperiodfollowingthe commencementof the case,dependingon the facts of each ’34case. The protractedperiodtaken by trusteesin maldng the electionand the uncertaintyof the durationof a

“reasonabletime”resultedin a strong lobbyof shoppingcentreassociationsprecipitatingthe 1984 342Amendments. The 1984Amendments resultedin a changeto paragraph365(d)(4)wiuichnow

338 SenateReportat 59.

See discussionchapterV(B)(3)(d),below.

‘° J.S. Battershall,“Commercial Leasesand Section365 of the BankruptcyCode”(1990)64 Am. Bankr.L. J. 329 at 330.

341 TheatreHoldingCoip. v. Mourn, 681 F.2d 102(2d Cir. 1982).

342 A.M SabinoandN.E. Susca,“TheDemiseof the ‘ShoppingCentreAmendments’to the BankruptcyCode and a Proposalfor Revitalizing BankruptcyCode Section365(d)(4)”(1990/91) 68 U. Det. L. Rev. 375 at 381. 160

requiresthe trusteeto makethe electionwithin a period of 60 days after the date of the order for relief

or within such additionaltime as the court fixes. If the trustee fails to assume the leasewithinthat period, the Code deemsthe lease 343rejected. Despite the impositionof a time limit, the courts again exhibittheir aversionto forfeitureof the leaseholdinterest through applicationof the doctrinesof waiv& and estoppel. Even if the

courts interpretedthe 60-dayperiod strictly,this maybe an inordinateperiod5 for the lessorto have vacant premises or a nonperformingtenant.

The BIA does not provide a specifictime within which the debtor mustrepudiatethe lease. To repudiate,however, the debtormust provide 30 days notice to the 347landlord. The courts have

Paragraph 365(d)(4)has been called “self-executing”given that rejection of the lease occurs automaticallyat the end of the sixty-dayperiod without the need for court approval [In Simpson, [1994]Bankr. LEXISNo. 431 (Bankr.W.D. OkIa.March 25, 1994)]. A significantbody of case law has developedconcerningthe extent of the obligationsof a trustee during the sixty-dayperiodin order to assumethe lease. In particular,those cases are concernedwith the issueof whetherthe court approvalfor the assumptionor for an extensionperiod must be given withinthe sixty-dayperiodor whetherthe mere filing of a motion withinthat period will suffice. As this paper is concernedwith the rejection of unexpiredleases, a full discussionof this matterwill not be undertaken. However,the reader is referred to Sabinoand Susca,ibid for a discussionof this matter.

See e.g., In re T.EP. Resources,56 B.R. 112(Bankr. S.D.N.Y. 1985),where the court held that the lessor waivedits rights to strictenforcementof the time limitationin paragraph365(d)(4)of the Codeby continuingto accept rent paymentsfollowingthe expirationof the 60-day period.

See e.g., In ie Haute Cuisine,Inc., 57 B.R 200 (Bankr.MD. Fla. 1986),wherethe courtheld that thelessor’sactionsresultedin the debtor notcomplyingwith its duty to obtaincourt approval. The lessorcouldnot takeadvantageof the debtor’sdetrimentalrelianceand wasthereforeestopped frombeing in a positionto relyon its strictrights. See also In n Ranch House of Orange-Brevard Inc., 773 F.2d 1166(11thCir. 1985).

Cf In re Haute Cuisine,Inc., ibid at 202, wherethe courtnoted that“sixtydays maybe an insufficientamountof time for the debtor-in-possessionor trusteeto makean informeddecisionon whetherto assumeor reject an unexpiredlease.”and In re American Hedthcare Management,Inc., 900 F.2d 827 at 830 (5th Cir. 1990),wherethe courtconfirmedthat the primarypurposeof paragraph 365(d)(4)is “toprotectlessors. . . fromdelayand uncertaintyby forcinga trusteeor a debtorin possessionto decidequicklywhetherto assumeunexpiredleases.”[citationsomitted].

BIA s. 65.2(1). 161 held that this30-dayperiodis the minimumnoticerequiredto repudiatethe 348lease. The maximum time withinwhich thedebtormust electto repudiateis the timeavailableto the debtorto file the proposalitself,which couldbe up to 7 9months? The CCAA does not prescribea periodwithinwhichthe debtormust formulateand complete the plan of arrangement. However,courtshave generallybeen reluctantto allowthe processto go on ad infinitumand they tend to followthe proceedingsvery closelyby allowinginterlocutorymotionson short°35notice. Janpar,supra note 264 at 10.

Shouldthe debtor chooseto file a proposalin the firstinstance,a meetingof creditorsmust be held within21 days after the proposalis filed [BIAs. 51]. Withinfive days after approvalby the creditors,the trusteemust apply for the court’sapproval,giving at least fourteendays noticeof the hearing. If the proposalis approvedby the court,paymentto the landlordof the statutory compensation must bemade “immediately”[IMAs. 60(1.5)]. In this case,the debtormust effectively makethe decision concerningthe repudiationof leasesprior to the filing of the proposal,as the proposalmustprovidefor repudiationand the compensation. However,the actualrepudiation maynot take effect untilafter the courtapprovesthe proposal. Wherethe debtorchoosesto file a noticeof intentionto file a proposal,however,the decision- makingperiodis extended inasmuchas the debtoris not requiredto file the actualproposaluntil 30 days after thefiling of the noticeof intention[131As. 50.4(8)1or “withinany extensionof that period”. Subsection50.4(9)allowsthe courtto grantextensionsto the debtorof the time withinwhichthe proposalmustbe filed. Each extensionperiodis not to exceed45 days and the aggregateof all extension periodsshall not exceed5 months,after the expirationof the initial30-dayperiod. In other words,the debtorcould havea total of 6 monthsto formulatethe proposal. Should theproposaland noticeof repudiationcontemplate repudiation immediately followingcourtapproval,the landlordcould potentiallybe waiting inexcessof 7 monthsbeforeit obtainsvacantpossessionof the premises. This assumesthe followingtime periods:

180days - maximumtime tofile proposalafter filingnoticeof intention 21 days - maximumtime for the holdingof the meeting 5 days - maximumtime withinwhichto applyto the court for court approval 14days - minimumtime for the givingof the noticeof hearing 220 days

This periodcouldbe even longerif the debtor choseto giveextendednoticeof the hearing.

350 See e.g., Re NorthlandPropertiesLtd (1988),73 C.B.R (N.S.) 171(B.C.S.C.), wherethe courtexhibitedits reluctanceto grantan adjournmentof the date for the meetingto considerthe plan of arrangementby stating:

“Withsomehesitation,I have concludeda refusalto grantsomefurthertime is less desirable than grantingan adjournment. I am not unmindfulof the historyof these proceedingsand what appearsto be an attempt touse thesystemto its utmostto avoidobligations that the 162

(e) Performanceof ObligationsDuring the Stayof Proceedings

Paragraph365(d)(3)provides:

The trustee shalltimelyperform all the obligationsof the debtor,exceptthose specified in section365(b)(2), arising from and afterthe orderfor reliefunder anunexpired leaseof nonresidential realproperty, untilsuch leaseis assumedor rejected... The courtmay extend,for cause, the time for performanceof any such obligationthat ariseswithin60 days after the date of the orderfor relief,but the timefor performanceshallnot be extendedbeyond such 60-thy period... Acceptanceof any suchperformancedoes not constitutewaiveror relinquishmentof the lesso?srightsunder such leaseor under thistitle.

In other words,by the time that the60-thy periodhas elapsed,the trustee should havefulfilledall of the debtor’sobligationswhich aroseduringthat period,strictlyin accordancewith the35lease. There are two difficultieswith paragraph365(d)(3). First, nosanctionis imposed fornoncompliance.’ The

Code doesnot providefor a deemedrejectionof the leaseor personalliabilityof the trusteefor failure to fulfilthe debtor’sobligations. The availabilityof the latterremedyhas been effectivein Canadian bankruptcyproceedings. The problemwith attemptingto impose suchliabilityin an American proceedingis that, usually,a trusteeis not administering the reorganizationproceeding. Instead,the debtorin possessionis usuallycontrolling thebusiness. In such a case,perhapssometype of security wouldallaythe concernsof the landlords.

The seconddifficultywith paragraph365(d)(3)arisesout of paragraph365(b)(4)which

petitioners haveto their creditors. However,havingproceededto this stage, in my view it is preferablethat aproposalshouldtake place if at all possible.”[at 172-173]

See e.g, the proceedingsinvolvingQuintetteCoalLimited,wherethe court allowedthe debtora periodof 6 monthswithinwhichto file its plan of arrangement. Althoughthe creditorsfelt this to be an inordinateamountof time, it shouldbe noted thatultimately,the plan of arrangementwas not actually approvedby the court until almost2 years after the proceedingswere commenced,one must be cognizantof the fact that this casewas a multinationalreorganizationinvolvinga substantial amountof money. The amountowedto creditorsat the commencementof the proceedingwas approximately$761,000,000. See generally,D.F. Tysoe, “QuintetteCoalLimited:Chronologyof Companies’CreditorsArrangementAct Proceedings”in The InsolvencyInstitute of CancidaSecond AnnualMeeting and ConferenceMaterials(Orillia:October20-22, 1991).

351 See In re WingspreadCoip., 116B.R. 915 (Bankr.S.D.N.Y.1990);In re Fisher, 51 B.R 680 (Bankr.S.D. Oh 1985);cf In re Orvco,95 B.R 724 (Bankr.9th Cir. 1989),wherethe courtheld that the lessoris requiredto establishthe quantumof its claim,ratherthan usingthe rates set forth inthe lease. 163 provides: Notwithstandingany otherprovisionof this section,f thereha been a default in an unexpired leaseof the debtor, ... the trusteemay not requirea lessorto provideservicesor supplies incidentalto such leasebeforeassumptionof such leaseunlessthe lessoris compensatedunder the terms of such lease for any servicesand suppliesprovidedunder such leasebefore assumptionof such lease. [Emphasisadded]

Readwith paragraph365(d)(3),this paragraphsuggeststhat if there has been no defaultin the lease, the trusteemay requirethe landlord toprovideservicesand suppliesprior to theexerciseof the electionto assumeor reject,providedthe landlordreceivespaymentfor such serviceson an ongoing basisor within the60-thy period,if the courthas grantedthat 352order. In other words,the landlord must provide servicesand supplieswithoutreceivingcurrentpaymentand becausethere is no legislativesanctionfor nonpayment,the landlordis at risk that paymentmay not be forthcoming atall.

Furthermore,the landlord, besidesbeingrequiredto provideservicesand suppliesto the trusteewith respectto the demisedpremisesin question,must provideservicesthat wouldotherwisebe common costsrecoverableunderthe lease, suchas security, parking,snowremoval,heating,ventilation,air conditioningand the like. Thiswill result in othertenantshavingto bear a proportionof those 353costs.

Withthis background, wenow discussthe questionof the landlord’sentitlementto adequate protection duringthe periodbetweenthe orderfor relief and the electionto assumeor rejectthe unexpiredlease. Subsection362(a)of the Code imposesan automaticstay of proceedingsagainsta

352 See In re MonarchCapitd Corporation[1994]LEXISNo. 124at 21-22(Bankr.D. Mass. February8, 1994). In fact, it has been saidthat the main purposeof section365 of the Codeis:

• . to allow a debtorto reject executorycontractsin orderto relievethe estateof burdensomeobligationswhile at the sametime providing‘ameans wherebya debtorcan force othersto continueto do businesswith it whenthe bankruptcyfiling might otherwisemake them reluctantto do so.” [In re ChateaugayCorporation,10F.3d 944 at 954-955(2d Cir. 1993)quotingIn re RichmondLeacingCo. v. CapitalBank,NA., 762 F.2d 1303at 1360(5th Cir. 1985)].

The foregoingdiscussionis basedon the writer’sknowledgeof commerciallease transactions in Canada. Whether theresults suggestedactuallyhappen inthe United Statesis based solely on conjecture. 164 landlordseekingto recover unpaid charges and attemptingto terminatethe leasebasedon prepetition 3Mdefaults. The concept of adequate355protection appliesto the use, sale or leaseof property. The courtsare not in agreementas to whether adequateprotectionis availableto landlords. They have takenthree differentapproachesto the issue.The first is an approachnot adoptedby the courtsin relationto real propertyleasesbut used in relationto otherexecutory357contracts. In NationalLabor RelationsBoard v. Bildisco cwi 358Bildisco, the United StatesSupremeCourtheld thatsubsection 362(a)of the Code did not staythe rightsof the nondebtorparty. Rather,the rights of the nondebtor party were temporarilyunenforceable.The remedyof the third party wouldnot be relief fromthe automaticstay pursuantto subsection362(d),but the remediespursuantto section365 and 503(b)(1), whichprovidean administrativeexpensepriority for the actualand necessarycosts and expensesof preservingthe estate. In a situationinvolvinga real property lease, the landlordwould seekto recover the costs of services and suppliesfromthe estate in priorityto unsecuredcreditors. This approach does not satisfactorilyresolvethe issue. Commencementof the case doesnot renderall rightsof the landlordtemporarilyunenforceable.Section365 specificallyprovidesthat certainprovisionsof the leaseremain359enforceable. It is the stay of proceedingsthat preventsthe landlordfrom exercisingall of its rightsunderthe lease. To exercisethose rights,the landlordmust seek relief fromthe stay.

G.R Schmitt,“TheBankruptcyCodeRequirementof Compliancewith Lease Obligations- Does ‘All’MeanEverything?”(1989/90) 10N. Ill. U.L. Rev.225 at230.

For a discussionof the conceptof adequateprotection,see chapter V(A)(1)(b),above.

Code s. 363(e) provides:

(e) Notwithstandingany other provisionof this section,at any time, on request of an entitythat has an interest in propertyused, sold, or leased, or proposedto be used, sold, or leased,by the trustee, the court, with or withouta hearing, shall prohibit or conditionsuch use sale, or lease as is necessaryto provide adequateprotectionof such interest.

D.W. Borderwieclc “ThePostpetition,Pre-Rejection,Pre-AssumptionStatus of an Executory Contract”(1985)59 Am. Bankr. L.J. 197at 213.

358 465 U.S. 513 at 532, 79 L. Ed. 482 at 499 (1984).

E.g, Code s. 365(c)(3). 165

Shouldthe court denythe relief,the landlordis entitledto have its interestadequatelyprotectedunder subsection362(d)or 363(e). In re 36Sweetwate, illustratesthe secondapproach. In that case, the court refusedto award adequateprotection° based on the legislativehistory. Before the passage of the Code, earlierbills providedthat adequateprotectionwould be availableto both secured creditors and to landlords.

Howeverultimately,the Code provided separateforms of protectionfor secured creditorsin sections

361 and 363(e) and for lessors in section 365.361 The portions of the House Report and the Senate Report discussingsection 361 do not mention landlords,only secured 362creditors. Commentatorshave criticizedthis approachon the groundthat it breachesthe fundamentalprincipleof statutory interpretationthat the court need not go beyondthe plain and unambiguouswordingof the statute if the languageadmits only one 363meaning. However,subsequentcases have followedSweewcter? In re 365DeSantis illustratesthe final approach. In that case, the court awardedadequate protectionto the landlordbased on the plain meaningof subsection363(e). The court held that the requirementof timely performanceof the obligationsimposedby the lease pursuant to paragraph 365(d)(3)was merely a componentof adequate3protection. Because of paragraph 362(b)(10),which ° 40 B.R 733 (Bankr. D. Utah 1984).

361 Ibid at 739-740.

362 Ibid at 742.

W.A. Schorlingand RP. Simons, “AdequateProtectionfor the NondebtorParty to Executory Contractsand UnexpiredLeases” (1990) 64 Am. Bankr. L.J. 297 at 299.

See e.g., In re Ccfe Partneic/Washington1983, 81 BR. 175(Bankr. D.D.C. 1988),where the court held:

“[A]sa matter of law under Section 365, a non-debtorlandlord is not entitledto interim ‘adequateprotection’. Nor, as a corollaryto that principle, is a non-debtorlandlordentitledto relief from the automaticstay imposedby Section362(a) in the absence of ‘adequate’ protection. Rather, the exclusiveremedies for the landlordare found in Section 365.” [at 180].

66 BR. 998 (Barikr.E.D. Pa. 1986).

Ibid at 1002. 166 providesthat the commencementof a bankruptcycase doesnot result in an automaticstaybeing imposedagainstlandlordswhoseleaseshave expiredprior to the commencementof the case,the stay binds otherlandlords. Thoselandlordscannotbe limitedto section365 for their remediesas it:

7wouldmeanthat a lessoris effectivelystayeduponthe filingof the bankruptcypetition but the lessor cannotobtainrelief fromthe stay whenthe trusteeutilizesthe leaseholdunder section363 withoutadequateprotectionor when thetrusteefails to complywith the leaseterm as requiredby section368365(d)(3).” Althoughit has been suggestedthat “giventhe needfor flexibilityin modemsophisticated transactions,adequateprotectionmust be availablein conjunctionwith section365,369 a better solutionwouldbe to providea more effectivemethodof enforcingparagraph365(d)(3)throughthe requirementof securityor the impositionof personalliabilityfor breach. In most cases,if the debtor ultimatelyrejectsthe lease,the landlordis looking forno morethan occupationrent, as definedin the lease,whichwould includeoperatingcosts as additional°37rent. The landlordis entitledto be adequatelyprotectedfor the amountof occupationrent and failureto providethat protectionshould result in an immediatedeemedrjection of the lease.

Underthe BIA, duringthe periodbetweencommencementof the proposalproceedingsand courtapprovalof the proposal,the landlordmay not terminateor amendthe lease on the basisonly of the insolvencyof the 371debtor. Furthermore,by virtueof the stayof proceedings, the landlordmay not commenceor continueany action,executionor otherproceedingfor3 the recoveryof its claim. If there is a breachof the leaseduringthe interimperiodwhichis not basedon the solvencyof the

367 Ibid at 1001. Ibid.

Schorlingand Simons,supra note 363 at 314.

° The landlord’sclaim for other amountssuchas acceleratedrent is unsecuredand accordingly, adequateprotectionof such amountsis unnecessary.

371 BIA s. 65.1(1).

BIA s. 69.1. 167 debtor,the landlordmay be able to arguethat it is in a positionto terminatethe lease. The prohibitionon terminationappliesonly to the insolvencyof the debtorand the failureto pay rent

“priorto” the commencementof the proceeding. However,becausethe stay of proceedingsappliesto judicialand extrajudicial373proceedings, the landlordmust obtainleaveof the courtand, in so doing, must showeither:

(a) that it is likelyto be materiallyprejudicedby the continuedoperationof the stay;or (b) that it is equitableon other groundsto make sucha 374declaration. If the landlordis not receivingcurrent performanceof the leasetemis or if the premisesare vacant,the landlordmay be able to showmaterialprejudice. However,unlikethe Code,there is no positiveduty on any personto maintainthe obligationsunderthe leasependingthe filing and approval of the 375proposal. The landlordmust weighthe benefitsof repossessingthe premisesagainstreceiving the prioritypayment onrejection.

Underthe CCAA,the courtsare inclined toallow thedebtorto continuein occupationof the demisedpremiseswithoutbeingrequiredto pay for the useand occupationduring the periodbetween the initialapplicationpursuantto the CCAAand the time of surrenderof the demised premisesto the landlordpursuantto the approvedplan. Debtorsmay recognizethis factor,as they usuallyinsert provisionsin the initialorder allowingfor the paymentof occupancy376costs. However,if the parties

Vcchonv. CanadaEmployment& ImmigrationComm. (1985),57 C.B.R.(N.S.) 113(S.C.C.).

‘ BIA s. 69.4.

In a liquidationcase, because thepropertyof the bankrupt vestsin the trustee,the liabilityto pay occupationrent is a personalliabilityof the trustee [ReAuto Experts Ltd (1921), 1 C.B.R. 418 (Ont.S.C.). See also e.g., Landlord’sRights on BankniptcyAct, RS.A. 1980,c. L-7; cf Commercid TenancyAct, supra note 333, s. 32(9)].

376 E.g., in the proceedingsinvolvingSilcorpLtd., the following provisionappearedin the order issuedby the OntarioCourtof Justice(GeneralDivision)whichwas grantedon June 11, 1992:

“24. THIS COURTFURTHERORDERSTHATthe relevantApplicantpay occupation rent for any leasedor subleasedpremiseswhichsuchApplicantoccupiesfor the period commencingwith thedate of this Order duringwhich suchApplicantenjoysactualoccupation of such leasedor subleased premises,however,with respectto leased orsubleasedpremises for whichthe leaseor subleasehas been abandonedby the relevantApplicant,the landlord 168 are unableto agree on the quantumof the occupancycosts,the courtwouldhave to determinethe issue. Theredo not, however,appearto be any reportedcaseson thispoint.

As the courtsare inclinedto providethe debtorwith anopportunityto attempta reorganization,they usuallygranta very broad stay of proceedingspursuantto section 11of the

CCAA. The ordersgenerallymirrorthe wordingof section 11whichstaysthe commencementor continuationof all actions,suits and proceedings,includingproceedingsunderthe BIA. However,in the eventthat there are significantcontractsor interests,the debtormay want specificallyto address thosemattersin the 3Vorder. Any reformmust addressthe issueof performanceof obligationscontainedin a real property lease during theperiod between commencementof the proceedingsand rejectionof the lease. The reforms must provide a meansof securingperformanceto adequatelyprotectthe landlordandthey shouldprovidethe landlordwith remediesfor breachof performanceor failureto provideadequate protection.

(e) The Landlord’sClaimor Compensationfor Breach

The quantum of and priority accordedto a claimof a landlordfollowingthe decisionof the trusteeor debtorto reject or repudiatean unexpiredlease is perhapsthe most significantdifference

shallhave the right to take possessionof the leased or subleasedpremisesand to enterinto new lease arrangementsand the stay providedfor in this Orderwith respectto such leasedor subleasedpremisesshall cease tohave effect.”

In the SilcorpLtd. matter,giventhe significantnumberof leasesand subleases(SilcorpLtd. operatedthe Mac’sConvenienceStorechain andthe Baskin RobbinsIce Creamstores),the debtor choseto includethe followingin the courtorder:

“23. THIS COURTORDERSTHATall persons,finns, corporationsand other entities having other agreementswith either Applicantare herebyrestrainedfrom accelerating, tenniriating,determiningor cancellingsuchagreements. .. and the landlordsof premises leasedor subleasedby the relevantApplicantare herebyspecificallyrestrainedfromtaldng any step to terminateany lease or subleaseto which suchApplicantis a party vthetherby noticeof terminationor otherwise,unlessthe leaveof this Courtso to do has beenfirst obtained.” 169 betweenthe rights of Canadianlandlordsandtheir counterpartsin the United States. If the debtorhas not assumedthe unexpiredleaseprior to the rejection,paragraph365(g)(1)of the Codetreatsthe rejectionas a breach immediatelybeforethe datethe filingthe petition. This givesthe landlorda prepetitionallowableclaim under section502,that is an unsecured378claiim However,if the leasehas been assumedprior to its rejection,the claimfor a postpetition breachunderparagraph365(g)(2)is givenan administrativeexpensepriority under section503 and paragraph379507(a)(1). By not allowing thelandlorda priority claim,the Code encouragesthe reorganizationof the debtor,as the landlord’sclaim is merely38unsecured. It also forcesthe trustee to considercarefully whether toassumeor reject the lease,as°an imprudentdecisionto assume followedby a decisionto rejectwill result in a priorityclaimbeingaccorded tothe landlord. Often, a debtorseekingto reorganizeis encounteringcash flow difficulties. A policythat requiresthe estateto part with cash neededfor operations,whenthere is no directbenefitflowingto the estate,discourages reorganizations.Shouldreorganizationsbe anobjectiveof a bankruptcysystem,landlords musthave someincentiveto supportthe reorganizationeffortsof the debtor.

378 In re Abernathy, 10B.R. 418 (Bankr.MD. Ala. 1981);cf In re ChateciugcryCoip., supra note 352,wherethe courtheld that “. .. a debtormay incur priorityexpensesunderan executorycontract or unexpiredlease,withoutan expresselection,if the bankruptestatederivesbenefitsunderthat contract.”[at 955] ‘Withrespect,the Code specificallyprovidesfor the priorityof claimsof a landlord and accordingly,if the lease is rejected,the landlordis entitledto no morethan an unsecuredclaim.

D. Fogel, “ExecutoryContractsand Unexpiredleasesin the BankruptcyCode”(1979-1980)64 Minn.L. Rev. 341 at 378. Administrativeexpenseshave been describedas “speciallyfavoredpost- petitionclaims,givenpriorityin asset distributionover most otherclaimsagainst the bankruptcy estate.”[In re Mid Region Petroleum,Inc., 1 F.3d 1130at 1132(10th Cir. 1993)].

380 The court in Mid Region Petroleum,Inc., ibid justifiedthe subordinationof certain claimsas follows:

“Oneof the goalsof Chapter11 is to keep administrativecoststo a minimum in orderto preservethe debtor’sscarceresourcesandthus encourage rehabilitation.In keepingwith this goal, s. 503(b)(1)(A)was not intendedto ‘saddledebtorswith specialpost-petitionobligations lightly orgivepreferential treatmentto certain selectcreditorsby creatingbroadcategoriesof administrativeexpenses.’The policybehind givingpriorityto administrativeexpensesin Chapter 11proceedingsis “to encourage creditors tosupplynecessaryresourcespost-petition’. [at 1134]. 170

Of most concernto debtors who are consideringproposalproceedingsunderthe BIA is the priority payment accordedto a landilordfollowingrepudiationof its lease. The priority payment representscompensationto the landlordequal to the lesser of 6 months rent under the lease and the rent for the remainder of the leasefrom the date onwhich the repudiationtakes 38effect. For the court to approvethe proposal,the proposalmust provide for the prioritypayment’ and the tenant must satisfythe court that it can and will makethe payment. Followingapprovalof the proposal,the court may annul it, which resultsin the bankruptcy3 of the tenant. This provision shoulddeter any 383 tenant from repudiatinga lease with no intentionof meetingthe prioritypayment.

The priority paymentprovisionplaces an undueburden on tenants who are legitimately attemptingto reorganizetheir affairsto continue canying on business. The BJA’sproposalprovisions apply only to insolventpersons, which are, by defmition,unable to meettheir obligationsor have ceased paying current obligationsas they generallybecomedue orhave a negative net 3wofth. Accordingly,such person does not have sufficientcash flow to makethe priority payment or does not have unencumberedassets to raise sufficientfunds to makethe payment. Without outside funding, therefore,the repudiationremedy will usually be illusory. Because of the requirementfor the priority payment,the CCAA is the “remedyof 385choice” for debtors seekingto disclaim lease obligations,as the court hasa discretionnot to award damagesor compensationfor breach.

381 BTAs. 65.2(3).

382 B1.As. 60(1.5).

BIAs. 63.

BIA s. 2 “insolventperson”.

385 Newbould,supm note 163at 51. 171

(f) Standardsfor Rejectionor Repudiation

The Codedoes not providethe trusteewith any guidanceconcerningthe standardsgoverning the decisionto assumeor reject an unexpiredlease. Accordingly,trusteesmust resort to ge-Code case law to determinepossiblestandards. Underthe “onerousand burdensome387test,” the trustee’s rightto reject an unexpiredlease arisesonly if there wouldbe an actual neteconomiclossto the estate unlessthe trusteerejectsthe contractor if it can show that“thecontractcreatesa drain on the debtor’s assetsby requiringthe outlayof finds for an obsolete388purpose.” The objectivenatureof this standardhas been describedas an “inappropriatelimit” on the discretionof the trusteeto fashionan optimalreorganizationstrategy. The courtshave agreedwith this analysisand have not appliedthis standard 3 to any great extent. The test that appearsto have foundfavouris the “businessjudgment°39test,” whichprovidesa moreflexiblestandard. It allowsthe courtto evaluatethe decisionof the trusteeto assumeor rejectin lightof the circumstancesof the ’39case. The businessjudgmenttest requiresthe trusteeto balancethe competinginterestsinvolvedin the reorganizationcase. The trusteemustweighthe interestsof the debtor,the landlordand the generalcreditorsof the estateto determinethe most prudentcourseof actionand, of course,the trusteecannotignorethe fact that the debtoris seekingto continue carrying on the business,which is the overridingconsiderationin a reorganizationcase. If the trusteehas

386 Ehrlich, supra note 321 at 20.

American Brake Shoe and Foundiy Companyv. New YorkRailway, 278 F. 842 (D.C.N.Y. 1922).

388 Bkr-L Ed, CodeCommentaryand Analysiss. 15:97.

389 NortonBankruptcyLaw & Practices. 23.08. Seealso In re Chi-FengHuang, 23 B.R 798 at 800 (9th Cir. 1982).

‘‘° Group of InstitutionalInvestoi v. Chicago,Milwaukee,St. Pcul & Pcrtfic Railroad Co., 318 U.S. 523 (1943).

In e Minges, 602 F.2d 38 (2d Cit. 1979), wherethe courtheld that it was unnecessaryto showthat the rejectionwouldaid in the debtor’srehabilitation. 172 exercisedits discretionreasonably,the court will notupset its business392judgment. This, it has been said,

would furtherthe goalsof the Codeplacingresponsibility foradministeringthe estatewith the trustee,not the court, it wouldexpeditethe administrationof estatesand encourage rehabilitationby permittingthe replacementof marginalbusinessarrangementswithprofitable business393arrangements. Underthe BIA, within 15days after beinggivennoticeof the repudiationof the lease,the landlordmay applyto the court fora declarationthat the repudiationis inapplicableto its 394lease.

The debtor mustthen showthat it cannot makea viableproposalwithoutrepudiationof that and all otherrepudiated395leases. The debtor neednot showthat it can makea viableproposal;onlythat the proposalwouldnot be viablewithout the repudiation. This standard,like the standardsimposedby the Americancourts,focuseson the effect3of the leaseon the debtorwhich,in turn, determines the viabilityof the proposal. However,the Canadiantest allowsthe courtsto lookbeyondthe “business judgment”of the debtorand examinethe viabilityof the proposalitself If the proposalcannot succeed,giventhe positionof the creditors, onewonderswhetherthe courtwill allowthe repudiation.

In a CCAAproceeding,the parties or thecourtsusuallydeal with disputesconcerningthe fairnessof treatment or proposedtreatment of landlordsprior to the courtapplicationto approvethe plan of arrangement,throughinterlocutoryproceedingsor negotiation.

392 In re Marina Enteiprises, Inc.,14B.R 327 (Bankr.S.D.Fla. 1981);In re Summit Land Co., 13B.R. 310 (Bankr. D.C.Utah 1981).

Bkr-L Ed, Code Commentaryand Analysiss. 15:97 Use of the businessjudgmenttest has recently beenconfirmedin In re Orion Pictures Coiporation,4 F.3d 1095at 1099(2d Cir. 1993), wherethe court said:

“Inreviewingthe trustee’sor debtor-in-possession’sdecisionto assume an executorycontract, then, a bankruptcycourt sits as an overseerof the wisdom withwhichthe bankruptcyestate’s propertyis being managedby the trusteeor debtor-in-possession, andnot, as it does in other circumstances,as the arbiterof disputesbetweencreditorsand the estate.”

BIA s. 65.2(2).

Ibid

396 Janpar, supra note 264 at 10. 173

4. Consideiulionsfor Refonn

The BIA is directedto a particulartype of debtor,viz., one that can secure additionalcapital to make certain priority payments,includingpayment of amountsto Her Majesty in respectof employeesource deductions,to employeesand tolandlords. In otherwords,the BIA requiresthe debtorto use capitalfor unproductiveantecedentdebts. In the absenceof that requirement,the debtor coulduse the fundsfor prospectiveworkingcapital. If a debtorcan raise significantmonies, those monieswouldbe better directedto ensure the ongoingviabilityof the operation. Legislationthat favoursone groupof antecedentcreditorsover otherscan hardlybe consideredequitableand doesnot encouragethe debtor’s397rehabilitatioii The macroeconomicconsequencesof effectivelydisallowing reorganizationproceedingsmay be moredetrimentalto the prioritypayeesthan providingthemwith a preferentialpayment. For example,an employeewouldpreferto receiveapro rata unsecuredclaimin a reorganizationproceedingand retain employmentin a reorganizedentitywith sufficientworking capitalto receivinga prioritypayment of two thousand398dollars from an employerwith a shortageof workingcapital,as the employermay ultimatelyface a liquidationproceeding.

Any reform shouldeliminateall preferredclaimsthat do not add currentor prospectivevalue to the debtor. In particular,the policymakersshouldeliminatethe preferredclaim of the landlordin a liquidationproceeding,as suggestedby the Colter Committee3Repoft With the currentpriority enjoyedby landlords,they haveno incentiveto supportthe reorganizationeffortsof their tenants. It may be very elementaryto observethat the landlord,in a liquidationproceeding,may receiveup to6 months°40rent, which is the quantumof the prioritypayment due followinga repudiationof the lease.

Of course,prioritymust be accordedthe claimsof creditorswhichare providingcurrent servicesto the debtor,such as the trustee’sfees and disbursements,creditorswhichrendersuppliesand servicesfollowingthe commencementof the proceedingsand occupationrent.

398 BIA ss. 60(1.3)and 136(l)(d).

Seesupra note 273 and accompanyingtext.

°° BIAs. 136(1)(f). 174

This is an inappropriateway to encouragethe cooperationof landlordsin the reorganizationeffortsof their tenants. After all, in most instances,the landlord willwelcome therejectionof a leaseby an insolventtenantto secure fulloccupancyof the freeholdwith solvent101tenants.’ As currentlydrafted, the BIA providesa landlordwith an opportunityto profit fromthe rejectionof a lease,as the landlord will receivethe 6-monthprioritypaymentand it may be able torelet the premiseswithinthe 6-month periodfor a rental rateexceedingthat whichthe insolventtenantwas paying.

Criticsnote thatto deprivethe landlordof a preferredstatuspermits theinsolventdebtorto breachcontractsthat thepartiesnegotiatedand enteredin goodfaith. Thispoint is well takenbut the natureof a reorganizationsystemis that it compromisesall creditors andequityholders,to a certain extent,in the interestsof all concernedparties. This objective wasconcisely statedby FarleyJ. in

Lehndolf

It appearsto me that the purposeof the CCAAis also to protect theinterestsof creditorsand to enablean orderlydistributionof the debtorcompany’saffairs. This may involvea winding- up or liquidationof a companyor simplya substantial downsizingof its businessoperations, provided thesame is proposedin the best interestsof the creditors402generally. [emphasis added].

The Canadianpolicymakersshouldreviewthe common lawstandardsestablishedunder the

CCAA. They couldtranslatethe more desirablestandardsinto legislationprovidingthe courtsa marginof flexibility. For example,it may be reasonableto providesomerecompenseto landlordsfor the loss of their bargains. Tofix this amountat the equivalentof 6 monthsrent in all circumstancesis unnecessarilygenerous. Requiringa promptdecisionby the trusteeor debtorto enablethe landlordto mitigateits lossesand provisionfor currentpaymentof occupationrent wouldtreat both sides equitably. Of course,the landlordmustbe assuredpaymentof occupationrent. Failureto provide occupationrent tothe landlordshouldresult in personalliability onthe part of the entityin possession of the demisedpremises. Alternatively, thatentitycouldprovide thelandlordwith adequatesecurity.

401 J.Z. Krasnowieckiand E.W.Vass, “ShoppingCenters andthe New BankruptcyCode”(1980) 36 Bus. Law. 79.

402 Supranote 149at 32. 175

This recognizesthe “value-added”aspectof the leaseduringthe reorganizationproceeding. Thiswill also provide the landlordwith the necessaryadequateprotectionduringthe period betweenthe commencementof the proceedingsand the abandonmentof the premisesby the debtor.

In the UnitedStates,the timewithinwhichthe trusteemust make its decisionto assumeor rejectan unexpiredleasehas caused much403litigation. To imposea time limit of 60 days fettersof the discretionof the court. The 60-thy periodshouldbe the maximum,but the courtshouldhavea discretionto abridgethe timein appropriatecircumstances. Finally,the temiinologyshouldaccurately reflect the result404sought. The conceptof disclaimer moreaccuratelyreflects theobjectivesof the legislation. Usingthis term wouldpreventthe courtsfromusing conceptsthat carrycertain “conceptualbaggage”that the policymakersdid not intend. Also,partieswill not assumeobligationsor liabilitiesthat were notin the contemplationof the policymakers.

C FINANCINGTHE PROCEEDING

Whena debtor is forcedto seekthe protectionof a reorganizationregime,the underlying difficultyis usuallya lack of unencumberedcash requiredto carryon the businessin the ordinary course. This results in the debtorattemptingto pay the most aggressivecreditors,attemptingto protectthe principalsof the debtorthroughthe paymentof claimsthat would otherwiseimpose personalliabilityon them, ignoring theproblem entirelyin the hopesthat its fortuneswill see a turnaround,or seeking the sanctityof availablereorganizationprocedures. Shouldthe debtor seekto invokethe provisionsof a reorganizationregime,the firsttask is to fmd availablecash withwhichto operatethe business during the period betweenthe commencementof the proceeding and confirmation of the plan of arrangement.

Withoutstatutoryprovisions governingaccessibilityto cash duringthe proceeding,the

‘° See generally, Sabinoand Susca,supra note 342.

See chapter V(B)(2),above. 176 operatingcapitalmay come fromthree sources. First,the debtormay have cash from operations that it earmarkedfor the possibilityof an insolvencyproceeding. This source of cash is usually unavailable,as the debtorwill have expendedall availablecash in its attemptto maintainthe operation or the cashwill be subjectto security,suchas an assignmentof rents or receivables. The second sourceis cashproducedthroughoperationsor throughliquidationof assets orparts of the business.

Again,in all likelihood,the proceedswill be pledgedto a creditoror encumberedby some typeof securityinterest,such as an assignmentof proceedsor generalsecuritycoveringall or substantiallyall of the debtor’sassets. The fmal source is the extensionof trade creditor debt orequityfmancing.

The likelihoodof an insolventdebtorobtainingcredit, withoutstatutoryprovisionsaccordingspecial protections,is highly unlikely.

As the cash or assetsthat the debtorcould use to generatecash are usuallysubjectto a securityagreement,any statutory regimethat allowsthe debtoraccessto these resourcesmay adversely affectthe creditorholdingthe security. The followingstatementreflectsthis tensionbetweenthe interestsof securedcreditorsand debtors:

On theone hand,the Court shouldbe anxiousto assurea securedcreditor thatits security interestin cash collateralis not lost becauseit is used up or dissipatedby the Debtor. On the otherhand,the Courtmust also assurethat the Debtor’scashwhich is the life’sbloodof the business,is availablefor use even if to a limited405extent. Thus,the courtsmust attemptto balancethe interestsof the debtoragainstthose of the secured creditor“to determinethe fundingarrangementwhichwill keepthe debtoroperatingwhilemaintaining adequateprotection forthe 406creditor.” This sectionwill examinethe provisionsof the Codethat attemptto strikethe delicate balance betweenthe interestsof the debtorin havingan opportunityto put fortha plan of reorganizationwith a viewto rehabilitationand those of the creditors whowouldotherwisehave priorityover the cash resourcesof the debtor. In particular, wewill examinethe useof eithercash reservesor cash

405 In ir Mickler,9 B.R. 121at 123(Bankr.MD. Ha. 1981).

406 In ,e Prime,Inc., 15BR. 216 at219 (W.D. Mo.1981). 177 generatedthroughoperationsor liquidation,that are subjectto a security 07interest” and the obtaining of new credit.

As neitherthe BIAnor the CCAA contains provisionsgoverningthe fmancingof the debtor’s operationsduringthe periodbetween commencementof the proceedingand presentationof a plan, otherthan throughborrowingsof an interimreceiver,this section willexaminehow the Canadian courtsapproachthese matters. In particular,this section will examinethe issue of whetherthe absence of specificprovisionsgoverningthese matters promotesthe objectivesof the legislation.

1. Use of Cash Collatenil

The policymakersintendedthe Codeto reflect thechangescaused by the adoptionof the

UniformCommercial Codeby all statesin the United States,exceptLouisiana,whichadoptedit only 408partially. In otherwords,the increaseduse of secured creditrequiredaccommodatingprovisionsin bankruptcylegislation. The TasséReportrecognizeda similar increasein use of securedcreditand madesimilar109recommendations.’ Theoretically, insolvency legislationshouldprotecta secured creditor’sinterestin the collateral,providedthe secured creditorhas taken all necessarystepsto protect that interest. The extentof the protectiondependson the nature of the collateral.

The Code givesspecialprotectionto a creditorthat holdsa securityinterestin “cash collateral.” The reasonfor this specialprotectionis that cashcollateralis liquid,fungibleand easily dissipated,consumed or41concealed. In providingspecialprotectionto securedcreditorswith an interestin cash collateral,° the Code attemptsto reconcile theinterestsof securedcreditorsanddebtors.

407 This type of cash is referredto in Codeas “cashcollateral”. See discussion,chapterV(C)(1), below.

408 RM Alderman,A Transxtiond Guideto the UniformCommercialCode, 2d ed. (Philadelphia:AmericanLaw Institute,1983)at vii. Seealso HouseReport at3, 116-117.

TasséReportat 56-57, 96-98.

410 HouseReportat 182;In re Mickler,supra note 405 at 123,wherethe court described cash collateralas “highly volatile”and “subjectto rapid dissipation.” 178

Securedcreditorsare interestedin protectingcollateralin whichthey have a negotiatedinterestand in maintainingtheir prioritypositionsoverthat collateral. The debtorusuallyrequiresthe cashcollateral to meetday to day expensesto survivelong enoughto preparea planof reorganization.411 Paragraph363(c)(1)of the Code grantsthe trustee theright to use, sellor lease propertyof the estate,whetheror not subject toa securityinterest,in the ordinarycourseof business,withoutcourt 412approval. Paragraph363(c)(2)exceptscash collateralfromthe generalgrant. The trusteemaynot be use, sell or lease cash collateral withoutthe consentof all partieswith an interestin it or the authorityof the court, after noticeand 413hearing.

Subsection363(a) of the Codedefines“cashcollateral”as:

cash,negotiableinstruments,documentsof title, securities,depositaccounts, orother cash equivalentswheneveracquired inwhichthe estateand an entityotherthan theestatehave an interestand includesthe proceeds,products,offspring, rents,or profitsof propertysubjectto a securityinterestas providedin section552(b) of this title, whetherexisting beforeor afterthe commencementof a case under this414title.

411 This issue arises as a resultof the provisionsof the Codethat permitthe trusteeor debtorin possessionto operatethe businessof the debtorpursuantto section 1108of the Code. Seediscussion chapter IV(A)(1),above.

412 See e.g, In re Sea QueenKontcratosLines Ltd, 10B.R. 609 (Bankr.D. Me. 1981).

413 In re Rankin, 49 B.R. 565 at 570 (Bankr.W.D.Mo. 1985).

414 The HouseReportrecommendeda broader definitionusingthe tem “softcollateral” insteadof the definitionrecommendedby the SenateReport,whichwas ultimatelyadopted. The definitionof “softcollateral”includedinventory, accounts,contractrights,generalintangibles andchattelpaper. The SenateReportmade it clearthat thecollateralneed notbe cashcollateralon the datethat the proceedingis commenced,but wouldextendto proceedsof “non-cash”collateralwhich is disposedof, providedthat the proceedsremainsubjectto the lienon the originalcollateralunder section552(b)of the Code [SenateReport at 55]. Subsection552(b)of the Codeprovides:

“Exceptas providedin sections363, 506(c),522, 544, 545, 547,and 548 of this title, if the debtorand an entity enteredinto a securityagreement beforethe commencementof the case and if the securityinterestcreatedby such securityagreement extends topropertyof the debtor acquiredbeforethe commencementof the case and to proceeds,product, offspring,rents, or profitsof such property,then such securityinterestextendsto suchproceeds,product, offspring,rents, or profits acquiredby the estateafterthe commencementof the caseto the extentprovidedby such securityagreement andby applicablenonbankruptcylaw, exceptto any extentthat thecourt,after noticeand hearingand based onthe equitiesof the case,orders otherwise.” 179

The 1898U.S. Act containedno specialprovisionsgoverningthe debtor’suse of cash 415collateral, and left developmentof the law concerningthe debtor’suse of cash collateralto the courts. The courtstook two divergentapproachesto this problem. In ReconstructionFinanceCoip.v.

416Kaplan, the court sanctionedthe use by the debtorof cash collateralon the basis that the 1898U.S. Act madeno distinctionbetweencash collateraland othertypes of collateral. As such,the court orderedthe creditorto turn over the cash collateralfor use in the debtor’sreorganization.The Second CircuitCourtof Appealstook a differentapproachin ThirdAve. Transit Coip. v. 417Lehman, where the courtimposedvery strict guidelinesgoverningthe debtor’suse of cash collateral. Thedebtorhad to show thataccessto the fundswas imperative,therewereno other sourcesfrom whichit could obtainthe fundsand there was a stronglikelthoodthat it couldaccomplisha reorganizationwithina reasonabletime, withoutinjuringthe interestof the securedcreditor.

In enactingthe Code,Congresschosenot to adopteitherof these approaches. It recognized the uniquenatureof cash collateraland attemptedto protectthe securedcreditor’sintereststhrough substantiveand proceduralmeans.

The Codeprovidesvarioussafeguardsthat are structuredto protectthe securedcreditor’srights in cash collateral. Paragraph363(c)(2)requiresthe debtorto obtainthe consentof each entitythat has an interestin the cash collateralor securea courtorderallowingit to use the cash collateral. The debtorusuallyseeksthe consentthroughagreementwith the 418creditor. The agreementwill outline the parametersfor the debtor’suse of the cash collateraland will usuallybe incorporatedinto an

415 S.C.Mount,“Standardsand Sanctionsfor the Use of Cash CollateralUnderthe Bankruptcy Code”(1984)63 Tex. L. Rev. 341 at 345.

416 185F.2d 791 at 798 (1st Cir. 1950).

417 198F.2d 703 at 705-706(2d Cir. 1952).

D.T. Polednak,“Is the SecuredCreditorReally‘Secure’?:A Surveyof Remediesand Sanctions for a Debtor’sUnauthorizedUse of Cash Collateralin Chapter11Bankruptcy”(1992)WashburnL. J. 344 at356. 180

419order. To be enforceableunder paragraph363(c)(2),the partiesmust have entered into the agreement42postpetition and althoughit does not haveto be in writing, it must be 42expressed. Shouldthe°creditor merely unconditionallyconsent to the debtor’suse of the cash collateral,’ there is no need to have the court approvethe agreement. However, the creditor may attemptto seek concessionsor rights thatare unrelatedor only marginallyrelatedto use by the debtor of the cash collateral,as considerationfor allowingthe debtor to use 4it. For example,the creditormay attempt to obtaina release of potential or existinglender liabilityclaims, have prepetition liens valithted or have the debtor acknowledge thequantumof a 4debt. The creditormay also seek to controlthe progressand outcomeof the proceeding. Tnsucha case, the creditorwill likelyrequire the debtorto obtain courtapproval of the 424agreement. If the debtorfeels that the concessionsthe creditor is seekingare unsatisfactory,it maywish to have the court rule on the issue, despite the risk that the court may not approvethe debtor’suse of the cashcollateralover the objectionsof the securedcreditor. The debtor would seekcourt approval under subparagraph363(c)(2)(B)of the Code. Althoughthe debtormay have valid reasons for attemptingto obtain court approval,the creditormay also feelthat taldngthe matter to court will producebeneficialresults. Shouldthe securedcreditor feel that the debtoris unable to show adequate

419 Ibid

420 In re Pine Lake VillageApartment Co., 16 B.R. 750at 756 (Bankr.S.D.N.Y. 1982).

421 In re Cmss Baking Co., 818 F.2d 1027(1st Cir. 1987)where the court held that the secured creditordid not discharge theburden of showingthat it had takenthe requisite steps to protect its securityinterest.

Norton BankruptcyLaw & Practices. 87:8.

Ibid

424 Court approval would be obtainedpursuantto U.S. Bankruptcy Rule4001. A discussionof the bindingeffect of the courtapprovalthus obtained appears in S.A. Stripp, “Balancingthe Interests in OrdersAuthorizingthe Use of Cash Collateralin Chapter 11”(1991) 21 Seton Hall L. Rev. 562. 181 protectionof its 4interest, it may refuse to consent. The debtor’sonly alternativeis to seekcourt approval. The court has discretionto prohibitor conditionthe debtor’suse of the cashcollateralin suchmannerand to the extentnecessaryto providethe securedcreditorwith adequateprotectionof its 426

The Codedoes not prescribea standardfor the courtsto use in determiningthe rightsof the partiesin cash collaterallitigation. The hearingand noticerequirementsof section363(c)(3)however, are lenientand tend to favourthe debtor’s427interests. Most courtsattemptto balancethe rightsof the securedcreditorand the 428debtor. However,others havefocusedon the needsof the 429debtor or the adequacyof the protectionaccordedto the secured43creditor. The conceptof adequate431protection, when°the debtorproposesto use cashcollateral,arises becauseof subsection363(e),wiiichprovides:

Notwithstandingany otherprovisionof this section,at any time, on requestof an entitythat has aninterest inpropertyused, sold, or leased,orproposedto beused, sold, orleased, bythe trustee,the court,with or without a hearing,shallprohibitor conditionsuchuse, sale,or lease

425 See Code ss. 363(e)and 363(o).

426 HouseReportat 345. See also Re GeorgeRuggiere Chiysler-Plymouth,Inc., 727 F.2d 1017 (11thCir. 1984)wherethe court allowedthe debtorto use the cash collateralthat exceededthe wholesaleprice of the inventorysuppliedby the creditor,notwithstandingthat the debtexceededthe valueof the collateralby about $1 million. Adequateprotection,the court held,was limitedto the lesserof the amount of the securedclaimand the amountof the collateral. In this case,the latter figure governed.

Mount, supra note 415 at 349.

428 See e.g, In .‘eCerrico Redty Coip., 127B.R. 319at 324-325(Bankr.E.D.N.Y.1991);In QualityInterioi, Inc., 127B.R. 391 at 395 (Bankr.N.D. Oh. 1991);See quote fromIn ie Mickler, supra note 405 and accompanyingtext.

429 In , InternationalHorizons,Inc., 11 B.R. 366at 368 (Bankr.N.D. Ga. 1981). 430 In ie Prime, Inc., supra note 406 at 219.

431 The generalconceptof adequateprotectionis discussedin chapterV(A)(1)(b),above. 182 as is necessaryto provideadequateprotectionof such 432interest. Paragraph363(o)(1)caststhe burdenof proof on the debtorwith respectto the issueof adequateprotection. The debtormustpropose the methodof protectionthat, in its view,will adequatelyprotectthe secured433creditor. The court willthen determinethe adequacyof the protection. Section363 providesthat, oncethe creditorrequestsprotection,the courtshall conditionthe useof the cash collateralby requiringthe debtorto providethe secured creditorwith adequate protectionor prohibitthe debtorfrom usingit. Section361, whichsets forththe alternativemeansof providing adequateprotection,refers specificallyto section363.

In providingadequateprotection,the courtsfollowthe Congressionalintent thatentitlesthe securedcreditorto essentiallywhat it bargainedfor and, in attemptingto makethat determination, the courtsoften focus on the diminutionof the valueof the creditor’sinterestin the collateral. Cash collateralis unique,in that valuationof the collateral posesno difficulty. That is, diminutionin value is equalto the amountof the cash used. Accordingly,to adequatelyprotectthe creditor, thecourtmay require debtorto providea replacementlien orperiodicpayments,as it is the value of the secured

432 The hearingreferredto in subsection363(e)of the Codeis consideredto be a “finalhearing” in accordancewith the terms paragraph363(c)(3)of the Code. Paragraph363(c)(3)of the Code providesthat the initialhearingto determinewhetherthe trusteemay use, sell or leasethe cash collateralis a “preliminaryhearing”and that the trusteewill succeed“onlyif there is a reasonable likelihoodthat the trusteewill prevailat the fmal hearingundersubsection(e) of this section.” Stripp, supra note 424explains the distinctionbetweenan orderresultingfrom a preliminaryhearingand one emanatingfrom a final hearing. A preliminaryor interlocutoryorder,may be revisedat anytime prior to the entryof a fmal order. A fmal order,on the otherhand,is only subjectto reviewon appeal. The authorconcludes that notwithstandingthe designationof an order orhearingas fmal, mostcash collateralordersare interlocutory.[at 585-589]. This characterizationmay have significanteffectson the parties,not the least of whichare the legaland othercostsof undertakingan appeal. In addition, there is no assurance thatan appealwill be entertainedby the courtsas leavemay be required, dependingon how the court characterizesthe order [28U.S.C.s. 158(a)].

‘ See e.g., In re O.P. Held, Inc., 74 B.R. 777 (Bankr.N.D.N.Y.1987). The arguments andthe considerationsare the sameas those discussedin chapterV(A)(1)(b)and accordingly,the readeris referredto that chapter.

‘ HouseReport at339. 183 creditor’sinterestthat requiresprotection,not the collateral435itself. Alternatively,the valueof the creditor’snon-cashcollateralmay be sufficientto offsetthe diminutionin the valueof the cash 436collateral. Paragraph363(c)(4)providesthat, withouta courtorder authorizing theuse of the cash collateralor the consentof each entitywith an interestin the cashcollateral,the debtormust segregate and account forany cash collateral inits possession,custodyor control. In all likelihood,the cash collateralorder or any agreementamongthe parties,will requirean accountingof the funds.’

We shouldnot downplaythe importanceof the segregationand accountingof funds. Although it is not necessaryto protectthe valueof the creditor’sinterest inthe collateral,it may be necessaryto protectthe securedcreditor’ssecurityinterestin “proceeds.” The Codeentitlesthe securedcreditorto maintainits interestin proceedsto the extentprovidedby the securityagreemententeredintoby the debtor andthe securedcreditorand “byapplicablenonbankruptcylaw.”438 The UniformCommercial

Codeis the mostimportantnonbanlcruptcylaw that is applicable. Subsection9-306(2)of the Uniform

CommercialCodeprovides:

Exceptwherethis Articleotherwiseprovides,a securityinterestcontinuesin collateral notwithstandingsale, exchangeor other dispositionthereofunlessthe dispositionwas authorizedby the securedparty in the securityagreementor otherwise,and also continuesin any identfithle proceeds includingcollectionsreceivedby the debtor.[emphasisadded]

Segregatingand accountingfor the fundsmay meetthe requirementsof the UniformCommercial

Stripp,supra note 424 at567-568.

436 NortonBankruptcyLaw & Practices. 87:7.

One author suggestedthat an accountingmay be an integralpart of adequateprotectionand that ordersfor adequateprotectionmay contain“severerestrictions”on the debtor’suse of the collateral. Unlessone can characterizethe dutyto accountand the restrictions imposedon the trustee as the “realization”by the secured creditorof the “indubitableequivalentof suchentitJs interestin suchproperty,”the duty to accountand restrictionsare in factnot componentsof adequateprotection, but those elementsare grantedpursuantto the court’spor under section 105(a)of the Code. Althoughthe right of the courtto make suchordersis not questioned,one must draw a distinction betweenthe elements containedin the orderto makeit clearthat adequateprotectionspeaksvalue only toand notto collateralrights.

438 Code s. 552(b). 184 Code,as the proceedsremain439identifiable. The Codedoes not providesanctionsfor the useof cash collateral inviolation of the Code,a cash collateral order or a consent agreementamongthe 44parties. However,the courts imposesuch sanctionspursuantto subsection 105(a)of the 44Code. °The sanctionsare drawn from otherremedies in the Code, such as the appointmentof a 442trustee,’ conversionor dismissalof the case, liftingthe automaticstay or grantingof retroactiveadequateprotection,such as through the grantingof a replacement5lien.’’ The courts have also drawn from other areas of the law, such as liabilityfor the tort of conversion and 447contempt. Many of the sanctionsare directed towards the debtor’smisdeed, and althoughpunitive in nature, they fail to take accountof the underlyingobjective of a business reorganizationsystem and the possibilityof injuryto parties other than the wrongdoer. In other words, notwithstandingthe debtor’smisuse of the cashcollateral,the business may be worth savingfor the benefitof all. It may be more appropriateto imposepersonal sanctionsagainst those who

It is beyond the scope of this paper to discussthe complexitiesinvolved in section 9-306of the Uniform CommercialCode. One author has calledthis provision “awesomelycomplex”{T.M Quinn, ed.,Unfonn Commeirial Code Commentaiyc&Law Digest (Boston:Warren, Gonnan & Lamont,1978)at 9-168].

° Mount, supra note 415 at 361.

‘ In re Aerosmith Denton Coip., 36 B.R. 116at 119(Bankr.N.D. Tex 1983),where the court exercised thebroad discretion given it by the Code s. 105to grant the creditor a replacementlien to secure the cash collateralwrongfullyused by the debtor.

442 Anchorage Boat Sdes, Inc., supra note 56. See also discussionin chapter IV(A)(4), above.

In re Hewitt, 32 B.R 605 (Bankr.W.D.Wash. 1983).

Anchorage Boat Sdes, Inc., supra note 56; see also discussionin chapterV(A)(1)(b),above.

In re Aerosmith Denton Coip., supra note 441;In re Catheer, 793 F.2d 1436at 1443-1444 (5th Cir. 1986).

116 In 7V Koran Enteiprises,Inc., 61 B.R 321 (Bankr.W.D. Mo. 1986).

In iv Krisle, 54 B.R..330 (Bankr.D.S.D. 1985). In thiscase the debtorwas incarcerateduntil suchtime as he purgedhis contemptby complyingwith a court orderrequiringhim to turn over cash collateralwrongfullytaken fromthe DIP account. His attorney wasalso incarceratedfor participating in the schemeby advisingthe debtor,without propergrounds,to disobeythe court order. 185 precipitatedthe misuse,such as the directorsor officers of the debtoror the trustee,while not destroyingthe possibilityof reorganization.The impositionof personalliabilitycould serveto recompensethe creditorfor any lossthat it suffers.

Neitherthe BIA nor the CCAA containsprovisionsprohibitingthe debtor’suse of cash collateralduringthe reorganizationproceeding. Oncethe insolventpersoncommencesa proposal proceeding,the BIA specificallyallowsit to use the cash448collateral. As the BIA containsno provisionfor the courtto provideadequateprotectionto the securedcreditor,the insolventperson coulddissipatethe cash collateraland the securedcreditorwouldhave no recourseotherthan to seeka declarationthat the stay of proceedingsno longeroperatesin respectof that 449creditor. Thismay be smallcomfortto the securedcreditorif it is unawsreof the commencementof the reorganization proceedingsfor a periodduringwhichthe insolventpersonis realizingon the creditor’scash 45collateral. ° The courtstake a similarapproachwiderthe CCAA. That is, the rights of securedcreditors

448 BIA s. 69.1(1)(b)provides:

“Subjectto subsections(2) to (6) and sections69.4 and 69.5,on the filing of a proposalunder subsection62(1)in respectof an insolventperson,

(b) no provisionof a securityagreementbetweenthe insolventpersonand a secured creditorthat provides,in substance,that on (i) the insolventperson’sinsolvency, (ii) the defaultby the insolventpersonof an obligationwiderthe security agreement,or (iii) the filingof a noticeof intentionunder section50.4or of a proposalunder subsection62(1)in respectof the insolventperson, the insolventpersonceasesto have suchrightsto use or deal ‘withassetssecuredunderthe agreementas he wouldotherwisehave,has any force or effectuntil the proposalhas been fully performedor the insolventpersonbecomesbankrupt;”

Subsection69(b)which dealswith the filingof a noticeof intentionto makea proposalis, in substance,the sameas the foregoing.

BIA s. 69.4.

450 Under subsection50.4(6),the proposaltrusteehas 5 days withinwhichto notifvcreditorsof the filing of the notice of intentionto makea proposal. 186 are subordinatedto the objectivesof the CCAA In Chef 45Recdy, the BritishColumbiaCourtof Appeal stated: ’ if the bank signifiesand collects the accountsreceivable,[the debtor]will be deprivedof workingcapital. Collapse and liquidationmustnecessarilyfollow... Giventhe economic circumstanceswhichprevailedwhenthe C.C.A.A. enacted,it is difficultto imaginethat the legislatorsof the day intendedthat resultto 452follow.s This positionis untenable. This decisioncompromisesthe rightsof the securedcreditorto those of the debtor. Moreover,the enhancedvaluethrough reorganizationwill aceme,not to the securedcreditor,but to the trade creditorsand equityholders. This situationreinforcesthe needfor sometype of protectionbeingaccordedto securedcreditorsduringthe conductof the reorganization proceedings.

To use cash collateral,the debtormust provideadequateprotectionto the securedcreditor.

Furthermore,the debtormust be able to satisfythe courtthat the reorganizationproceedinghas some prospectof success,on an objective453basis. Althoughthis may be a difficultmatterto establishat the outsetof the case,the standardwill not be so stringentat that stageand will requirethe courtto make an objectivedeterminationbasedon the evidencepresented. Later in the case,the debtorfacesa more onerousburden. The debtormustpresentevidenceof a pressingneed for use of the cashcollateral.

The sanctionsfor misuseof the cashcollateralshouldbe harsh and strictlyenforced,reflectthe degree of culpabilityattendanton the misuseand imposepersonalliabilityon the individualsinvolved.

2. O44ainingCicdit

The Codeand the BIA containprovisionsallowingthe debtorto obtaincredit andgrant securityto fmancethe reorganizationproceedings. The Codeallows directfmancingthroughthe

451 ChefRecdy,supra note 95.

452 Ibid at 320.

‘ See discussionchapterffl(C)(3),above. 187 trusteeor the debtorin 454possession. The BIA permitsneitherthe insolventperson northe proposal trusteeto obtainfmancingbut may permit an interim receiverto borrowand grantsecurityduring the reorganization455proceeding. In most instances,the debtor will not haveunencumberedassetsavailablewith whichto obtain fmancingto maintain theoperations andput fortha plan of 456reorganization. Withoutspecial protection,lenderswill be unwillingto advancefundsto such a debtor. After all, if an existing secured creditor has securityon all or substantiallyall of the propertyof the debtor,it is unthinkable that a lenderwouldadvancenew fundson the assurancethat the new lenderwouldhave a security interestsubordinateto existingsecurityinterests. Becauseof the specialtreatmentaccordedto lenders extendingnew fmancing underthe Codeand because the debtoris, in some cases,relievedfromthe obligationof maintaining prepetitiondebts in goodstanding,postpetition fmancingmay be less speculativethan fmancingan entitythat has not soughtthe protectionof the Code.

The previous sectionin this chapterdealtwith the debtor’suse of cash collateralas a meansof fmancingthe proceeding. Section364 is the exclusivechapterof the Codedealingwith the obtaining of new creditby the 457estate. That section,like all of the administrativepowers,attemptsto balance the interestsof the debtorin reorganizingits affairswith the equitabletreatmentof 458creditors. It attemptsto adequately protectthe interestsof existingcreditors.

Subsections364(a)to (d) provide:

(a) If the trusteeis authorizedto operatethe businessof the debtor. . . , unless thecourt ordersotherwise,the trustee mayobtainunsecuredcreditand incurunsecureddebt in the

Code s. 364.

BIA ss. 31and 47.2.

456 NortonBankruptcyLaw & Practices. 38:1.

SenateReportat 57 statesthat section364 of the Code “governsdl obtainingof creditand incurringof debtby the estate.”[emphasisadded]

458 JJ Rickert,“Cross-Collateralization:An AppropriateMethodof Section364 Post-Petition Financing” (1993)66 TempleL. Rev. 239 at 239. 188

ordinarycourseof businessallowableunder 503(b)(1)of this title as an administrative expense.

(b) The court, after noticeand a hearing,may authorizethe trustee to obtainunsecured creditor to incurunsecureddebt otherthan undersubsection(a) of this section,allowable undersection503(b)(1)of this title as an administrativeexpense.

(c) If the trustee is unableto obtainunsecuredcreditallowable under section503(b)(1)of this title as an administrativeexpense,the court,after notice anda hearing,may authorize the obtainingof credit orthe incurringof debt - (1) with priorityover anyor all administrativeexpensesof the kind specifiedin sections503(b) or 507(b) of this title; (2) securedby a lien on propertyof the estatethat is not otherwisesubjectto a lien; or (3) securedby a junior lien on propertyof the estatethat is subjectto a lien.

(d) (1) The court,after noticeand a hearing,may authorizethe obtainingof creditor the incurringof debt securedby a senior or equallien on propertyof the estatethat is subjectto a lien only if - (A) the trusteeis unableto obtainsuchcredit otherwise;and (B) there is adequateprotectionof the interestof the holderof the lien on the propertyof the estateon whichsuch senioror equal lien is proposed tobe granted. (2) In any hearingunderthis subsection,the trusteehas theburdenof proofon the issue of adequate protection.

The structureof those subsections requiresthe trusteeto seek fmancingat variouslevels,each succeedinglevelrequiringthe trusteeto overcome more stringent proceduraland evidentiaryobstacles but providingpotential postpetitionlenderswith an increasinglevelof 459security. At the “lowest” level is unsecured creditobtained“inthe ordinary courseof business.”° The trusteemay obtainthis

“ NortonBankruptcyLaw & Practices. 87:15.

460 Code s. 364(a). Somecourts have defmedthe term “ordinarycourseof business”usingits plain meaning. See e.g., In re LockwoodEnteiprises,52 B.R. 871 at 874 (Bankr.S.D.N.Y.1985), wherethe courtdeterminedthat thecreditwouldfall withinthe meaningof the term if the creditis of the typewhichis normallyor customarilysoughtby the debtor inits business. In analyzingthis issue, the courtswill lookto the historyof the business andthe generalpracticesin the industry. Examples of mattersthat do not fall within its ambitare the purchaseof capitalassetsor an unusuallylarge volumeof suppliesor the provisionof extensiveservices areexpensesincurredoutsideof the ordinary courseof business[In re PhotoPromotionAssociates,Inc., 87 B.R. 835 (Bankr.S.D.N.Y.1988)1, servicecharges,interestand late penalties[In re Kenney’sFranchise Coip.,21 B.R. 461 at 462 (Bankr. W.D.Va. 1982)1,and amountsadvanced thatwill not assist inthe reorganizationand rehabilitationof the debtoror for whichthe creditorhas someulteriormotive [Re C.E.N, Inc., 86 B.R. 303 at 305-306 (Bankr.D. Me. 1988)1. 189 type of credit without court 46approval. To receive an administrativeexpense462priority, subparagraph 503(bXl)(A)requires that the’ expenses are“actual,necessarycostsand expensesof preservingthe estate.” In other words,the postpetitionlending mustbe beneficialto the debtor’sobjectivesand creditors 463generally, be actual and necessary and providea substantialcontributionto the estate and the unsecured465creditors. In addition, subsection364(a) requires the obtainingof the credit or incurringof debt to be “in the ordinarycourse of business.” This is an importantqualification,as credit extendedoutside the ordinarycourse of businessrequires court approval. Failure to obtain

461 Norton BankruptcyLaw & Practice s. 38:2.

462 Code s. 503(b)(1). An administrativeexpense,althoughconsideredto be a priority claim,only gives the postpetitionclaimantpriority over otherunsecuredclaims. However, it is still an unsecured claim that is subordinateto secured claims. This makes postpetitionlendingusing this method relativelyundesirable,as assets in a reorganizationproceedingare generallyfully encumberedin favour of securedcreditors. Sincethe value of the assets usually falls below the securedclaims, administrative expensesare often not paid in full [MM Jaffe, “Chapter 11 Strategies andTechniques- Creditors’Committees,EffectiveUse of Plan Provisions, Objectionsto Confirmation,Financinga Chapter 11 Case, ‘Cramdown’and How it Works”(1985) 59 Tulane L. Rev. 1298at 13241. Because of this limited protection,credit grantedunder subsection364(a)will be limitedto creditorswith the least amount of power vis-a-visthe estate. Typically,these would includetrade creditors [MR. Rochelle, “Post-FilingLoans to the Chapter 11 Debtor: Good Money After Bad” (1990) 107Banking L.J. 344 at 345]. Even trade creditorsmay be unwillingto extendcredit tothe trustee until creditworthinessis proven [Thid]. However, giventhe often fierce competitionin the marketplace, trade creditorsmay be more than willing to supplygoods and servicesto reputable trustees on normal credit terms. Shouldthe trade creditor demand cash on delivery,the trustee will more than likely locate other supplierswho will provide goods and serviceson terms. Accordingly,use of subsection 364(a) is likely very prevalent.

‘ See In tr Thwmond, 41 B.R. 464 at 465 (Bankr.D. Or. 1983). In re Patch Graphics,Inc., 58 B.R. 743 at 745 (Bankr.W.D. Wisc. 1986);In In r SMB Holdings, 77 B.R 29 at 32 (Bankr. W.D.Pa. 1987),the court reflected its views on this requirement as follows:

“The goods and services provided must have been givento or actually benefit the debtor-in- possession,and must notbe intendedto further the self-interestof the particular claimant. Therefore,only when potential creditorsare inducedto provide goodsand/or servicesto the debtor-in-possessionare the purposes of the administrativepriority fulfilled.” [citations omitted].

In re Patch Graphics,Inc., ibid.

Code s. 364(b). 190 courtapprovalmay result in the denialof the claimas an administrativeexpense,in whichcase,the creditorwill rank as an ordinaryunsecuredcreditor,subordinateto securedcreditorsand administrative expenseclaimants. Althoughthe creditormay beable to obtainleavenuncpro tune,this reliefis discretionary7 and the courtmay deny theapplication. Subsection364(b) is the next level8of obtainingcredit. That subsectionallowsthe trusteeto incur unsecureddebt outsidethe ordinarycourse of business,with leave of the court,and accordsa claimfor such a debt the priorityof an administrativeexpense. The claimof the creditor,shouldit decideto advance or grantcredit withoutcourtapproval,will be an ordinaryunsecuredclaim, subordinateto administrativeexpenses. Again,the creditormay seek leavenuncpro tune and incur the risk thatthe courtwill not grantthis 9relief. The debtorneed not use the fundsacquired

In , Photo PromotionAssocica’es.,Inc., siq,ra note 460. The rationalefor denyinga lenderan administrativeexpensepriorityon its failureto secureapriori approvalfrom the court is that:

“Togivepriorityto a claimantnot clearlyentitledtheretois not only inconsistentwiththe policyof equalityof distribution it dilutesthe value of the priorityfor those creditors Congressintendedto prefer.”[In re MammothMan, Inc., 536 F.2d 950 at 954 (1st Cir. 1976)]. ef In re GroendykeCo., 131F.2d 573 (7th Cir. 1942)wherethe court held that the moneyswere advancedby the principalof the debtorin the ordinarycourseand accordingly,were givenan administrativeexpense priority.

‘ In re Cawade Oil Co., 51 B.R 877 at 882 (Bankr.D. Kan. 1985),wherethe courtsaidthat such approvalwouldonly be givenin “unusualcircumstances”;for the requirementsto obtainleave nuncpro tune, see In r AmericanCooler Co., 125F.2d 496 at409 (2d Cir. 1942)wherethe courtset forththe following“guide-posts”for the courtto considerin decidingwhetherto grantleavenuncpro twic:

1. leavewouldhave been authorizedif a timelyapplicationhad been made; 2. the creditorshave not been harmedby a continuationof the business made possibleby the loan; and 3. whetherthe debtorand lenderhonestly believedthat they had the authorityto enter into the transaction.

See also GenerolElectricCapitd Coq,. v. Hoemer, 143B.R 840 (Bankr. W.D.MIcK 1992),where the court held the foregoingto be thresholdstandardsand, in addition,the “equitiesmust strongly favourthe creditor and there must be an absenceof prejudiceto any interestedparties.” [at 851-852]..

Ibid and accompanyingtext. 191 exclusivelyfor operationof the business,per se, but it may use the funds to enhanceor preservethe estate, such as throughthe prosecutionor defenceof a 47lawsuit. If the trustee is unable to obtainunsecuredcredit° under either subsection364(a) or 364(b),the court may allow the trusteeto obtaincredit or incura debt under subsection364(c). That subsection grantsthe creditor, a “superpriority”administrativeclaim, that will rank ahead of all other administrativeexpenseclaims, a lien on unencumberedpropertyof the estateor a subordinatelien on previously-encumberedproperty of the 47estate. Although subsection364(c) frames the incentivesfor grantingthe priorityas alternatives,a creditor’ may seek securityfor its claim and a superpriority administrativeexpenseclaim for any deficiency. To obtain credit under subsection 364(c),the trusteemust show that it was “unable4to obtain unsecuredcredit”under subsections364(a) or 364(b). Althoughthe trustee need not show that it has canvassedevery possible source of unsecured4credit, the courtsusuallytake a pragmaticapproachand requirethe trustee to show that it made a bonafide effort to obtain financingunder subsections364(a) or 474364(b). The trusteemust also show that the credit is necessaryfor the preservationof the 475estate and that the proposedtransaction is fair, reasonableand adequate in the 476circumstances.

470 See e.g., In ie Hartley,39 B.R. 273 (Bankr.N.D. Oh. 1984).

471 Code s. 364(c)(1),(2) and (3), respectively.

Jaffe, supra note 462 at 1325.

In m Ames DepartmentSto,rs, Inc., 115B.R 34 at 40 (Bankr. S.D.N.Y. 1990).

‘ In re SnowshoeCo., 789 F.2d 1085at 1088(4th Cir. 1986);In re 495 Centrd Park Avenue Corp., 136B.R. 626 (Bankr. S.D.N.Y. 1992);cf In re Crouse Group,Inc., 71 BR. 544 at 550 (Bankr. E.D. Pa. 1987),cfJ’d75 BR. 553 (ED. Pa. 1987),wherethe court was“unconvincedthat the Debtors have madethe requisiteexhaustiveunsuccessfulefforts to obtaincrediton terms in accordancewith s. .“ 364(b). Only one lendinginstitutionwas approached. [at 5501.

In ie Gloria Manijcturing, 65 B.R 341 at 348 (Bankr.E.D. Va. 1985). The court in this case found that “thebusiness was to continueas an operation”and accordingly,grantednuncpro tune leave to borrow[at 348].

476 In te Croue Giviq, supranote 474 at 549; In te Aqua Assocka’es,123BR. 192at 196 (Bankr.E.D. Pa. 1991). 192

As securityprovidedto a newcreditorunder subsection364(c)is subordinateto the claimsof existingsecuredcreditorsor on unencumberedpropertyof the estate,the new security does not impair the interestsof preexistingsecuredcreditors. Thus,there is no necessityto adequatelyprotectthe interestof a preexistingsecuredcreditor.4 However,undersubsection364(d),the courtmay authorize the trusteeto obtaincredit or incura debt by grantinga securityinterestin propertythat is senioror equalto a preexistingencumbrance.The trustee,in seekingauthorizationfor this type of transaction, must showthat a credit facilityon less onerousterms was 478unavailable and that the interestof the existingcreditoris adequatelyprotected. Clearly,this is the type of securitythat any postpetition lenderwouldwant, but the trustee4 must showthat otherpotentialcreditorsare unwillingto lend on less onerousterms.

Under subsection364(d),the trusteehas the burdenof showingthe methodand adequacyof the proposed48protection and the courtshave sho a reluctanceto authorizethis type of transaction becauseof a potential° declinein valueof the 481collateraL As with all issuesinvolvingadequate protection,the courtsattemptto strikethat seeminglyelusivebalancebetweenthe rightsof the debtor to reorganizeits affairsand rehabilitateitselfwith those of the preexistingcreditorto the benefitof its bargain. The courtsmust attemptto place a value on the collateral,consideringsuch qualitative factorssuch as the natureof the businessof the debtor,the prospectsfor a successfulreorganization, the existenceor lack of an equity482cushion, and the likelthoodthat the collateralwill depreciateor

NortonBankruptcyLaw & Practices. 38:6.

478 Code s. 364(d)(1)(A).

Codes. 364(d)(1)(B).

480 Code s. 364(d)(2).

481 See e.g, AnchorSavingsBankPSB v. Sky Vdley, Inc., 99 BR. 117at 123(Bankr.N.D. Ga. 1989),wherethe court expressedits concernthat “somecreditorwhich bargainedfor its firstpriority positionwill alwaysbe nudgedaside.”

In ,r O’Quinn,98 BR. 86 at 89 (Bankr.MD. Fin. 1989). 193 appreciate. The partiesplace evidentiarymatters beforethe court,which requiresthem to address valuationissues.

Subsection364(e)protectsa creditorwho has grantedcreditor advancedfundson the strength of a courtauthorizedpriorityor securityinterest,in the eventthat a court overturnsthe original authorizationon 483appeal. The creditorwill receivethis protection,providedthere was no stayof the originalauthorization,pendingappeal,andthe grantingof the creditor the advancingof the funds was done in good4faith, whetheror not the creditorknewof the pending485appeal. Failureto showthe foregoingmay result in the creditorlosingthe protectionaffordedby subsection364(e)andhavingthe administrativeexpensepriorityor securitytaken 4away. A 487“controversial” practicehas developedwherea prepetitioncreditorattemptsto cross collateralizeits prepetitiondebt with postpetitionassets. This practicedevelopedunderthe Chandler

Act and is describedas follows:

[Thisappeal]concernsa practiceeuphemisticallycalled“cross-collateralization.”.. . Whatthis term meansis that in return for makingnew loansto a debtorin possessionunderChapterXI, a fmancinginstitutionobtainsa securityintereston all assetsof the debtor,both thoseexisting at the date of the order and those createdin the courseof the ChapterXI proceeding,not only

483 The rationaleunderlyingthis provisionis:

• . to overcomepeople’snaturalreluctanceto deal with a bankruptfirm whetheras purchaser or lenderby assuringthem that so long as they are relyingin goodfaith on a bankruptcy judge’sapprovalof the transactionthey need not worryabouttheir prioritymerelybecause somecreditoris objectingto the transactionand is trying to get the districtcourt or courtof appealsto reversethe bankruptcyjudge. The proper recoursefor the objectingcreditoris to get the transactionstayedpendingappeal.”[In n EDC Holding Company,676 F.2d945 at 947 (7th Cir. 1982)].

In re EllingsenMccLean Oil Co., 834 F.2d 599 (6th Cir. 1987)

485 Code s. 364(e). See e.g, In re EllingsenMccLean Oil Co., ibid

See e.g, In re EDC Holding Company,supra note 483 at 947 wherethe courttook awaythe specialpriorityof the lenderon the groundsthat it lackedgoodfaith when advancingfundsunderthe approvalorder.

NortonBankruptcyLaw & Practices. 87:22. 194 for the new loans,the proprietyof whichis not contested,but for existingindebtednessto 4it. Cross-collateralizationgivesa preferenceto a creditor thatis undercollateralizedor unsecuredat the time the petition is filed. The Codeinvalidatesmost after-acquiredpropertyclausesin prepetition securityagreements. Thus,any attemptby a prepetitionundersecuredcreditorto obtaina security interestin4 postpetitionproperty,that wouldotherwisebe availablefor unsecuredcreditors,not only givesthe undersecuredcreditora preferredposition,but also may be a violationof subsection552(a) of the Codewhichprovides:

propertyacquiredby the estateor by the debtorafterthe commencementof the case is not subjectto any lien resultingfrom any securityagreemententeredinto by the debtorbeforethe commencementof the case.

Furthermore,the trusteehas the powerto avoidan unauthorizedtransferof propertythat occursafter commencementof the case.° Subsection547(b) of the Codedescribesthe elementsof a voidable preferenceas follows:

Exceptas providedin subsection(c) of this section,the trustee mayavoid any transferof an interestof the debtorin property - (1) to or for the benefitof a creditor; (2) for or on accountof an antecedentdebt owedby the debtorbeforesuch transferwas made; (3) madewhilethe debtor wasinsolvent; (4) made - (A) on or within90 days beforethe date of the filing of the petition;or (B) betweenninetydays and one year beforethe date of the filingof the petition,if such creditorat the timeof suchtransferwas an insider;and (5) that enablessuchcreditorto receivemorethan such creditorwouldreceiveif - (A) the case were a case underchapter7 of this title; (B) the transfer hadnot been made;and (C) such creditorreceivedpaymentof suchdebt to the extentprovidedby the provisionsof this title.

Exceptfor the periodsset forth in paragraph547(b)(4),a transactioninvolvingcross-collateralization falls withinthe descriptionof a voidablepreference. Takenin combinationwith the trustee’s

488 In n Texion Coiporation,596 F.2d 1092at 1094(2d Cir. 1979).

489 Codes. 552(a).

° Code s. 549. 195 authorizationto avoidpostpetitiontransfers, one mustquestionwhetherthe court,in authorizinga cross-collateralizationtransaction,is participatingin the facilitationof a preferencein favourof the formerlyundersecuredor unsecuredcreditor.

The Codeexcepts,fromthe preferencesections,transactionsfor “newvaiue”whichinclude moneyand moneys worth ingoods,servicesor new 49credit. The approvalof cross-collateralization agreementsmay be justified on the basisthat the estate’ receivesnew value (in the form of the new advanceor theextensionof new credit)andthe Codedoesnot specifythat the new valuebeara reasonablerelativevalue to the postpetitionsecurity. In otherwords,the Code does not measurethe valueof the considerationgivenfor the new valueand accordingly,cross-collateralizationmaybe legitimateconsiderationfor the new value.

Thereis a divisionin the Americanbankmptcycourtsconcerningthe issue of the legitimacy of a cross-collateralizationtransaction. The courtsthat have approvedthis type of transactionappear to view it as the only availablemeansof providing thedebtoran opportunityto reorganize,rehabilitate itselfand avoid493liquidation. The courtsconsiderthe adequacyof the noticegivento the affected creditorsand the “extent”of the 494preference. The latterpart of the test appearsto suggestthat the courtsexaminethe quantumof the new credit againstthe amountof the prepetition claimsoughtto be

“p’ Code ss. 547(a)(2) and 547(c).

492 Cf BIA s. 97, whichprotects transfersby the bankruptthat are made for “adequatevaluable consideration”from avoidanceas a preferenceor settlement. Subsection(2) of that sectiondefmes adequatevaluableconsiderationas “a considerationof fair and reasonablemoneyvaluewith relation to that of the propertyconveyed,assignedor transferred.

In re Ellingsen Mcrlean Oil Co., supra note 484;In re Adams Apple Inc., 829 F.2d 1484(9th Cir. 1987). In the lattercase,the court expressedthe policy underlyingits decisionto upholdthe validityof the cross-collateralization:

“Cross-collateralizationclausesmay providethe only meansfor savinga failingcompany. If the lenderis the sole lenderwillingto fmancethe debtor,a cross-collateralizationclause may bethe differencebetweenan ongoing enterpriseand a companyin liquidation.”[at 140].

See e.g., In re Ames DepailmentStores, Inc., supra note 473; In re PCX, Inc., 54 B.R 833 (Bankr.E.D.N.C.1985). 196 495secured. Severalcommentatorshave criticizedthe authorizationof cross-collater 4ization. The recent decisionin In n 497Saybrook, may satisf’ the critics. Saybrookheld that cross-collateralizationis an impermissiblemethodof securingthe postpetitionfinancingin a reorganizationproceeding,as it is inconsistentwith the fundamentalpoliciesunderlyingthe Code,includingthe policyof treating creditorsof the same class 498equally. Because of this conflictwith the fundamentalpoliciesof the Code,the courtscouldnot exercisetheir equitablepowersto authorizesuch a transaction,in violation of the Code’spriorityand distributionschemes.

Saybrookimposedan absolute4prohibitionon cross-collateralizationtransactions. Whetherthis approachis appropriatewill undoubtedlybe the subject-matterof future50debate. The fundamental questionsare whetherpreferentialtransactionsare inherentlyevil and whether° the courtsshould disallowthem under all circumstances,as suggestedin Saybrook. Althoughthe quantumof the consideration,as used in the ’50B1A mayprovidean answer,that answerdoes not accountfor the policiesunderlyinga reorganizationregime. If the fundamentalpoliciesrequirea balancingof the interestsof the debtorin reorganizationand rehabilitationagainstthose of the creditorsand the equalityof treatmentof the creditors,a more flexibleapproachmay be preferable. That is, preferences

NortonBankruptcyLaw & Practices. 87:22.

496 See e.g, RC. McCullough,“Analysisof BankruptcyCodeSection364(d):Whenwill a Court Allowa Trustee to ObtainPostpetitionFinancingby Grantinga SuperpriorityLien?”(1988)Corn.L.J. 186,wherethe author statedthat the conceptof cross-collateralization“violatesthe spirit of the Code” and that it shouldonly be allowedin the most extraordinarycircumstances,if any [at 2101.

963 F.2d 1490(11th Cir. 1993).

498 Ibid at 1494-1496.

Ibid at 1495.

°° The debate appearsto havestarted with a recentarticlereferredto earlier,see Rickert,supra note 458.

501 Supra note 492. 197 possessan inherentlydistastefulquality,but if the preference willultimatelyresult in a reorganized debtorthat enhancesthe realizationprospectsof all creditors,perhapsthe preferenceis not so evil as it first appears. The creditorscan givethe court guidancein this regard. That is, shouldall affected creditorsapproveof the grantingof the preference,this may showtheir support forthe broaderpolicy of the legislation. On the otherhand,the courtshouldbe ry of any transactionto vkiichthe affected creditorsobject.

The intent of the preferred creditormay also be a relevantconsideration.Underthe BIA,the courtmay upholda preferentialtransactionif the creditorcan showthat it advancedthe fundswith the bonafide expectationthat thedebtorwouldcontinue inbusiness andsolve itsfinancial502difficulties. Shouldthe creditorhonestlybelievethat its new value,howeversecured,will allowthe debtorto reorganizeitself for the benefitof all creditorsof the estate,the court shouldconsiderthis factor. This introducesthe final factorthat the courtmay consider,which is the likelthoodof a successful reorganization.If it appearsthat the debtoris doomedto failure,on an objectiveanalysis,this may implythat thepreferredcreditordid notnecessarilyhave altruisticintentions.

Neitherthe BIA nor the CCAAcontainsprovisionsallowingfor the borrowingof fundsand the grantingof securityby the debtor,monitor(under theCCAA) or the proposaltrustee(under the

BIA). The absenceof any suchprovisionhas resultedin the debtorusingpreviouslypledgedaccounts receivableand inventoryto fmance the503proceeding. The courtsunder theCCAAhave limitedthe rightto borrowand grant securityin priorityto existingchargesby requiringthe consentof the affected504creditors. Recently,the BritishColumbiaSupremeCourtalloweda postpetitioncreditor to take securityon certainunencumberedassetsof the debtor. This strategyis not unlikethe security

502 Re A.R. Coiquhoun& Son Ltd (1936), 18 C.B.R 124(Sask.KB.).

The concernswith this methodof proceedingare discussedszqra notes 448 to 452 and accompanyingtext.

In the contextof a receivership,see Bankof AmericaCancdav. Wilann InvestmentsLimited (1993), 20C.B.R.(3d) 223 (Ont. Gen.Div.) 198 allowed underparagraph364(c)(2)of the 505Code. The courtexercisedits inherentjurisdictionin grantingthe order. Becauseof the flexibilityof the CCAA,the courtsare in a positionto fashion fmancingorders appropriate tothe circumstances.In so doing,the courtsshouldanalyzethe facts againstthe policyobjectivesof the CCAA.

The BIA only permitsfmancingat the instanceof an interimreceiver. The appointmentof an interimreceiver maybe detrimental tothe reorganizationeffortsof the debtor,becauseof the costsof the interimreceiverand its advisorsand the possibleloss of controlby the debtor. The debtor must thereforeweigh thesedetrimental effectsagainstthe necessityfor fmancing.

Section47.2 of the BIA permitsthe court to makean orderwith respectto paymentof the fees and disbursementsof an interimreceiver, includingan order grantingthe interimreceivera charge on assetsof the debtorto securethe fees and disbursementsthat ranksaheadof existingsecured creditors. Subsection47.2(2)removesfrom theterm “disbursements,”paymentsmade inoperatingthe businessof the debtor. Althoughone 506writer suggestedthat section47.2 of the BIA neitherallows nor prohibits theright of an interimreceiverto seeka first chargeon assetsof the debtorfor operating expenses,it is arguablethat subsection47.2(2)createsthat prohibition.

Subsection31(1)of the BIA provides:

(1) With the permissionof the court,an interim receiver ora trustee,prior to the appointmentof inspectors,may makenecessaryor advisableadvances,incurobligations, borrow moneyand give security on the propertyof the debtorin suchamounts,on such terms and on suchpropertyas may be authorizedby the courtand those advances, obligationsand money borrowedshallbe repaidout of the propertyof the debtorin priorityto the claimsof the creditors.

This subsectionappearsto applyonly wherethe court hasappointedan interimreceiverduringthe period betweenthe filing of a petitionfor a receiving orderand the grantingof the order. However,it maybe muchbroader. Inspectorsare appointed only after thecourthas granteda receivingorderin a

505 Re WestarMining Ltd (1992), 14 C.B.R. (3d)88 (B.C.S.C.).

506 K Ham, “CorporateRestructuringUnderPart ifi of the Bankruptcyand InsolvencyAct” in CoiporateRestructuring(Toronto:CanadianInstitute,1992)Tab ifi at 35. 199 liquidationproceeding,whichmay lead one to the foregoingconclusion. However,the words“priorto the appointmentof inspectors”modifythe word“trustee”and do not referto the interim receiver.

Thus,an interimreceiver,whether appointedprior to a receivingorder in a liquidationproceedingor in a proposalproceedinghas the powersset forth in subsection31(1) of the BIA. The balanceof the sectiondoes not suggesta similarconclusion,as thoseprovisionsrefer onlyto the “bankrupt”or

“trustee.”Accordingly,thosepowers,dutiesand limitationsare applicableonly ina liquidation scenario. Thosesubsectionsprovide:

(2) For thepurposesof givingsecurityunder section427 of the Bank Act, the trusteeor interim receiverif authorizedto carry on the businessof the bankruptis deemedto be a person engagedin the class of businesspreviouslycarriedon by the bankrupt.

(3) The creditorsor inspectorsmay byresolutionlimitthe amountof the obligationsthat may be incurred,the advancesthat may be madeor moneysthat may be borrowedby the trusteeand may limit the periodof time duringwhichthe businessof the bankruptmay be carried onby the trustee.

(4) All debts incurred andcreditreceivedin carryingon the businessof a bankruptare deemedto be debts incurredand creditreceivedby the estate of the bankrupt.

The leadingtreatise on bankruptcy lawin Canadahas suggestedthat:

Securitygivenby an interimreceiver onthe assetsof the debtorto obtainloansis subordinate to the claimsof securedcreditors. An interim receivershould,therefore,satisfyhimselfthat there is sufficientequityin the pledgedassetsto coverthe amountborrowedby him, or in the alternative,he shouldobtain theagreementof secured creditors tothe subordinationof their claimsto the borrowingby the interim507receiver. Withthe greatest respect,subsection31(1)of the BIA doesnot suggestthat conclusion. Infact,the closingwordsof that subsectionrequirethe interimreceiveror trusteeto repaythe advancesmade and the obligationsincurred“inpriorityto the claimsof the creditors.” Section2 of the BIA definesthe term “creditors”as includingsecuredcreditors. Thus,the courtcan onlyauthorizethe interim receiver to borrowor incurobligationson securitythat takespriorityover existingsecurity. The courtsmay be more inclinedto grant such securityif adequateprotectionis providedto existingsecuredcreditors.

L.W. Houlden and C.H Morawetz, TheAnnotatedBankniptcyand InsolvencyACt 1993 (Scarborough:Carswell 1992)at 47. 200

3. Conclusion

Do thevariousprovisionsaccomplishthe objectivesof the legislative regimes?If the objectiveof the regimeis to encouragerehabilitationand reorganizationof the debtorand treat creditorsfairly and equitably,the Code substantiallyaccomplishesthat objective. The hallmarkof the

Americansystemis to provideadequateprotectionto partieswith an interestin the collateral. The absenceof this concept in Canada limitsthe options of a debtor seekingto reorganize. Althoughone may questionthe adequacyof the protectiongrantedto secured creditorsin the United States,given their apparentdiscontentas exhibitedby the volumeof litigationand commentarieson the issue,the systemis fairerto partieswith an interestin the collateralthan a systemthat allowsthe debtorto use the collateralwith no compensationor protectionbeing accordedto the affectedparty,as is presently the case in Canada.

The interventionof an interimreceiverunder theBIA to seek fmancingis an unnecessaryand an unreasonablerequirement. It is subjecting an alreadyinsolventdebtorto furthercoststhat neither contributeto the going-concernvaluenor assist in the debtor’sreorganizationefforts. The requirement for an interimreceiveris especiallyonerousin a situationwherethe creditors andthe debtorare workingtogetherto reach an amicablesolutionto their mutual difficulties.

if the policymakersprovidethe courtswith sufficientflexibilityconcerningissues,suchas adequateprotection andcross-collateralization,the circumstanceswill dictatewhat is fair. In sum,the flexibilityof the CCAAis the most desirablesystem. This is especiallyevidentin cases wherethe courtshave adoptedsomeof the moreappealingconceptsused in the United States,such as in the

Westar508case. The BIA is not workable,giventhe requirementfor the interventionof an interim receiver, if an objectivesof the BIA is to encourageproposalproceedings,the systemhas failed.

508 Supranote 505. 201 HAYIER VI

IK)VING R)WARI) CONFIRMATIONOF A PLAN OF REORGANIZATION

The objective of a proponentof a plan of reorganizationis to fonnulate a plan that the creditors,the holdersof the equity interests in the debtor and the court willaccept. In movingtoward this objective,the three statutoryschemesmay appear to be facially similar, in some respects,and the issues encounteredoften have a similarfocus. However,the legislativeschemeshave ftindamental differenceswhich go to the very rootof the reorganizationprocess. In addition,the courtsinterpreting the seeminglysimilarmechanisms,take divergentapproaches.

This chapter will examinecertain issues that arise during the movementtoward confirmation of the reorganizationplan. The steps precedingconfirmationwill be briefly presented. Thiswill allow the reader to contextualizethe discussion specific issues that follow.1 of We will then consider the time withinwhich a plan proponentmust submitthe plan of reorganization. This may provideus with some idea of the overall views of the policymakersand the judiciary of the reorganization process.

As a prelude to an examinationof the issues surroundingthe classificationof creditorsunder each statutoryregime, we will examinethe voting acceptancerequirementsand how these requirementsaffectthe classificationof claims and interests. Classfficationof claims andinterests under the plan is perhaps the most importantmatter for considerationof the plan proponent.

Classificationwill determinewhetherthe creditors and equity interestholders willaccept the plan

A detailed outlineof the mechanicalstepsleadingtoward confirmationwould not contributeto an examinationof the issuesbeingconsideredin this paper. The reader is referred to subchapterII of chapter 11 of the Code, division I of part ifi of the BIA and part I of the CCAA,which set forth the steps leading to confirmation,as well as the many excellenttreatises and articles which provide explanationsof these steps, such as L.W. Houlden and CR Morawetz,Bankniptcy and Insolvency Law of Cancth 3d ed. (Scarborough:Carswell 1993)at 2-122 - 2-128; D.H Goldman,D.E. Baird, Q.C., and MA. Weinczok, “ArrangementsUnder the Companies’CreditorsArrangementAct” (1991), 1 C.B.R. (3d) 135;J.D. Honsberger,Debt Restnicturing(Aurora: Canada Law Book, 1993);P.F. Coogan, “Confirmationof a Plan Under the BankruptcyCode” (1982) 32 CaseW. Res. L. Rev. 301; Norton BankruptcyLaw and Practice, vol. 4. 202 beforethe plan proponentsubmitsit to the courtfor confinnation. Forthe plan proponent,the matter of classificationis more of an art than a scienceand the approachthat the courtstake in determining whetherto approvethe classificationis basedmoreon the policyobjectivesof the legislationthan on an analysisof the commonalityof interestsamongthe membersof the class.

Finally,this chapterwill examinethe much-misunderstoodconceptof the so-called“cram do’wi”mechanismunder theCode. The concept,as used in the United States,does not presentlyexist in Canadaunder theBIA or the 2CCAA. We will examinecram do to clarifythe conceptand determinethe desirabilityof incorporatingit intoCanadianreorganizationpractice.

A. Stq Pnceding Confinnafion

Underthe Code,oncethe planproponent has negotiateda satisfactoryplan with the partiesin interest,it summary,3 along disclosurestatement, thecontents must provide theplan or a with a iitten of which thecourthas approved,to all claimand interest4holders. The Codeoutlines thedisclosure statementrequirementsas part of the provisions governingthe solicitationof acceptancesor rejections

2 TnOlympia& YorkDevelopmentsLtd v. Royd TrustCo. (1993), 17C.B.R (3d) 1 (Ont.Gen. Div.), R.A. Blair J. said:

“I think it relatively clearthat a courtwouldnot sanctiona plan if the effectof doingso were to imposeit upon aclass,or classes,of creditorswho rejectedit. Sucha sanctionwouldbe tantamountto the kind of unfairconfiscationwhichthe authoritiesunanimouslyindicateis not the purposeof the legislation.”[at 181.

In thischapter,the term “plan proponent”will refer to the partyputting forth thereorganization plan for considerationby the creditors andthe equityinterest holders.Althoughin most instances,the plan proponentwill be the debtor,it appearsthat all of the statutoryschemesbeingreviewedprovide that personsotherthan thedebtormay proposea plan. Section50(1) of the BTAallowsan insolvent person,bankruptor trusteeof the estateof a bankruptor a receiveror liquidatorof the propertyof an insolventperson tofile a proposal. TheCCAAis less clear in this regard butit refersto a compromiseor arrangement“proposedbetweena debtorcompany andits [securedand unsecured] creditors”[CCAAss. 4 and 5], withoutspecifyingwho is authorizedto put forth the plan. However, the meetingto considerthe compromiseor arrangementmay be orderedat the instanceof the debtor,a creditor,a trusteeunderthe BIA or a liquidator. Finally,the Codeprovides the debtorwith an exclusivetime periodwithin whichto file a plan and thereafter,any party in interestis authorizedto file a plan [Codes. 1121].

Codes. 1125(b). 203 of the plan. The disclosurestatementmust contain“adequateinformation”in that it mustprovidethe voting partieswith sufficientinformationto allowthem tomake5 an informeddecisionto acceptor rejectthe 6plan. However,nonbankruptcy orstate law doesnot governthe standardof disclosure. The court may, however, considerthe standardsused by the nonbankruptcy orstate agencies7 to determinethe adequacyof the information. Followingthe solicitation8 of acceptancesor rejections,the partiesin interestvote on the proposedplan. The plan proponent providesa ballotto each partyin interestalongwith the plan and the disclosurestatement. The Codeprovidesthat if at leasttwo-thirdsin amountand one-halfin number the9allowedclaims the class votein favour the plan,the planis accepted of of of by that 0class.’ Only votes of creditorsactually votingare consideredin determiningwhetherthe requisite

Code s. 1125(a)(1)defmes“adequate information”as:

• . informationof a kind, and in sufficientdetail,as far as is reasonablypracticablein light of the natureand historyof the debtorand the conditionof the debtor’sbooks andrecords,that wouldenablea hypothetical reasonableinvestortypicalof holdersof claimsor interestsof the relevantclass to makean informedjudgmentaboutthe plan, but adequateinformation need not includesuch informationabout any otherpossibleor proposedplan;”

The court is givendiscretionas to the actualcontentof the disclosure statementand the adequacyof the information containedtherein,see ValleyNationd Bank of Arizona v. Trustee,609 F.2d 1274(9th Cir. 1979);In re Brandon Mill Fanns Ltd, 37 B.R. 190at 191(Bankr.N.D. Ga. 1984). The defmitionof adequate informationand the flexibilityexercisedby the courtsin interpreting the defmitionallowsthe courtsto develop theadequacyof the information containedin the disclosure statementon a case by case basis. This appearsto reasonableinasmuchas differenttypes of caseswill require differentlevelsof disclosure. For example,a publicly-held multinationalreal estate conglomeratewill requireand be ableto afforda disclosure statementcontaining moreelaborate and sophisticated informationthan a closely-heldcompanywhichoperatesa cornergrocerystore.

6 E.B. Hopper,II, “Confirmationof a Plan Under Chapter11of the BankruptcyCode and the Effectof Confirmationon Creditors’Rights”(1982) 15md. L. Rev. 510at 506.

“ Code s. 1125(d). Nonbankruptcyor state law, suchas securitieslegislationprescribestandards of disclosure foraltogetherdifferentpurposes,such as for seeking equityfmancing. 8lbid Hopper,supra note 6 at 507.

‘o Code s. 1126(c). 204 majoritieshave acceptedthe plan. For a class of equity holders to accept the plan, at leasttwo-thirds in amount of the allowedintereststhat have voted must vote favourably.” If solicitationor procurementof votes of an entity were not in good faith or if the votes of an entity were not cast in good faith, the courts willdisregardthose 12votes. The Code creates a presumptionconcerningacceptanceor rejection of the plan with respectto two types of classes of claims or interests. It conclusivelypresumesacceptanceof the plan by a class and the membersof the class that remain13unimpaired under the plan and the plan proponentneednot attempt to solicit acceptancefrom that 4class.’ Conversely,the Code presumesthat a class rejects the plan, if the plan provides that the class members willnot retainor receive any property underthe plan.15

Followingacceptanceof the plan, there is a hearing to determinewhether the court will confirm the6plan.’ In the eventthat all classeshave acceptedthe 7plan,’ the court may confirmthe plan under subsection 1129(a)of the 8Code.’ 11 however,all classes have not accepted theplan, the court may neverthelessconfirm the plan, providedat least oneimpaired class of claimantshas

“ Codes. 1126(d).

12 Codes. 1126(e).

‘ See Code s. 1124. The conceptof impairmentis defmed, infra note 117.

14 Code s. 1126(e).

15 Codes. 1126(g).

16 Code s. 1128(a).

17 Codes. 1129(8).

18 In additionto the requirementthat the plan be acceptedor deemedacceptedby the required majorities,Code s. 1129(a)sets forth a numberof other requirementsthat must be met in orderto confirm a “consensualplan. These includevery broad, generalrequirements,such as the requirement that the plan comply with the Code and that the plan be proposed in good faith, technical requirements,such as the requirementfor the payment of fees and the approvalby governmental regulatorycommissionsof proposed rate changes,and substantiverequirementsor threshold standards that the plan must meet in order to be confirmed. The substantiverequirementswill be discussedinfra notes 241-246. 205 acceptedthe 9plan.’ The CCAA does not set forththe comprehensive proceduraland substantivemattersthat the

Codeaddressesand accordingly,case law has established mostproceduralmatters. The CCAAis unique incontemplatingthat the first applicationis the one seekingan order summoninga meetingof creditors, classof creditorsor shareholdersof the company. The wordingof the CCAAcontemplates the existenceof a compromiseor arrangementbetween°2 the debtorand its creditorsat the time of the initialapplication. However,in most instances,becauseof the urgencyof the matter,the debtor company’2 will seek an order summoning themeeting,grantinga stay of proceedingsand providinga time within which acompromiseor arrangementmustbe 22filed. The plan will set forth a description of classesof creditorsfor votingpurposes. Althoughthe CCAAdoes not provideany guidanceto the debtor concerningthe methodor criteriafor the classificationof creditors, clearly,it permitsthe debtor

19 Code ss. 1129(b)and 1129(a)(10). Confirmationof the plan over the objectionof the dissidentsis known as “cramdown”whichwill be fully exploredin chapterV1(D),below. Subsection 1129(b)provides, inpart, that a court may invokethe cram downprovisionsset forth therein“ifall of the applicablerequirementsof subsection(a) of this sectionotherthan paragraph(8) are met with respectto a plan”. Ratherthan examiningthe substantive provisionsof subsection1129(a),at this juncture,such examinationwill be undertakenin the contextof the cramdown. 20 CCAAss.4and5.

21 The opening wordsof ss. 4 and 5 of the CCAAare “Wherea compromiseor anarrangementis proposedbetween adebtorcompany”and its creditors[emphasis added],whichsuggeststhe existence of a compromise or arrangementat the timeof the initialapplication.

22 For example,in the CCAAcase involving Olympia& YorkDevelopmentsLimited,the order of the Ontario Courtof Justice(General Division)granted onMay 14, 1992(Court FileNo. B125/92) provided:

“3. THIS COURTORDERSthat the applicantsbe and are herebyauthorizedand permittedto file with this Court,on or beforeJuly 13, 1992or such later dateas maybe orderedby this Court,a plan of compromiseor arrangement(the “Plan”)between,inter alia, the Applicantsand their securedand unsecuredcreditorsas they deemappropriateincluding, pursuantto Section3(b) of the Act, a compromiseor arrangementbetween eachof the Applicantsand the holdersof bonds issuedpursuantto a trust deed running in favourof a trustee,executedby each of the Applicants.” 206 to classifyits creditorsfor voting23purposes. The courtwill usuallydirectthe proponentto sendan informationcircularto all parties affectedby the 24plan. The circular,which maybe a part of the plan itself,will describethe plan and the fmancialand other informationthat will allowthe creditors to makean informeddecision concerningthe feasibilityand attractivenessof the 25plan. A proof of claimform,proxy,ballotand noticeof meetingof the creditorsusuallyaccompany the informationcircularand the plan providedto the 26creditors. The CCAAdoes not specifythe proceduralaspectsof the meetingof creditors, althoughseparatemeetingsof the classesof creditorsare not necessaryso long as the classesvote 27separately. Creditorsor a class of creditorsare consideredto have accepted theplan if a majorityin numberrepresentingthree-fourthsin value vote28favourably. Calculationof the requisitemajoritiesis basedon thosethat actuallyvote on the proposedplan, either in personor by 29proxy. Unlikethe Code,there is no provision in theCCAA thatpresumesrejectionor acceptanceof the plan bythe creditors ora class of them. A determinationof acceptanceor rejectionis madepurelyon the votes

23 The openingwordsof section6, for example,provide“Wherea majority innumber representing three-fourthsin value of the creditors,or class, as the casemaybe. . .“ [emphasisadded]. The issue of classificationunderthe CCAAwill be exploredin chapterV1(C)(2),below.

24 Goldman,Baird and Weinczok,supra note 1 at 156.

25 B.P. O’Leary,“AReviewof the Companies’CreditorsArrangementAct” (1987)4:3 National InsolvencyReview38 at 40. The circularwill includeinformationsufficientto meet the disclosure requirementsunderprovinciallegislationif the debtoris a publicly-held company

26 Ibid at 40.

27 Re WellingtonBuilding CoiporationLimited (1934), 16C.B.R. 48at 54 (Ont. S.C.).

28 CCAAs. 6.

29 Thid; Re Alabama New Orlea’is,Texas & Pcrf Ic JunctionRailwayCo. [189111 Cli 213 at 245 (C.A.). See also Re Bilton Brothe, Limited (1939),21 C.B.R 79 (Ont. S.C.),whereUrquhartJ. reluctantlyheld that eventhoughthe class may be consideredto have rejectedthe planbasedon the claimsfiled,the plan had been acceptedby those presentand voting andas such,the plan was sanctioned. 207 cast in favourof or againstthe plan and the votesof the majoritywill governthe treatmentof the entireclass. The CCAA also hasno provisionfor the cram downof the plan on dissentingclassesof creditors. In other words,beforethe court will sanctiona plan,the requisite majoritiesof eachclass must votein favourof the °3plan. Shouldthe requisitemajoritiesacceptthe plan, the plan proponent willthen applyfor the court’ssanctionof the ’3plan. The court’sinitialconcernis whetherthere has been substantial compliancewith the words and spiritof the 32CCAA. The courtwill lookto the originalorderto ensure compliancewith all proceduralstepsoutlined in the order. It will also lookto the planandthe proceduresinvokedin havingthe plan approvedto satisfyitselfthat classificationand votingwere 33proper. The substantive mattersof concernto the court arewhetherthe plan is fair and reasonabl& and whether thecreditorsvotingaffirmativelyfor the plan did so in good35faith. 4 Underthe BIA, the plan proponentmay commencethe reorganization proceedingsby filing the proposalitself with a licensed36trustee. Alternatively,the plan proponentmay file a noticeof intentionto makea proposalwith the official37receiver. Alongwith the proposalor, if the insolvent files a noticeof intentionto makea proposal,within 10days after thefiling of the noticeof intention, the debtor mustfile a projected cash-flowstatementwith the official38receiver. A trusteemustreview

° Goldman,Baird and Weinczok,supra note 1 at 194.

‘ CCAA s. 6.

32 Re Daiiy Corporationof Cancda, [1934]3 D.L.R.347 (Ont.C.A.).

Re NorthlandPropertiesLtd (1988),73 C.B.R.(N.S.) 171at 182-183(B.C.S.C.),affd (1988), 73 C.B.R.(N.S.) 195(B.C.C.A.).

Ibid

See discussion,infra notes 134-151.

36 BIA s. 50(2).

BIA s. 50.4(1).

38 BIA ss. 50(6);50.4(2). 208 the cash-flowstatement and provide a reportas to the reasonablenessof the statement. The trustee’s report is, similarly, filed with the official39receiver. In the event that the debtor proceedsby filing a notice of intentionto make a proposal,it has 30 days within whichto file the proposal. The court may extendthis period on the debtor’s4°applicatioit Subsection50.5requiresthe trustee named in the noticeof intentionto advise on, assistin negotiationsof and participate in the preparationof the proposal. The intent of this provisionis to interject a neutral third party betweenthe debtor and its creditorsthat will, presumably,facilitatethe makingof an acceptableproposal.

The BIA’sdisclosurerequirementsare not so onerousas those of the Code and the CCAA.

Paragraph50(2Xa)provides that if the debtor is bankrupt,the plan proponentmust file, along withthe proposal,a copy of the statementof affairs prepared at the outset of the bankruptcy,settingforth the assets and liabilities of the bankrupt,along with a list of its creditorsand particularsof any securities held by ’4them. If the debtor is not bankrupt,a statementshowingthe fmancialposition of the debtor at the date of the proposalmust accompanythe 42proposal. If the debtor files a proposal to commence the proceeding,a projected cash-flowstatementmust accompanythe 43proposal. On the other hand, if the debtorfiled a notice of intentionto makea proposal and has afreadyfiled a projected cash-flow statement, itmust file a revised projectedcash-flowstatement.’ Providedthe court has not ordered the nondisclosureof the projectedcash-flowstatementunder subsection50(8), any creditor may

Ibid

4° BIA ss. 50.4(8)and (9). The timing for the filing of the proposalwill be discussedin chapter Vl(B), below.

41 BIA s. 158(d).

42 BIA s. 50(2)(b). SeeJcrkson(Trusteeof) v. Lowiy(1987), 65 C.B.R. (N.S.) 261 (Ont.S.C.), which held that the filing of the statementshowingthe fmancialposition of the debtor is mandatory, althoughthe court permitted some flexibilityin the form and substanceof the statement.

4° BIA s. 50(6). 44Ibid 209 requesta copyof the statementfromthe 45trustee. A meetingof creditors,calledby the trustee,must be held within21 thys after the debtorfiles the proposal. The trusteemust giveeach known creditorand the officialreceiverat least 10thy’s noticeof the meeting. A copy of the proposal,a condensed statementof the assetsand liabilities,a proxyand a votingletter will accompany thenoticeof 47meeting. The courtmay considera meeting unnecessary,if it is clearlyevidentthat a proposal cannot48succeed. The creditorsvote by 49class. However,the BIA, unlike the Codeand the CCAA,providesthat the proposalis acceptedby the creditors“if, and only if,” all classesof unsecuredcreditors acceptthe proposalby a simplemajority in number and two-thirds in value of those actually50voting. The proposalis bindingonlyon secured creditorsto whomthe insolventpersonmakesa proposaland who acceptthe proposalby the same majoritiesas required in the case of the unsecured5creditors. This has the effect of allowingsecured creditorsto opt-outof the proposalprocess. Secured’ creditorsthat opt-outof the processmay realize on theirsecurity,whichdefeatsthe objectivesof the debtorin seekingto reorganize its affairs. Often, a securedcreditorwill maintainsecurity on all or substantiallyall of the debtor’sassets. If sucha securedcreditorrejects theproposalor opts-out,the proposalwill likelynot succeed,despiteits theoreticalacceptanceby the unsecuredcreditors.

Before the courtcan approvethe proposalunder theBIA, the court mustbe satisfiedthat the

“ BIA s. 50(7).

BIA s. 51(1).

“‘ Ibid

48 Re TriangleDrugs (1993), 16C.B.R. (3d)1 (Ont. Gen..Div.).

BIA ss. 54(b) and 50(1.4).

50 BIA s. 54(2)(d) [emphasisadded].

‘ BIA s. 62(2)(b). 210 requisitemajority of unsecured52creditors has acceptedthe proposal and that the proposal is reasonable and calculatedto benefitthe generalbody of 53creditors. Althoughapprovalof the proposalby the court is 54discretionary, the BIA prescribescertain situationsin which the court cannot approveit, such as where the proposal fails to provide for prioritypaymentsto the Crown, employeesand the landlord under a lease that the debtor has 55repudiated. The proceduresthat precede confirmationof a proposalare similarin all of the statutory schemesbeing examined. However,the acceptancethresholds,the means for establishingthose thresholdsand the absence of a cram down mechanismunder both of the Canadiansystemsare obviousdifferences. In addition,the time withinwhich the plan proponentmay file the plan and the method of classifyingcreditorsunder each of the statutoryschemesmay also point to fundamental normativedifferencesamongthe schemes.

B. The Time Mthin Which the Plan Must be I1led

Under the Code, the debtor has the exclusiveright to file a plan, withinthe first 120days of the 56case. If the debtor files the plan within the 120-dayperiod,the debtor has an additional60 days withinwhich to secure acceptanceof the 57plan. The Code terminatesthis “exclusivity58period” if the court appointsa trustee, the debtor does not file a plan withinthe 120-dayperiod, the debtor files a plan within the 120-dayperiod but the creditors and the court do not accept it within 60 days

52 BIA s. 58.

BIA s. 59(2).

BIA s. 60(5).

BIA s. 60(1) to (1.5). See chapterV(B), above, for a full discussionof the rights of landlords under commercialleases. See also BIA s. 59(2) and (3).

56 Code s. 1121(b).

Code s. 1121(cX3).

58 Norton BankruptcyLaw & Practice s. 88.1. 211 thereafteror the courtabridgesor extendsthe exclusivityperiod “for59cause.” Oncethe exclusivity period has terminated, any party in interest includingthe debtor, a creditor,the trustee,an equity securityholderor a creditors’or equitysecurityholders’committeemay file a °6plan. For the courtto abridgeor extendthe exclusivityperiod,a party in interestmustmakethe requestwithinthat periodand notafter it has 6expired. The applicanthas the burdenof showing causefor abridgment or62extension. The Code’ does not defme“cause.” However,the legislative history providessome insightas to the legislativeintent. The HouseReport suggestedthat court shouldconsiderfactors such as the size of the debtor,delayby the debtoror recalcitranceamong the 63creditors. The Senate Report suggestedthat the court shouldnot grantextensionsif they are merely

Code s. 1121(c)and (d). A discussion concerning theappointmentof a trusteeappearsin chapter1V(A)(4),above.

60 Codes. 1121(c).

61 In re Perkins, 71 BR. 294 at297 (W.D. Tenn.1987). TIthe motionis filed withinthe 120-day period but is scheduledto be heard following theexpirationof that period, the issuemay be moot [NortonBankruptcyLaw & Practices. 88:3].

62 In re All Seasons Industries,Inc., 121B.R 1002at 1004(Bankr.N.D. md. 1990);cf In re ManzeyLand and Cattle Company, 17B.R. 332(Bankr. D.S.D.1982),wherethe court grantedthe debtorsextensionsnotwithstandingthe expiryof the exclusivityperiod. Thiscase was decidedbefore the 1984Amendmentsthat added the following(emphasized) words toCode s. 1121(d):

“On request of a party in interestmcde within the respectiveperiods specified in subsections (b) and (c) of this section and after noticeand hearing,the courtmay forcause reduce or increasethe 120-dayperiodor the 180-thy periodreferredto in this section.”.

63 HouseReportat 406. See e.g., In re Pine Run Trust,Inc., 67 B.R 432 (Bankr.E.D.Pa. 1986), wherethe court granteda limited extensionon the basis that the debtorwas not unusuallylargeand the issuesto be dealt with were not sufficientlycomplexto justify a lengthyextension. Conversely, wherethe case involved complexissues,the courtmay be preparedto allow eithera set periodwithin whichto file theplan or granta numberof shortextensions,whichwouldallowthe court toclosely monitor the progressof the debtorin formulatingthe plan [seee.g., In re Manville ForestProducts Corp., 31 B.R. 991 at 995 (Bankr.S.D.N.Y.1983),wherethe courtpermittedthe debtora numberof extensionson the basis of the “sheermass,volume and complicationsof the Manvillefilings.” See alsoRe Texcro, Inc., 76 BR 322 (Bankr. S.D.N.Y.1987),wherethe court also grantedan extension and, in so doing,said “. . . in the historyof this country therehas neverbeen a Chapter 11 case as largeas the Texacocases.”[at 327];cf the approachtaken underthe BIA which legislatively mandatesshortextensionson application. The approachtaken in the BIA is discussedinfra notes69- 72]. Delayin commencingthe proceedingsby the debtorhas been usedas the basis forabridging 212 used as a pressure tacticto forcethe partiesto acceptan unsatisfactoryplan or if there is no probabilitythat theplan proponentwill formulatea plan of reorganizationand have it acceptedby the requisiteTMmajorities. Althoughthe size and complexityof the case are relativelyobjectivefactors,the otherfactorscited by the legislativehistorysuggestthat the courtconsider theconductof the 65parties. Thistype of analysisis not unlikethe approach thatthe courtshave taken in determiningwhetherto granta securedcreditorrelief fromthe automaticstay althoughagain,one must questionwhetherthe courtshouldpunish thepartiesthat wouldbenefitfrom a reorganizationon the basisof the misdeeds of the debtor orcreditors.

A further questionis whether 120days is sufficienttime to formulatea plan. Onewriter suggestedthat plan proponents frequentlyseek extensions“becausemost chapter 11cases take significantlylongerthan 120daysto arriveat a fully negotiated67plan.” A complexcase suchas that

the exclusivityperiod [seee.g., In re TexasExtrusion Coip., 844F.2d 1142at 1160(5th Cir. 1988), cert. denied sub nom. TexasExtrusionCoip. v. Lockheed,488 U.S. 926 (1988)1. Conversely,if the debtorhas put forwarda plan and the partiesare in the processof negotiatingits terms, thecourtmay be willingto grantthe extensionsoughtby the debtor [Re Gibson& CushmanDredgingCoip., 101 B.R. 405 at 410 (E.D.N.Y.1989).

64 Ibid See e.g., In re Gage!& Gage!,24 B.R 674 (Bankr.S.D. Oh.1982),wherethe court said that the“extension. . . wouldnot only be fruitless,but probablycounterproductive.”[at 675];cf In re ManzeyLand and CattleCompany,17B.R 332, wherethe court grantedthe extensionoverthe strong objectionsof the sole securedcreditor.

65 See e.g., In re CrescentBecrh Inn, Inc., 22 B.R 155(Bankr.D. Me. 1982),where thecourt allowed thecreditors’requestfor an abridgementof the exclusivityperiodon the followingbasis:

it appears that the majorobstaclein the pathto a successfulreorganizationin this case is the principalparties’acrimoniousrelations. They continuetheir bitter feudingnot onlyat their own expense,but at the expenseof all creditorsof the debtor. Shortening thedebtor’s exclusiveperiod for filinga planwill permitany party in interest,includingparties with perhapsa more objectiveview of the debtor’scircumstances,to file a plan.” [at 161].

See discussionin chapterV(A)(4),above.

67 Karasilc,“Extendingthe Debtor’sExclusive Rightto File a Planof Reorganization”(1985) 90 Corn.L.J. 359 at 359. The writerdoes not providestatisticsto supportthis statementor provide any detailsas to the types of debtorsthat seekextensions. 213 involvingthe Johns-Manvillegroup of companiescouldjustify an extension. However,debtorsof this size and complexityare the exceptionrather than the rule, given the thousandsof Chapter 11 casesfiled eachyear. Therefore,in “mostcases”the 120-dayperiod shouldbe sufficienttime to formulatea plan. Duringthis period, creditorsmay not enforcetheir rights, in the absence of an order lifting the automatic stayand, althoughsecuredcreditorsmust be adequatelyprotectedduringthis period, one must question whether the protectionis adequate in the view of securedcreditorswho frequently seekorders lifting theautomaticstay.

If most casesunder Chapter 11take significantlylonger than 120days, one must also ask whether a proceedingunder the BIA has any chance of resulting in a reorganization,when the maximumperiodwithinwhich a debtor may formulatea proposal is 6 months, includingall discretionaryextensions. Under theBIA, the insolventperson must formulatethe proposal and file it with the official receiver within30 days after the date it filed the notice of intentionto make a 69proposal. The court may grant the debtor an extensionof the 30-thy period providedthe debtor appliesto the court withinthat 70period. If the court grants an extensionand the debtor requiresa furtherextension,it must apply before the expirationof the extensionperiod previously 71granted. The court has a discretionto grantor deny the request for an extensionand is limited to grantingan extensionnot exceeding45 days for any individualextensionand not exceedingan aggregateof 5 monthsbeyondthe initial 30-thy periodY

Johns-ManvilleCorporationand 20 of its affiliates, includingsome of its internationalaffiliates, filed reorganizationpetitions underChapter 11. The consolidated debts $600 million and consolidatedliabilities were approximately$1 billion [LA. Flyer, “WillFinancially Sound Corporate Debtors Succeedin Using Chapter 11 of the Bankruptcy Actas a Shield Against Massive Tort Liability?”(1983) 56 Temple L.Q. 539 at 541-542n. 11 and 121.

69 BIA ss. 50.4(8), 62(1)and 50.4(1).

70 BIA s. 50.4(9).

71 Ibid 72Ibid 214

Unlike theCode,the BIA givesthe courtssomeguidancein attemptingto determinewhether to grantthe requestedextension. To obtain anextensionorder,the debtormust satisfythe courtthat:

(a) it is actingin goodfaith and with due diligence;

(b) it would, in all likelihood,be ableto makea viableproposalif the court grantedthe extension;and (c) no creditor wouldsuffermaterialprejudiceif the court grantedthe 73extension. Conversely,any interested partymay seekto havethe initial30-dayperiodor any extension terminatedbefore its actualexpirationbasedon:

(a) lack of goodfaith onthe part of the debtor;

(b) absenceof a likelihoodthat the debtorcan makea viable proposal beforethe expirationof the periodin question;

(c) absenceof a likelihoodthat even if it could putforth a proposalwithinthat period, whether viableor not, the proposalwouldbe unacceptableto the creditors;or

(d) material prejudiceto the creditors“asa whole”by continuationof the period in 74question. The debtor mustsatisfythe courtthat all three criteriaexist,to obtainthe extension75order. If however,a creditoris seekingto have the periodin question terminated,it need onlyshowone of the factorsset forth insubsection50.4(11). One of the factorsis that the debtorhas not actedor is not actingin goodfaith and with due 76diligence. Unlike the casesdecided underthe Code wherethe conductof the debtorand its principalsis a factorthat the courtsappearto considercovertly,the BIA

Ibid

BIA s. 50.4(11).

BIA s. 50.4(9).

76 BIA s. 50.4(11)(a). See e.g., Re Malenfant (1992),19C.B.R. (3d)295 (C.S. Qué.)[headnote only],wherethe court questionedthe goodfaith of the debtorin obtainingextensionsfor the filingof a proposalusing affidavitsthat contained“half-truths”.[at 297]. 215 requiresthe courtto considerthe conductof the 77debtor. Whether theapplicantis seeking anorder extendingor terminatingthe existingperiod,the courtmust considerthe issue of the likelihoodof the debtorbeingable to make a viableproposal. One of the first cases todeal with theseprovisions lookedto the cases decidedunder theCCAA to determinethe appropriate78test. In High Street, the courtheld that to determine whethera proposal willbe viable, “youmust considerwhethersuch proposalhas a probablechanceof acceptance.”Relying onaffidavitevidenceof the debtor’s president,statingthat the debtor expectedto receivean unconditional offer topurchasecertainkey assetsof the debtorduringthe extensionperiod,the courtheld that the objecting creditorcouldnot say that it would notacceptany proposalbasedon those facts. Accordingly,the court grantedthe order.

Withrespect, thecourtin High Street failedto apply thetest upon whichit purportedto rely.

Althoughthe test requiredthat theproposal must have“a probablechanceof success,”the court grantedthe extension toallowthe debtorto formulatea proposalthat had onlya “possible”chanceof acceptance,giventhe positionof the objectingcreditor. Knowingthe facts,the secured creditorchose to object tothe debtor’sapplicationfor an extension. The creditor arguedthat duringthe extension period,it would suffer prejudicebecause of accruinginterestand realtytaxes. Presumably,the debtor’spresident wasable to swearthat thedebtor wasin a positionto sell certain key assets based on negotiationsthatprecededthe date of the application. If the price that the debtorwas seekingfor the assetssatisfiedthe creditor,basedon the presentvalue of the creditor’sclaim against the debtor, it wouldnot have objectedto the application. However,it appearsthat the terms of sale werenot satisfactoryto the creditor. Accordingly,at best, there was nothingmorethan apossibilitythat the creditorwould acceptthe proposalresultingfromthe sale and, in all likelihood,the creditor would

In fact, this was the primary basis forthe decisionin Re High Street ConstructionLtd (1993), 19C.B.R (3d) 213 at 215 (Ont Gen Div.) [hereinafter High Street]. If a proposalhas no probable chanceof acceptance,a courthas noalternative but todismissthe applicationfor the extension, notwithstandingthe bonafides of the debtor andits principals.

78 HighStreet, ibid, citing, Nova Metal ProductsInc. v. Cominskey (Trusteeof) (1990),1 C.B.R. (3d) 101(Ont. CA.) [hereinafterElan] and (i7fracc ManagementInc. v. Zevenberger(Trusteeof) (1990),3 C.B.R (3d) 151(Ont.Gen.Div.). 216 reject it. Thus,the court should havedismissedthe debtor’sapplicationfor an 79extension. It will be recalled thatto obtainan extensionof the time withinwhichto file the proposal,the debtormust show thatit would likelybe able to makea viable proposalif the courtgrantedthe extension. Conversely,an interestedparty could seekterminationof the initial30-thy periodor any °8extensionon the basisthat it is unlikelythat the debtorwill be able to make a viableproposalbefore the expirationof the periodin 8question. In both situations,the issue is whetherthe debtor willbe ableto makea viableproposal.’ On the otherhand,paragraph50.4(11)(c)of the BIA providesthat the courtmay terminatethe initial30-thy periodor any extensionif “theinsolventpersonwill not likely be ableto makea proposal,beforethe expirationof the periodin question,that will be acceptedby the creditors.” To applythis paragraph,the creditorneednot addressthe issueas to the viabilityof the plan. All that is necessaryis for the applicant toshowthat it is unlikelythat the creditorswill acceptthe plan. If a creditorappliesfor the terminationof the period inquestionand advisesthe courtdefmitivelythat it wouldnot be preparedto acceptany proposalput forthby the debtorunlessit receivedpaymentin full as well as compensationfor opportunitycost, the creditorhas createda presumptionthat the debtorcan rebut only byshowingthat it is “likely”that it couldput forthand

‘ Similarreasoningwas appliedin Re MagosinCoopDégelis, (1993),24 C.B.R.(3d)49 (C.S. Que.) [headnoteonly],wherea creditorappliedto havethe initial30-thy periodterminated. In that case,the courtheld that the word “likely”does not require the debtorto provebeyonda reasonable doubtthat it couldput fortha proposalthat would beacceptedby the creditors. The debtormerely had to provethat it was “morethan probable”that sucha plan couldbe put forth. Even thoughthe objectingcreditorargued thatit was unlikelythat the debtor couldput forth a proposalthat would be acceptedby the creditors, giventhat the creditor representedmorethan two-thirdsin valueof the unsecured creditors,the court dismissedthe creditor’sapplicationon the basisthat a “reasonable proposalcould be acceptedby the applicant.” The court held furtherthat an orderterminatingthe thirty-dayperiodwas contraryto the spiritof the BIA and shouldbe grantedonly in exceptional circumstances.

° BIA s. 50.4(9)(b).

81 BIA s. 50.4(11)(b). 217 complywith a proposalincludingsuch a 82provision. The time withinwhicha debtormust fomiulatea proposalunderthe BIA is relativelyshort.

Unlessthe debtoris preparedfor the possibilityof havingto expeditiouslyfile a noticeof intentionto makea proposal,it will be difficultfor the debtorto formulatean acceptableproposalin sucha short period. One must rememberthat the debtor,duringthat period,must attempt to operatethe business.

Therewill also be the addedresponsibilitiesof preparingthe projected cash-flowstatementand, in all likelthood,there willbe endilessmeetingswith accountants,lawyers,possible debt orequity participantsand appraisers. In addition,the debtor mustdeterminethe type of arrangementsthat may be acceptableto key creditorsto negotiatewith them in a waythat will ensuretheir supportat the meeting. These activitiestake time and althoughthe debtormay seek extensions,courtapplications take additionaltime and fmancialresources,whichare scarce for an insolventdebtor. Althougha debtormay obtainadditionaltime throughthe filing of an assignmentunder theBIA, the stigmaof bankruptcyand the total loss of controlto a licensedtrusteemay causethe debtorirreparableharm.

It is interestingto note that the Tassé Reportand the ColterCommitteeReportrecognizedthat the debtorusuallyrequiressomeperiodto formulatea proposalor plan of arrangement. Accordingly, the reportsrecommendedthat any reforms shouldallowthe debtorto file a notice of intentionto make a proposal,which would stay therights of creditors andpermit the debtorto formulatea plan or

82 In Re Baldwin ValleyInvestors’Inc. (1994),23 C.B.R. (3d)219 at221 (Ont. Gen. Div.) [hereinafterBaldwin Valley],the courtmade the distinctionbetweenthe necessityof showingthat a proposal was“viable”and a situation where the viabilityof the proposalis not in issue. In that case, the courtrefusedto grantthe debtor the requestedextension,on the groundthat it couldnot provide particularsof proposedthird parties that would bewillingto convertthe currentdebt fmancingto equityfmancing. Thecourtheld that even if the debtorwere successful inits argumentas to the viabilityof its proposal,the fact that the creditorwhichheld virtuallyall of the debthad lost total confidencein the debtorand merelywantedto enforceits securitymeant thatthe creditorsimplyhad to bring a motionunderparagraph50.4(11)(c). In otherwords,the creditorneed not wait for an additionalperiod if it is confidentthat the debtorcouldnot meetits demands. 218 83proposal. The Tassé Reportdid not prescribe a time withinwhichthe debtors to file the proposal,althoughit referredto the periodas a “shortstay of proceedings.” The ColterCommittee Report,on the otherhand,recommendeda periodof 852ldays. Ultimately,the BIA prescribedthe periodat 30 days,with a right to seek extensionsfromtime to time. The Code and the CCAA providethe debtorwith considerablymoretime. This is one furtherreasonto questionwhether

Canadianpolicyrnakerswere committedto providinga readilyaccessiblereorganizationregimeto debtors.

The CCAAprescribesno time periodswithin whichthe debtormust file a plan of compromise or arrangement.As the debtorwill be formulatinga plan duringthe periodin whichthe stay of proceedingsis operative,the period will correspondto the stay period. As such, the considerations concerningimpositionand liftingof the stay of proceedingswill applyequallyto the issueof whether to allowthe debtortime or additionaltime within whichto formulatea planY However,we should notethat thediscretionexercisedby the courtunderthe CCAAallowsthe flexibilitynecessaryto prescribea period that suitsthe debtor, givingdue considerationto the situationand rightsof the creditors. In so doing,the court shouldconsidersomeof the same factorsas under theBIA and the

Code. In particular,the courtsshouldbe mindfulof the periodsprescribedby the BIA and the Code, which apparentlyreflectthe intentof the policymakersin marketeconomiesthat are the sameas (in the case of the BIA) or similar to (in the case of the Code)the circumstancesthat the court is considering.

Tassé Reportat 91; ColterCommitteeReportat 56. The ColterCommitteeReportchoseto identifythe noticewith the purposeit wss meantto serve. That report calledthe documenta “notice of stay.”

Tassé Report at 175.

85 ColterCommitteeReportat 56.

86 BIA s. 62(8)and (9).

87 See discussionin chapterV(A)(4),above. 219

It is difficultto garnerany generalrules concerningthe time periodsgrantedby the courts underthe CCAA. One authorstatedthat “[s]taysof proceedingsof sixtyto ninetythys on the initial applicationunderthe CCAAare not 88uncommon.” Another authorstatedthat “[u]nderthe CCAA, courtswill typicallygivethe debtor3-6 monthsto file a planof 89arrangement.” Actually,the courts appear toreviewthe circumstancesand prescribea time basedon those circumstances.The starting point for large,complexcases appearsto be 6 9months. Counseltreat 6 monthsas a startingpoint and willrequestthat relief in the initial9motion.° The courtwill then decidewiaetherthat periodis appropriatein the circumstancesand may’ granta shorterperiod,shouldthe matter notbe of a complex nature. In some instances,the court may granta relativelyshortperiod withinwhichto formulatea plan with leave toseekextensionsfromtime to 92time. This hasthe advantageof allowingthe court to monitorthe progressof the debtorin formulatingits plan of arrangement orcompromise. The disadvantage forthe debtorhowever,is the legaland othercosts involved inhavingto report

88 MJ. MacNaughton,“Debtors’Strategiesin Reorganizations”in CoiporateRestructuring (Toronto:CanadianInstitute,1992) Tab V at 21.

89 K. Ham, “CorporateRestructuringUnder Partifi of the Bankruptcyand InsolvencyAct” in CoiporateRestructuring(Toronto:CanadianInstitute,1992)Tab ifi at 41.

9° E.g, the court,in the proceedings involvingOlympia& YorkDevelopmentsLimited gavethe companyapproximately6 monthswithinwhichto formulatea plan. A later decisionin those proceedingsdescribed thecompanyas follows:

“TheOlympia& York groupof companies constituteone of the largestand most respected commercialreal estateempires inthe world,with prime holdings inthe main commercial centresin Canada,the U.S.A.,Englandand Europe.”[Olympia& YorkDevelopmentsLtd v. Royal Trust Co., supra note 2 at 3].

It shouldbe noted thatthe debtorin that case actually formulatedits plan within7 monthsafter the initialorder. Both thecreditorsand the courtapproved theplan (as amended). In the proceedings involvingQuintetteCoal Ltd.,whichwas also a case of somecomplexity, the BritishColumbiaSupremeCourt grantedthe debtora periodof 6 monthswithinwhichto formulatea plan.

9° See e.g.,Diemoster ToolInc. v. Zukov (1991)3 C.B.R (3d) 133(Ont. Gen Div.) [hereinafter Diemaster].

92 See e.g., TimberLodge Ltd v. Imperial Life Assurance Co. (1992), 17 C.B.R.(3d) 126 (P.E.I.S.C.)[hereinafterTimberLodge]. 220 periodicallyto the courtY

The court in Re Perkins Holdings7’took an alternateapproachwhere it made no order concerningthe time within whichthe debtorcouldformulatea plan, but allowedadjournmentsof the initialapplication. This allowed thedebtortime withinwhichto explorevariousalternatives. Finally, when it appearedthat the debtorwas makingsignificantprogresstowardnegotiatinga sale of its operations asa goingconcern,the court orderedthat a planbe preparedwithin7 days of the date of the order. On its face,this decisionappearsharsh. However,as the courtallowedthe debtoralmost3 monthsto negotiatea sale that wouldallowit to put forth a plan, the decisionis extremelyfair.

The standardsused by the courtsin detenniningwhetherto terminateor grantan extensionof the periodto formulatea plan are, not surprisingly,the same asthose used whenconsideringwhether to lift the stayof proceedings. The courtsinitiallyinquireinto whetherthe debtoris makingany progresstowardthe formulationof a 95plan. Theythen look at the prospectsof a plan being formulatedand approvedby the creditors. Thereis a divergenceof opinionin this regard. 9Elan and its 97progeny, stand for the propositionthat if a major creditorthat is in its own class or comprises the requisitemajority within aclass, advisesthe courtthat it will not accepta planunderany

TimberLodge, ibid, is a goodexampleof this mannerof proceeding.In that case, the court allowed the debtortime withinwhichto formulateits plan with the conditionthat thedebtorhad to appearbefore thecourtperiodicallyto reporton the progressbeing made. If no progresswas sho, the staywouldbe lifted. Thisprocedurecontinuedfor a periodof approximately5 months,at which time thecourt determinedthat progresstowardformulationof a planhad haltedand accordingly,the staywas lifted.

‘ (1991),6 C.B.R..(3d) 299 (Ont. Gen.Div.).

See e.g, Icor Oil & Ga Co. Ltd v. CancdianImpend Bank of Commerce(No. 2) (1990),102 AR. 225 Alta. Q.B.),wherethe court granted thedebtors’requestfor a 14-dayextensionon thebasis that progress wasbeingmadetowardthe formulationof a plan. It did not appear tothe courtthat circumstanceswould changesignificantlyduringthe extensionperiod The courtalso notedthe substantialeffecton unsecuredcreditorswhichwouldresult shouldthe extensionnot be granted.

Elan, supra note 78.

E.g. Ruit TneaswyFinancialInc. v. CangoPetroleumsInc., (1991),3 C.B.R (3d) 232 (Ont. Gen Div.). 221 circumstances,“[t]hereis no usefulpurposeto be served inputting a plan of arrangementto a meeting of creditors if it is knownthat it cannot 98succeed.” Phi114’s,on the other hand, requiredthe creditor to satisfythe burden of proving that the debtor’sprospectof makinga compromiseor arrangementis

“doomedto failure” before the court will terminatethe periocL The creditor must satisfythe court that the debtorcouldnot obtainfmancingor makeother arrangementswith anothersourcethat would facilitatea payoutof the objecting10creditor. Thisplaces a very heavyburden on the creditor.’°’ The divergentapproachesin° Elan and Phillz2,’sillustratethe antitheticalinterests at stakein attemptingto balance the rights of the debtor and the objectingcreditor. It is submittedthat the court in Icor examined the correctissue and, as part of that examination,consideredthe objectivesof a reorganizationstatute. The issue consideredby the courtwas whetherthe debtorwas makingprogress toward the formulationof a plan. In reaching its decision,it not only weighed the interestsof the applicantsand respondents,but also consideredthe interestsof third party creditors and the effect on them of vacating or maintainingthe stay.

Finally, we shouldnote that the courts, in dealingwith extensionapplicationsunder the

CCAA,take an approachsimilar to that taken by the courts in the United States with respect to the conduct of the parties. Althoughthe courts do not expresslymention theconductof the parties as a factor to be considered,it is obvious, in some cases, that conduct is the primaryfactor governing the court’sdecision. In Perkins,the court was impressedwith the fact that “the company itself had recognizedits fmancialproblems and retained outside help in an attempt to resolve 2thent”°

98 Elan, supra note 78 at 301.

Re Phillip’sManufrturing Ltd, (1992), 9 C.B.R (3d) 25 (B.C.C.A.)[hereinafterPhillip’s].

‘°° Ibid at 28.

101 It is interestingto note that in HongkongBank of Cancth v. Chef RecidyFoodsLtd, (1990), 4 C.B.R. (3d) 311 (B.C.C.A.),which was the case that originatedthe “doomedto failure”concept,the creditorultimately succeededin havingthe stay of proceedingsliftedwhen it was shown thatthe debtor ceased operations.

102 Re PerkinsHoldings,supra note 94 at 306. 222

Conversely,in liftingthe stay of proceedings,the court in TimberLodge stated:

The applicanthas stated that after theJune 29th hearingit was too preoccupiedwith the appeal processto really put any effort intothe restructuringplan. I am unableto acceptsuchan argument.’°

The3 period within whichthe plan proponentmust formulatea planreflectsthe policy underlyingthe reorganizationregime. The approachtaken by the legislationand courtsin determining whetherto terminateor extendthe periodis even morereflective. TheBIA is very restrictivein these matters. We may speculatethat the policymakers intendedthat only small,uncomplicatedentitiesthat would notrequire a protracted period withinwhichto formulatea planwoulduse the BIA and that all other entitieswoulduse the CCAA. However, theBIA containsnothingthat suggeststhat it is to be so limited. ShouldParliamentrepealthe CCAA,the BIA is not a feasible solution formostcomplex reorganizations.

Althoughthe Codeprovidesa longerperiodfor the debtorto formulatea plan, prescribing time periodsmay notbe appropriate insomecircumstances.Althoughin the case involvingOlympia

& YorkDevelopmentsLimited,the debtorput forth a plan within7 months,one couldcontemplate casesof even more complexitythat couldtake longer. Conversely, the120-thyperiodduringwhich the debtor alonemay formulate andfile a planunder theCodemay be excruciatinglylong in the case of a small closely-heldcorporation.

Prescribingany type of periodnecessarilyinvolvesline-drawingthat may not be appropriatein legislationintendedfor casesof differingsize and complexity. Theright to abridgeor extend the prescribedperiodsmay tempertheir strictness. However,the courtswill inevitablyuse the prescribed periodsbenchmarksand the policywill evolveaccordingly. While the parties havethe advantageof knowing,with certainty,the periodsthat they are facingat the outsetand may governthemselves accordingly,it is a waste of fmancialand otherresourcesto require the partiesto have to resort tothe courts,from time to time, to deal with these issuesif they recognizeat the outsetthat the prescribed

103 TimberLodge, supra note 92 at 130. 223 periodsare inappropriate.

In this manner,the systemestablishedunderthe CCAAis superiorto those of the BIA andthe

Code. Althougha rather strictregimeis evolvingunderthe CCAA,the courtsstill have the necessary flexibilityto tailor theremedyto fitthe circumstances.While the6- monthperiod is a benchmarkfor a debtorseekingrelief under theCCAA,in appropriatecircumstances,the court may providea longer period,suchas in the case of massivetort liabilityor environmentaldamage. In such a case,however, the courtmightallowthe debtorthe 6-monthperiodwith leaveto reapply forextensions,from timeto time. Conversely,the courtsunder the CCAAhavereduced therequested6-monthperiod,in appropriatecircumstances.Althoughin somecasesthe periodis very short,the circumstancesshow that the debtorusuallyhad sufficienttime withinwhichto formulateits plan.

Althoughthe CCAAdoes not prescribeany time periodswhich maylead one to criticizeit for its lackof predictability,the case law underthe CCAAhas establishedthat predictability. Counsel shouldbe familiarwith the facts of the reportedcasesto providesoundadviceto their clients. For unusualcircumstances,the CCAAallowsthe necessaryflexibilityto fashionan appropriateremedy.

C Classificationand Voting on the Plan

Thoughchronologically,classificationof claims takesplaceprior to votingon the plan of reorganization,this paper willfirst examinethe votingprocedure,and will thereafterexaminethe issue of classffication.The reasonfor examiningthese issues in reverse chronologicalorder is that the voting proceduremay governthe classificationof claims. Each of the statutoryschemesrequiresthe classesto acceptthe plan by prescribedstatutorymajorities. Neither of the statutoryschemesused in

Canadapermitsthe cram downof a plan on rejectingclasses. Under the CCAA, if a plan is rejected by a class,the court may not sanctionthe 4plan.’°

‘° CCAA s. 6 provides that once the statutory majoritieshave agreedto the compromiseor arrangement,the court may sanctionthe plan. The courts have consistentlyheld that the court cannot sanctiona plan unlessthere has been strict compliancewith all statutoryrequirements[seee.g., Re 224

Similarly,the BIA requirescreditorsto acceptthe proposalprior to the trustee applyingto the court for105approval. The BIA considersa proposalto be acceptedby the creditorsif and onlyif all classesof unsecuredcreditorsvote in favourof the proposalby the requisitestatutorymajorities.’° Shouldsecuredcreditors choosenot to acceptthe proposalor if the debtordid not make6 a proposalto the secured creditors,they maysimplyproceed to realize on theirsecurity,unaffectedby the balance of the proposalproceedings. As mentioned107previously, the rejectionof the proposalby secured creditorsmay effectivelyrender the acceptedproposalunworkable.

As the Canadianreorganizationregimesdo not allowthe cramdownof the planon dissident classes,the debtor’sobjectiveis to minimizethe number of classes,to dilutethe votingstrengthof an individualcreditor orgroupof creditors.’° For example,a planthat providesa separateclassfor each securedcreditor provideseach creditor8 an opportunityto exercisea veto over the plan. On the other hand,a plan thatputs all secured creditorsin one classmay allowvotesof subordinatesecured creditorsto dilutethe votes of an objectingcreditorwith first rights tothe collateral. Thecourtsand the legislationin Canadashowa preferenceagainst the creationof a multiplicityof 09classes.’

NorthlandPropertiesLtd, supra note 33 at 182-183(B.C.S.C.).

105 BIA s. 58.

106 BIA s. 54(d).

107 Supra note 50-51and accompanyingtext.

108 A similar concernhas been raisedin the contextof the Codewhereit has been statedthat the plan proponent“mayattemptto ‘rig’the vote by placingdissidentclaimantsin a class whose other claimantscan be countedon to supportthe plan and carry thevote.”[D.A.Skeel,“TheNatureand Effectof CorporateVotingin Chapter 11ReorganizationCases”(1992)78 Va. L. Rev. 461 at 4771.

‘ See e.g., BIA s. 54(b)(i),whichprovidesthat theunsecuredcreditorsshall constituteone class unlessthe plan proponentchoosesto providefor morethat one classof unsecuredclassesin the proposal. Similarly,the AlbertaCourtof Queens Benchin Noreen EneigyResourcesLtd v. OakwoodPetroleumLtd, [198912 W.W.R.566 (Alta.Q.B.),in reviewingthe classificationundera CCAAproceedingheld that:

“Toacceptthe ‘identityof interest’propositionas a starting pointin the classificationof creditorsnecessarilyresults ina ‘multiplicityof discreteclasses’which wouldmake any reorganizationdifficult,if not impossible,to achieve.”[at 28]. 225

Classificationis also importantunderthe Code. To have a plan confirmedunder the Code, whetherunderthe provisionsallowingfor confirmationon the acceptanceof all classesor underthe cram down provisions,at leastone impairedclass of claimsmust acceptthe °1plan.’ Again, avoidance of a multiplicityof classesassiststhe debtor inattainingthis threshold.”

Accordingly,as a preludeto an examinationof the classification1 issueand to appreciatethe objectivesof the debtorin seekingto avoidmultipleclassesand the creditorsin challenging their placement incertain classes,this sectionwill considerthe votingrequirements. We willthen examine the criteria for classification,to determinewhetherthe criteriaadoptedby the BIA are consistentwith currentapproaches.

1. Voting on the Plan andRequinidMajoiifies

Underthe Code,to acceptthe plan, at least two-thirds in amount andone-halfin numberof the membersof the class whoseclaimsare 2allowed” must approveit.113 Withrespectto interest holders,at least two-thirdsin amountof the allowedinterestsof such classwho voteon the plan must approve4it” In both cases,the court may disregardvotesnot cast in good faith or thoseprocuredin bad 5faith)’ With certain exceptions,the statutorymajoritiesare calculatedbasedon the actual

110 Codes. 1129(a)(10).

The courtsin the United States similarlyseekto avoida multiplicityof classes. Seee.g, In n Paliscdes-on-the-Desplaines,89 F.2d 214 at 217 (7th Cir. 1937).

112 Codes. 502 governsthe allowanceof claims orinterests. Provideda claim or interestholder files a proof of such claim or interest ina timely manner and no party in interest objects, theclaim is deemedallowed. The sectiongoeson to provide forthe procedureand matters tobe considered shoulda party in interestobject. This paperwill not discussthe provisionsconcerningallowanceor disallowanceof claims. The readeris referredto the provisionsof the Code in this regard.

113 Codes. 1126(c).

114 Codes. 1126(d).

115 Code s. 1126(e). 226 number of votes cast for or against the 116plan. The exceptionsare the statutorypresumptionsthat deem a class to have acceptedor rejected the plan. Subsection1126(f)of the Code creates a presumptionof acceptanceof the plan if the class remains 117unimpaired. Although the Codedoes not expresslypreclude an unimpairedclass from voting, deemed acceptanceis a conclusivepresumption” and from a practical perspective,one couldhardlyexpect an unimpairedclass to reject a8plan where the rights and interestsof the membersof the class remain intact. Conversely,subsection 1126(g) presumesrejection of the plan by a class, if the plan providesthat the members of that class do not retain or receiveany property on account of their claims. Again, rejection is a conclusive

116 House Report at 410; Re Jeppson, 66 B.R 269 at 294 (Bankr.D. Utah 1986).

117 Impairmentof a class of claims or interests is discussed insection 1124of the Code which provides:

“Exceptas provided in section 1123(a)(4)of this title, a class of claims or interestsis impaired under a plan unless, with respect to each claim or interest of such class, the plan- (1) leaves unaltered thelegal, equitable,and contractualrights to which such claim or interest entitles the holderof such claim or interest; (2) notwithstandingany contractualprovisionor applicablelaw that entitlesthe holder of such claim or interestto demand or receive acceleratedpayment of such claim or interest after the occurrenceof a default - (A) cures any suchdefault that occurredbefore or after the commencement of the case under this title, other than a default of a kind specified in section 365(b)(2) of this title; (B) reinstatesthe maturity of such claim or interest as such maturity existed before such default; (C) compensatesthe holder of such claim or interest for any damages incurredas a result of any reasonablereliance by such holder on such contractualprovisionor such applicablelaw, and (D) does not otherwisealter the legal, equitable,or contractualrightsto which such claim or interest entitles the holder of such claim or interest;or (3) provides that, on the effective dateof the plan, the holder of such claim or interest receives, on accountof such claim or interest, cash equal to - (A) with respect to a claim, the allowedamountof such claim, or (B) with respect toan interest, if applicable,the greaterof - (i) any fixed liquidation preferenceto which the temis of any securityrepresentingsuch interestentitle the holder of such interest;or (ii) any fixedprice at whichthe debtor, under the ten’risof such security,may redeemsuch securityfrom such holder.

118 Norton BankruptcyLaw & Practices. 91:21. 227 presumption,” althoughone wouldnot expectsucha classto accepta plan. The two-thirds majority 9refersto the dollaramount,in respectof claims,and the numberof sharesheld by those voting, in respectof 20interests.’ Priorto the 1984Amendments,an issuearose as to whetherdeemed acceptanceunder subsection1126(f)was sufficient to satisfythe requirementthat one classof claimantsmustacceptthe plan beforethe court could invokethe cramdown21provisions.’ This issue,however,now appearsto be moot,since paragraph 1129(a)(10)provides that,for the cram downto apply, “at least oneclassof claimsthat is impairedunder theplan has acceptedthe plan.” [emphasis22added]) The 1984 Amendments however,did notresolvethe issueof whetherthe class is deemedto have acceptedthe plan if no membersof the class vote. In re Ruti-Sweetwater,Inc.,123 held that the failureto vote

“ This conclusionis supportedby the legislativehistory, see HouseReportat 411 and Senate Reportat 123. The SenateReport statedthat such a class “is conclusivelydeemedto have rejectedthe plan”and “[t]hereis obviouslyno needto submita plan for a vote by”that class. Even if the class votesto acceptthe plan, the court may disregardthe acceptance. This is especiallyrelevantin a case wherethe acceptancewas obtainedby questionablemeans to use thecram downprovisions. Seee.g., In re WaterwaysBarge Panershi, 104B.R 776 at 783 (Bankr. W.D. Miss.1989).

120 NortonBankruptcyLaw and Practices. 91:18. Skeel,supra note 108,undertakesa very interesting analysisof the normativeconcernsunderlyingvotingby the shareholdersin the contextof corporatelaw as againstthose involvedin a bankruptcyscenario. The authorsuggeststhat the one share,one vote approachin a nonbankruptcyscenarioreflectsthe fmancialstake that a shareholderhas in the corporation. Conversely,in a bankruptcysituation,the statutorymajorities are anattemptby the policymakersto accountfor the differencesin the origin and the amountof the claimsof the creditors [at 488]. It is submitted, however,that theorigin and amountof the creditors’claimsare accounted for inthe classificationprocedure. Subsection1122(a),whichwill be discussed,supra notes 169-207 and accompanyingtest, requires thatclaimsor interestswithin a classmust be substantiallysimilar. The statutorymajorities attemptto balancethe interestsof the large claimholdersby requiringthe plan to be acceptedby a two-thirdsmajorityin amountand by givingthe smallclaimholderssomecontrol by requiringthat the planbe acceptedby a majorityin number.

121 E.D. Fogel, “Confirmation andthe UnimpairedClassof Creditors:Is ‘DeemedAcceptance’ Deemedan Acceptance?”(1984)58 Ant Bankr.L.J. 151at 152.

122 The issueof classifyingcreditors inorderto gerrymandervotes will be discussed,infra notes 199-201 and accompanyingtext.

123 836 F.2d 1263(10th Cir. 1988). The rationalefor this holdingwas:

“Tohold otherwise would beto endorsethe propositionthat a creditormay sit idlyby, not participatein any mannerin the formulationand adoptionof a plan inreorganizationand 228 shouldbe consideredto be an acceptanceof the plan. However,In re M Long124Arabians cameto a contraryconclusion.

Section6 of the CCAAprovidesthat the courtmay sanctiona compromiseor arrangementif a majorityrepresentingthree-fourthsin value of the creditors,or class of creditors,presentandvoting whetherin personor by proxy,acceptthe compromiseor arrangementat a meetingof the creditors calledfor that purpose.’ Like the situationunderthe Code,the CCAA calculatesthe statutory majoritieswith referenceto onlythe creditorsactuallyvoting onthe compromiseor arrangement, either inpersonor by 26proxy.’ The rationale underlyingthis approachmay be that statedby Stanley Edwards:

it may be arguedthat it is reasonable toassumethat thosewho do not vote are contentto be boundby the decisionsof those whodo, andthat under theC.C.A.A.and the Dominion Companies Act,the sameprincipleshouldgovernas in electionsof labourunionand legislativerepresentatives,and as in democraticreferenda. Becauseof the usual apathyof creditorsand investorsgenerally,it wouldotherwisebe virtuallyimpossibleto effecta reorganizationin many27cases.’ The dollar amountof the claimsis used tocalculatethree-fourthsin value thresholdandthe majorityin numberis calculatedby counting theactualnumberof the creditorsvotingon the 28plan.’ Classificationof claimswouldbe a fruitless exerciseif the courtsinterpreted theCCAAas

thereafter,subsequentto the adoptionof the plan, raise a challengeto the planfor the first time. [This]approachwould effectivelyplace all reorganization plansat risk in termsof relianceand fmality.”[at 1266-1267].

124 103B.R.211at215(9thCir. 1989).

125 CCAAs. 6.

126 Supranote 29. One author criticized theproxy systemand suggestedways that the plan proponent couldalleviate theconcerns,see S.E. Edwards, “ReorganizationsUnderthe Companies’ CreditorsArrangementAct” (1947)25 Can.Bar Rev. 587 at 609-611. One basis for his criticismwas that section6 allowsfor the modification oralterationof the plan prior tothe vote beingtaken. Clearly,the claimholder,in such a case, is not ina positionto considerthe meritsof the modifiedor alteredplan and must necessarilyentrustthe votingrightswith the proxyholder.

127 Edwards,ibid at 612.

128 Re WindsorHomeFurnitureCo. (1954),34 C.B.R.53 (Ont. S.C.). 229 permittingall classesto vote as one group. Thus,each class mustvote separatelyto determine whetherthe requisitemajorityof each classhas acceptedthe 29plan.’ The provisionsof the BIA governingacceptanceor rejectionof a proposal by the creditors’ are anomalousin at least two respects. First,acceptance the proposal is 3 votes of based only on° the of the unsecuredcreditorsand the securedcreditorsto whomthe proposal is made. This may resultin the proposalbeing statutorilyaccepted,but not being bindingon securedcreditorswho voteto reject the 3proposal.’ ’ Re WellingtonBuilding Coip., supra note 27. ‘

‘3° BIA s. 54 provides:

(1) The creditorsmay, in accordancewith this section,resolveto acceptor mayrefusethe proposalas made or as alteredat the meetingor any adjournmentthereof. (2) For thepurposeof subsection(1), (a) the followingcreditorswith provenclaimsare entitledto vote: (i) all unsecuredcreditors,and (ii) those secured creditorsin respectof whosesecuredclaims the proposal was made; (b) the creditorsshallvote by class,accordingto the class of their respective claims,and forthat purpose (i) all unsecuredclaims constituteone class,unlessthe proposalprovides for morethan one classof unsecuredclaim;and (ii) the classesof securedclaimsshallbe determinedas providedby subsection50(1.4); (c) the votes of the secured creditorsdo not count forthe purposesof this section, but are relevantonly for the purposeof subsection62(2);and (d) the proposalshallbe deemedto be acceptedby the creditorsif, and only if, all classesof unsecuredcreditorsvote for the acceptanceof the proposalby a majorityin numberand two thirds in valueof the unsecuredcreditorsof each classpresent, personallyor by proxy,at the meetingand voting onthe resolution. (2.1) For greatercertainty,subsection224(1.2)of the Income TcrcAct shall not be construed as classifjing as securedclaims,for the purposeof subsection(2), claimsof Her Majestyin right of Canadaor a provincefor amountsthat couldbe subjectto a demandundersubsection 224(1.2)of the Income T Act or underany substantiallysimilarprovisionof provincial legislation. (2.2) Wherethere is no quorumof securedcreditorsin respectof a particularclassof securedclaims,the securedcreditorshavingclaimsof that class shallbe deemedto havevoted for the refusal of the proposal. (3) A creditorwho is relatedto the debtormay vote againstbut not forthe acceptanceof the proposal. (4) The trustee,as a creditor,may not vote on the proposal.

‘3° Supra notes 50-51and accompanyingtext. 230

The secondanomaiyis the BIA’sthresholdfor acceptanceof the proposal. Recall thatthe

CCAA,requiresa majorityin number representingthree-fourths invalue of the votingcreditorsto acceptthe plan. Like the Code,the BIA requiresonly a majorityin number representingtwo-thirdsof the creditorsto acceptthe plan. Theoretically,this placesthe debtorat an advantage,but the opting- out right of securedcreditorsmay outweighany suchadvantage.

It is also interestingto note that the apathyof secured creditors innot attendingthe meeting and votingcreatesa presumptionof refusalof the 32proposal.’ The BIA does not makea similar presumptionin respectof unsecuredcreditors,whichleadsone to concludethat there may be a presumptionof acceptance,based onthe rationaleof Edwards,quoted33above.’ Subsection1126(e)of the Codeallowsthe court,after noticeand hearing,to designatean entitywhosevote was not cast in good faith orwhose acceptanceor rejectionwas not solicitedin good34faith.’ Once so designated,the court willdisregardthe votes of that entityfor the purposesof determiningacceptanceor rejectionof the plan.135 The House136Report cites the exampleof a creditor with a conflictof interestin the proceedings. Thisexamplehas formedthe basis forthe rejectionof a creditor’svote whosemotivewas at cross-purposeswith its statusas a creditor,such as wherethe creditor’sprimarymotivewas tosee the debtor’sbusinessfail sothat thecreditor’sbusinesswould

132 131As. 54(3).

133 Edwards,supra note 126. The BIA appearsto addressthe potentialproblemof there beinga lackof a quorumof securedcreditorsand those in attendancevotingto acceptthe plan. TheBIA doesnot providefor a quorumof creditorsat a meetingto considera proposal. However, the proceduralprovisionsgoverning meetingsof creditorsgenerallywouldapply [131Ass. 105to 115]. Subsection106(1)of the BIA providesthat one creditorentitledto vote, or its representative, constitutesa quorumfor a meetingof creditors. Thus,if the sole securedcreditorattendingthe meetingor votingby proxyvotesin favourof the proposal,that vote rules the rest of the class. BIA s. 62(2)(b)providesthat securedcreditorsto whoma proposalis madewill be consideredto have acceptedthe proposalif a majorityin numberrepresentingtwo-thirds in value of the securedcreditors actuallyvoting resolveto acceptthe plan.

134 Supra note 115and accompanyingtext.

135 Codess. 1126(c)and (d).

136 HouseReportat 411. 231 137thrive. Another approachtaken by the courtsin determiningwhether there is bad faith, is to attempt to determinewhetherthe creditor is seeking some type of preferentialtreatmentvis-a-vis other creditorswithin the class in question. The presenceof such a motive is consideredto indicatea lack of bonafides by the voting 38party.’ In attemptingto determinethe motives of the voting party, the court must exercise some cautionto avoid disqualifyingthe votes of creditorswith a legitimatereason for voting for or againstthe 39plan.’ This limitationon the court’sdiscretion is causefor concern,as it requires the court to determinethe primary motivationof the creditor in a case where thereare several reasonableexplanationsfor the creditorvoting as it did.

An interestingissue that the Americancourtshave considered,is that of the bonajIdes of a party that acquires a control position within a class or veto power with respect to the plan throughthe acquisitionof claims of other creditors. In re Allegheny Intemctional,Inc.‘4° held that the creditor,in acquiringthe claims of other creditorsto control the reorganizationprocess and exercise a veto power over the plan, did so for reasonsother than to 1Irther its interestsas a creditor. Accordingly,the court disregardedthe votes of that creditor in tabulatingthe votes. The courtsmust becautiousin disregardingthe votes of creditors simplybecauseof the way that the creditor acquiredthe votes.

Havingacquireda significantposition withinthe class givesthe creditor a strongerposition but, at the same time, the creditor possesses greaterrisk, as it now has a greater fmancial stake in the debtor.

Thus, the court must ascertainthe true motivationof the creditorto determine its bonafides or lack thereof.

The plan proponentmust satisfy the courtthat those voting on a plan nader the CCAAdid so

137 In re P-R Holding Coiporation, 147F.2d 895 at 897 (2d Cir. 1945);In re McrLeod Co., 63 B.R 654 (Bankr. S.D. Oh. 1986).

138 Youngv. HigbeeCo., 324 U.S. 204 at 211-212(1945).

139 Norton BankruptcyLaw & Practice s. 91:24, citing In re FederalSupportCo., 859F.2d 17 (4th Cir. 1988).

‘4° 118BR. 282 (Bankr. W.D. Pa. 1990). 232 in goodfaith. This is not an expressrequirement underthe CCAA. Like the Americancases,the courtswill disregardthe votes of a party receivinga preferentialadvantagevis-a-vis othermembersof its 4class.’ Any advantagegivento one memberof a class,to the exclusionof others, breachesthe fundamental’ objectiveof equalityand equityamongthe creditors. 42Edwards’ suggestedthe adoptionof the more general approach.He submitted that“if membersof any class votedagainstthe proposalbecauseof interestsotherthan those of the class, their votescouldproperlybe 43disregarded.” Edwardsbased this submissionon the holdingin British AmericanNickel CoiporationLimited v. O’BHen,’ and in particular,the statementof Viscount

HaldanewhereHis Lordshipsaid:

their Lordshipsdo not thinkthat thereis any real difficultyin combining theprinciplethat whileusuallya holderof sharesor debenturesmay vote as his interestdirects, heis subjectto the further principlethat wherehis vote is conferredon him as a memberof a classhe must conformto the interestof the class itselfwhen seekingto exercisethe powerconferredon him in his capacityof being amember. The secondprincipleis a negativeone, one whichputs a restrictionon the completenessof freedom under thefirst, without excludingsuch freedom wholly.‘

The courtsin Canadahave citedthis propositionwith approval.’ Accordingly,it appearsthat the courtsin Canadahave taken theapproachof the Americancourtsby disregarding thevotesof creditorswho have someulteriormotivethat maynot coincidewith those of othermembersof the class in whichthey are placed. Certainly,there is somemerit in this approach, giventhe collective natureof a reorganizationproceeding. However,there is also an inherentdanger,giventhat the court must attemptto ascertainthe primaryintentionof the creditorfromthe surroundingcircumstances.It

‘i” Hochbergerv. Rittenbeig, [1916154 S.C.R.480; Sadler Manufcrturing Co. Ltd v. Golt (1954), 35 C.B.R. 67 (Que.S.C.).

142 Edwards,supra note 126.

“s Ibid at 613.

‘‘‘ L.R [1927]A.C. 369(P.C.).

145 Ibid at 373-374.

‘ See e.g., Re NorthlandPropertiesLimited,supranote 33 at 185(B.C.S.C.). 233 may be in order to considermore stronglythe ccweatof ViscountHaldane at the end of the above quotation. The courtsmustnot unduly fetterthe franchisegivencreditorsin choosingwhetheror not to adopta plan. After all, it may be unreasonableto expecta creditorto totallydisregardits self- interestand act for the collectivegood. The courtmust start fromthe positionthat the creditorhas total freedomto vote as it pleases,regardlessof its motives inso voting. It is only when the actions of the creditoractuallyharm other creditorsor the public interestthat thecourtsmust attemptto weigh the collectiveactionagainstthe interestsof the creditorin 47question.’ This approachhas the advantageof allowingthe plan proponentto draftthe initialplan on the footingthat all creditorswill act in totalself-interestand, therefore,requiresthe debtorto presenta reasonableplan, bearingin mind the interestsof the creditors. The votingprocedureand the “specialmajorities”balance,to a certain extent;the effectsof this self-interest. The courthowever,is the fmal arbiterof whethera plan is fair and 48reasonable.’ To suggestthat a creditor,when actingin its own interest,is lackingbonafides is perhapsundulyharsh and improper. The representativesof a creditor havea fiduciarydutyto ensure that the creditorderivesthe most advantagefromthe reorganizationproceeding. It wouldbe an unfortunatesituationif, in fulfillingthat duty,those representativesare held to be actingin bad faith vis-a-vis other membersof the class. It is the courtthat ultimatelydecideswhetherthe planis fair and reasonable,and inso doing, itmust considerthe interestsof acceptingand rejectingcreditors.

This is not to denythat a creditorcouldbe actingin bad faith. One may envisiona situation wherethe plan proponentpromisesa creditora secretadvantage. Whetherone choosesto refer tothis type of arrangementa fraudon the othercreditorsor as evidenceof bad faith of the debtor andthe

‘‘ This type of approachs alludedto by ThackrayJ. in Re Quintette Cod Ltd (1991),10 C.B.R.(3d) 197at 222 (B.C.S.C.)wherehe said:

“I have commentedearlierwith respectto concernsas to the motivationof CdFIbeingself- serving. Thereis nothingevil aboutthis. Indeed, itwould beinappropriatefor CdFInot to fight for its rights if it truly believes thatto do sowill give it a healthiercomplexion. However,I must considerthe rights of manyothers,and the public interest bearsheavilyupon my thinking.”

148 Re Northland PropertiesLimited, supra note 33 at 201 (B.C.C.A.). 234 creditorin question,the courtshave disregardedthe votesof the creditorin those 149circumstances. The decisionsunderthe formerCanadianAct took an approach similarto that under theCCAA. If the debtorand certaincreditorsreacheda secretarrangementwhich gavethose creditorsan advantage to securethe votesof those creditors, the courtwouldhold the proposalto be illegaland 15unenforceable. The basis of these decisionsis that such arrangementsresult in there beinga °violationof the fundamentalprincipleof equality thatmust existamongthe 51creditors.’

2. Classificationof Claimsand Intensts

Classificationof claims andinterests“is simplya methodof recognizingdifferencein rightsof creditorswhich calls for differencein 52treatment.” Simplethoughthis statementmay seem,the issue of classificationis vital to any reorganization regimeand resultsin a significant amountof litigation.

Thereare two aspectsof reorganizationproceedingsthat makethe issueof classification particularlycontentious. Given the“special”votingmajoritiesnecessaryto accepta plan undereach of the statutoryschemes,classificationmay determinethe plan’sfate. Multipleclassificationsmay

149 Hochbeiger v. Rittenberg,supra note 141whereFitzpatrickC.J.C.said

“Herethere was a previoussecretunderstandingthat the appellants shouldreceivesecurity for their debt and a directadvantage overall the otherswho were contractingon the assumption that all were beingtreatedalike. The notes suedon weregivenin pursuanceof an agreement, whichwas void, asmade in fraudof the other creditors.. .“ [at 452].

DuffJ. appearedto take the less harshapproachof holdingthat the schememerelylackedbonafides. He said:

“Anyadvantage,therefore,obtainedby them as the price of their participation, whichwas not madekno to the otherparties, mustbe an advantagewhichthey couldnot retainwhhout departingfrom the line of conductmarkedout in such circumstancesby the dictatesof good faith.”[at 455].

150 Cha,nandyv. Albert (1928), 10C.B.R..32 (Ont. C.A.);Lcferte v. Pelal7deau(1929),11C.B.R. 89 (Que.S.C.).

151 Glensev. Ste. Marie (1943),26 C.B.R. 125(Que.S.C.).

152 In re RockyMountainFuel Co., 152F.2d 747 at 750 (10th Cir. 1945)[hereinafterRocky Mountain]. 235 provide a particularcreditorwith a disproportionateamountof power in a particularclass, to the point of allowingthat creditorto exercisea veto over the plan. On the otherhand, a debtor who is in a position to justify the creation of few classes may nullify the untoward effectsof a disgruntledcreditor by dilutingthe creditor’svote with those of others that are satisfiedwith the resultsthat the debtor is seeking.

The other aspectof the classificationissue makingit a particularlyfruitful battlegroundis that it will ultimately determinethe distributiveaspectsof the proceeding. Under all of the statutory schemes,the plan musttreat memberswithin each class equally,though there may be discrimination betweenclasses. This issue is particularlyacute in situationswhere the claim of a particularcreditor may fall within twoor more classes.

Classificationhas some practical importancein determiningwhether the plan has satisfied the preconfirmationrequirements. Subsection 1129(a)(lO)of the Coderequires at leastone class of impairedclaims to acceptthe 53plan,’ whether the plan is to be confirmed undersubsection 1129(a)or under the cram do provisions. Thus, it is importantfor the plan to include a class of impaired claimsthat will vote 54favourably.’ Under the CCAA, each class of claims mustacceptthe plan before it will be presentedto the court for55sanction.’ Becausethe CCAA does not containany provisionsallowing for the cramdo of a plan on dissentingclasses of creditors, it is imperativethat the debtor attemptto dilute the voting rightsof potential dissidents toattainthe requisitemajorities.

Similarly,the insolventperson, under theBIA, mustclassify the unsecuredcreditors toensure acceptanceby the requisitemajorities. Theremay be an advantage tothe insolventperson proceeding under the BIA, as the BJA containsa presumption thatall unsecuredcreditors shouldbe placedin one

153 Code s. 1124which is reproduced,supra note 117.

‘‘ L.S. Robin, “Classificationof Claims:An Examinationof DisregardedLegislativeHistory” (1993) 98 Com. L.J. 225at 225.

CCAA s. 6. 236 56class.’ To bind securedcreditors tothe proposal,the insolventpersonmust includethem in the proposaland classifythem in a mannerthat will attain acceptanceby the requisite57majorities.’ Casesconsidering theissueof classificationdiscussthe teststhat establisha proper classificationof claimsor interests. Somespeakof classifyingclaimsaccordingto the “nature”of the 58claim’ othersspeakof the commonalityof interestsof the claimants inthe 59debtor.’ However,one mustnot ignore theunderlyingreasonfor attemptingto arriveat a properclassificationschemein a reorganizationcase. If the creditorsunanimouslyagreeto accept or reject theplan, the issueof classificationwill not be relevant. However,evenone dissentingclaimor interestholderraisesa questionconcerningthe proprietyof the classificationof that claim or interestholder. In otherwords, becausethe hallmarkof the votingstructureis a specialmajorityrule, the courtsmust protectthe rights of the dissentersand the questionbecomesone of whetherthe rights of the minoritytake precedenceover the rehabilitationrights of the debtor. Unlike the elaborate corporatelaw regimesthat protectthe rights of the 60minority,’ neitherthe BIA, the Code nor the CCAA provides thedissenting minoritywith specialrights or protection.

156 BIA s. 54(2)(b)(i)providesthat, in voting ona proposedplan, the creditorsare to vote by class and forthat purpose, “all unsecuredclaims constituteone class, unless the proposalprovides for more than one class of unsecured claim”

157 BIA s. 54(2)(a)(ii)allows“securedcreditorsin respectof whosesecuredclaimsthe proposal was made”to vote on the plan and paragraph62(2)(b) makesa proposal thatis acceptedby the creditorsand approvedby the courtbindingon, inter dia

“thesecuredclaimsin respectof whichthe proposal was made andthat were in classesin whichthe securedcreditorsvotedfor the acceptanceof the proposalby a majorityin number and two thirds in value of the securedcreditorspresent,personallyor by proxy,at themeeting and voting on the resolutionto acceptthe proposal.”

158 In re Los Angeles Land & Investments,Ltd, 282 F. Supp.448 at 453 (D. Haw. 1968) [hereinafterL.A. Land], affd 447 F.2d 1366(9th Cir. 1971);Re NorthlandPropertiesLimited,supra note 33 at 191(B.C.S.C.).

SovereignLife AssuranceCo. v. Dodd, [189212 Q.B. 573 at 583 (C.A.).

160 See e.g., Business CorporationsAct, S.A. 1981,c. B-15, s. 184;CompanyAct, RS.B.C. 1979, c. 59, s. 231. 237 One commentatorstatedthat “[t]hefunctionof classification ... is one to whichfew immutableprinciplescan be 161pronounced.” This comment,alongwith the considerablebodyof case law consideringclassificationissuesin both Canadaand the United States,suggeststhat the courts have mouldedthe principlesto fit the circumstancesof the particularcase. The malleabilityof the conceptsused in classifyingclaimsallowsthe courtsto approveor rejectthe debtor’sclassification, dependingon whether thecourtviewsthe reorganizationof the debtoras desirable. In otherwords, the court has the powerto givethe debtornew life or condemnit to deathon the classificationissue alone. Therefore,classificationshouldhold morethan a passinginterest forall parties,and debtors seekingto reorganizetheir affairsshoulddedicate significanttime to the task of classifyingand formulatinga meansofjustifyingthe classification.

This sectionwill providean overviewof the legislativeschemesgoverningclassificationand will brieflyexaminethe legislativehistories. Followingthe overview,we will examinethe case lawto determinewhether thecourtshave establishedprinciplesor tests that a plan proponentmay use in classifyingclaims. Finally,this sectionwill considerthe issueof whetherthe courtsshould maintaina broaddiscretionconcerning theclassificationissueor whethera less flexibleapproach wouldbe preferable.

The first four subsectionsof section 1123illustratethe importanceof the classificationissue underthe Code. The sectionoutlinesthe requiredelementsof a plan. Thosesubsectionsprovidethat a plan must designate classesof claims andinterests,specifywhichclassesare unimpairedand the treatmentof any impairedclass and treat of each memberwithina classthe same,unlessthe member agreesto less favourabletreatment. The only section inthe Codethat givesany guidanceconcerning

161 C.F. Vihon, “Classificationof UnsecuredClaims:Squaringthe Circle”(1981)55 Am. Bankr. L.J. 143at 145. See also, J.C. Anderson,“Classificationof Claimsand Interests inReorganization CasesUnderthe New BankruptcyCode”(1984)58 Ant Bankr. Li. 99 at 100wherethe authornoted that “[u]nfortunately,classificationconceptswerenot very clear or consistentlyappliedin reorganizationcasesunder theold Act; the new Codedoes not remedythis problem.” 238 the compositionof a class is section 1122which provides:

(a) Except as providedin subsection(b) of this section,a plan may place a claim or an interestin a particularclass only if such claim or interestis substantiallysimilarto the other claims or interestsof suchclass.

(b) A plan may designatea separateclass of claims consistingonly of every unsecured claim that is less than or reducedto an amountthat the court approvesas reasonableand necessary for administrativeconvenience.

Subsection(b) is the “de minimu” exceptionto classification. Usually, the plan provides for full payment of the de minimus claims toavoid the necessity of havingto pay several small 62dividends’ and prevent a claimant with a very small stakein the reorganizationfrom raising issues that may delay or hinder the debtor’sreorganizationefforts. The legislativehistory noted that, before its codification as subsection(b), the practice of paying small claims infull was commonin 63reorganizations.’ Subsection(a) requires only that the claims or interestsplaced in a particularclass be

“substantiallysimilar.” It doesnot, however,requirethat all similarclaims or interestsbe placed in the same class. As the plan usuallyclassifies securedclaimants separately,given the unique natureor priorityof their claims, this issue usually arises only with respect to unsecured64claimants.’ Should the claims or interestsin a particularclass not be substantiallysimilar,the court must deny confirmationof the plan, as it does not complywith the 65Code.’ Subsection 1122(a)is in keeping with the voting policy referred to earlier,’ where the minorityshouldbe boundonly by the decisions of claim or interest holders havingsimilarinterestsor stakes in the debtor.

The CCAA is not so specific as the Codewith respect to the requirementof the plan

162 R Lapowsky, “Confirmationof Plans in Chapter 11”(1992) 97 Corn.L.J. 110at 114.

163 SenateReportat 118 ii 26, citing Brokett v. WinkleTeira CottaCo., 81 F.2d 949 at 952(8th Cir. 1936);In i New Rochelle Coal & Lumber Co., 77 F.2d 88 at 882-883(2d Cir. 1935);In i RealtyAssociates Securities Coiporation,53 F. Supp. 1010at 1011(E.D.N.Y. 1943).

164 See supra notes 192-207and accompanyingtext, where this issueis examinedmore fully.

165 Code s. 1129(a)(1). ‘ Supra notes 158-160and accompanyingtext. 239 proponentto classifycreditors,althoughit clearlyexhibitsan intention thatthe debtormay classify claims. For example,sections4 and 5 referto the debtorproposinga compromise orarrangement with its unsecuredand securedcreditors“orany class of theni” Similarly,the voting67section’ refers to the specialmajoritiesof the creditors“orclassof creditors.” TheCCAA, however,containsno provisionto guidethe debtorin establishingclassesof creditors.

The BIA also envisagesthe classificationof creditorsalthough,like the CCAA,it doesnot makeclassificationmandatory. Subsection50(1.2) provides:

A proposal must be madeto creditorsgenerally,eitheras a mass or separated into classesas providedin the proposal,and may also be madeto securedcreditors inrespectof any class or classesof securedclaim,subjectto subsection(1.3). [emphasisadded]

Subsection50(1.3)then provides thatif the securedcreditorsare placedinto separateclasses,the insolventpersonmust makethe proposalto all of the secured creditorsin that class. Unlike the Code and the CCAA,the BIA sets forth certaincriteriathat governwhethercertainsecuredcreditorsfall withina particular class and givesthe courtthe powerto determinethe proprietyof any classification scheme setforth in the proposal.168

Morethan any other issuediscussedin this paper, the historyhas influencedthe issueof classification underthe Code. In fact, the House Report andthe SenateReportsaid of section1122:

This sectioncodifiescwrent case law surroundingthe classificationof claimsand equity securities. It requiresclassificationbasedon the nature of the claimsor interestsclassified, and permits inclusionof claimsor interestsin a particularclass only if the claim or interest being includedis substantiallysimilarto the other claimsor interestsof the 69class.’ It wouldthereforebe useful to examinethe evolutionof the legislationand the way in which the courtshave interpretedits terms.

Section77B providedthat the court could “deternine ... for the purposesof the plan and its acceptance,the divisionof creditors ... into classesaccordingto the nature of their respective

167 CCAAs. 6.

168 BIA ss. 50(1.4)and (1.5).

169 House Reportat 406; SenateReportat 118. 240 claims.” First, we must note that it was the court,not the debtor,that determinedthe classificationof creditors. The secondaspectof this sectionwhichbears attentionis that classeswere to be divided accordingto the “nature”of the claim. The leadingcase of In ie Paliscdes-on-the-Desplaines’ construedthis provisionbroadly. The court did not followits legislativemandatethat requiredit to look at the natureof the claimsbut instead,focusedon the broaderpolicy issuesinvolvedin a reorganizationcase. It rejected thenotionthat creditorsof equalrank°7 with claimsagainstthe same propertyshould alwaysbe placedin the sameclass or that creditorswith claimsagainstdifferent propertiesshouldalwaysbe placedin differentclasses. Rather, thecourtfocusedon whetherthe creditorwas harmed bythe classificationand whether the classificationfosteredthe confirmationof a plan that was in the bestinterestsof the 171creditors. In otherwords,if the creditorswouldreceive more underthe reorganizationthan in aliquidation,the courtwouldupholdthe classificationwhether or not the natureof the claimsin the classwere similar.

Section7Th was repealedin 1938by the ChandlerAct, whichdividedthe reorganization sections intothree chapters,being ChaptersX XI and Xfl) The provisionsof each chapter

170 Supranote 111.

171 Ibid A contraryapproachwas taken in St. Louis UnionTrustv. Champion ShoeMahineiy Co., 109F.2d 313 (8th Cir. 1940),wherethe courtheld that, despitethe fact that the classification fostersthe policygoalsof a reorganizationproceeding,a classificationwill not be upheldif it derogatesfromthe rights of a seniorcreditorto its agreeduponpriorityposition. Sucha classification would notbe fair andequitable. However,in these earlycases,this case appearsto be an anomalyas the courtsgenerally favoured the approachtaken in the Paliscdes-on-the-Desplainescase. Seee.g, ContinentalInsurance Co. v. LouisianaOil Refining Coip., 89 F.2d 333 (5th Cir. 1937);In n Ogden Apartment Bldg Coporation, 90 F.2d 712 (7th Cir. 1937);In re Sixty-Seven WallStreet Restc&rant Coip.,23 F. Supp672 (S.D.N.Y.1938).

172 For our purposes,the provisionsof ChapterX and ChapterXI are the most relevantas they were intendedto deal, respectively,with reorganizationsof publicly-heldcorporationsand closely- held corporations,where the debtorwas seekingto reorganizeits affairswith its unsecuredcreditors. ChapterXII was a specializedchapterdealingwith arrangementsinvolvingreal property bypersons otherthan corporations. 241 concerningclassificationwere similarto the othersand to section7713.173 There arecertain fundamentaldifferencesbetweenthe provisionsof the ChandlerAct and those of the Code. Underthe

ChandlerAct, the court classifiedclaimants. Under theCode,the debtor classifiesthe claimand interestholdersand the court’sonly role inthe classificationprocedureis to confirmthe plan, oncethe plan proponentsatisfiesit that the plan complieswith the applicableprovisionsof the Code,including section1122,or refuseto confimithe 174plan. In addition,somecase law underthe ChandlerAct held that there was a presumptionthat all creditorsof equalrank shouldbe placedin the same75class.’ Othersheld that this was not an absolute176requirement and if there was equitablereasonfor a separateclassificationof claimantsof equalrank,the court wouldpermit 77it.’ The Codeappearsto haveresolvedthis debate,as the onlyrequirementis that the claimsor interestswithina classmustbe “substantiallysimilar”to each 78other.’ Thereis no a requirementthat all such claimsbe placedin the sameclass. Thus, one must reviewthe casesdecidedunderthe ChandlerAct with somecaution.

The trend that startedunder thesection7713cases continuedin the early ChandlerAct cases.

173 Vihon,supra note 161at 155. ChandlerAct ss. 197and 351providedas follows:

“197. For the purposesof a plan and its acceptance,the judge shall fix the divisionof creditorsand stockholdersinto classesaccordingto the natureof their claimsor stockinterests. For such classification, andif necessary,the judge shall,uponthe applicationof the trustee,the debtor,any creditoror any indenturetrustee,fix a hearingon noticeto the holders of the securedclaims,the trustee,the debtorand such otherpersonsas the judge may designate,to determinesummarilythe value of the securityand classifyas unsecuredthe amountin excessof such value.

351. For the purposesof the arrangementand its acceptance,the courtmay fix the division of creditorsinto classesand, in case of controversy,shall,after hearing anduponnotice, summarilydeterminethe controversy.”

174 Codes. 1129(a)(1).

175 Rocky Mountain,supra note 152at 751;In re L.A. Land, supra note 158at 453. 76 j A.G ConsultantsGrain Division,Inc., 77 B.R. 665 at 676 (Bankr.N.D. hid. 1987). v See e.g, Dudley v. Mealey, 147F.2d 268 at 271 (2d Cir. 1945),cert. denied, 325 U.S. 873 (1945);In re Sixty-Seven WallStreet RestaurantCoiporation,supra note 171.

178 Code s. 1122(a). 242

The courtswere not concernedwith the legislative mandateof classifyingclaimsand interests accordingto their similarityin nature. Theyfocused,instead,on the broaderpolicy of encouragingthe rehabilitationeffortsof the 79debtor.’ This policywas especiallyimportantif there was minimalharm imposedon creditors.180 One authorsuggested that thesedecisionswere basedon an “economic realism”ratherthan on an exercisein statutory interpretationand that the courtswere merely attemptingto enforcethe underlyingpoliciesof the reorganization181system. The court in Winston Mills suggesteda further rationalefor this approachby holding thatthe reorganizationprocesshad built-inchecksand 182balances, in thatthe negotiationsbetweenthe debtorand its creditorsandthe necessityof acceptanceof the plan bythe requisitestatutorymajoritieswouldcontrolabusesin the classificationprocess. This rationale,with respect,ignoresthe economicrealitythat often,in reorganizationcases,there is a disparitybetweenthe bargaining positionsof the partiesand oneparty may exact an advantageby merely threateningto withholdits consentto the plan. The courttook a more stringentapproach inIn re Hudson-Ross,] 183 Tnthat case,the partieshad reachedan agreement beforethe commencementof the reorganizationthat set forththe substanceof the plan, including theclassificationof claims. Notwithstandingthe agreement,the court refusedto confirmthe plan, on the basisthat the classificationwas discriminatory andarbitrary. The courtheld that, to sanctionthe plan, the plan proponent must satisfyit that the classificationwas

WesternMesa Oil Coip. v. Edlou Co., 143F.2d 843 (9th Cir. 1944),whichwas a caseunder ChapterXI. Examplesof other ChapterXI casesadoptinga similarapproachare Bartle v. Markson Bros. Inc., 314 F.2d 303 (2d Cir. 1963)and In re WinstonMills, Inc., 1 C.B.C. (2d)121(Bankr. S.D.N.Y.1979). The lattercase is interestingin thatthe courtrefusedto intervenein the classification which werethe result of “debtor-creditordialogues.”[at 1271 Tnother words,it appears thatthe court assumedthat there must havebeen somereasonablebasis for the creditorsagreeingto diverse treatmentand, on that basis,chosenot to questionthe wisdomof the partiesin interest.

180 In re RealtyAssociatesSecuritiesCoiporation,53 F. Supp 1010(E.D.N.Y.1943),whichwas a ChapterX case. See also RockyMountain,supra note 152.

181 Vthon,supra note 161at 158.

182 In re Winston Mills,Inc., supranote 179.

183 In re Hudson-Ross, Inc.,175F. Supp 111(N.D. Ill. 1959). 243 necessaryand proper, had a reasonablebasis and was in the best interestsof creditors.’ Had the foregoing cases beenthe only authoritieson which Congress’8relied in establishingthat section 1122 “codifiescurrent case law surroundingthe classificationof claims,”one would wonder exactlywhat the current case law was, especiallygiventhe vague languageof section 1122. The courts appearedto ignore the requirementthat claims and interestswere to be classifiedaccordingto their 85“nature.” However, in reviewing thecases, one may fmd certain verybasic, albeit vaguely framed,principles and surmisethat it is these basic principlesof classificationto which Congress alluded. These basic principles are as follows:

1. creditors and shareholders,becauseof their different interests in the debtorand its assets should be separately186classified; 2. shareswith differentattributes,such as preferred and commonshares, shouldbe placed in separate187classes;

3. secured claims of the sameor differentrank againstdifferent collateral or of different rank againstthe same collateralshould be separately88classified,’ and 4. if claimants are placed in the same class but the plan proposesto treat individual membersof the class differently,separateclassificationis necessary.’

Onemay attemptto generalizethe foregoingrules by sayingthat the plan shouldseparatelyclassify

‘‘ Ibid at 112.

185 See ChandlerAct ss. 197and 351, supra notes 170-182.

186 In ie Phoenix Hotel Co. of Lexington,Ky., 83 F.2d 724 at 726-727(6th Cir. 1936),cen’. deniedsub nom. Security Trust Co., Trusteev. Baker, 299 U.S. 568 (1936). ‘ In n Deep Rock Oil Coip., 113F.2d 266 at 268 (10th Cir. 1940),ceil. denied sub nom. Standani Ga & Electric v. Taylor,311 U.S. 699 (1940); ContinentalInsurance Co. v. LouisianaOil Refining Corp., 89 F. 2d 333 (5th Cir. 1937);cf US. Financial,Inc., 648 F.2d 515 at 525 (9th Cir. 1980), cert.denied sub nom. Kelce v. US. Financial,Inc., 451 U.S. 970 (1981). ‘ Kyser v. MxA dam, 117F.2d 232 at 237 (2d Cir. 1941);Mokava Corp. v. Dolan, 147F.2d 340 at 344 (2d Cir. 1941);cf In fl? Pdiscdes-on-the-Desplainessupra note 111at 217-218. 189 In r Boston MetropolitanBuildings,Inc., 92 F. Supp. 843 at 848 (D. Mass. 1950);cf Rocky Mountain,supra note 152 at 750-751. 244 claimantsor interestholdersif they have different190rights or if the nature of their respective claims 191differs. Althoughthese propositionsappearto beg the issueof classification,they pointto a recognitionby the courtsthat requiresthem to lookto somethingmorethan the policyconsiderations governinga businessreorganization.Althoughthe bankruptcycourtsare courtsof equity,they cannot ignorethe legislativemandatebestoweduponthem.

Amied with these generalprinciplesestablishedunderthe currentcase law, we mayundertake an examinationof the Codeto determinewhetherthe courtshave followedthe Congressionaldirective.

Like the casesunderthe Chandler Act,the casesunderthe Codedo not allow for the extractionof any consistent anduniversally-appliedprinciples,otherthan perhapsthe generalprinciplesoutlinedabove.

The most fruitfularea of concernis whetherthe planproponentmay put unsecuredcreditorsinto separateclasses. Somecourtsallowthe plan proponent toclassifyseparately unsecuredclaims,

190 Rocky Mountain,supra note 152at 750.

191 L.A. Land, supra note 158at 453-454,described theconceptof the “nature”of the claimas follows:

“Thetest to be appliedappearsto be one directedtowarda determinationof the ‘nature’of the claim. This wouldencompassan analysisof the legalcharacter orqualityof the claimas it relatesto the assetsof the debtor. Basically,it is simplya methodof recognizingthe rightsof creditorswhichcall for differencein treatment.

The courtsrecognizethat the word ‘nature’is used in no technicalsense inlaw but is used in its ordinary commonvernacular,whereinit meanskind, sort, speciesor character. Wherethe differencesare in the rates of interest,in the amounts,in the dates of maturity,in the namesof payees,the mannerin whichthe claimarose and such otherminordetails,they cannotaffect the ‘nature,’i.e., the kind of claim,otherwisea separate classwouldhave to be providedfor nearlyeverytype of situationwhichwould be anun thinkablecalamity whenthe objectand aim of the statuteis regarded.” [citationsomitted]

The courtthen wenton to provide anexampleof the foregoingproposition,quotingCollieron Bankruptcy,Vol. 6A, Section9.13(1),as follows:

The fact that [unsecured]claimsmay take various forms - as for example,notes,accounts, ‘wittencontracts,torts and the like - wouldnot ordinarilycompelseparateclassfficationsince an unsecuredindebtednessor liabilityis the commondenominatorof all.” 245 providedthere is a reasonablebasis forthe separate92classification’ and that thedebtoris not abusing the reorganizationprocessthroughthe classification93procedure.’ Othercourtshold that there is a presumptionthat similarclaimsshouldbe placedin the sameclass and they wouldonly allow separationof similarclaimsif there is a valid businessreasonfor so doing.’” Both tests however, prohibitclassificationsthat are arbitraryor 95unreasonable.’ There is a dangerin adoptingeitherof the tests withoutqualification. Pine 96Lake’ illustrates this concern. In that case,the courtheld that the plan couldclassify anunsecureddeficiencyclaimof a securedcreditorwith other unsecuredclaims,notwithstandingthat the deficiencyclaimantagreedto subordinateits claimto those of the generalcreditors. The courtarrivedat its conclusionby focusing on the “type”of claim ratherthan the “nature”of the claim. The court, in L.A. Land, set forththe followingtest:

The test to be appliedappearsto be one directedtowarda determinationof the ‘nature’of the claim. This wouldencompassan analysisof the legalcharacteror the qualityof the claimas it relatesto the assetsof the debtor.’

II’the court in Pine Lake appliedthis test, the plan shouldhave classifiedthe claimsseparately.

Althoughboth sets of claimantsin Pine Lake wouldbe consideredunsecuredcreditors,the “legal 98character” of each of their claimswas different,whichmay have causedthem to view the proposed plan differently. For example,assumingthat the securedcreditor’sdeficiencyclaim madeup 85% of

192 In re Jersey City Medical Center, 817 F.2d 1055at 1061(3d Cir. 1987);In re US. TruckCo., Inc., 800F.2d 581 at 586 (6th Cir. 1986).

193 In reA.G. ConsultantsGrain Division, Inc., siqra note 176.

‘ In re GreystoneIII Joint Venture,948 F.2d 134at 139(5th Cir. 1991)[hereinafterGreystone]; cf In re Pine Lake VillageApanment Co., 19 B.R 819 at 831 (Bankr.S.D.N.Y.1982)[hereinafter Pine Lake].

195 In re Holywell Coip., 913 F.2d 873 at 880 (11thCir. 1990).

196 Pine Lake,supra note 194. ‘ Supmnote 158 at 453. 198 Ibid 246 the total unsecured claims, the deficiencyclaimant wouldsupporta proposedplan that would pay all unsecured creditorsa pro rata share of a certain sum. However,the balance of the unsecuredcreditors would reject the plan on the basis that, if the court enforcedthe subordinationagreement,they would receive payment on their claims before any paymentto the deficiencyclaimant. However,the class would accept the proposed plan, as the deficiencyclaimant holdsthe balance of power.

Conversely,a rule permittingthe plan proponentto create a multiplicityof classes couldalso result in abuse, such as throughthe gerrymanderingof 1votes. The courts coulduse the goodfaith requirementin paragraph 1129(a)(3)of the Code to control the gerrymanderingof votes throughthe classification20procedure. Thus,°the courts must return to the vague standardthat requires an examinationof the “nature” of the particularunsecured claim in issue. In manycases, the parties themselves,throughthe process of negotiation,will establishthe classificationof claims and interests. This would render an examinationof the issue by the court unnecessary. However, if a creditor objects to the classification, the court must conduct a thorough examinationof the natureof the claims or interests in the impugned class.

Generally,the principles establishedunder the ChandilerAct concerningsecuredclaimants apply under the201Code. In other words,secured claimsare classifiedaccordingto whetherthey are

‘ In re MastercrcftRecord Plating Inc., 32 B.R. 106at 108 (Bankr. S.D.N.Y. 1983),rev’d on other grounds,39 B.R. 654(S.D.N.Y. 1984),wherethe court stated that “[c]lassificationcannotbe used to divide like claimsinto multiple classes in order to create a consentingclass so as to permit confinnation.” A stronger statementof this policy was made in Re S. & W Enteiprise, 11 B.C.D. (C.RR) 630 at 634 (Bankr.N.D. Ill. 1984),where the court stated that “[TJhemanipulationof unsecuredclaims. . . for the sole purpose of complyingwith the votingrequirementof section 1129(a)(10)shall not be tolerated.”

200 W. Blair, “Classificationof UnsecuredClaims in Chapter 11 Reorganization”(1984) 58 Am. Bankr. L.J. 197at 225. See e.g., Greystone,supra note 194,where the court said:

“[Thereis] one clear rule that emerges from otherwisemuddled caselaw unders. 1122claims classification:thou shall not classify similarclaims differently in order to gerrymanderan affirmative votein a reorganizationplan.” [at 139].

201 Supra notes 186-191. 247 of the samerank and whetherthey have securityin the sameor differentcollateral. The courtshold, as a generalproposition, thatthe plan shouldclassifysecured claimsseparately,unlessthereare other securedcreditorsthat havethe samepriorityranldngandthe samerightsto the 202collateral. Although this may create hardshipon the debtorby givingeach securedcreditora veto over the plan,the securedcreditorshave differinginterestsin the assetsof the debtordependingon the natureof the collateraland their priorityto it. Furthermore,the rightsof each secured creditorwill differ, dependingon the contentsof the securityagreement.

The commentatorsgenerallyagreethat a flexibleapproachto the classificationissuewhich permitsthe debtorto separatesubstantiallysimilar claimsinto separate classesis 203favourable. The primaryadvantagein allowing flexibilityis that the plan proponentmay adjustthe classesto ensure that it meetsthe prerequisitesto confirmationof the plan. It alsoputs minimal constraintson the courtsthat mustconsider diversefactualsituations. This approachalso appearsto fit withinthe Congressionalmandate that “[t]hepartiesare left to their ownto negotiatea fair 204settlement.” Allowingthe partiesto reachcompromiseswith respectto individualclaims meetsthis objective. The plan proponentis then free toplacethe claimor interestholderin the appropriateclass. A restrictive classification regimerequiringall substantiallysimilarclaimants,such as unsecuredcreditors,to be placedin the same classmay inhibitbargainingamong the parties becauseof the difference inthe economic needsand interestsof the 205claimants. In otherwords,classificationniles that provideless flexibilitydeprivethe partiesof the necessaryflexibilityto fashiona solution. One authorexpressed the rationalefor the necessityof flexibilityas follows:

Finally,there is significantsupportfor broaddiscretionin the classificationof creditorsunder the BankruptcyCode,such as the requisitefor flexibilityand the avoidanceof one creditor

202 In re Richard Buick, Inc., 126B.R 840 at 852-854(Bankr.E.D. Pa. 1991).

203 See e.g.,Robin,supra note 154;Blair,supra note 200; Andersor supra note 161.

204 House Report at 224.

205 Blair, supra note 200 at 224. 248

holdinga veto power over theproposedplan. Whenthe precedingconcerns are addressedby permittingbroad discretionin the classificationof creditors,the BankruptcyCode’spromotion of reorganizationis 206reinforced. This rationalesuggeststhat reorganizationis the primaryobjectiveof such a proceeding,ignoringthe goalof treatingcreditorswith similarclaimsequally. However,an unwaveringpolicyof flexibility appearsto encourageabuse. One wonderswhy the rule concerningacceptanceof the pian by an impairedclass even exists,if the planproponentcan merelystructurethe classesto attain that acceptance. One might takethe positionthat protectionof the creditors’interestsis more important than the reorganizationitself. Treatingsubstantiallysimilarclaimsdifferentlyis contraryto one of the normativebases of a reorganizationregime. Courtsthat take the positionthat classificationto secure appropriatevotes may be an abuseof the bankruptcyprocessaddressthis concernof equalityof creditors.

Sincethe enactmentof section77B,the policymakers have continuallystressed that classification should be basedon the natureof the claim. This fits withinthe policythat the majority can dictatethe decisionof the class only if all membersof the classhave a similarinterestsin the assetsof the debtor. To deviatefromthis policyin the interestsof attainingacceptanceof the plan doesnot fitwithinthe legislativemandate. Certainly,the courts generallyfollowthe broadprinciples outlined207earlier and quiteproperlyallowthe plan proponentflexibilitywithinthoseprinciples. However,to allowthe plan proponentto completelyignorethose fundamentalprinciplesgivesjudicial sanction outsideof the mandate accorded under thelegislation.

The CCAAand the BIA take differingapproachesto the classificationissue. The CCAAtakes an approach similarto that of the Codein thatthe plan proponentis providedwith very little guidance

206 Robin,supra note 154at 224.

207 Supranotes 186-191and accompanyingtext. 249 in establishingacceptable classificationsof 208creditors. The BIA providessomeminimalguidance, whichmay proveto be a two-edgedsword. On the onehand,the factorsprovidedin the BIA may providesome guidancein how to structurethe classes. On the other,the courtsmay hold that the factorsare requirements,whichwill significantlyreducethe flexibilityexhibitedunderboth theCode and the CCAA. This may havethe untowardeffectof reducingthe ability tonegotiatea plan for the benefitof all in a casewhere reorganizationis the mostattractivesolution.

In lookingat the CCAA, oneis temptedto concludethat the classfficationof creditorsis not subject toany 209rule and that the courts are freeto establishclasseson whatever basisthey choose.

However,the CCAAwas based largely onthe EnglishJoint Stock CompaniesAircingementAct

(1870),210 underwhich arich body of case law haddeveloped. In addition,the legislativehistorymay providesome guidanceconcerningthe intentionof the policymakersin using theterm “classesof creditors.” In discussingwhat are now sections6 and 7 of the CCAA,the HonourableC.IHLCahan, who was the Memberof Parliamentsponsoring the passageof the bill thatbecame theCCAA,said

“[e]cchclass of creditorswho havethe same interestmay decide. . . with respectto any proposed compromise. “211 This is in keepingwith the policythat the decisionof the majoritymaybinda dissentingminority,only if the interestsof all of the class membersare the sameor substantially similar. Otherwise,the plan and the courtswouldbe “sacrificingthe rights of the 212minority.”

208 Referenceis madeto the plan proponentbeingthe person,in the first instance,to propose the classificationof creditors. This is based on the caseRe HellenicTrustLtd, [1975]3 All E.R 382 (S.C.),whichheld that thedebtor hasthe primaryresponsibilityof classificationof creditors.

209 The CCAAdoes not requirethe classificationof creditors inthe plan. Throughoutthe legislation,referenceis madeto creditors“or any classof them”which suggeststhat creditorsmaybe classified. Needlessto say, the CCAAprovidesno guidanceas to how this classificationis to be determined.

210 33 & 34 Vict. c. 104.

211 Houseof CommonsDebates(9 May 1933)at 4723 [emphasisadded].

212 Edwards,supranote 126at 603. 250 213Edwards proposedthe use of the “identityof interests”test for classification,basedon the legislativehistory. Althoughthe courtsoverwhelminglyrejectthis test on the basis of their interpretationthat it requires the placementof creditors in oneclass only f they have identical 214interests, it is submittedthat neitherthe legislativehistorynor Edwardscontemplatedsucha naow scopefor that test. The test did not contemplatethat the interestshad to be identicalbut merelythat they be, in American parlance, “substantiallysimilar”suchthat all claimantswithin the classhave similar interestsin eitherrejectingor acceptingthe plan.

Classificationaccordingto the “interests”of the creditorsmay be based onthe statementof LordEsherMR in SovereignLift Asswvnce Co. v. 15Lkd whereHis Lordshipsaid: The Act says that the personsto be summonedto the meeting(all of whom, be it said in passing,are creditors) are persons who can be dividedinto differentclasses - classeswhichthe Act of Parliamentrecognises,though it does not defmethem. This,therefore,must be done: they must be divided into differentclasses. What is the reasonfor such a course? It is becausethe credito, composingthe thfferent classes have differentinterests;and, therefore,if we fmd a different stateof facts existingamongdifferentcreditors,whichmay differently affecttheir mindsand theirjudgments,they must be dividedinto different216classes. In the samecase,BowenL.J. said:

It seems plain that we must give sucha meaningto the term “class”as will preventthe section being so workedas to result in confiscationand injustice,and that it must be confmedto those personswhoserights are not so dissimilaras to make it impossiblefor them to consult together with a view to their common217interest. An Ontario court appliedthis rationalein Re WellingtonBuilding Coip. 218Ltd, wherethe court held that securedcreditorswith differentpriorities on the same propertyshould beplacedin

213 Edwards,supra note 126at 602-603.

214 See e.g, Skiar-PepplerFurnitureCoip. v. Bank of Nova Scotia (1991),8 C.B.R (3d) 312 at 318 (Ont.Gen. Div.); Re Woo ward’sLtd (1993),20 C.B.R (3d) 74 at 82 (B.C.S.C.).

215 [1892] 2 Q.B. 573 (C.A.).

216 Ibid at 579 [Emphasisadded].

217 Ibid at 583 [emphasisadded].

218 (1934), 16 C.B.R 48 (Ont. S.C.). 251 differentclasses. To hold otherwise wouldallow subordinatecreditorsto destroy the priority, rights and security of the securedcreditorsholdingprior mortgageson the 219property. This approach,however, may foster a multiplicityof classes,which is disadvantageousto the plan proponent, asit may provide individualcreditorswith veto powers. The result may be fewer reorganizations.A compromisemay be struck usingthe final words in the statement of Lord Bowen, quotedabove, where he statesthat the plan may classify dissimilarclaimantstogether, providedtheir interestscoincideto such an extent as will allow themto consulttogether.° The Alberta Court of

Appeal appliedthis approach,now kno as the “conimonalityof interest,”in the reorganization proceedingsinvolvingthe acquisitionof the assets of Dome PetroleumCo. by Amoco Canada Petroleum’22Co. Although thecommonalityof interesttest does not requireor even encouragethe plan proponentto place identical interests in the same class, neither does it even appear to followthe fundamentalprinciples establishedunder the 222Code. The commonalityof interest test may also be a two-edgedsword for the plan proponent. It allows the debtor to place diverse creditorsin the same class based on the nature of the debt, the

219 Ibid at 55.

220 RN. Robertson, “LegalProblemson Reorganizationof Major Financial and Commercial Debtors”CanadianBar Association - Ontario,ContinuingLegalEducation,5 April 1983at 20

221 Tnthis case, the partieschose to use the arrangementprovisionsof the CcincdaBusiness CoiporationsAct, RS.C. 1985,c. C-44. Althoughthe fundamentalpremise of these provisionsdiffers from the CCAA,the decisionsappearedto analogizethe substance andproceduresof each. As a result, the decisionsarisingfrom these proceedingsmay have some precedentialvalue in proceedings under the CCAA. Seee.g, Savagev. Amoco Acquisition Co., (1988) 68 C.B.R (N.S.) 154(Alta. C.A.), leaveto cpped to the S.C.C.refused70 C.B.R (N.S.) xxxii (note). Use of the commonalityof interesttest vvs also approvedin Re CainpeciaCorp.(1991), 10 C.B.R (3d) 100 (Ont. Gen Div.), leaveto apped to C.A. refused(1992), 86 D.L.R (4th) 570n.(Ont C.A.), leaveto cpped to S.C.C.refused (1992), 86 D.L.R. (4th)570n.(S.C.C.).

m See discussion,siq3ranotes 186-191and accompanyingtext. For example, in Re Woodward’s Ltd, supra note 214, Tysoe 3. allowedterminatedemployees andtrade creditors, which were acknowledgedto be creditors with different legal rights, to be placed in the same class on the basis of their commonalityof interest as unsecuredcreditors. 252 creditor,the security oron the remediesof the 223creditors. Alternatively,it may require the placement of diverse interestsin separateclasses,which may give a singlecreditor a veto overthe 224plan. The result will depend on whether the court views 225reorganization or equalityof creditors of equalrankas the primarypurpose of the 226legislation. The case involvingWoodward’s227LtcL took an interestingand somewhatnovel approachto the classificationissue. In that case Tysoe J., extended theapplicationof the commonalityof interest test by lookingbeyond the legal rightsof the creditors seekingseparate classification,to the effect of the proposedplan and the consequencesof a liquidationon those creditors. He explainedhis approach as follows:

The case authoritiesfocuson the differencesin the legal rightsof the creditors indetermining whether their interests are sufficientlysimilaror dissimilarto warrantcreditors being placedin the same class or separateclasses. Iagreethat it is the legal rights of the creditors thatmust be consideredand that other external matters that could influencethe interests of a creditorare not to be taken in account. However,it is my view that the legal rights shouldnot be

223 Diemoiter, supra note 91; Non’hlandPropertiesLtd v. ExcelsiorLife InsuranceCo. of Canada (1988), 73 C.B.R. (N.S.) 175(B.C.S.C.),cffd (1988), 73 C.B.R. (N.S.) 195(B.C.C.A.);Norcen Energy ResourcesLtd v. OakwoodPetroleumsLtd (1988), 72 C.B.R. (N.S.) 20 (Alta. Q.B.).

224 Re NsC Diesel Power Inc. (1990), 79 C.B.R (N.S.) 1 (N.S.S.C.)

225 In Oakwood,supra note 109,Forsyth J. held that separateclassificationof securedcreditors holdingseparatesecurityover differentassets or securityhaving differentrelative values was unwarrantedand said:

“First,it is clear that the C.C.A.A.grants a court the authorityto alter the legal rights of parties otherthan the debtor companywithouttheir consent. Second,theprimaiypurposeof theAct is tofailitate reorganizationsand this factor mustbe given due considerationat every stage of the process, includingthe classificationof creditors madeunder the proposedplan. To accept the ‘identityof interest’propositionas a starting pointin the classificationof creditorsnecessarilyresults in a ‘multiplicityof discrete classes’which would makeany reorganizationdifficult, if not impossible,to achieve.” [at 28, emphasis added].

226 See e.g, Nova Metal ProductsInc. v. Cominskey(Trusteeof) (1990), 1 C.B.R. (3d)101(Ont. C.A.),where the court held that securedcreditorswith discrete interests should be classifiedseparately.

The Nova Scotia Courtof Appeal rejected thenotion that equality of treatment among creditors wasa necessaryor even a desirable goal in Re KeddyMotor Inns Ltd (1992), 13 C.B.R. (3d) 245 at 255 (N.S.C.A.).

227 Re Woodward’sLtd, supra note 214. 253

consideredin isolationand that they mustbe consideredwithinthe contextof the provisionsof the reorganizationplan. It wouldbe appropriateto segregatetwo sets of creditorswith similar legal interestsinto separateclassesif the plan treats them differently. Conversely,it may be appropriateto includetwo sets of creditorswith differentlegalrights in the same classif the plan treats them in a fashionthat givesthem acommonalityof interest despitetheir different legal rights. In addition,whenthe courtis assessingwhetherthere is a sufficientcommonality of interestto includetwo sets of creditors inthe sameclass, it is necessary in my viewto examinetheir legalrightswithin the contextof the potentialfailureof the reorganizationplan. The treatmentof the twosets of creditorsunder theplan shouldbe comparedto the rightsthey would havein the event of the failureof the plan (i.e.,bankruptcyor other228liquidation). Withrespect,the objectof classificationis to ensurethat the plantreats creditorsof equal rankthe sameand that only creditorshavingthe sameinterestin the debtor’sassetsshall determinethe fate of the classwithinthe plan To allowdiverseintereststo affecteach other’srights, simplybecausethe plan treatsthem similarlymay allowthe plan proponentto manipulate theclassesto furtherdilutethe votesof dissidentcreditors. This approachgivesthe debtoran inordinateamountof powerandputs the “cartbeforethe horse.” It is the preproceedingrightsthat shouldgovern classification,not the rightsas establishedunderthe plan.

Thus,the sameproblemsand concernsthat plaguethe classificationissueunderthe Code arise in Canada. The courts take eithera restrictiveapproach,resultingin a multiplicityof classesor a liberal approach,resultingin fewerclasses,but classescontainingcreditorswith diverse andpotentially conflictinginterests. The formerapproachappearsto coincidewith the legislativeintentof the classification procedurewhile the latter providesthe plan proponentwith an opportunityto dilutethe votesof a dissidentcreditor. This issue,morethan any otherexaminedin this paper, requiresthe policymakersto determinewhetherbusiness reorganizationsare preferableto the rightsof creditors and interestholders. The policymakerscan require thecourtsto adopta liberal orrestrictiveapproach andto provideflexibility,dependingon the circumstances.

This paperhas been generallycriticalof the BL&and its apparentlack of interestin fostering reorganizationeffortsof the insolvent229person. A similarcriticismis made of the way that the BIA

228 Ibid at 80-81.

229 See e.g., chapterV(5). 254 dealswith the classificationissue. Whilethe presumption that thedebtorcan classifyall unsecured creditorstogethermay allowthe dilutionof the interestsof dissidentcreditors,the mannerof classifyingsecured creditorsleavesthe insolventperson withlittle alternativebut to createa multiplicityof classes. Subsection50(1.4)of the BIA provides:

Secured claimsmay be includedin the same class if the interestsof the creditors holdingthose claimsare sufficientlysimilar togivethem a commonalityof interest,taldng into account (a) the nature of the debts givingrise to the claims; (b) the nature and priorityof the security in respectof the claims; (c) the remedies availableto the creditorsin the absenceof the proposal,and the extentto whichthe creditorswouldrecovertheir claimsby exercisingthoseremedies; (d) the treatmentof the claimsunderthe proposal,and the extentto whichthe claimswouldbe paid under theproposal;and (e) such furthercriteria,consistentwith those set out inparagraphs(a) to (d), as are prescribed.

This subsection codifies thecase law underthe CCAA. However,it does not provide theadded elementof allowingthe courtto considerthe policies underlying thereorganizationprocess. This resultsin the insolventpersonhavinglittle latitudein classifyingsecured claimsand requiringthe creationa multiplicityof classes,each with a potentialveto. This givessecuredcreditorsan inordinate amountof power in determiningthe fate of the debtor. If reorganizationsare to be encouragedunder the BIA policymakersmust givethe insolventpersonmore flexibilityoverthe classificationissue.

C CRAMDO Under theCode,if a class of creditorsor interest holdersrejects theproposedplan,the court may “cram”the plan downon the dissentingclass,providedthe plan meets certain requirements.

Thereis no conceptof cram downin Anglo-Canadianlaw, although thepolicymakers° andthe 3judiciar9 are well awareof the concept. Neitherthe reportedcasesnor the commentarieson the ’ ° See e.g., ColterCommittee Reportat 53.

231 See e.g., Olympia & YorkDevelopmentsLtd v. Royal Trust Co., supra note 2; Multidev ImmobiliaInc. v. Société AnonymeJust Invest (1988),70 C.B.R (KS.) 91 (Que. S.C.)Thesecourts take a uniqueapproachto the issueof a non-assentingclass of creditors. In bothcases,ratherthan refusingto sanctionthe plan,the courts“carvedout” the portionof the plan that concernedthe objectingcreditorand sanctionedthe balanceof the plan. In Olympia& York DevelopmentsLtd, the 255

Anglo-Canadianbusinessreorganizationregimesjustify its rejection.

This sectionwill examinethe normativeand historicalbasesof the cram downunderthe Code andthe prerequisitesthat the planmust meetto invokeit. The objectof this examinationis to determinewhetherCanadianpolicakers shouldreevaluatethe conceptwith a view to incorporating someof its more desirablefeaturesinto Canadianlaw or whether thepresentCanadianregime,which prescribesthat rejectionof the pian by evenone class of creditorsor interestholders resultsin a completefailureof the plan, is preferable.

Under Chapter 11, there are two waysthat a plan proponentmay attain confirmationof a plan. First, the plan proponentmay obtain the unanimousconsentof all 232impaired classes of claimsand interest3holders. Oncethe proponentobtainsthe consents,it may seek confirmationby the court undersubsection1129(a). The proponentmay invokethe second methodonce it meets all requirementsof subsection 1129(a),except that an impairedclassrejectsthe plan. In such a case, the plan proponentmay seekto have the plan crammed downunder subsection 1129(b)overthe

“carvedout” creditors maintainedsecurityover assetsof the debtorand were therefore,allowedto realizeon the security. It may be arguablethat, in appropriatecircumstances,the conceptof cramdownmaybe invoked. In Re Alaba,nc New Orleans,Texas& PcijfIcJunctionRailwayCo.,supranote 29, Bowen L.J. stated:

“Now,I have no doubtat all that it wouldbe improper forthe Courtto allowan arrangement to be forcedon any classof creditors,if the arrangementcannotreasonablybe supposedby sensiblebusinesspeopleto be for the benefitof that class as such,otherwisethe sanctionof the Courtwouldbe a sanctionto what wouldbe a schemeof confiscation. The objectof this sectionis not confiscation. ... Its objectis to enablecompromisesto be madewhichare for the commonbenefitof the creditorsas creditors,or for the commonbenefitof someclassof creditorsas such.”[at 243, emphasisadded].

On the basis of this statement,if one were in a positionto arguethat the plan was, accordingto sensiblebusinesspeople,for the benefitof the classof dissentingcreditors,one may bein a position to cramthe plan down onthe class in question. This issuehas not been raised in any of the reported casesto date.

232 The definitionof impairmentis set forthsupra note 117.

233 Recallthat unimpairedclassesare conclusivelypresumedto haveaccepted theplan under subsection1126(f)of the Code. 256 objectionsof the dissentingclass providedthat, inter dict I. the plan does not discriminate234unfairly; 2. the plan is fair and 235equitable; and 3. the provisionsof 1129(a)are met includingthe fact that each impairedclass will receive as much underthe plan as it would if the debtor were liquidatedas of the effective date of the plan and that confirmationof the plan will not likely be followedby a further liquidationor reorganizationof the reorganized237entity. If the plan meets all provisionsof subsection 1129(b),the courtmust confirm the 238plan, although there is considerablescopewithinsubsections 1129(a)and 1129(b)for the court to fmd somebasis on which to reject the plan.

The cram down provisionsare rarely 239used. However,the provisions are valuableas a threat, as the consequencesof failing to negotiate and arrive at an acceptableplan may seriouslyaffect all partiesin 240interest. Thus, with the threat of cram down beingever-present,the parties will usually negotiatea plan with a view to havingit acceptedand confirmedunder subsection 1129(a).

Cramdown requiresthe courtto balancediverseinterestsand ensure that the plan protectsall parties as far as is possible in the circumstances. The tests that the courts apply in attemptingto balancethese diverse interestsillustratethe complexityof applyingthe concept. Whetherthe plan is to be confirmedunder the provisionsof subsection 1129(a)or subsection 1129(b),it must meet the

234 Code s. 1129(b)(1).

235 Ibid

236 Code s. 1129(a)(7)(A)(ii),which is knownas the “best interestsof creditors”test.

237 Code s. 1129(a)(11), which is knownas the “feasibility”test.

238 InitStoffel,41 B.R. 390(Bankr.D. Minn. 1984). The court,inthat case, foundthatnotall of the requirementshad been met. See also, KN. Klee, “All You Ever Wanted to Know AboutCram Down Under the New BankruptcyCode”(1979) 53 Am. Bankr.L.J. 133at 140-141.

239 Norton BankruptcyLaw & Practice s. 93:1.

240 For an excellent analysis of the risks incurredby the partiesand the possible negativeimpact of a cramdown,see RF. Broude, “Cramdownand Chapter 11 of the Bankruptcy Code: The SettlementImperative”(1984) 39 Bus. Law.441. 257 feasibilityand the best interestsof creditorstests. If the proponentis seekingto cramthe plan do, the plan must also be fair and equitableand must notdiscriminateunfairly. We will examinethe componentsof each of these tests.

The feasibilitytest is foundin paragraph1129(a)(11) of the Codewhichprovidesthat a plan will be confirmed onlyif

Confirmationof the plan is not likelyto be followedby the liquidation, orthe need forfurther reorganization,of the debtoror any successorto the debtorunder theplan, unlesssuch liquidationor reorganizationis proposedin the plan. Thisprovision requiresthat confirmationmust “buymore than temporaryrelief for the 24debtor.” To satisfythis requirement, thedebtormusttenderevidenceof its projectedcash flow and’earningsto show thatit will fulfil its obligationsunderthe 242plan. Thisrequirementis not unlikethe requirement underthe BIA for the insolventpersonto submita cash flow 243statement. The courtmustcarefully reviewthe assumptionsupon whichthe evidenceis basedto ensurethat the assumptionsare reasonablein the circumstances.The prospectivenatureof this examinationmakesit “anestimate compoundedby a 2guess.” This providesthe courtwith a greatdeal of flexibilityin deciding whether toconfirmthe plan.

The best interestsof creditorstest requiresthat, for a plan tobe confirmed,each memberof an

241 RJ. Hugos, “In re Aweco: The Fifth Circuit Requiresthe Fair and EquitableStandardto reconfirmationCompromisesUnder Chapter 11(1986) 38 Baylor L. Rev. 461 at 465.

242 Broude, supra note 240 at 448. See also In re US. Truck Co., Inc., supra note 192at 589, where the court listed the followingfactors as germaneto its inquiryas to the futureviabilityof the reorganizedfirm:

1. the adequacyof the capital structure; 2. the earningpowerof the business; 3. economicconditions; 4. the abilityof management;and 5. any other relatedmatterswhichdeterminethe prospectsof a sufficientlysuccessful operationto enableperformanceof the provisionsof the plan.

243 BIA s. 50.4(2) to (5).

244 HouseReportat 225. 258 impairedclass:

will receiveor retainunderthe plan on accountof such claimor interestpropertyof a value,as of the effectivedate of the plan, that is not less than the amountthat suchholder would so receiveor retain if the debtorwere liquidatedunderchapter7 of this title on such 245date.

Thistest seeksto ensurethat each memberof a dissentingclass,as opposedto the class as a whole, receivesat leastas muchas that memberwouldreceiveon a liquidation. To satisfythe best interests of creditorstest, the plan proponentmust tenderevidenceshowingthe liquidationvalue of the debtor’s assetsand the distributionof that value amongthe creditors. This valuationmust showthat the plan treatsthe creditorsat least as well as they wouldbe2treatedin a liquidation. This evidenceis plagued by the sameintangibleconcernsas the feasibilitytest.

The fmal two tests applyonly if the plan proponentseeksto use the cram do provisions, whichprovide:

Notwithstandingsection510(a)of this title, if all the applicablerequirementsof subsection(a) of this sectionotherthan paragraph(8) are met with respectto a plan, the court,on requestof the proponentof the plan, shall confirmthe plan notwithstandingthe requirementsof such paragraphif the plan does not discriminateunfairly,and is fair and equitable,with respectto each class of claimsor intereststhat is impairedunder,and has not accepted,the 247plan. Paragraph1248123(a)(4) requiresthe plan to treat membersof a class the sameand thus, it dealswith unfairdiscriminationamongclass members. The fair and equitabletest dealswith unfair discriminationamongdisparateclassesand holdsthat all classesmaintaintheir relativepriorityvis-a

245 Codes. 1129(a)(7)(A)(ii).

246 Broude,supra note 240 at 448-449.

247 Codes. 1129(b)(1).

248 Code s. 1123(a)(4)providesthat a plan shall:

“(4) providethe sametreatmentfor each claimor interestof a particularclass,unlessthe holderof a particularclaimor interestagreesto less favourabletreatmentof suchparticular claimor interest;” 259 vis otherclassesof claimsand 249interests. The unfair discriminationprohibitionrequirementset forth in subsection1129(b)appliesin respectof classesof equalo25rank. The prohibitionagainstunfair discriminationforbidsthe plan proponentfrom treatingsubstantiallysimilar classesdifferently,unless there is goodreasonfor so 25doing. One may take the positionthat any plan that separatelyclassifies similarlysituatedclaim or interest’ holdersis discriminatoryto one of the classes. However,the plan proponenthas the burdenof provingthat the discriminationis not 252“unfair.” Provided thereis a reasonablebasis for the discrimination,that it is necessaryto a successfulreorganizationandthat the plan is proposedin goodfaith,the courtmay allowthe 253discrimination. However,the courtmay disallowthe discriminationshouldthe plan proponentnot satisfy the burdenof 254proof. The fmal test, whichis “thekey to cram 255down,” is the fair and equitabletest. The words “fairand equitable”are words of art thathave acquireda specificmeaningthroughjudicial

249 Northern PxfIc RailwqyCompanyv. Boyd, 228 U.S. 482 at 504 (1912). The “fairand equitable”or “absolutepriority”rule will be discussed,infra notes 258-285and accompanyingtext.

250 HouseReportat 416. The HouseReport recognizedthat the probleminherentin both the “unfairdiscrimination”test and the “fairand equitable”test wouldbe in attemptingto establish whethera class maintainsa prioritypositionover or is subordinateor equalto anotherclass. It appearedto leavethe questionopen tobe dealtwith on a case by case basis by saying“Oneaspectof this test that is not obviousis that whetherone class is senior,equal,or junior to anotherclassis relativeand not absolute.”[at 4161. This, it is submitted,is the root of the problem thatplaguesthe classification issuewhich is discussedin chapterVI(CX2),above. 251 In i 222 LibertyAssocic1tes,108B.R. 971 at 991 (Bankr.E.D. Pa. 1990). 252 Ibid

In re Aztec Co., 107B.R 585 at 590 (Bankr.MD. Tenth 1989). See also In te 11,111,Inc., 117B.R. 471 at 478(Bankr.D. Minn. 1990).

254 See e.g., Pine Lake, supra note 194,wherethe plan attemptedto separatelyclassifytrade debt and a securedcreditor’sunsecureddeficiencyclaim;In ie Economy Cast Stone Co., 16B.R 647 (Bankr.E.D. Va.1981),wherethe plan attemptedto placethe claimof an insiderin the sameclassas trade creditors.

W.W.Miller,Jr., “BankruptcyCodeCramdownUnderChapter11:New Threatsto ShareholderInterests”(1982)62 BostonU. L. Rev. 1059at 1063. 260 256interpretation. In particular,they requirea planto maintainabsolutepriorityamong creditorsand interest7ho1ders? The essence of the concept of absolutepriorityis that a class of creditorsmay assert its priority rights against a subordinateclass of creditorsor againstall classesof interest 258holders. Of course,in a complexreorganization,this statementmay be more difficultto applythan to state. However,it illustratesthat the courtmust be keenlyaware of the priorityrankingof the variouscreditorsand interestholders.

Congresscodifiedthe fair and equitableconceptin paragraph 77B(f)(1),althoughthe concept developedin equity receivershipsbefore the enactmentof section 25977B. That paragraphprovided that a judge could confirma plan if satisfied,inter dia, that “it is fair and equitableand does not discriminateunfairly in favour of any class of creditorsor stockholders,and is feasible.” Giventhe similaritybetween thisparagraphand subsection 1129(b)of the Code, the case law precedingthe passage of the Code continuesto have precedentialvalue in any case applyingthe fair and equitable standard. The fair and equitablestandardonly applies in a cram down situation. In other words, if no party objects tothe plan, adherenceto the absolutepriority rule is unnecessary.

To confirm the plan under Chapter X the proponenthad to satisfy the court that the plan was fair and 26equitable, whether or not any party objectedto it. In other words, the absolutepriority rule was invioable° and the parties had no latitudeto negotiateother arrangementsin derogationof the rule. Thisrequireda valuationhearing in all Chapter X cases to ensurecompliancewith the absolute

256 Cacev. Los Angeles Lumber ProductsCo., 308 U.S. 106at 115(1939) [hereinafterL.A. Lumber].

ConsolidatedRockPmthicts Co. v. DuBois, 312 U.S. 510 (1941L.A.Lumber, ibid at 115-119.

258 SeeLouisville Tiust Co. v. Louisville,New Albanyand ChicagoRailwqy Comjxiiy, 174U.S. 674 at 684 (1899),wherethe United States SupremeCourtdescribedit as the “familiarrule”that “the stockholder’sinterest in the property is subordinateto the rights of creditors;first of secured andthen of unsecuredcreditors.”

L.A. Lumber,supra note 256at 115.

260 ChandlerAct s. 221(2). 261 priorityrule. This stepwas criticizedin many of the discussionsleadingup to the passage of the Codeas expensive,time-consuming,26imprecise and discouraging262negotiation. Thus,the policymakersdraftedthe Code in a ythat’ wouldavoidthe applicationof the fair andequitabletest and its concomitant requirementfor a valuation hearingif all parties consent tothe 263plan. The absolutepriorityrule would applyonly if a class of impairedcreditorsor interest holdersobjectedto the plan and then, only to the affectedclasses. A seniorclass could agreeto a junior classreceiving morethan thejunior classwould receiveon an applicationof the absolutepriorityrule, so longas any intervening classreceives thefull value of its 2Mclaims. The nile doesnot applyto classesseniorto the objectingcreditoror interest265holder. Thus,it is in the bestinterestof all partiesto negotiatea plan that the requisitemajorities willaccept. This may mean that seniorcreditorsshouldallowjunior creditorsor interestholdersto receive somethingunderthe plan, even if on a liquidationor under the fair and equitabletest, they wouldreceivenothing. This wouldavoidthe costs of a valuationhearing that erodethe amountotherwisepayableto the senior creditors andwouldensurean expeditious conclusion tothe case.

The Code specifies factors tobe consideredin determining whethera plan is fair and equitable in respectof a class of creditorsor interestholders. The factorsdependon whetherthe dissenting

261 Note, “TheProposedBankruptcyAct: Changesin the AbsolutePriorityRule for Corporate Reorganizations” (1974)87 Harv.L. Rev. 1786at 1793-1797.

262 v Brudney,“BankruptcyCommission’sProposed‘Modifications’of the Absolute Priority Rule”(1974)48 Am. Bankr.L.J. 305at 314,wherethe authorsaid:

“. .. the absolutepriorityrule restrainsseniorsfrom making compromisesunderwhichjuniors are allowedto participate before theseniorsare fully compensated,and requiresthat the enterprise bevalued - as realisticallyas possible - before determiningwhich classesmay participatein the reorganizedenterpriseand how muchthey are entitledto receive.”

263 Code s. 1129(a).

264 Code s. 1129(b)(2)(B).

265 MM Jaffe, “Chapter11 Strategiesand Techniques- Creditor Committees,EffectiveUse of Plan Provisions, Objectionsto Confirmation,Financinga Chapter11 Case,‘Cramdown’andHow it Works”(1985)59 TulaneL. Rev. 1298at 1332. 262 impairedclass consistsof securedcreditors,unsecuredcreditorsor interestholders.

To be fair andequitableto a classof securedcreditors,subparagraph1129(bX2XA)requires that the plan provide:

(i) (1) that the holdersof such claimsretainthe liens securingsuch claims,whetherthe propertysubjectto such liens is retainedby the debtoror transferredto anotherentity, to the extentof the allowedamountof such claims;and (II) that each holderof a claimof suchclass receiveon accountof such claimdeferred cash paymentstotallingat leastthe allowedamountof such claim,of a value,as of the effectivedate of the plan,of at leastthe value of suchholder’sinterestin the estate’s interestin suchproperty; (ii) for the sale, subjectto section363(k)of this title, of any propertythat is subjectto the liens securingsuch claims,free and clearof such liens,with such liensto attachto the proceedsof such sale, and the treatmentof such liens on the proceedsunderclause(i) or (iii) of this subparagraph;or (iii) for the realizationby suchholdersof the indubitable equivalentof such claims.

For all the alternatives,a valuationof the securedcollateralis necessary. The Codeprovidesno guidanceas to whetherthe value shouldbe the goingconcern orliquidationvalue. Subclause

1129(b)(2)(A)(i)(ll)adds to this uncertainty. It requiresthe debtorto make deferredcashpaymentsto the creditorthat must, at least,be equalto the amountof the allowed securedclaimand have a present valueequalto the value of the collatera1? Thisrequiresthe courtto choosean appropriatepresent

266 B. Weintrauband A.N. Resnick,“CramDownof the UnsecuredCreditor:Section111(b)(2) Relief”(1983-84)16U.C.C.L.J.159at 160. The authorsposit the followingexample:

current amountoutstanding $15MM originalcollateralvalue $18MM currentcollateralvalue $12MM

In this scenario,the lien wouldremainon the collateralsecuringthe amountof $15MM. The deferred cash payments musthave a face amountof $15MMand have a present valueof $12MM. Although the presentvalueof the deferredpaymentsare only $12MM,eventually,the debtormust pay off the full securedamountwhichis $15MM. This result assumesthat the securedcreditormakesan electionunder subsection1111(b)of the Code. Recallthat under subsection506(a) of the Code,an undersecuredcreditor’sclaim is treatedas bifurcated. That is, the claim is consideredsecured upto the value of the collateraland is unsecured for the balanceof the claim. This value is fixedas atthe date of the filing of the petitionand as such, the securedcreditorwill notbe in a positionto take advantageof any appreciationin the valueof the collateralafter that date. Under subsection1111(b),the undersecuredcreditormay elect to have its entireclaim treatedas secured,whichresultsin its unsecuredportion beingwaived. However,making the electionwill allowthe creditorto take advantageof any possibleappreciationin the valueof the collateralup to the full value of its claimand preventsthe debtorfrom “cashingout”the creditorsin 263 value rateand the ratenecessaryto calculate thepayments tothe securedcreditorwhilethe debtoris performingits obligationsunder the 267plan.

For the plan tobe fair andequitableunderclause 1129(b)(2)(A)(i),the plan need not provide the secured creditorwith its strict contractualrights. In sucha case,the creditorwouldbe considered unimpairedand resort to the fair and equitablestandard wouldbe 268ulmecessary. The plan may rewritethe contract, forexample,to extendthe term or adjustthe interestrate closerto the market rate, providedalways that thestreamof paymentsbeingmadeto the creditorhas a presentvalueequal to the present valueof the secured269claim.

The secondway for the plan to be consideredfair and equitableto a dissentingimpaired securedcreditoris underclause 1129(b)(2)(A)(ii)wherethe plan contemplatesa sale of the collateral, free and clearof liens,with the liens attachingto the proceeds. The plan musttreat the lien on the

times whenthe marketfor the collateralis weak.

267 These ratesmay be the market ratefor eitherminimal,good orterriblerisks. The courtsdo not seemto have agreedon the appropriaterates tobe used in these circumstances. See e.g., In re 222 LibertyAssociates, supra note 251 at 994 (currentmarketrate);In re Monnier Brothers, 755 F.2d 1336 at 1338(8th Cir. 1985)(contractrate);In re Mitchell, 77 B.R 524 at 525, 527 (Bankr.E.D.Pa. 1987) (the lesserof the contractrate and the rate of yieldfor treasurybills due to matureon the dateof terminationof the debtor’splan);In re Jordan, 130B.R. 185at 192(Bankr.D.N.J. 1991)(costof fundsto the creditor). Choosing theappropriaterate requiresthe courtto makethe fundamental determinationof whichparties shouldbear therisk of futureperformanceby the reorganizeddebtor. In otherwords,the rateof interestpayable tothe creditorshouldbe higher if the courtperceivesthat the risk should beborneby the partiesthat will ultimatelystandto gainthe most fromthe reorganization. Again,the securedcreditor’sinterestin the reorganizeddebtoris fmite and is determinedby the ultimate valueof the collateral. Shouldthe reorganizeddebtor meetwith significant success,the interestholders willbe the beneficiariesof the successand shouldthereforebearthe risk of the future performanceby the debtor. SeeD.G. Baird and T.H Jackson, “Corporate Reorganizationsand the Treatmentof DiverseOwaershipInterests:A Commenton Adequate Protectionof Secured Creditors inBankruptcy”(1984)U. Chi.L. Rev. 97. See also, In re D. & F Construction,Inc., 865F.2d 673 (5th Cir. 1989),wherethe court heldthat thealternativesin subparagraph1129(b)(2)(A)were non-exclusiveand refusedto hold that the plan was fairand equitablenotwithstandingthat the provisionsof that subparagraphmay have been “literallymet.”[at 675]. Tnso doing,the court did not givethe words “fairand equitable”their meaningas wordsof art, but imposeda broader, moreliteralmeaning.

268 NortonBankruptcyLaw & Practices. 93:7.

269 fljj 264 proceeds inone of the other fair and equitablestandardsdiscussedhereiii Under subsection363(k),to which clause 1129(bX2XAXii)is subject,the secured creditor may bid at the sale and if successful, offset its claim againstthe purchase priceof the collateral.

The fmalway of satisfiing the fair and equitablestandardis to provide the securedclaimant with the indubitable270equivalent of its allowed securedclaim underclause 1129(b)(2)(A)(iii). In the event the securedcreditor makes the electionunder subsection1111(b)of the 27Code, that gives it a securedclaim on the collateral for the full amountof its claim, the plan will meet’ the indubitable equivalentstandardonly if the debtor providespayments,replacementliens or other propertyor considerationequalto the value of the 2debt. The legislative historysuggeststhat the plan maymeet the standardby returningthe collateral tothe securedcreditor, as the value of the secured claim is necessarilyequal to the value of the collateralsecuringthe 2claim. Under subparagraph1129(b)(2)(B)of the Code, a plan will be consideredfair and equitableto a class of unsecuredcreditors if:

(i) the plan providesthat each holderof a claim of such class receive or retain on account of such claim property of a value,as of the effective date of the plan, equal to the allowed amount of such claim; or (ii) the holder of any claim or interestthat is junior to the claims of such class will not receive orretain underthe plan on accountof suchjunior claim or interest any property.

Simply stated, the plan must provide the unsecuredcreditor with property equal in value to the

270 See discussion,chapter V(AXlXb), above,that describesthe conceptof “indubitable equivalent.”

271 Supra note 266.

The court in In m Sun CountiyDevelopment,Inc., 764 F.2d 406 at 409(9th Cir. 1987), allowedthe debtor to provide the securedclaimantwith substitutecollateral inorder to satisfythe indubitableequivalent standard. However,the BankruptcyCourt for the Districtof North Dakota would notpermitthe debtor to undertakethe same strategy in In ie Hoff, 54 B.R. 746 at 753 (Bankr. D.N.D.).

273 124 Cong. Rec. Hi 1103-05(daily ed. 28 Sept 1978);S. 17421(daily ed. 6 October 1978); remarksof Sen De Concini,reprinted in A.N. Resnick and E.M Wyski, eds., BankniptcyReform Act of 1978:A LegislativeHistoiy, vol. 17, doc. 59 (Buffalo:William S. Hem, 1979);see e.g., In re SandyRidge DevelopmentCoip., 881 F.2d 1346at 1350(5th Cir. 1989),reh’gen banedenied, 889 F.2d 663 (5th Cir. 1989). 265 allowedamountof the claim or alternatively,property of a value less than the full amountof the claim,providedjunior creditorsor interest holdersreceivenothingunderthe plan. The latter alternativeis a codificationof the absolutepriority274rule. Difficultiesarise if, in seekingto obtainthe consentof all creditors,a seniorclass agreesto giveup someof its valueto a junior classof creditors or interestholders. if an interveningclass doesnot receivethe full amountof its claimunderthe plan, the plan cannotbe confirmedon the basisthat a class lowerin priorityto the intermediateclassis receivingsome275value.

Finally,subparagraph1129(b)(2)(C)providesfor the fair and equitabletreatmentof a classof interestholders. That subparagraphprovidesthat the plan is fair andequitableif:

(i) the planprovidesthat each holderof an interestof such class receiveor retainon accountof such interestpropertyof a value,as of the effectivedate of the plan, equalto the greatestof the allowedamountof any fixed liquidationpreferenceto which suchholderis entitled,any fixedredemptionprice to whichsuchholderis entitled,or the valueof such interest;or (ii) the holderof any interestthat isjunior to the interestsof such classwill not receiveor retainunderthe plan on accountof suchjunior interestany property.

This standardis not unlikethe fair and equitablestandard applicableto unsecuredcreditors. However, giventhat the claimsof interestholdersare generallythe mostjunior, it appearsthat any planthat eliminatesownershipinterestsunderclause 1129(b)(2)(C)(ii)wouldbe confirmed. However,as interestholdersare receivingnothingunder theplan, they are deemedto have rejectedthe 276plan.

Accordingly,they could force a valuationhearing,which,becausethey are receivingnothingunderthe plan, coststhem nothingand erodesthe debtor’spropertythat would otherwisebe available to creditors. Shouldthe valuationhearingindicatethat there is equityin the reorganizedentity,a classof creditorsis necessarilyreceivingmorethan the full valueof its claims,to the detrimentof the interest

274 Norwest Bank of Woiihingtonv. Ahlei, 485 U.S. 197at 202 (1988),n3v’g794 F.2d388 (8th Cir. 1986)[hereinafterAhleJ. See also In i Snyder, 967 F.2d 1126at 1128(7th Cir. 1992). I.D. Labovitz, “Outline of ‘CramDown’ProvisionsUnder Chapter11 of the Bankruptcy ReformAct of 1978”(1981)86 Corn.L.J. 51 at 52.

276 Code s. 1126(g). 266 holders. Thus,the plan cannotbe confirmecL Practically,this givesthe interestholdersa significant amountof bargainingleveragethat may prompt a senior class of creditorsto give up some valueto the interestholdersto securetheir 278consent. Debtorscommencethe vast majorityof reorganizationcases in both Canadaand the United

States. Unlessthe debtoris a largepublicly-heldcorporation,the principalsof the debtorare also its majorshareholders. Thus,part of the reorganizationplan usuallygivesthe formershareholderssome interestin the reorganizeddebtor. For theformershareholdersto retainan interestin the reorganized debtor,it will be necessaryfor the plan to followthe absolutepriorityrule, whichmeansthat theplan mustpay in full all claimsand interestsseniorto the shareholders. The courtshave createdan exceptionto this generalnile however,knownas the “newvalue”exceptionto the absolutepriority rule. This exceptionwas createdby L.A. Lwnbei whichestablishedthat thefollowingcriteriamust be presentfor the new value exceptionto operate:

1. the debtormust have a need for the new value contribution,

2. the ownershipinterestretainedor receivedmust be the fair equivalentof the contributionmade; and 3. the contributionmust be in moneyor money’s28wortK The courtheld that the intangiblecontributions the formerowners° to the reorganized of entitywould not satisfythe criteriaand accordingly,the test is obiter ’28dictum. However,the case has found

277 NortonBankruptcyLaw & Practices. 93:14.

278 Tnthe eventthat the debtoris clearlyinsolvent,it has been suggestedthat a party in interest seek a “preemptivecram down”whichsummarilyeliminatesthe interestholderfrom the reorganizationprocessand preventsit from seekinga value for its valuelessinterestthrough negotiation,L.M LoPucki and W.C.Whitford,“PreemptiveCramDown”(1991)65 Ani Bankr.L.J. 625.

Supranote 256.

280 Ibid at 121-122;see also,In ie 222 LibertyAssociates,supra note 251 at 984-985.

281 Ibid at 121-122. 267 considerablesupport under the 2Code. If L.A. Lumber is consideredthe seminal case that establishedthe new value exceptionprior to the passageof the Code,A283hlers’ is the case that establishedthe exceptionunder the Code.

However,like L.A. Lumber,the court in Ah1ei refusedto allow the former shareholdersthe rightto retainan interest under the plan on the basis that their “labor,experienceand expertise” was not new value. Thus, the two leadingcases that purportedlyestablishand maintainthe2new value exception actuallyrefusedthe shareholdersthe right to use it. This has prompted a debate as to whetherthe new value exception even exists under the 285Code. However,as the court in Ahlei held that an intangiblecontributionwill not constitutenew value and most principals of the debtor have few personalassets to contributeto the reorganizeddebtor, it is difficult to imaginethis being a significant issue. It will only become an issueif the shareholdersare able to obtain outside fmancing thatwill allow them to contribute“moneyor moneys worth,” in which case, the existingcreditorsbenefit from the enhancedvalue or at leastthe new value protects their interests in the interim.

Shouldwe import the concept of cram down into Canadianreorganizationlaw? The answerto this questiondepends on how far the policymakerswish to go in makingreorganizationpart of

Canadiancommercialculture. This section has attemptedto illustratethat the cram down mechanism is not simply an exercise in lookingat the plan, determiningwhether it is fair or reasonableand then

“crammingit down”on recalcitrantcreditors. In fact, it is a very complex analysis upon whichthe

282 See e.g, In i Snyder,supra note 274 at 1128-1131,where the court discussesthe historyand present status of the new value exception. In so doing, it makes a strong argumentfor the continued existenceof the exceptionunder the Code. See also In r LcxncauBoat Co., 13 B.R. 788 at 791-794 (W.D.Mo. 1981);cf Greystone,supra note 194at 142.

283 Supra note 274.

284 Ibid at 199. It should be notedthat the UnitedStatesSupremeCourt specificallyrefusedto rule on whether the new value exceptionsurvivedthe enactmentof the Code [at 203 n. 3].

285 See e.g., In re Sovereign Group1985-27,Ltd, 142B.R. 702(RD. Pa. 1992)and In re Bonner Mall Parineihi, 142B.R. 911 (D. Idaho 1992),that heldthat the new value exceptionsurvivedthe passage of the Code, and In re A.V.B.i, Inc., 143B.R 738 (Bankr. C.D. Cal. 1992),which heldthat the new value exception did not survivepassage of the Code. 268 entire structureof Chapter 11 is based. One author calledcram down the “heartof chapter .“ To attemptto import certain aspects of the cram down without analyzingthe entire systemand individual mechanismsembodiedin Chapter11 would have chaotic and unjust results. Accordingly,this paper does not advocatethe importationof cram down without a thoroughanalysis of all aspectsof Chapter

11.

We have seenthat the prospect of a cram down rather than the actual mechanismis a useful tool in the United States. A simplermechanismthat gives the court discretionto impose a plan on recalcitrantcreditors should there be impropermotives forrejecting a plan mayproduce the same results. The discretionexercisedby the courts,whichallowsthemto disregard votesof creditors improperlyexercisedor obtained,is a formof cram downalreadyused in this country. In other words,if a classrejecteda plan and the court fmdsthat the membersof the class constitutingthe majoritydid not cast their votes in goodfaith,the court essentiallyimposesthe plan on the classby disregardingthe will of the majority. However,if there are valid businessreasonsfor the class rejectingthe plan, itis difficultto see why the court shouldbe able to imposethe plan on the rejecting class.

The answerto this concernfrom an Americanperspectiveis the fair andequitableor absolute priorityrule. With the predominanceof securedcredit in Canada,as opposedto the moreprevalent equityfinancingthat is foundin the UnitedStates,the absolutepriorityrule may be practically meaningless. In most cases,a securedcreditorcan controlthe reorganizationproceedingssimply becauseit has all of the assetsencumberedby its securityinterests. Becauseof its uniqueposition,it will be in a separate classand usually,it will dominate theunsecuredcreditor class because of the shortfallin its securityposition. Accordingly,rejectionby the securedcreditorwill defeatthe plan in any event. A requirementthat the plan follow theabsolutepriorityrule in such circumstanceswill doomany plan to failure.

286 Miller,supra note 255 at 1063. 269 Cramdo is usellil, as demonstratedin the United Statesfor almost a centiuy. However,the entire reorganizationsystem facilitates its use. Without importingthe entire systemthat supportsit, the cram do mechanismcannot work equitably. 270

CHAPTERVII

CONCLUSION

The Codeis presentlyunderattack,by the academiccommunities’and policymakers. ProfessorElizabeth Warrenperhapsbest summedup the reasonfor the attackas2 follows: After twelve years of experiencewith the new BankruptcyCode, people are angry with the bankruptcyprocess. Creditorsare angrywith debtorswho have resistedpaymentandthwarted their collectionefforts. Employeesare angrywith companiesthat have laidthem off whilethe big boys remainin theirhigh paying jobs. Tortvictimsare angrywith companiesbecause they are not getting enoughmoneyto compensatethem for all that they have lost. Judgesare angrywith the disputantsbecausethey haveneitherthe timenor the resourcesto monitorthe cases in their care. And everyoneis angrywith the lawyersbecausethey are gettingrich?

The attackhas takenplace on two levels. The first is on Chapter11 itself and its results. The “first shot”in this attackcamefrom an articlepublishedin the YaleLaw Journal in 1992.” Thisarticlewas basedon empiricalevidencethat caused theauthorsto concludethat thebusinessreorganization process:

1. was inefficientbecauseof the costs incurredin completingthe procedureandthe lengthof time that the proceduretakes;

2. encourages mismanagementbeforeand after commencementof the proceedings;

3. does not protect the partiesto the bankruptcyproceedings;and

1 See e.g., D.G. Baird, “TheDark Side of Chapter11:A Commenton ProfessorTriantis’Article” (1992)20 Can. Bus. L.J. 261; M Bradleyand M Rosenzweig,“TheUntenableCase for Chapter11” (1992) 101Yale L.J. 1043.

2 Bills were passedin 1992by the Senateandthe Housethat wouldhave createda National BankruptcyReviewCommissionto provideCongresswith suggestedamendmentsto the Code. The bills had differences thatwere resolved,but the compromisebill was notpassedbecauseof the end of the legislativesession. On September15, 1993,however,the BankniptcyAmenthnentsAct of 1993 receivedapprovalof the SenateJudiciaryCommittee. Thislegislationseeksto rectifysomeof the problemareasthat have been identifiedin the caselaw and by commentators overthe 16yearsof the Code’sexistence,but it does not suggestthat Chapter11be repealed. The passageof this proposed legislation“is quite a way from approvalby both the Senateand the House.”[MM Sheinfeld, “October3, 1993 Supplementto the Futureof Chapter11:Tensionsin ReorganizationPractice” [unpublished]].However,this suggeststhat Congresshas recognizeda need to amend thecurrent system employedby the Code.

E. Warren,“TheUntenableCase forRepealof Chapter11”(1992) 102Yale L.J. 437 at 477.

Bradley andRosenzweig,supra note 1. 271

4. encouragesbad faith filingsbecause of the easy accessthat debtors have to the courts.

Thesepropositions causedan immediate responsefrom commentatorswiio criticizedthe methodology of the 5authors, and the analysis of the data 6obtained. The second level of attack is basedon bankruptcypolicy. On the leadingedge of this attack are ProfessorsThomas Jackson and Douglas7Baird. This attack is founded in law and economicsand focuseson the fact that a reorganizationproceedingdoes not result in an efficient deploymentof the debtor’sassets. It assumes that a bankruptcysystem should mirror an agreementthat the creditors would negotiate among themselvesconcerningthe deploymentof the assets of the 8debtor. The creditorswould seek to avoid collectioncostsand risks of losing the race to the swiftestthat occursin state collectionproceedings,and settle insteadfor perhaps less than full recoveryby usingthe collectiveproceeding of bankruptcy. However, creditorsand interest holders would likely not choose reorganization. They would9 likely choose a liquidationof the assets of the debtor, given thecosts attendanton a reorganizationproceeding,the time requiredto completeit and the “potentialdistortions from a fictive valuation of a °1firm” that is necessaryin any reorganizationproceeding. Professor Baird summedup a criticism of reorganizationpolicy on this level as follows:

Warren,supra note 3.

6 Warren, ibid; L.M LOPUCki,“StrangeVisions ina StrangeWorld: A Reply to Professors Bradley and Rosenzweig”(1992)91 MIch.L. Rev. 79.

‘ See e.g., D.G. Baird, “LossDistribution,Forum Shopping,and Bankruptcy:A Reply to Warren” (1987) 54 U. Chi. L. Rev. 815; D.G. Baird, “TheUneasy Case for CorporateReorganizations”(1986) J. Legal StucL127 [hereinafterUnecy Case];D.G. Baird and T.H Jackson, “Corporate Reorganizationsand the Treatmentof DiverseOwnershipInterests:A Commenton Adequate Protectionof Secured Creditors inBankruptcy”(1984) 51 U. Chi. L. Rev. 97; T.R Jackson, “Bankruptcy,Non-BankruptcyEntitlements,and the Creditors’Bargain (1982) 91 Yale L. J. 857 [hereinafterCreditors’Ba,gain]

8 Creditors”Bargain, ibid at 860. Professor Jacksonrefers to this as the “creditors’bargain model.” See also UneasyCase,ibid at 127-128

Creditors’Bargain, ibid at 863-864.

10 UneasyCase,supra note 7 at 128. 272

• . . reorganizationsprovidebreathingspacefor troubledenterprises. They do not existto implementthe investors’bargain .. . Rather,they existto preventthe creditors’individual (or collective)interestsfrom destroyinga finn as a goingconcernby forcingit to liquidate piecemeal,destroyingbothjobs and assetsin the process. Bankruptcylaw, underthis view, tries to ensurethat a firm survives,quite apartfromwhetherthe ownersas a groupwsnt it to or not... This approachto bankruptcylaw frequentlyseemsto assumethat we are betteroff if a particularfirm stays in business. It doesnot squarelyface the possibilitythat all interested partiesmightbe betteroff as a groupif the firms assetswere put to a different1use.’ To avoid leavingthe readerwith the false impressionthat Chapter 11has no defenders,one mustnotethat the foregoingapproacheshavetheir own critics.12 The “lossdistributiontheory” espousedby 13Warren denouncesthe simplisticapproachtakenby Baird and Jacksonthat bankruptcy law is meantto rationalizethe problemsencounteredin debt collection. It seesthe bankruptcyprocess as attemptingto accommodateand effectivelysort out, not onlythe interestsof creditors,but also a broaderrange of 14interests, such as tort claimants,“unemployable”employees,customers,adjacent propertyowners and the 5like.’ Warren’s“traditional6vie” has been describedas follows: Accordingto the Traditionalview,the only “system”at work in the law of bankruptcyis one that providesfor the case-by-caseadjustment, realignment,and reformulationof bankruptcy purposesalongfunctionallines. It seemsfair to state,then, that the Traditionalviewregards the centralpurposeof bankruptcy,if it can be calledthat, as the apportionmentof losses occasionedby firm collapseaccordingto a set of principles,none of which is pre-eminentby 17defmition. Warren,describesher theoryas “a dirty, complex,elastic,interconnectedview of bankruptcyfrom whichI can neitherpredictoutcomesnor even necessarilyfully articulateall the factorsrelevantto a

UneasyCase,supra note 7 at 134.

12 See e.g., supra note 6.

13 E. Warren, “BankruptcyPolicy”(1987)54 U. Clii.L. Rev. 775.

14 Ibid at 777.

15 Ibid at 787-788.

16 L. Ponoroffand F.S. Knippenberg,“TheImpliedGoodFaith Filing Requirement:Sentinelof an EvolvingBankruptcyPolicy”(1991)85 N.W.U.L.Rev. 919 at %l.

17 Ibid at 961-962. 273 policy18decision.” However,this shouldnot derogatefromthe utilityof her theory, as it reflectsthe complexweb of bankruptcylaw in practice.

Contemporarylaw reformersmust considerWarren’sapproach. That approachappearsto raise morequestionsthan answers and the questionsraisedconfrontsquarely thenormativeconsiderations that underliebankruptcyreform. Clearly,there is no correctanswerto these inquiriesand the “most correct”answersdependon whetherone approachesthe issuefromthe perspectiveof the debtor,a creditor,an equity interestholderor someotherthird party affectedby the process. The fundamental questionposedby Warrenis:

if the justificationfor bankruptcyis also distributional,the relevantinquiryis necessarily larger:what are the valuesto be protectedin the distributionalscheme,and is the implementationschemeeffective?’

If law reformersare not prepared9 to considerthis fundamentalpremise,bankruptcyreformwill merely be a piecemealcompositeof variousrules with no tmifiedobjective. With respect,the latest amendmentsto the proposalprovisionsof the BIA have resultedin this type of regime.

This chapterbrieflyand superficiallyreferredto the foregoingtheoriesto showthat there is no unityamongAmerican scholarsconcerningthe policiesunderlyinga bankruptcysystemand whethera businessreorganizationsystemservesany useful purpose. Bradleyand Rosenzweigwent so far as to

20 suggestthe repealof Chapter11 This paperwill not debatethe issueof whetheror not Congress shouldrepeal Chapter 11. In fact, one must questionthe role of a Canadianbankruptcypractitionerin the debate. However,the debatepointsto a seriousfailingof Canadianpolicymakersin amendingthe formerCanadianAct. As mentionedpreviously,the processof bankruptcyreformin Canadastartedin

1966with the formationof the committeethat producedthe Tassé Report. AlthoughParliamentdid

18 Warren, supra note 13at 811.

19 Warren,supra note 13at 796.

20 Bradleyand Rosenzweig,supra note 1 at 1078,where theauthors said “[c]hapter11shouldbe repealed.abolishingcourt-supervisedcorporatereorganizationsand, in effect,precludingresidual claimantsfrom participatingin any reorganizationof the firm.” 274 not enactmajoramendmentsuntil 1992,it madethe amendmentshastilyand withoutthoroughly understandingthe normative considerationsoutlinedby Warren. Furthermore,it appearsthat certain aspectsof Chapter 11and the CCAAwere incorporatedinto the BIA withoutcarefulconsiderationof the how those provisionswork withinthe host system.

As a result,the BIA is a piecemealcompositeof mechanismsthat do not addressvital issues and placerestraints onthe courtsthat will notallowthe developmentof equitableconcepts. One wonderswhetherthe policymakersfelt that businessreorganizationwas a necessarypart of a bankruptcyand insolvencysystem,giventhe opting-outrightsof securedcreditors andthe overt protectionaccordedto landlords. The flexibilityof the CCAAat least encouragesthe partiesto attemptto reach a workablesolution. The prioritypayments,opting-outrights and requirementfor an independentproposaltrusteeunderthe BIA and the costs attendanton a proceedingunderthe CCAA haveresultedin Canadahavingno reorganizationregimeavailablefor the averageCanadiandebtor; onlythe “elite”may reorganize! If the policymakersconcludethat the Canadianbusinesscommunity wantsa reorganizationsystem,they must enactlegislationto accomplishthe objectiveof maldngthe systemaccessibleto all debtors.

It may be trite to say that apersondrafting legislationmust havea thoroughknowledgeof the objectivesof the proposedlegislationand the meansof accomplishing21theni In the preparingthe amendmentsto the formerCanadianAct, the policymakershad accessto two comprehensivereportsof the currentand proposedbankruptcyregimes. The TasséReportand the ColterCommitteeReportset forth objectivesof bankruptcylegislationwhichshowthe delicatebalancing requiredof the person draftingthe legislation. On the extremeends of the spectrumare the respectiveinterestsof the debtor and its creditorsand somewherewithinthe spectrumare largersocietalinterests. Those considering future amendmentsto the Canadian businessreorganization regimeswouldbe welladvisedto reacquaintthemselveswith those reports.

21 G.C. Thornton, “LegislativeDrafting”2d ed. (London:Butterworth,1979)at 106. 275

Neitherthe Codenor the CCAAare modelsthat the policymakersshouldseekto emulateentirelyin any reformsto the BIA. An analysisof these modelspointsto weaknessesand vaguereferencesthat Canadianpolicymakersshould seekto avoid. However,there are certainaspects of each of thosemodels andthe casesdecided thereunderwhichshouldbe consideredimportantto any reorganizationregime. In particular,the conceptof adequateprotectionseeksto balancethe diverse interestsinvolvedin a reorganizationproceeding. if properlyframed,the conceptwill facilitatethe reorganizationeffortsof the debtorby protectingthosethat are most likelyto challengethe effortsand encouraging partiesto providefinancialsupportto the debtor. In addition,the partiesin interest should controlthe reorganizationproceeding,not an independentthird partythat has little or no interestin the fate of the debtoror its creditors. The partiesin interest shoulddeterminewhether interjectionof an independentpersonis necessaryor desirable. Finally,as reorganizationis a collectiveproceeding, theconductor motivesof a party or groupshouldnot determinethe fate of the reorganization.Whetherthe debtorhas propermotivesin commencingthe proceedingor a creditoris seekingto obtainsomeunfairadvantage,shouldnot formthe basis fora dismissalof the proceeding.

Instead,once the plan proponentcommencesthe proceedings,the interestsof all partiesand the benefitsaccruingfrom a reorganizationmustbe considered. The legislationmustprovidepersonal sanctionsagainst theoffendingparty. As presentlyframed,the CCAA has the necessaryflexibility to accomplishthese objectives;the BIA doesnot.

The objectivesof this paperwere twofold. First,to showthat in formulatingany proposalsfor reformof a businessreorganizationsystem,it is usefulto look beyond thestatutesand case law developeddomestically. This notion is neithernew nor originalin bankruptcyreform. The

BankruptcyAct, 194 “wasbased on the studyof bankruptcylegislationof othercountries, particularlythat of England,Australiaand the United23States.” The analysisshouldbe functional,in

S.C. 1949,c. 7.

L. Duncanand J.D. Honsberger,Bankruptcyin Can&a, 3d ed. (Toronto:CanadaLaw Boolç 1961)at 18. 276 the sensethat the policyakers shouldconducta thoroughstudyof the legislation,case law and commentaries,to appreciatethe impactof the provisionunderconsideration. This suggested methodologywas illustratedin this paper.

More importantly,however,as a preludeto that study,Canadianpolicyniakersmust wrestle withthe fundamentalquestionof whetherthe Canadiancommercialcommunityeven wantsa system of businessreorganizations.In this regard,the policymakersshouldrefer to the debatesin the

Americanlawjournals concerningbankruptcyand reorganizationpolicy. In addition,the processof bankruptcyreformhas alsobegunin the UnitedStates. Canadianpolicymakersshouldkeep themselvesapprisedof developmentsin that regard. In particular,Canadianrepresentativesshould attendor reviewthe proceedingsof any Congressionalhearings. If the policymakerssee business reorganizationsas desirable,for whateverreason,the next step is to determinethe valuesthat will be protectedand the legislativemethodof effectivelyprotectingthose values.

Chapter11 does not resolveall of the foregoingissues. However,it providesus with illustrationsof how we may or may not wantto reformour businessreorganizationsystems.

Ultimately,there is no reorganizationsystemthat will pacifyall constituencies.Undertakingthe thoroughstudysuggestedby Edwardsat the outsetof this paper may not provideus with the “fairest and mostfeasibleschemepossible”but it will allowus tojustify the schemeultimatelyadopted.