Chapter 27 - lecture notes PDF

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Chapter 27: Bankruptcy and Insolvency27-1 Business Failure Bankruptcy and insolvency law evolved o Bankruptcy Insolvency Act (BIA) and the Companies’ Creditors Arrangement (CCAA)27-2 Informal Steps Before contemplating bankruptcy, may first try to solve its financial problems by way of negotiated ...

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Chapter 27: Bankruptcy and Insolvency 27-1 Business Failure 

Bankruptcy and insolvency law evolved o Bankruptcy Insolvency Act (BIA) and the Companies’ Creditors Arrangement (CCAA)

27-2 Informal Steps   

Before contemplating bankruptcy, may first try to solve its financial problems by way of negotiated settlements. The key to negotiated settlements is ensuring that all creditors agree. May push through agreements that is unfair to others or that simply ignores them

27-3 Proceedings before Bankruptcy  

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Should seek lawyer or accountant Trustee in Bankruptcy: The person who has legal responsibility under the BIA for administering bankruptcies and proposals. o Will explain the options o The trustee will also begin to assess the estate and prepare a preliminary statement of assets and liabilities  Estate: The collective term for the assets of a bankrupt individual or corporation. Insolvent: Unable to meet financial obligations as they become due or having insufficient assets, if liquidated, to meet financial obligations. o unable to meet obligations as they become due, ceased paying, have assets less than liabilities Insolvency: factual state about person’s assets and liabilities Bankruptcy: legal mechanism where assets are transferred to trustee

27-4 Proposals a nd Arrangements 

It may be possible for an insolvent debtor to avoid bankruptcy by making a proposal or entering into an arrangement with creditors.

27-4a Proposals unde r the BIA   

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A proposal is a procedure governed by the BIA that allows a debtor to restructure its debt in order to avoid bankruptcy. When a debtor makes a proposal, the debtor offers creditors a percentage of what is owed to them, or an extension of the deadlines for payment of debts, or some combination of the two. There are two types of proposals under the BIA: o Division I proposals: are available to individuals and corporations with no limit on the total amount of debt that is owed.  this gives a business the opportunity to remain business and ultimately be successful. o Division II proposals: are available to individuals with total debts less than $250 000 (not including a mortgage on a principal residence). Division II proposals are known as “consumer proposals.”  The debtor must also attend two mandatory counseling sessions, and the proposal will be recorded on the debtor’s credit record for several years. Must stop making payments to unsecured creditors Majority of creditors vote to agree (two types of proposal based on debt sizes) If approved, terms are binding on creditors and applied If the debtor does not make the payments set out in the proposal, or fails to comply with conditions contained in it, then the trustee or any creditor can apply to have the proposal annulled.

27-4b Arrangements under the CCAA       

The CCAA may be used by corporations that have total debt exceeding $5,000,000 The CCAA is a federal statute that allows an insolvent company to obtain protection from its creditors while it tries to reorganize its financial affairs. More complex process- for larger corporations but provides for more flexibility Would begin with application for temporary protection from creditors for 30 days for a Plan of Arrangement, can be extended Monitor to monitor business and prepare plan Plan of arrangement presented to creditors, must approve 2/3 of vote Debtor in Possession (DIP) Financing: Secured credit provided to companies during the reorganization process with priority over existing secured creditors. o Will need to balance interests of creditors o Use to fund business operations

27-4c Remedies for Creditors 

The creditor often has a difficult choice to make: allow the debtor additional time to pay, or take legal action for the recovery of the debt.

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A secured creditor can seize its collateral and sell it to pay down its debt, or appoint a receiver to take control of the debtor’s business An unsecured creditor can sue the debtor and try to obtain judgment, which can then be enforced against the debtor. A creditor with a guarantee can pursue the guarantor for payment upon default by the primary debtor. A supplier can threaten to discontinue selling to the debtor Any creditor can threaten to commence legal action in the hope that the threat will persuade the debtor to bring the debt into good standing.

27-5 Bankruptcy  

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Bankrupt: The legal status of a debtor who has made an assignment or against whom a bankruptcy order has been issued (also used to describe a debtor who is bankrupt). The bankruptcy process is governed by the BIA. The purposes of the BIA are: o to preserve the assets of the bankrupt for the benefit of creditors. o to ensure a fair and equitable distribution of the assets to creditors. o in the case of personal bankruptcies, to allow the debtor a fresh financial start. There are three methods by which a person may become bankrupt: o Assignment in Bankruptcy: The debtor’s voluntary assignment to the trustee in bankruptcy of legal title to the debtor’s property for the benefit of creditors.  An assignment in bankruptcy occurs when a person voluntarily assigns her assets to a trustee in bankruptcy. o Bankruptcy Order: An order of the court resulting in a person being declared bankrupt.  be granted if the creditor is owed at least $1000 and the debtor has committed an act of bankruptcy.  Act of Bankruptcy: One of a lists of specified acts that the debtor must commit before the court will grant a bankruptcy order. o Lastly, bankruptcy occurs automatically if the creditors reject a Division I proposal, or if the creditors accept a Division I proposal but the court rejects it.

27-5a The Bankruptcy Process  

When ordered by Bankruptcy Court- give full permission to trustee to own assets and dispose of them to distribute to creditors Inspector: A person appointed by creditors to act on their behalf and supervise the actions of the trustee in bankruptcy.

Protection of Assets    

the trustee gives public notice of the bankruptcy in order to identify and protect the assets of the estate and to identify all liabilities. the trustee may continue running the business for a period of time assets that were transferred before bankruptcy- paying certain creditors before others can be reversed and may have to repay

Transfers at Undervalue 

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Transfer of property or provision of services for less than fair market value. o Where a transfer at undervalue is found, the court can declare the transfer to be void or can order that the other party to the transaction pay the bankrupt estate the amount by which the consideration for the transaction was less than fair market value. See whether Arm’s Length: People who are independent of each other and not related. o If the parties to the transaction are at arm’s length, then a transaction is a transfer at undervalue if: o Less than market value, within a year before bankruptcy, debtor is insolvent, intention defraud, defeat, or delay interests of creditor (highly specific to case) o If the parties to the transaction are not at arm’s length, then a transaction is a transfer at undervalue if it took place within one year prior to bankruptcy. In that case, there are no solvency or intent criteria. o If a non-arm’s length transaction took place within five years prior to bankruptcy, it is a transfer at undervalue if the solvency and intent criteria

Preferences    

A preference is a payment that benefits one creditor over another. Transfer can also be void If arm’s length: within three months and intent to prefer one over another If not arm’s length: within a year the effect of the payment was to prefer one creditor over another.

Fraudulent Conveyances 

Every transfer of property that is made with the intent to defeat, hinder, delay, or defraud creditor is void.

Bankruptcy Offences

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Criminal acts defined by the Bankruptcy and Insolvency Act (BIA) in relation to the bankruptcy process. Penalties for bankruptcy offences range from conditional discharges to fines up to $10 000 and prison terms up to three years.

27-5b Identification of De bts 

Proof of Claim: A formal notice provided by the creditor to the trustee of the amount owed and the nature of the debt. o The trustee examines each proof of claim and either accepts or rejects the claim. o Creditors whose claims are rejected have the option to challenge the rejection in court.

27-5c Distribution to Creditors   

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Unpaid Suppliers: allowed to recover any goods shipped in the past 30 days which were not paid for, provided the debtor is bankrupt and the goods are in the same condition as when shipped. Deemed Statutory Trusts: The federal government has passed legislation which deems property to be held in trust in regard to unremitted payroll deductions and GST/HST which has been collected but not remitted. Secured Creditors: with properly perfected security interests are entitled to take possession of their collateral and dispose of it, regardless of bankruptcy. Can take collateral and dispose of it and sue for the remaining amount of debt as a unsecured creditor, can also start as a unsecured creditor for full amount. Preferred Creditors: Certain unsecured creditors who are given priority over other unsecured creditors in the bankruptcy distribution. o Preferred creditors, in order of priority, include: funeral expenses, trustee fees and expenses, including legal fees, arrears in wages (up to $2000 per employee for the previous six months), municipal taxes, arrears of rent and accelerated rent, in each case up to three months. Unsecured Creditors: The remaining funds in the bankrupt estate, if any, are paid to the ordinary unsecured creditors in proportion to the amounts they are owed. Employees: who are owed wages are deemed to be secured creditors, with a first charge on the current assets of their employer, for up to $2000 per employee. the final distribution of assets o CRA is paid in full for the unremitted payroll deductions. o the bank is paid in full under its mortgage as a secured creditor. o the trustee’s fees and municipal taxes are paid in full as preferred creditors. o the remaining claims of unsecured creditors are paid at the rate of $0.1577 for each dollar owed.

Credit can be either secured or unsecured. Secured credit is when the creditor which you owe money to, has an interest in all or some of the debtor’s property in order to secure repayment of the debt. This means that if one was to default on their payments, the creditor has the right to sell or seize your property in order to pay the loan off. Examples of secured credit would be a mortgage or a car loan. The car loan issuer can repossess the vehicle and take ownership of it. If you default on mortgage payments the bank is able to start the process of foreclosure and resell the property in order to recoup the funds owed. Unsecured creditor is when the creditor which you owe money to does not have interest in any of the debtor’s property as security if the debtor defaults on payments. Examples of unsecured credit would be credit cards or a personal loan. Although defaulting on your payments would negatively impact your credit or be sent to a collections department, the creditor does not have the right to any collateral from the debtor. 27-6 Personal Bankruptcy  

Discharge of Bankruptcy: An order releasing the debtor from bankrupt status and from most remaining debts. a first-time bankrupt will receive an automatic discharge of bankruptcy nine months following bankruptcy. For a second bankruptcy, automatic discharge occurs 24 months following bankruptcy. If an automatic discharge is not available for any reason, the bankrupt must apply to the court for a discharge and the court will conduct a hearing.

Chapter 27 Quiz Which transaction would a court be least likely to recognize as being an arm's length transfer at under value? 

a transaction that took place within five years prior to the bankruptcy

Boutique Clothiers Ltd. is owned by Kat Marshal and is unable to pay its debts as they fall due. The business' assets, which consist mostly of women's clothing, are valued at about $8,000 and the business has liabilities exceeding $25,000. Kat is planning to close the business at the end of the month and plans to take the remaining clothing inventory and give it away to friends and family members. If Boutique Clothiers Ltd. declares bankruptcy, which statement best describes the situation?

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This would be a non-arm's length transfer to Kat and will be deemed a transfer at undervalue and void.

What is the key to reaching a negotiated settlement when a business is having financial problems? 

ensuring that all creditors are in agreement and the agreement is fair to all creditors

What is the role of a trustee in bankruptcy? 

The trustee has the legal responsibility under the Bankruptcy and Insolvency Act for administering bankruptcies and proposals.

What is the difference between being insolvent and being bankrupt? 

Insolvency refers to the factual question of whether you can meet your financial obligations as they fall due or whether you have sufficient assets to pay all of your debts; bankruptcy is a legal mechanism in which your assets are transferred to a trustee and then sold with the proceeds distributed to creditors.

What is the purpose of the proposal procedure under the Bankruptcy and Insolvency Act? 

to restructure the debts so the debtor can avoid bankruptcy

What is the legal consequence to the debtor if a proposal under the Bankruptcy and Insolvency Act (BIA) is not approved? 

For a Division I proposal, the debtor will automatically be deemed to be bankrupt. For a Division II proposal, the debtor can make further proposals.

Which of the following is least likely to lead to an individual being legally declared bankrupt? 

The debtor becomes insolvent.

If the bankrupt's creditors consist of a credit card company, the federal government for unremitted payroll deductions, unpaid employee wages under $2,000, and the municipality for unpaid municipal taxes, in what order will the trustee in bankruptcy distribute the proceeds of the debtor's estate? 

first to the federal government, then to the employees, followed by the municipality, and then the credit card company

Which statement best describes personal bankruptcies? 

The debtor will be allowed to retain certain assets, such as some clothing, furniture, and an inexpensive vehicle.

ACME Motors* is unable to meet its short-term liabilities and the value of its assets is not enough to cover its debt. ACME Motors can be described as being which of the following? *The names used are fictitious; any likeness in name to actual persons or businesses is unintentional and by coincidence only. 

insolvent

Centra Holdings* is experiencing financial difficulty. Its current debt is in excess of $7 000 000, mostly to secured creditors. Centra is hoping to come to some arrangement with its creditors to avoid bankruptcy and keep the business operating while the company restructures. To accomplish this, Centra Holdings would likely avail itself of which process? *The names used are fictitious; any likeness in name to actual persons or businesses is unintentional and by coincidence only. 

the Companies' Creditors Arrangement Act (CCAA)...