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INSOLVENCY & BANKRUPTCY ISSUES FOR
INFORMATION TECHNOLOGY
Michael A. Fitch, Q.C. Fasken Martineau DuMoulin LLP
Suite 2100, 1075 West Georgia Street Vancouver, B.C. V6E 3G2
April 2002
.
* The author acknowledges with appreciation the contribution to this article by Patrick Shea of Gowling LaFleur
Henderson LLP, Toronto, who prepared an earlier version for this year’s Toronto Conference of IT CAN.
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Insolvency & Bankruptcy Issues for Information Technology
II. The Framework
The Canadian insolvency regime is centred around two pieces of federal legislation: the
Bankruptcy and Insolvency Act1 and the Companies’ Creditors Arrangement Act2. The
BIA is a comprehensive statute that provides for both the liquidation, through
bankruptcy, and the reorganization of insolvent debtors. Unfortunately, the statute dates
from the late 1940’s and, while it has been amended on a number of occasions, it still has
major gaps in how it deals with contracts and intangible property in the context of both
liquidations and reorganizations.
The CCAA stands in stark contrast to the BIA. Originally enacted in the 1930’s, it
provides only for the reorganization of larger, more complex insolvent businesses.
Rather than providing detailed substantive and procedural provisions to govern all
aspects of the reorganization like the BIA, the CCAA provides a general framework and
then leaves it to the debtor to work out the details of the process under court supervision.
Much of the law under the CCAA developed by way of judicial interpretation.
In addition to the liquidation and restructuring regimes of the BIA and the CCAA, this
paper deals briefly with court-appointed receivers and interim receivers. Both are
appointed by the court in insolvencies and play an important role in liquidations and
reorganizations where they are used to effect asset sales.
The aim of liquidation is to maximize the value of the insolvent company’s assets. This
generally involves selling the insolvent company’s assets to the party or parties willing to
pay the highest price. In the case of an information technology business, this can involve
selling intellectual property free and clear of contractual rights, such as licenses, or
selling hard assets, such as computers, together with contractual rights such as licenses.
The aim of restructuring, on the other hand, is to preserve the going concern value of a
business. Although restructuring may involve selling assets, it will usually also involve
terminating or disclaiming unprofitable contracts, renegotiating contracts (often under 1 R.S.C. 1985, c. B-3, as amended (the “BIA”). 2 R.S.C. 1985, c. C-36, as amended (the “CCAA”).
Insolvency & Bankruptcy Issues for Information Technology
trustee. In Canadian Imperial Bank of Commerce v. Bramalea Inc.12 the court dealt with
the enforceability of a clause in a partnership agreement triggered by insolvency or
bankruptcy alone, which purported to allow a solvent partner to purchase the insolvent
partner’s interest for less than its fair market value. Blair J. found that such a contractual
provision is not enforceable and is void on the basis that it violates public policy where it
has the effect of depriving the creditors of value.
It is, therefore, likely that other events of default will have to be relied upon by a licensor
when attempting to terminate a license agreement where a bankruptcy trustee for the
licensee attempts to retain the license.
b. Disclaimer of Contracts by a Trustee
The opposite situation arises in circumstances where the bankrupt has by contract granted
rights in its property to a third party, and the third party wishes to prevent the bankruptcy
trustee from disclaiming that contract. Although the BIA contains no provision that
directly permits the trustee to disclaim commercial contracts, the English case law
appears to suggest that a bankruptcy trustee may disclaim a commercial contract13, and in
practice trustees routinely do so.
However, one reported case that suggests that if a bankruptcy trustee has the right to
disclaim commercial contracts, it cannot disclaim a contract that has the effect of
transferring property. In Re Erin Features No. 1 Ltd., the British Columbia Supreme
Court decided that a bankruptcy trustee could not disclaim a contract granting exclusive
marketing rights to a film because the contract was actually a transfer of property14.
Prior to its bankruptcy, the bankrupt had negotiated an agreement that granted exclusive
marketing rights in Canada to Modern Cinema Marketing Ltd. for a film entitled
Lighthouse. After the bankruptcy, the trustee sought to terminate this agreement.
12 44 B.L.R. (2d) 188 (Ontario Court of Justice). 13 See L. Duncan and J.D. Honsberger Bankruptcy in Canada (3d) (Canada Law Book, 1961) at 136 and
333. See, however, M.J. Forte and A.C. Chester “Licenses and the Effect of Bankruptcy and Insolvency Law on the Licensee” included in the materials for the Turnaround Management Association’s Third Annual Symposium (February 1, 2001).
14 Re Erin Features No. 1 Ltd. (1991), 8 C.B.R. (3d) 205 (B.C.S.C.).
Insolvency & Bankruptcy Issues for Information Technology
However, the court characterized the arrangement as a sale by Erin of property, namely
the exclusive right to market the film. As a result the contract could not be disclaimed by
the trustee15.
It should be noted that it is generally accepted by information technology and intellectual
property practitioners that a transfer of a license does not constitute a transfer of property.
Specifically, a license has been described as nothing more than permission from the
licensor to the licensee to make use of its intellectual property16. As a result, it seems to
be possible for a bankruptcy trustee to disclaim a license, leaving the affected licensee
with nothing more than an unsecured claim in the bankruptcy for damages resulting from
the termination.
6. Assignment of Contracts by Trustee
The issue of disclaimer is probably more theoretical than real in the context of most
license agreements since the primary role of a bankruptcy trustee is to maximize the
value of the estate for creditors. Assuming that the license grant provides a continued
income stream to the bankrupt into the future, the trustee is not likely to disclaim
contracts but rather to attempt to preserve them as part of the bankrupt’s unencumbered
property that the trustee will attempt to assign as part of the asset sale to increase the
proceeds available for distribution to creditors. In the context of a bankruptcy involving
intellectual property or intellectual technology assets, the issue is likely to be whether the
purchaser acquires property, such as technology, subject to, or free of, rights, such as
licenses, that were granted in that property by the bankrupt. In that context, the key issue
is whether or not the trustee can assign contracts to a purchaser, such as software
licenses, without the consent of the other party to the license agreement.
The BIA is silent with respect to a bankruptcy trustee’s general ability to assign a
contract, but there is nothing to suggest that the ordinary common law with respect to the 15 Re Erin Films has been criticized -- see G.G.S. Takach and E.L. Hayes “Case Comment” 15 C.B.R.(3d)
66. However, the criticism has related to whether property was conveyed and not with the concept that a pre-bankruptcy contract that has the effect of conveying property cannot be disclaimed. An exception would be if the conveyance was a settlement or preference.
16 W.A. Adams and G.G.S. Takach “Insecure Transactions” 33 C.B.L.J. 321 at 350.
Insolvency & Bankruptcy Issues for Information Technology
assignment of contracts would not apply to such an assignment by a bankruptcy trustee.
However, Bramalea suggests that contractual clauses that restrict assignment in an
insolvency are not enforceable.
The general common law test with respect to the reasonableness of a refusal to consent to
an assignment has two parts17:
(a) first, the court must determine the basis for the refusal to consent; and
(b) having determined the basis for the refusal to consent to the assignment, the
court will then determine whether that basis is reasonable.
In determining whether consent is unreasonably withheld the court will also consider the
following:
(a) the covenant in the agreement and its purpose in that context;
(b) all of the circumstance of the case including the commercial realities of the
market place and the economic impact of the assignment on the non-
assigning party;
(c) the non-assigning party is not entitled to refuse his consent so as to be able to
acquire a further commercial benefit for himself by insisting on conditions
which were outside of the original agreement and thus obtain more
advantageous terms; and
(d) it is unreasonable for the non-assigning party by withholding his consent and
insisting on different terms and conditions, to rewrite ex post facto the
assignment covenant which it and the parties had previously freely
negotiated.18
17 Lehndorff Canadian Pension Properties Ltd. v. Davis Management Ltd., [1987] B.C.J. No. 1228 (Sup.
Ct.), aff’d [1989] B.C.J. No. 990 (C.A.) at para 51. See also Welch Foods Inc. v. Cadbury Beverages Canada Inc. [1999] O.J. No 544 (Gen. Div.), aff’d [2001] O.J.
18 Jo-Emma Restaurants Ltd. v. A. Merkur and Sons Ltd. [1989] O.J. No. 1803, 7 R.P.R. (2d) 298 (Dist. Ct.) at p. 3
Insolvency & Bankruptcy Issues for Information Technology
It is important to point out that the failure to respond to a request to assign a contract can,
in and of itself, be considered unreasonable.19 For example, the Alberta Court of Queen’s
Bench has found that: “[…] Notice of Termination is not an answer to the request for
consent. The [Landlord] is obliged to state reasons for withholding its consent” and “[…]
failure by [Landlord] to answer the request for its consent, except to issue a Notice of
Termination…, without more and without further explanation, provides no reasons for
withholding consent. Obviously that is tantamount to an unreasonable withholding of its
consent.”20
There are no bankruptcy cases on this issue. The application of these cases in an
insolvency has, however, been considered in the context of a CCAA restructuring and is
discussed later.
7. Property Rights on Asset Sales by Trustee
Where transfers of assets occur in a bankrupt estate, the BIA provides that sales of
property by the bankruptcy trustee vest in the purchaser all of the legal and equitable
estate of the bankrupt in that property21. Acquisitions from a bankruptcy trustee will,
therefore, be subject to certain interests in the bankrupt’s property held by third parties22.
These would include, for example, proprietary interests that may exist in favour of third
parties, since the bankruptcy is not able to impact those property rights. This issue was
recently considered by the Alberta Court of Appeal in Bank of Montreal v. Dynex
Petroleum Ltd.23 The issue in Dynex was whether the sale of oil and gas properties by a
bankruptcy trustee would be subject to overriding royalty interests (an unencumbered
share or fractional interest in the gross production from an oil and gas property) granted 19 Cornish v. Boles (1914), 31 O.L.R. 505 (C.A.). St. Jane Plaza Ltd. v. Sunco Inc., [1992] O.J. No. 1339
(Gen. Div.) at p. 4. 20 Zurich Canadian Holdings Ltd. v. Questar Exploration Inc. [1998] A.J. No. 609 (Alta Q.B.) at paras 64
and 66. 21 BIA s. 84. 22 It should be noted that courts have, for practical reasons, made orders in the context of a bankruptcy
vesting assets in a purchaser free and clear of the claims of secured creditors and statutory deemed trusts. These types of orders are typically made in situations where the amount owing by the bankrupt in respect of unremitted source deductions is in excess of the purchase price being paid for the assets.
23 182 D.L.R. (4th) 640 (Alberta Court of Appeal).
Insolvency & Bankruptcy Issues for Information Technology
d. Disclaimer of Contracts
With one exception, the BIA is silent with respect to the ability of a reorganizing debtor
to disclaim contracts. The BIA permits a reorganizing debtor to disclaim real property
leases and to make provision for any damages caused by the disclaimer in its proposal36.
In the event that a reorganizing debtor were to terminate a contract after filing a Notice of
Intention, any damages suffered by the other party to the contract would most likely not
be subject to the proposal. Rather, they would not be compromised and the debtor would
remain liable for the damages notwithstanding its reorganization. This is because in a
BIA reorganization (unlike the CCAA) claims are determined as at the date of the filing
of the Notice of Intention37. Arguably, any claim arising from a termination after that
date would not be subject to the proposal. This is one of the primary reasons why most
large corporations will seek to reorganize under the CCAA rather than the BIA, since the
termination of unprofitable contracts is often a major component of a typical restructuring
strategy.
e. Selling Assets/Assigning Contracts
The BIA, not surprisingly, does not deal with the sale of assets or assignment of contracts
by a reorganizing debtor. That being said, it is clearly possible for a reorganizing debtor
to sell assets or assign contracts and seek an order vesting those assets and/or contracts in
a purchaser free and clear, during the restructuring process. In this type of transaction,
the same issues will exist with respect to the ability of the court to vest assets free and
clear of interests arising under contract as will be discussed below in the context of
CCAA reorganizations.
2. CCAA Reorganizations
Rather than provide detailed substantive and procedural provisions to govern all aspects
of the reorganization, the CCAA provides only a general framework for the 36 BIA s. 65.2 37 BIA s. 62(1.1). If a proposal is filed, as apposed to a Notice of Intention, the date for determining claims
Insolvency & Bankruptcy Issues for Information Technology
In addition to the negotiated compromises found in BIA reorganizations to protect
suppliers, the exercise of inherent jurisdiction by the court and the flexibility of the
CCAA process make it possible for the court to create structures that limit a suppliers’
risk exposure during a CCAA reorganization. For example, in the CCAA reorganization
of Smoky River Coal Ltd., the Alberta Court of Queens’ Bench made an order which
created a charge, limited to $7 million, over the debtor’s property to secure amounts
owing to “Post-Petition Trade Creditors”39. The charge was created to encourage the
debtor’s regular trade creditors to continue to provide essential goods and services during
the company’s reorganization. The order made in Smoky River Coal was similar to the
Order made by the British Columbia Supreme Court in the 1992 reorganization of Westar
Mining Ltd. In Re Westar Mining the court made an order granting suppliers a priority
charge to secure credit supplied during the restructuring.40 Specifically, the judge stated
that “the essential problem here is how to enable the company to continue operating until
September 30, 1992. … I accept the argument that the most equitable compromise is to
make security over [the debtor’s assets], with the highest possible priority, available to
those who will finance the company’s continuing operations.”
At the conclusion of a successful CCAA reorganization, the “sanction” order of the court
approving the restructuring plan typically contains a provision which compels the parties
to all executory contracts to honour such contracts in accordance with their terms on the
basis that all insolvency or financial defaults existing at the date of the proceedings or
created as a result of the proceedings are deemed to have been cured by the restructuring
process. The contracting party is thereby prevented from terminating a contract after the
stay of proceedings terminates. The contracting party is instead limited to an unsecured
claim under the restructuring plan for any damages resulting from such defaults.
39 See Re Smoky River Coal Ltd. (2000), 19 C.B.R. (4th ) 281 (Alts. Q.B.). 40 See Re Westar Mining Ltd. (1992), 70 B.C.L.R. (2d) 6 (S.C.) and Re Companies’ Creditors
Insolvency & Bankruptcy Issues for Information Technology
receivership context or whether the reasoning in the case will be considered in the CCAA
context.
It may also be the case that parties to contracts with an insolvent debtor in receivership
can seek to have the receiver bound by these contracts. In Coopérants, Société mutuelle
d’assurance-vie c. Raymond, Chabot, Faford, Gagnon Inc.50, the Supreme Court of
Canada found that a liquidator under the Winding-up and Restructuring Act51 – what they
analogized to a receiver appointed by the court – was in a different position than a
bankruptcy trustee and would be bound by an agreement that provided for specific
obligations arising in the event of insolvency. It should be noted, however, that the court
did not have any evidence with respect to the value of the assets in question. Moreover,
it is unclear if this case would be followed where the court has ordered that a receiver
may disclaim contracts.
VI. Interim Receivers
The interim receiver is a creation of the BIA. The BIA provides for the optional
appointment of a bankruptcy trustee as an “interim receiver” to preserve the property of
an insolvent debtor pending the hearing of a Petition52, or to preserve the interests of a
secured creditor pending the enforcement of security53, or to preserve a reorganizing
debtor’s property or the interests of creditors generally in a reorganization54. The court
has a broad jurisdiction under the BIA in that context to direct an interim receiver to take
possession and exercise control over the debtor’s property and business, and “take such
other actions as the court considers advisable.”55
50 (1996) 39 C.B.R. (3d) 253 (S.C.C.). 51 R.S.C. 1985 c. W-11, as amended. 52 BIA s. 46. 53 BIA s. 47. Section 244 of the BIA requires that a secured creditor enforcing security over all or
substantially of an insolvent debtor’s inventory, receivables or other property provide that debtor with ten day’s notice.
54 BIA s. 47.1. 55 BIA s. 47(2)(c) and s. 47.1(2)(d).
Insolvency & Bankruptcy Issues for Information Technology
In recent years, the interim receiver role has evolved to that point that it now serves a
function that goes far beyond the preservation of the insolvent debtor’s assets. The
concept has also been used in the context of some CCAA proceedings, particularly where
an asset liquidation is the result of the restructuring attempt. One of the more common
applications of an interim receiver is to facilitate the sale of assets located in more than
one jurisdiction or to “avoid” some of the adverse consequences of a court-appointed
receiver, such as the application of the rights of unpaid suppliers to recover goods
shipped to the insolvent debtor56. As mentioned above, the secured creditors in Playdium
accomplished the transfer of the company’s assets through the appointment of an interim
receiver.
In practice, it is not unusual to see interim receivership orders that include comprehensive
stays of proceedings and provisions restricting the termination of contracts. In this
respect, they often resemble orders made under the CCAA or in conventional
receivership proceedings.
VII. Insolvency Reform
The federal government is currently engaged in a process to review Canada’s insolvency
legislation, with the intention of presenting amendments to both the BIA and the CCAA
to Parliament for its consideration later this year.
Although it is impossible to predict what specific amendments, if any, might arise from
this latest insolvency review process, a joint proposal from the Insolvency Institute of
Canada and the Canadian Institute of Insolvency and Restructuring Professionals has
recommended several amendments which, if accepted, might assist in bringing more
clarity to some of the issues facing parties affected by the insolvency of a corporation
carrying on business in a knowledge based industry. For example, the proposed
amendments include a much more detailed regime for the adoption or disclaimer of
executory contracts and protection of rights for the holders of property interests.
However, none of these proposed reforms appear to be directed towards the unique issues 56 An interim receiver does not fall within the definition of “receiver” in the BIA and, as a result, does not
trigger the rights provided to unpaid suppliers under section 81.1 of the BIA.