Bankruptcy and Insolvency: Priorities; Anti-Deprivation Rule

Chandos Construction Ltd. v. Deloitte Restructuring Inc.2020 SCC 25 (38571)

“Chandos Construction Ltd. (“Chandos”), a general construction contractor, entered into a construction subcontract with Capital Steel Inc. (“Capital Steel”). Clause VII Q(d) of the subcontract provides that Capital Steel will pay Chandos 10 percent of the subcontract price as a fee for the inconvenience or for monitoring the work in the event of Capital Steel’s bankruptcy. When Capital Steel filed an assignment in bankruptcy prior to completing its subcontract with Chandos, Chandos argued it was entitled to set off the costs it had incurred to complete Capital Steel’s work and to set off 10 percent of the subcontract price, as provided for by clause VII Q(d). Capital Steel’s trustee in bankruptcy applied for advice and directions as to whether clause VII Q(d) was valid. The application judge found the provision to be a valid liquidated damages clause, but the Court of Appeal reversed the decision.”

The SCC (8:1) dismissed the appeal.

Justice Rowe wrote as follows (at paras. 1-2, 25-31, 39-41, 43-44):

“This case concerns a common law rule (the “anti-deprivation rule”) that operates to prevent contracts from frustrating statutory insolvency schemes. Chandos Construction Ltd. (“Chandos”) entered into a construction contract (“Subcontract”) with Capital Steel Inc. (“Capital Steel”). A provision of the Subcontract would award Chandos a sum of money in the event of Capital Steel’s bankruptcy, which later occurred. This case deals with whether that provision was invalid by virtue of the anti-deprivation rule.
I conclude that it is, essentially for the reasons of the majority of the Court of Appeal of Alberta. Accordingly, the appeal is dismissed.


As to the existence of the anti-deprivation rule, I see no error in Rowbotham J.A.’s consideration of this issue, in that the rule has existed in Canadian common law and has not been eliminated by either this Court or Parliament.

Justice Rowbotham correctly found that there has been support for the anti-deprivation rule in the decisions to which she referred; I would add Watson v. Mason (1876), 22 Gr. 574 (U.C. Ch.) and Hobbs v. The Ontario Loan and Debenture Company (1890), 18 S.C.R. 483, at p. 502 (per Strong J.), even if Hobbs is from a period in Canadian history where no federal bankruptcy legislation existed (R. J. Wood, Bankruptcy and Insolvency Law (2nd ed. 2015), at pp. 33-35).

No decision of this Court has eliminated the anti-deprivation rule. Coopérants, as Rowbotham J.A. stated, was not an anti-deprivation case as there was no deprivation (Coopérants, at paras. 43-44).

Nor has Parliament eliminated the anti-deprivation rule. As Rowbotham J.A. observed, Parliament did not implement ss. 65.1 , 66.34 , or 84.2  of the BIA  so as to eliminate the anti-deprivation rule: the anti-deprivation rule protects third party creditors, whereas Parliament’s changes were directed toward protecting debtors (see Bill C-22: Clause by clause Analysis, cl. 87, s. 65.1 and cl. 89, s. 66.34, reproduced in the Attorney General of Canada’s book of authorities, at Tab 4; Standing Senate Committee on Banking, Trade and Commerce, Debtors and Creditors Sharing the BurdenA Review of the Bankruptcy and Insolvency Act and the Companies’ Creditors Arrangement Act (2003), at pp. 74-75). This goal of protecting the debtor is relevant only where the debtor persists after the proceedings conclude. It is common for the debtor to persist after a restructuring or after the bankruptcy of a natural person. It is uncommon for the debtor to persist after a corporate bankruptcy as, typically, no assets remain for the corporation after all creditors are paid.

Moreover, as the intervenor Attorney General of Canada submitted, Parliament’s actions are better understood as gradually codifying limited parts of the common law rather than seeking to oust all related common law. As this Court has repeatedly observed, Parliament is presumed to intend not to change the existing common law unless it does so clearly and unambiguously (Parry Sound (District) Social Services Administration Board v. O.P.S.E.U., Local 324, 2003 SCC 42, [2003] 2 S.C.R. 157, at para. 39; Heritage Capital Corp. v. Equitable Trust Co., 2016 SCC 19, [2016] 1 S.C.R. 306, at paras. 29-30).

Indeed, the most relevant statutory provision in the BIA  is not s. 65 .1, s. 66.34, or s. 84.2, but rather s. 71 . As this Court recognized in Royal Bank of Canada v. North American Life Assurance Co., [1996] 1 S.C.R. 325, s. 71 provides that the property of a bankrupt to “passes to and vests in the trustee” (para. 44). This helps maximize the “global recovery for all creditors” in accordance with the priorities set out in the BIA  (Alberta (Attorney General) v. Moloney, 2015 SCC 51, [2015] 3 S.C.R. 327, at para. 33; see also Husky Oil Operations Ltd. v. Minister of National Revenue, [1995] 3 S.C.R. 453, at paras. 7-9). The anti-deprivation rule renders void contractual provisions that would prevent property from passing to the trustee and thus frustrate s. 71  and the scheme of the BIA. This maximizes the assets that are available for the trustee to pass to creditors.

 

As Bramalea described, the anti-deprivation rule renders void contractual provisions that, upon insolvency, remove value that would otherwise have been available to an insolvent person’s creditors from their reach. This test has two parts: first, the relevant clause must be triggered by an event of insolvency or bankruptcy; and second, the effect of the clause must be to remove value from the insolvent’s estate. This has been rightly called an effects-based test.


Overall, Chandos has not shown us good reason to adopt a purpose-based test. In my view, adopting the purpose-based test would create “new and greater difficulties” of the sort cautioned against in Watkins v. Olafson, [1989] 2 S.C.R. 750, at p. 762. As recognized in Bhasin, at para. 40, although a change to the Canadian common law may be appropriate when it creates greater certainty and coherence, it is not when the change would foster uncertainty and incoherence.

All that said, we should recognize that there are nuances with the anti-deprivation rule as it stands. For example, contractual provisions that eliminate property from the estate, but do not eliminate value, may not offend the anti-deprivation rule (see Belmont, at para. 160, per Lord Mance; Borland’s Trustee v. Steel Brothers & Co. Limited, [1901] 1 Ch. 279; see also Coopérants). Nor do provisions whose effect is triggered by an event other than insolvency or bankruptcy. Moreover, the anti-deprivation rule is not offended when commercial parties protect themselves against a contracting counterparty’s insolvency by taking security, acquiring insurance, or requiring a third-party guarantee.

In sum, the Court of Appeal was correct to consider whether the effect of the contractual provision was to deprive the estate of assets upon bankruptcy rather than whether the intention of the contracting parties was commercially reasonable.

The BIA’s affirmation of set-off and the anti-deprivation rule are not incompatible. While set-off reduces the value of assets that are transferred to the Trustee for redistribution, it is applicable only to enforceable debts or claims (see, e.g., Holt v. Telford, [1987] 2 S.C.R. 193, at pp. 204-6). The anti-deprivation rule makes deprivations triggered by insolvency unenforceable. The combination means that set-off applies to debts owed by the bankrupt that were not triggered by the bankruptcy.

The case at bar is quite different. The chapeau of clause VII Q provides that the clause triggers “[i]n the event [Capital Steel] commits any act of insolvency, bankruptcy, winding up or other distribution of assets”. Since, here, the clause was triggered by bankruptcy, the threshold for considering the anti-deprivation rule had been met Clause VII Q(d) itself provides the deprivation: “[Capital Steel] shall forfeit 10% of the within Subcontract Agreement price to [Chandos] as a fee”. The effect of this provision is to create a debt from Capital Steel to Chandos that would not exist but for the insolvency. It is this “debt” created by Clause VII Q(d) because of the insolvency that Chandos seeks to “set off” against the amount it owed to Capital Steel. One can hardly imagine a more direct and blatant violation of the anti-deprivation rule.”
Justice Côté (in dissent) wrote as follows (at paras. 47-50):

“In short, my view is that the anti-deprivation rule should not apply to transactions or contractual provisions which serve a bona fide commercial purpose. I reach this conclusion essentially for three reasons.
First, my reading of the jurisprudence is that courts applying the anti-deprivation rule in Canada have not been content to rest their reasons for decision merely on a finding that the effect of a transaction or contractual provision was to deprive a bankrupt’s estate of value. As I explain below, Canadian courts have looked past the effects of the arrangement and inquired into the presence or absence of a bona fide commercial purpose behind the deprivation.

Second, there is a principled legal basis for retaining a bona fide commercial purpose test. The anti-deprivation rule has its origins in the common law public policy against agreements entered into for the unlawful purpose of defrauding or otherwise injuring third parties. Unlike the related pari passu rule, the anti-deprivation rule should not be regarded as arising from an implied prohibition in the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3  (“BIA ”). Thus, the different legal bases of the two rules explain why the pari passu rule operates regardless of the parties’ intentions while the anti-deprivation rule takes into account the parties’ bona fide commercial purposes.

Third, as a matter of public policy, the considerations cited in support of an effects-based test are not sufficient to override the otherwise strong countervailing public interest in the enforcement of contracts. A purely effects-based test gives too little weight to freedom of contract, party autonomy, and the “elbow-room” which the common law traditionally accords for the aggressive pursuit of self-interest: see A.I. Enterprises Ltd. v. Bram Enterprises Ltd., 2014 SCC 12, [2014] 1 S.C.R. 177, at para. 31. In addition, Parliament has occupied much of the ground formerly covered by the common law such that there is a reduced need for a general anti-deprivation rule. Indeed, the many statutory protections already in place to safeguard the interests of creditors undermine any perceived policy need to expand the reach of the anti-deprivation rule for that purpose.”