Canada: Update on Bill C-501: An Act to Amend the Bankruptcy and Insolvency Act and Other Acts (Pension Protection)

Last Updated: October 17 2010

By Ian Aversa*

In the midst of the ongoing restructurings of Nortel and AbitibiBowater, New Democrat Member of Parliament John Rafferty (Thunder Bay – Rainy River) introduced a bill to amend the Bankruptcy and Insolvency Act (the "BIA") and the Companies' Creditors Arrangement Act (the "CCAA") with the goal of better protecting employees' interests in the context of formal insolvency proceedings. Bill C-501, An Act to Amend the Bankruptcy and Insolvency Act and Other Acts (Pension Protection), expands the super priority status of unpaid pension plan contributions under the BIA and the CCAA to include special payment requirements imposed as a result of an existing solvency deficiency in a defined benefit pension plan, and expands the super priority status of unpaid wages under the BIA and the CCAA to include an employee's claim for termination and severance pay.

Unpaid Pension Plan Contributions

Prior to July 7, 2008, unpaid pension plan contributions were generally held to be unsecured claims in a bankruptcy or receivership, even if they were subject to a deemed trust under provincial pension benefits legislation and could be compromised in a proposal or plan of arrangement. Currently, pursuant to provisions that came into force on July 7, 2008 with respect to defined benefit plans, super priority status is afforded to deficiencies with respect to 'normal payments'. The language in Bill C-501 proposes to expand the charge to include, in addition to the normal cost within the meaning of subsection 2(1) of the Pension Benefits Standards Regulations, 1985 (the "Regulations"), any amount considered to meet the standards for solvency determined in accordance with section 9 of the Regulations that were required to be paid by the employer to the fund.

Depending on the number of employees, special payment requirements imposed as a result of an existing solvency deficiency in a defined benefit pension plan, in addition to claims related to solvency deficiencies directly, can be large and, over time, become significant liabilities that, if Bill C-501 became law, would erode the security of secured lenders. In the context of a bankruptcy or receivership, these unpaid pension plan contributions would be secured by a claim on all of the assets of the bankrupt or employer in receivership, which would rank above every other claim or security against the debtor's assets, regardless of when it arose, with the exception of: (i) the special rights which currently exist for 30-day goods suppliers under section 81.1 of the BIA and for farmers and fishermen under section 81.2 of the BIA; (ii) deemed trust source deduction amounts (i.e. any unremitted employee income tax withholdings, Canada Pension Plan contributions and employment insurance premiums) under subsection 67(3) of the BIA; and (iii) the special priority afforded to unpaid wages, discussed below. In the context of proposal proceedings under the BIA or restructuring proceedings under the CCAA, a proposal or plan would have to provide for these amounts and the court would have to be satisfied that the employer could and would pay them before the proposal or plan could be approved or sanctioned by the court.

Termination and Severance Pay

In addition, Bill C-501 expands the super priority status of unpaid wages under the BIA and the CCAA to include an employee's claim for termination and severance pay, less any amount paid by the trustee, receiver or monitor for such termination or severance pay. In the context of a bankruptcy or receivership, these unpaid wages would be secured by a claim on all of the assets of the bankrupt or employer in receivership, which ranks above every other claim or security against the debtor's assets, regardless of when it arose, with the exception of the special rights granted under sections 81.1 and 81.2 and the amounts referred to in subsection 67(3) that have been deemed to be held in trust.

Currently, as of July 7, 2008, unpaid wages, including vacation pay, owing to an employee are secured, to the extent of $2,000, by security on all the current assets of a bankrupt or employer in receivership and must be provided for in any proposal or plan. Current assets are defined to include cash, cash equivalents (including negotiable instruments and demand deposits), inventory or accounts receivable, or the proceeds from any dealing with those assets. However, termination and severance pay are excluded from this definition and, consequently, do not benefit from the charge. Not only does Bill C-501 propose to elevate the priority of termination and severance pay to the super priority status of unpaid wages, it does not propose to limit the extent of its coverage in amount or in scope.

Going Forward

These changes are significant. Under the current regime, a prudent lender can quantify the exposure of its security to unpaid wages by reserving, from the amount provided to the borrower, an amount representing $2,000 per employee as a priority claim which will rank ahead of its security. The new legislation would remove this predictability and, depending on the number of employees and the extent of the liabilities with respect to unpaid termination and severance pay and unpaid pension plan contributions, the potential exposure to a lender may be significant at any particular time.

Mr. Rafferty has suggested that the implementation of Bill C-501 would not adversely affect capital markets since lenders do not lend with the assumption that their borrowers will become insolvent. Regardless of Mr. Rafferty's views, it is uncontested that lenders do, and will continue to, act prudently.

The changes proposed by Bill C-501 will undoubtedly create more uncertainty for lenders and, if Bill C-501 became law, lenders would be forced to retain larger reserves in order to offset the potential erosion of their security. For example, lenders who provide operating facilities based on a borrower's working capital would likely take an additional reserve from a borrower's working capital borrowing base and reduce the borrower's borrowing capacity in an amount equal to the assessed value of these new super priority claims. In addition, it is likely that certain loans that lenders might consider under the current regime would not be feasible if Bill C-501 became law, because it would be difficult for a lender to ever be fully satisfied that the amount of its reserves is sufficient to cover these new super priority claims in the event that a borrower commences formal insolvency proceedings.

While Bill C-501 has been read twice by the House of Commons, the first reading being on March 24, 2010 and the second being on May 26, 2010, it has been referred to the Industry, Science and Technology Committee where it has not yet been addressed. To proceed to Royal Assent, Bill C-501 would not only have to be considered by this Committee, but would then also have to advance to a third reading by the House of Commons, and then survive three readings by the Senate. It is clear that Bill C-501 is still in its infancy and has multiple barriers to cross before it can be enacted.

* Ian Aversa is an associate in the Financial Services Group. The author would like to thank Karen D. Levin, a student-at-law at Aird & Berlis LLP, for her assistance in preparing this article.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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