Canada: Ontario Commercial Court Rules Proceeds Of BIA Preference Action Subject To Rights Of Secured Creditors

On August 18, 2011, Mr. Justice Morawetz, of the Ontario Superior Court of Justice, released an important decision in regard to preference actions in the matter of Tucker v. Aero Inventory (UK) Limited (together with Aero Inventory plc, Aero).

Background

Administration proceedings were commenced against Aero on November 11, 2009, in the High Court of Justice of England and Wales. Norton Rose OR obtained recognition of the joint administrators appointed in the UK proceeding (the Administrators) as foreign representatives under Part IV of the Companies' Creditors Arrangement Act. Subsequently, over the objections of Air Canada, the Ontario court authorized the Administrators to assign Aero in bankruptcy in Canada for the express purpose of pursuing any reviewable transactions, settlements and preferences (Preference Actions) that may have taken place in Canada. The trustee in bankruptcy subsequently asserted Preference Actions under the Bankruptcy and Insolvency Act against Air Canada seeking to recover approximately US$75 million in respect of a number of transactions between Aero and Air Canada in the months before the commencement of the UK proceedings. In its materials, the trustee reported that the secured creditors of Aero were likely to suffer a significant shortfall in the recovery of their secured claims such that there was not likely to be any recovery for unsecured creditors (beyond certain statute-prioritized entitlements).

Air Canada subsequently brought a motion seeking, among other things, orders declaring that any proceeds of the Preference Actions were not subject to the rights of the secured creditors. Air Canada asserted that it would be entitled to participate in any recoveries from the Preference Actions against it as an unsecured creditor.

The result

The court noted the apparent inconsistency in Canadian and Commonwealth jurisprudence and academic commentary but accepted that the jurisprudence could be resolved by correctly applying insolvency principles and personal property security principles. Norton Rose OR argued that, in this case, the secured creditors had the equivalent of fixed charges in the transferred property rather than uncrystallized floating charges found in jurisprudence cited by Air Canada. Norton Rose OR pointed to the potentially anomalous result that would follow if an insolvent person could defeat such rights of a secured creditor by simply granting a preference immediately prior to assigning itself into bankruptcy if the subsequent reversal of the preference would be such that the proceeds would benefit only unsecured creditors (including, in this case, Air Canada, who purported to settle its unsecured claims through the transactions sought to be challenged).

The Ontario Court ruled that the proceeds of Preference Actions recovered by the trustee are brought into the estate and distribution is subject to the rights of secured creditors. The court further ruled that the bringing of Preference Actions and recovery of proceeds by the trustee does not preclude the secured creditors from pursuing other remedies they may have. The court noted that, while the secured creditors might have other remedies, at the outset of the proceedings, when investigations may not be complete, it may be difficult to pinpoint any specific remedy. Secured creditors will be aware that remedies under contract or statute would involve different factual elements and burdens of proof and might very well have involved significant costs and lengthy time periods to resolve outside the insolvency proceedings.

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