Following a recent ruling of the Ontario Court of Appeal,
parties may need to proceed cautiously in enforcing contractual
rights and remedies in circumstances where there is a risk of the
counterparty subsequently becoming insolvent.
The common law has long recognized that a contractual provision
which is explicitly and directly triggered by a
party's insolvency (and which thereby causes subsequent
prejudice to the rights of the insolvent party's creditors) may
be unenforceable as a matter of public policy.
The contract in question was a dealer agreement between a dealer
and a distributor. The contract permitted the distributor to
terminate the agreement in circumstances where the dealer had
failed to remedy a default in payment within 30 days. Upon such a
termination, any outstanding commissions owed by the distributor to
the dealer were to become unenforceable.
The dealer had failed to make payments to the distributor, and
the distributor accordingly gave the dealer the requisite 30 days
to make good its obligation or face termination of the
Unbeknownst to the distributor, however, the dealer had already
filed a notice of intention to make a proposal under the Bankruptcy and Insolvency Act. As a
result, before the 30 days had elapsed, and therefore
before the contract could be terminated, the dealer was
deemed a bankrupt.
The question for the courts was whether the distributor was
permitted to terminate the contract in accordance with its terms
— based on the dealer's breach of contract (through
non-payment), and not based on the
dealer's insolvency — with the concomitant right to
be relieved of its obligation to pay outstanding commissions to the
dealer (or, more accurately, to the dealer's trustee in
The Court of Appeal ultimately decided that, because the
termination of the contract was caused by the dealer's failure
to meet its payment obligation, and because this failure was
indirectly caused by the dealer's insolvency, the
termination itself should be deemed to have been caused by the
insolvency. For this reason, the traditional common law rule
 While the clause at issue in this case is triggered upon
termination of the agreement for any number of reasons, and not
only upon insolvency or bankruptcy, it was in fact triggered as a
consequence of [the dealer's] insolvency. The clause provides a
windfall to one of [the dealer's] creditors: [the distributor].
In the context of an insolvency, the clause is inequitable. We
agree with the trial judge that the principle in CIBC v. Bramalea [(1995), 33 O.R. (3d)
692 (Gen. Div.)] should be extended to declare the clause
unenforceable as against [the dealer's] trustee in bankruptcy
as contrary to the overriding public policy that requires equitable
and fair distribution among a bankrupt's creditors.
The Court's willingness to thus "extend" the
common law doctrine to the facts of the case caused the distributor
to be denied its explicit contractual rights. As a result, parties
to commercial contracts which contain otherwise-inoffensive
provisions may face a regrettable new area of uncertainty should an
untimely insolvency intervene.
The Canadian bankruptcy regime was designed with two key purposes in mind – provide options to ‘honest but unfortunate' debtors struggling with an unmanageable financial load and create an orderly means for creditors to recover amounts owed them.
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