I am tempted to draft a blog post listing the top ten ironies of
bankruptcy law. There is no shortage of contenders for that list,
and vying for the top spot would be the simple fact that you need a
lot of money to go bankrupt. Bankruptcy (or its cousins, creditors
arrangement and administration -- but not receivership, the
economies of which could also feature in a blog post of its own)
involves an influx of lawyers, accountants, and other professionals
who negotiate and bicker their way through the company's
balance sheet, all while charging by the hour. To make certain that
funds will be found to meet the costs of their efforts, the Court
may segregate some of the company's assets or cash at the
beginning of the insolvency process. This special pool of cash can
be called a "retention amount." An "executive
trust" or a "director's trust," if for the
benefit of the company's continuing management, serves much the
The facts of a company's demise often lead to the executives
being participants, possibly as defendants, in litigation arising
from the bankruptcy. This was the case in a very high-profile way
in the insolvency of Nortel Networks. Nortel Networks is the
subject of proceedings under the Companies' Creditors
Arrangement Act (the "CCAA"). Nortel itself had an
obligation to indemnify its executives, as is usually the case if
directors or officers are involved in litigation by virtue of their
corporate role. Nortel's insurers, Chartis Insurance Company of
Canada, were therefore obliged to pay the executives' legal
fees. With a ten-million-dollar retention amount set aside in the
Nortel bankruptcy proceedings, Chartis took the position that the
executives should deplete that reserve, and an executives'
trust of $12 million, before turning to them for indemnification.
Justice Morawetz of the Ontario Superior Court of Justice
disagreed, finding that the trust indenture gave the trustees full
discretion to permit access to the 12-million-dollar sum, and that
requiring the retention amount to be emptied before turning to the
insurance provision was to give Chartis priority over other,
unsecured creditors. Although Nortel itself owed the
indemnification duty to its executives, it could not actually pay
them without breaching of the stay of proceedings inherent in the
CCAA process. Therefore, as the payment by Nortel (who would access
the retention amount to pay it) was not permitted, the insurance
policy could be construed to require the insurer to pick up the
slack. Chartis appealed. The Ontario Court of Appeal, in a decision
released on August 15th, refused to grant leave to appeal that
The test for leave of an order made in the course of CCAA
proceedings is very high, as recently explored in the lawmaking
Re Timminco Ltd. decision of the Court of Appeal in 2012.
Leave may only be granted "sparingly" and in
circumstances where "there are serious and arguable grounds of
significant interest to the parties." The Court of Appeal
decided this was not a case in which that standard was met.
The insurer's position is understandable: they are not
unsecured creditors, as was repeatedly suggested in obiter by the
Courts in the Nortel matter, but rather contingent debtors to the
company. If a pool of assets is sacrificed at the beginning of the
process to cover the executives' costs of carrying on, and part
of carrying on is defending lawsuits, the pool of assets should
possibly meet those costs. On the other hand, the insurers'
obligations are typically payable regardless of the financial
health of the company, and Justice Morawetz's legal reasoning
on the effect of the CCAA stay (being that Nortel wasn't
permitted to pay) is sound.
The decision exposes the undergarments of the bankruptcy
process: creditors have to accept that a liquidated pool of the
company's remaining assets will be set-aside for insolvency
professionals; insurers are often the best deep-pockets available,
but they may not pay willingly and may act like a party with an
active stake in the eventual CCAA plan; and, despite the importance
of orders made in a CCAA context, successful appeal is very
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guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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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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