The Court of Appeal for Ontario (the "Court") held
recently that an otherwise valid contractual clause between parties
was unenforceable on the basis that it was a "fraud upon the
bankruptcy law." This equitable principle operates to
invalidate any part of an agreement that provides for an unfair
distribution of a bankrupt's assets among its creditors.
The case, Aircell Communications Inc. (Trustee of) v Bell
Mobility Cellular Inc., involved an independent dealer agreement
(the "Agreement") under which Bell appointed Aircell as
an independent dealer of telecommunication products and services.
Aircell would purchase inventory from Bell and collect commissions
once the products and services were sold. Aircell, however,
experienced financial difficulty. At the time, Aircell owed Bell
approximately $64,000 for inventory and Bell owed Aircell
approximately $188,981 for commissions.
The Agreement contained a provision entitling Bell to terminate
it on notice if, among other things, Aircell defaulted on any
payments or commenced any proceedings under the Bankruptcy and
Insolvency Act (the "BIA"). Aircell met with certain of
its stakeholders, including Bell, to discuss restructuring options.
Unbeknownst to Bell, Aircell had already filed a Notice of
Intention to Make a Proposal under the BIA. After the meeting, Bell
notified Aircell that it was terminating the Agreement due to
Aircell's failure to pay amounts outstanding to Bell. The
termination of the Agreement became effective in 30 days pursuant
to its terms. However, Aircell was deemed bankrupt before the 30
The Trustee in Bankruptcy of Aircell asserted a claim against
Bell to the extent that the unpaid commissions exceeded the amount
owed to Bell by Aircell for inventory. In turn, Bell relied on a
relieving clause in the Agreement which provided that Bell's
obligations to pay commissions "shall cease immediately"
upon termination of the Agreement.
The trial judge held that Aircell's failure to pay Bell was
due to Aircell's insolvency and, relying on the "fraud
upon the bankruptcy law" principle, declared the relieving
clause in the Agreement void. Bell appealed the decision to the
The Court upheld the trial judge's ruling and held that the
Agreement's termination was triggered because of Aircell's
insolvency. The Court determined that the relieving clause provided
a windfall to Bell. In the context of an insolvency, this type of
clause is inequitable because it runs contrary to the overriding
public policy that requires an equitable and fair distribution of a
bankrupt's assets among its creditors. In other words, the
relieving clause was a "fraud upon the bankruptcy law"
and was declared invalid by the Court.
The relieving clause, which was engaged upon any default of
Aircell, may have been valid outside of an insolvency proceeding.
However, contracting parties should be cognizant of the overriding
effects of insolvency on otherwise valid agreements and properly
take those effects into account to ensure the rights they bargained
for remain intact.
The Financial Services Group at Aird & Berlis LLP has a
great deal of experience in advising clients on the drafting and
negotiating of contractual clauses dealing with counterparty risk
as well as on priority disputes.
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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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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