Factoring is a common way for businesses to monetize current assets. Typically, in a factoring transaction, an enterprise sells its accounts receivable to a third party (commonly a bank, but not always), which, in exchange for a discount on the value of the receivables, takes on the effort and time commitment related to collecting the accounts.
But what happens if the seller of the accounts receivable goes bankrupt? Could creditors of the seller, or a trustee in bankruptcy, liquidator, monitor or administrator of the seller, attempt to recover from the purchaser the accounts receivable that were transferred?
In certain circumstances, yes.
Pursuant to Canadian insolvency statutes (including the Bankruptcy and Insolvency Act, the Companies' Creditors Arrangement Act, and applicable provincial laws governing creditors' rights generally), the sale and assignment of certain assets of a debtor during particular 'look-back periods' could be declared "void" or "voidable" and overridden or set aside by a Canadian court.1 Most relevant is section 96 of the BIA, which provides that a transfer at undervalue – meaning, a disposition of property for which the seller received either no consideration or consideration that was conspicuously less than the fair market value of the property that was transferred – could be found to exist by a Canadian court if:
- in the case of a determination that the seller was dealing with the purchaser at arm's length, the transfer occurred in the year prior to the date of the initial bankruptcy event, the debtor was insolvent at the time of the transfer (or rendered insolvent by it), and the debtor intended to defraud, defeat or delay a creditor; or
- in the case of a determination that the seller was not dealing with the purchaser at arm's length, if the transfer at undervalue occurred in the twelve months prior to the initial bankruptcy event (with no need to prove the debtor's intent or insolvency) or, if the transfer occurred within the five years prior to the initial bankruptcy event and the debtor was insolvent at the time of the transfer and intended to defraud, defeat or delay a creditor.2
If, pursuant to a BIA proceeding, a court determines that a transfer of accounts receivable was a transfer at undervalue, the court may give judgment against the purchaser for the difference between the consideration received by the seller and the fair market value of the property transferred, or the court may declare the transaction void as against a trustee in bankruptcy.3
What does the phrase "conspicuously less than fair market value" mean?
A review of the applicable case law offers little guidance with respect to how much of a discount on the price of an asset would constitute 'conspicuously less than fair market value.' For instance, it has long been clear that if a bankrupt seller received no consideration (or only nominal consideration) for a transfer of assets within the applicable look-back window, courts might unwind such transactions.4 However, in the case of Peoples v Wise, the Supreme Court of Canada commented that "there is no particular percentage that definitively sets the threshold for a conspicuous difference ... [but] the percentage difference is a factor."5
In various cases, discounts on the fair market value of assets of just over 6%6 and 6.67%7 were found not to be conspicuous; but in other circumstances, discounts of 17.5%8, and 55%, 71%, 77% and 82%9 were. As each case turns on its own unique facts, however, it cannot be said with certainty that the range of permissible discounts falls between the two poles. Perhaps the most helpful guidance can be distilled from the 2008 Quebec Court of Appeal case of Banque Nationale du Canada v. Produits Forestiers Turpin.10 In Turpin, the transactions at issue were determined at trial to have involved a discount of just over 12%, which was deemed to be a conspicuous difference. On appeal, however, the court revised the fair market value of the assets such that the transfer price was found to be discounted somewhere between 4.84% and 9.84% – which discount was found not to be conspicuous.
An instructive aspect of Turpin is that the court took standard industry practice into account in determining the fair market value of the transferred asset (in this case, lumber). In doing so, the court relied on the testimony of officials of the purchaser, who testified that the purchaser assumed risks and costs that justified a markup from the standard industry price. Furthermore, because the lumber industry was based on long-term business relationships rather than "one-shot deals," and thus customers were willing to invest more in certain relationships, the court noted that "these characteristics have a certain impact on the determination of fair market value."11
Implications for Factors
Considering that most factoring transactions involve a discount to the nominal or stated value of the accounts receivable being purchased, factors need to be aware that discounts which are "conspicuous" may attract risk in a proceeding under a Canadian insolvency statute. Unfortunately, there is no fixed rule as to how much of a discount could be deemed to be a conspicuous difference from fair market value. Factors seeking to purchase the receivables of Canadian businesses should generally be aware of market norms which would justify the application of certain discounts. If the seller of the receivables is at risk of becoming insolvent or bankrupt, or if the seller is not at arm's length from the purchaser, then the purchaser should be particularly vigilant to ensure that the receivables are sold at or near their fair market price.
1. Note as well that there are a number of procedural steps that a seller of the accounts receivable may take to reduce risks associated with the bankruptcy of the seller, such as compliance with 'true sale' corporate procedures and registration of the transfer of the accounts under the applicable provincial personal property statutes. See "Assignments of Conditional Sale Contracts," at page 7.
2. Bankruptcy and Insolvency Act, RSC 1985, c B-3 at s 96.
4. See, e.g., Dover Financial Corp (Syndic de), 2012 QCCS 68; Re Anderson, 2012 BCSC 956; Bank of Montreal v EL04 Inc., 2012 ONCA 80; PricewaterhouseCoopers Inc. v Legge, 2011 NBQB 255; Grant Bros Contracting Ltd. v Grant, 2005 NSSC 358; Re Kostiuk (1998), 6 CBR (4th) 46,  BCJ No 2296; Re Dilawri (1995), 36 CBR (3d) 70 (Ont Gen Div).
5. Peoples Department Stores Inc. (Trustee of) v. Wise, 2004 SCC 68,  3 SCR 461 at para 85.
6. Ibid at para 88.
7. Re Mendenhall (1999), 107 OTC 11, 12 CBR (4th) 271, 92 ACWS (3d) 747.
8. Skalbania (Trustee of) v Wedgewood Village Estates Ltd. (1989), 60 DLR (4th) 43,  5 WWR 254 (BC CA).
9. Re Mihalich, 2013 ABQB 66.
10. Banque Nationale du Canada v Produits forestiers Turpin inc., 2008 QCCA 1732. Note that the unofficial English translation of this Quebec case at http://canlii.ca/t/284ns was used and quoted for the purposes of this article.
11. Ibid at para 45.
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.