Canada: Intercorporate Debt And Equitable Subordination One Case Forward And One Case Back

Last Updated: February 25 2016
Article by Jeremy Opolsky

This article explores the perplexing status of the doctrine of equitable subordination in Canada. Equitable subordination — the subordination of a claim on the basis of a creditor's misconduct—has an uncertain place in Canadian insolvency law. More than 30 years after Canadian courts first considered whether the United States ("US") doctrine of equitable subordination has a home in Canada, there is no clear answer. This question has come before the Supreme Court of Canada twice. Both times the high Court has passed on answering. Recent cases have gone both ways on whether the doctrine exists inCanada.If the doctrine is available, even fewer cases have examined the conditions for its application.

Yet, answers on equitable subordination are increasingly relevant, especially in the context of intercorporate group debt. In two recent Canadian cases, Target and US Steel, creditors have sought to equitably subordinate the debts of the Canadian subsidiary's US parent or affiliates.1 Because of the continuing uncertainty surrounding the doctrine, creditors continue to seek to subordinate the claims of corporate affiliates. This uncertainty is the focus of this article.

The first section of this article looks broadly at the use of equitable subordination to challenge intercorporate debt, highlighting the Target and US Steel cases. The second section looks at the law of equitable subordination, providing a summary of the doctrine in the US and its origins in Canada. The third section looks at recent cases, ie, those cases in the past 10 years, of equitable subordination inCanadaand the relevant issues raised therein. These issues include whether the doctrine of equitable subordination is available in Canada at all, whether it requires a showing of inequitable conduct, and, if so, what is sufficient misconduct to warrant an application of the doctrine. This section draws on comparable US case law to explore the relevant issues.


Intercorporate debt is a reality of modern corporate groups. Corporations lend to their subsidiaries and affiliates to help these businesses begin, in the ordinary course, as intercompany loans and cash management, or when such corporations are in financial distress. The latter situation is not unusual. As theUS Court of Appeals for the Seventh Circuit's apt narrative describes:

[a] business is ailing. Revenues are down, profits gone. Rather than let it die, the owners decide to try reviving it. Doing so will require an infusion of new funds. The owners drum up the needed funds but face a choice: which legal form should the owners use, equity or debt?2

As the Seventh Circuit went on to note, a company will often choose to finance its subsidiary or affiliate in the form of debt. This decision "will provide the firm with needed funds while limiting the owners' risk that the company will go bankrupt and the new funds will end up in the wallets of the unsecured creditors".3 This question can become highly relevant if the debtor company becomes insolvent and files for creditor protection. Instead of holding solely equity interests, which recover at the end of the queue only after all of the creditors have been paid in full, the debtor's parent or affiliate may hold large debt claims that could share with, or if secured take precedence over, the claims of arm's length creditors.

Unsecured creditors of the debtor can object to the idea of the debtor's estate being distributed, in whole or in part, to its parent corporation as a result of its debt claims. Such creditors often seek to challenge the debt of these insiders utilizing two different, but related, doctrines. The first is the doctrine of recharacterization, which looks to ascertain the "true nature" of the claim and whether a debt claim should be recharacterized as equity.4 This doctrine has been widely adopted not only in relation to insolvency, but also in relation to tax and criminal law.5 It is now effectively embedded in Canada's insolvency statutes.6

The second doctrine is equitable subordination. Under this doctrine, the otherwise valid debt claims of a creditor may be subordinated to the claims of a debtor's other creditors.7 For the claim to be subordinated, it must have arisen from some inequitable conduct of the creditor that has resulted in loss to the debtor's other creditors or that has conferred an unfair advantage on the impugned creditor. This doctrine originated in the United States under the common law and then was codified into the United States Bankruptcy Code.8

In the context of challenges to intercorporate debt, recharacterization and equitable subordination often arise in similar circumstances. However, the differences between the doctrines are important. Recharacterization looks at whether a claim is indeed founded in debt and, if a challenge is successful, will treat a claim as equity. It requires no inequitable conduct or proof of harm by the claimant—it is a doctrine of interpretation and not based on equitable principles. Equitable subordination takes the claim's status as debt or secured debt as given and then, based on equitable principles, seeks to subordinate it to other unsecured claims.9 Equitable subordination is inherently a doctrine of "simple fairness"10 and is intended to be used "sparingly".11

In Target and US Steel, creditors raised both recharacterization and equitable subordination in their challenges to the claims submitted by the debtors' affiliate and parent respectively.

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* Jeremy Opolsky is an associate at Torys LLP. The author is admitted to the bars of Ontario and New York. The views expressed in this article are those of the author only and do not necessarily represent the views of his firm or his firm's clients. Many thanks to Jonathan Silver and Winston Gee, student-at-law and summer student respectively, for their invaluable research and editing assistance. Thank you also to Scott Bomhof, Andrew Gray and Alison Bauer for their thoughtful and probative edits to this article. Any errors remain, of course, those of the author alone.

1 Re US Steel Canada Inc, Court File No CV-14-10695-00CL (Ont SCJ) [US Steel]; Re Target Canada Co, Court File No CV-15-10832- 00CL (Ont SCJ) [Target].

2 In re Lifschultz Fast Freight, 132 F 3d 339 at 341 (7th Cir 1997) [Lifschultz Fast Freight].

3 Ibid at 342-43.

4 Canada Deposit Insurance Corp v Canadian Commercial Bank, [1992] 3 SCR 558, 1992 CarswellAlta 298 [CCB cited to CarswellAlta]; Re Central Capital Corp (1996), 132 DLR (4th) 223 (Ont CA).

5 See, eg, Bimman v Neiman, 2015 ONSC 2313; Joy Estate v 1156653 Ontario Ltd (2007), 38 BLR (4th) 69 (Ont SCJ); Big Comfy Corp v R, [2002] 3 CTC 2151 (TCC [General Procedure]).

6 Companies' Creditors Arrangement Act, RSC 1985, c C-36 s. 45 [CCAA]; Bankruptcy and Insolvency Act, RSC 1985, c B-3 [BIA].

7 CCB, supra note 4 at para 89.

8 US Bankruptcy Code,11 USC § 101 et sesqui.

9 Matter of Mobile Steel C, 563 F 2d 692 at 702 (5th Cir 1977) [Mobile Steel]. "It is important to remember that the issue is not whether the advances 'actually' were loans, but whether equity requires that they be regarded as if they were something else." See also, Janis P Sarra, "Corporate Group Insolvencies: Seeing the Forest and the Trees" (2008) 24 BFLR 63, explaining the difference between equitable subordination, piercing the corporate veil and recharacterization.

10 Re General Chemical Canada Ltd, (2006), 22 CBR (5th) 298, 2006 CarswellOnt 4675 (Ont SCJ [Commercial List]) at para 92 [General Chemical].

11 Ibid. See also, Lifschultz Fast Freight, supra note 2 at 341 ("Equitable subordination is a 'drastic' and 'unusual' remedy.")

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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