SCC Rules No Absolute Bar On Pre-post Compensation (setoff), Overrules Kitco And Provides Roadmap For Possible Pre-post Setoff In CCAA Cases - Financial Services

On December 10, 2021, the Supreme Court of Canada ("SCC") rendered its decision in Montréal (City) v. Deloitte Restructuring Inc.¹ and established a test for situations that might allow pre-filing claims to be set off against post-filing claims in proceedings under the CCAA². In doing so, the SCC rejected the absolute prohibition proposed by the Quebec Court of Appeal in Agence du revenu v. Kitco Metals Inc. ("Kitco")³, concluding that a court has the discretion to allow pre-post compensation (or set-off in common law provinces) in appropriate cases⁴. In tempering the principle in Kitco, the SCC noted that "the instances in which a court should not stay the right to effect pre-post compensation in an initial order will be rare, however"⁵ it is open for creditors to seek leave from the stay. In considering a creditor's request for relief from the stay to assert its pre-post compensation, the supervising judge's discretion must be exercised in furtherance of the CCAA's remedial objectives and must avoid the potential disruption that may be caused by such compensation. The SCC also stated that the remedial objectives of the CCAA, the context of restructuring by way of liquidation, and the impact of pre-post compensation on its progress, can be weighed by a court in exercising its discretion⁶.

This bulletin summarizes the reasoning of the SCC and highlights that creditors must promptly and carefully consider their position in the unique circumstances of each case to determine if their claim for pre-post compensation (set-off) might fall within the narrow opening created by the SCC. Any prospect for success will require the creditor to act in a timely manner with diligence and in good faith. We also suggest that the relief sought by a creditor is best fashioned to avoid material disruption to a viable and good faith restructuring effort by the debtor company. We believe that, with appropriate guidance, a creditor may be able to thread the needle in the appropriate circumstances.

FACTS

This matter involves SM Group, a debtor-engineering firm allegedly involved in fraud in obtaining and executing public works contracts. In 2018, in an attempt to avoid bankruptcy, SM Group filed for CCAA protection, stayed the rights and remedies of its creditors, and appointed Deloitte Restructuring Inc. as monitor ("Deloitte"). Following that order, SM Group continued to perform work for one of its creditors, the Ville de Montréal ("City"), including on the Samuel De Champlain Bridge and Turcot Interchange construction projects. However, the City refused to pay for that work, invoking its right to compensation between what it owed SM Group for the work performed post-filing, and two claims it allegedly had against SM Group that arose pre-filing.

These two claims came about in the context of the Charbonneau Commission of inquiry that brought to light the existence of schemes involving collusion and corruption in the awarding and management of public contracts in the construction industry. The inquiry prompted the passage of Bill 26⁷, which included a Voluntary Reimbursement Program ("VRP") meant to allow businesses to reimburse certain amounts improperly paid in the course of the tendering, awarding or management of a public contract in relation to which there may have been fraud or fraudulent tactics. The Charbonneau Commission's work uncovered a link between SM Group and certain central players in the collusion schemes. Prior to its CCAA proceedings, SM Group had agreed to a VRP with the City.

JUDICIAL HISTORY

In response to the City's position that it would effect compensation between what it owed SM group and the aforementioned VRP claims, Deloitte applied for a declaratory judgment to compel the City to pay for the post-filing services. The City contended that because the VRP claim was the result of fraud, it could not be compromised pursuant to Section 19(2) of the CCAA and accordingly, was not affected by the prohibition of pre-post set-offs under the CCAA, as interpreted by Kitco. The Judge of the Quebec Superior Court, however, rejected that argument and granted Deloitte's application, holding that pre-post compensation could not be effected in favour of the City.⁸ The decision relied on the principles outlined in Kitco, and its blanket rule that pre-post compensation was not possible.

The Quebec Court of Appeal subsequently maintained the decision of the Superior Court,⁹ so the City turned to the Supreme Court of Canada.

THE SUPREME COURT OF CANADA DECISION

Majority

The SCC dealt initially with the question of whether pre-post compensation was available to the City, deciding to temper the Kitco rule and reject an absolute prohibition of pre-post compensation¹⁰. In doing so, it notably warned against interpreting the CCAA as one would the Bankruptcy and Insolvency Act¹¹, i.e. "a comprehensive code that lays out all that is permitted or barred", and rather highlighted the important role of the discretion afforded to the CCAA court to make appropriate orders to achieve the CCAA's objectives¹².

The central question raised by the appeal was thus whether a court's discretion allowed it to stay a right to pre-post compensation invoked by a creditor and, by extension, to authorize pre-post compensation in appropriate cases. The SCC's analysis focused on the on the scope of a CCAA court's discretion and holding that sections 11 and 11.02 of the CCAA allow the court to stay rights held by creditors, including the right to effect pre-post compensation, if the exercise of those rights could jeopardize the restructuring process.¹³

Despite this marked departure from Kitco, the SCC also underscored that the instances where a court should lift the stay to permit a creditor to apply pre-post compensation or set off will be "rare."¹⁴ It further noted that section 21 of the CCAA allows compensation between two pre-filing debts for the purpose of quantifying claims against a debtor company as of the CCAA filing date. Section 21 is, however, only useful for quantification purposes and does not imply a broader authorization to apply pre-post compensation, much less in a way that would be shielded from a supervising judge's power to order a stay under sections 11 and 11.02 of the CCAA.¹⁵

The question then becomes - when will the court lift the stay and allow pre-post compensation in an initial order? While the SCC did not provide specific examples, it did emphasize that the supervising judge's discretion must be exercised in furtherance of the CCAA's remedial objectives.¹⁶ As summarized by the SCC, they include the following:

avoiding the social and economic losses resulting from the liquidation of an insolvent company; maximizing creditor recovery; ensuring fair and equitable treatment of the claims against the debtor company; preserving going-concern value where possible; protecting jobs and communities affected by the company's financial distress; and enhancing the credit system generally¹⁷

The SCC then reiterated the test for when a court can exercise its discretion under the CCAA established in Callidus¹⁸ and Century Services¹⁹, keeping three baseline considerations in mind: (1) the appropriateness of the order being sought, (2) due diligence of the party seeking the order, and (3) good faith on the applicant's part.²⁰

In applying this test to the present facts, the majority of the SCC determined that it would be inappropriate to lift the stay, as:

the City had not proved that the VRP claims amounted to fraud within the meaning of the CCAA, and even if it did, this would be no automatic reason to lift the stay²¹;
the City had not relied on any of the CCAA's remedial objectives other than alleging the protection of the public interest. The SCC took care to reiterate that "protecting the public interest does not mean that public bodies should be placed in a better position than other creditors because their claims relate to public funds"²²; and
the City had failed to act with the diligence expected in CCAA proceedings as it waited for months after learning of SM Group's insolvency to invoke compensation, letting it accrue millions in unpaid work in the meantime.²³

The appeal was thus dismissed.

Dissent

Justice Brown, dissenting, agreed with the majority of the SCC that the approach taken by the Court of Appeal in Kitco should be rejected. However, Justice Brown held that the discretion of a supervising judge under section 11 of the CCAA as to whether to allow a creditor to effect pre-post compensation or set-off is not limited solely to the exceptional circumstances described by the majority. Justice Brown would have allowed the appeal, solely for the purpose of remanding the case to the Superior Court to allow the supervising judge to exercise their discretion under section 11 of the CCAA (a discretion that the judge did not believe he had at the time of the original hearing)..

POTENTIAL IMPACTS OF THE CASE

Given the SCC's comments that "a supervising judge has the discretion to authorize pre-post compensation only in exceptional circumstances, given the high disruptive potential of this form of compensation"²⁴, a creditor will need to carefully consider when and how it fashions its requested relief. We contend that the SCC was judicious in opening this door and propose the following as instances where preserving a creditor's right to pre-post set-off or compensation would actually serve to further the objectives of the CCAA.

1. Claims resulting from fraud and other crimes

Although the SCC declined to follow that reasoning here, it did recognize that, in some instances, it would be inappropriate to stay the right of set-off of a creditor having a claim under section 19(2) CCAA, including as a result of fraud, especially in situations where staying such a right would offend "considerations of commercial morality that reflect societal norms"²⁵. The door may remain open for a creditor to claim set-off rights where, for instance, fraud was particularly egregious and proven in court for.

2. Payment processors

Turning now to the CCAA objectives of "preserving going-concern value where possible [.] and enhancing the credit system generally", set-off rights are sometimes so integral to the continued operations of a debtor company that they must be protected to ensure the continued operations and successful restructuring. For instance, payment processors manage debits and refunds in the ordinary course that are so interlinked to the day-to-day operations of a debtor that trying to suspend the flow of such funds would be counterproductive. In the CCAA proceedings of Beyond the Rack, a case that ran in parallel with Kitco, the Quebec Superior Court made the following comments, which now seem like direct foreshadowing of the conclusion reached by the SCC in SM:

"[183] Moreover, under CCAA proceedings where the ultimate goal is to give the opportunity to a company to restructure its operations and business with the critical assistance of certain key suppliers [such as the payment processors], nothing would prevent the Court to allow a critical supplier to make such a type of compensation, if necessary, even if the process could go against the rules between pre-filing claims and post-filing ones."²⁶

3. Cash collateralized letters of credit

The reasoning in this case also supports the existing common practice of exempting the cash collateral backing for outstanding letters of credit ("LC"), held by the issuer of such LC, from the effects of the stay, or new CCAA charges.

Indeed, LCs are often relied upon in the ordinary course of business, as required by various counterparties, and are essential to the continued operations of a debtor company (e.g. utility companies, regulatory entities, cash management providers, etc.). The preservation of the LC mechanism thus directly supports the continued support of such parties and avoiding unnecessary draws on LCs during the restructuring proceedings.

4. Cash management

One could argue that the continued use of a debtor company's regular operating accounts, unaffected by the stay under a CCAA initial order, is just as essential. Netting as well as set-offs are often effected between accounts and other cash management services in that context. The continued availability of such services, along with resolution of the concerns raised by their providers, is instrumental to a successful restructuring in that they generally allow the debtor company to operate in the ordinary course with the support of the cash management bank.

5. The credit system generally

Other financial arrangements, that if disrupted, would have a material negative impact on the credit system and the ability of companies to obtain credit in the future should be considered in light of the remedial principles of the CCAA. In particular, enhancing the credit system generally.

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

Footnotes

1 Montréal (City) v. Deloitte Restructuring Inc., 2021 SCC 53 SM.

2 Companies' Creditors Arrangement Act, R.S.C. 1985, c. C-36 CCAA.

3 Arrangement relatif à Métaux Kitco inc., 2017 QCCA 268 Kitco.

4 SM, para. 58

5 SM, para 57

6 SM, para 86.

7 An Act to ensure mainly the recovery of amounts improperly paid as a result of fraud or fraudulent tactics in connection with public contracts, CQLR, c. R-2.2.0.0.3 "Bill 26".

8 Arrangement relatif à Consultants SM inc., 2019 QCCS 2316.

9 Arrangement relatif à Consultants SM inc., 2020 QCCA 438.

10 SM, para 57, 62.

11 Bankruptcy and Insolvency Act, RSC 1985, c B-3.