Canada: Mind The Gap: Court Exercises Inherent Jurisdiction To Prime Secured Interest
Insolvency & Restructuring Bulletin

In Golfside Ventures Ltd (Re) (2023 ABKB 86) the Court of King's Bench of Alberta (the "Court") reaffirmed the Court's authority to exercise inherent jurisdiction in proceedings under the Bankruptcy and Insolvency Act (the "BIA") in circumstances where (1) the BIA is silent or has not dealt with a matter exhaustively; and (2) the benefit of granting the relief outweighs the relative prejudice to those affected by it.

The main issue in Golfside related to whether the Court could (and should) grant an Order creating a charge securing payment of the trustee's fees and expenses involved in administering the bankrupt's estate that was in priority to the claims of secured creditors. Pursuant to BIA s. 136(1), payment of the trustee's fees and expenses from the proceeds realized from the property of the bankrupt enjoys priority over most other creditors. However, this priority is subject to the rights of secured creditors. As a result, if the value of the secured creditors' claims exceeds the value of the bankrupt's estate, the trustee may find itself without recourse to recover the costs of its professional fees and expenses.

Golfside examines the interaction between the express provisions of BIA s. 136(1) and the Court's inherent jurisdiction to grant relief where it finds legislative gaps. It also provides useful guidance to insolvency professionals on the factors that the Court will consider when deciding whether to grant relief in bankruptcy proceedings on the basis of its inherent jurisdiction.

Background facts

The debtor, Golfside Ventures Ltd. ("Golfside") entered into a joint venture arrangement with Hustle Holdings Ltd ("Hustle") in 2008 for the development of some parcels of bare-land located near Redwater, Alberta (the "Lands"). Hustle's interest in the joint venture was subsequently transferred to Obcorp Holdings Inc. ("Obcorp"), and the principal of Obcorp, Donald Oborowsky ("Mr. Oberowksy"), took an assignment of a mortgage against the Lands from the town of Redwater relating to obligations owing under the development agreement for the Lands (the "Mortgage").

On February 19, 2019, Golfside made an assignment into bankruptcy and BDO Canada Limited was appointed as Golfside's bankruptcy trustee (the "Trustee"). Golfside's only material asset was the Lands, which had an estimated value of approximately $1.6 million. At the time of the Trustee's appointment, it was aware of three secured creditor claims; namely:

1. the Mortgage, which had a principal sum of approximately $430,000;
2. a claim by Metrocan Ventures Inc. ("Metrocan") – a company controlled by the same principal as Golfside's - for $1.08 million, which was secured by a general security agreement; and
3. a claim for unpaid municipal taxes by the town of Redwater for $121,000.

The Trustee was of the view that there was sufficient equity in the Lands to cover the fees and expenses involved in administering Golfside's estate (the "Trustee's Fees"); however, the Trustee took further steps to secure payment of the Trustee's Fees by agreeing with Metrocan to postpone and subordinate any and all claims Metrocan held against Golfside to the Trustee's Fees.

After Golfside's assignment into bankruptcy and after the Trustee was appointed, Obcorp registered a builders' lien in the approximate amount of $5,500,000 against the Lands in relation to work done as part of the joint venture (the "Obcorp Lien"). The Trustee disallowed the Obcorp Lien; however, on appeal, the Court held that the Obcorp Lien was valid and enforceable against the Lands but did not make any findings as to the quantum secured thereunder.

As the Obcorp Lien was a secured claim under the BIA, it stood to be paid in priority to the Trustee's Fees, pursuant to BIA s. 136. Accordingly, the Trustee applied to the Court for an Order creating a first-priority charge on Golfside's assets as security for payment of the Trustee's Fees, based on the Court's inherent jurisdiction and the principles of fairness.

Analysis

The definition of a "secured creditor" under BIA s. 2 includes a person holding a lien. Obcorp argued that the BIA provided a complete answer to the issue at hand in that the Trustee's Fees were subordinate to Obcorp's claim under the Obcorp Lien as Obcorp was a secured creditor under the BIA. Further, Obcorp claimed that the Trustee should have been aware of the Obcorp Lien at the time it was appointed as trustee, due to ongoing litigation between Obcorp and Golfside which commenced in 2012, and which related to the joint venture and the Lands.

The Trustee argued, however, that the Court retains inherent jurisdiction to grant a first-ranking charge over a debtor's assets to secure repayment of a trustee's fees and expenses, relying on the decision of Topolniski J. in Re Residential Warranty Company of Canada Inc. (2006 ABQB 236; aff'd 2006 ABCA 293). In that case, Her Ladyship stated that "inherent jurisdiction is available to ensure fairness in the bankruptcy process and fulfilment of the substantive objectives of the BIA, including the proper administration and protection of the bankrupt's estate". Topolniski J. held that there are two preconditions to the Court exercising its inherent jurisdiction in the context of a BIA proceeding:

1. the BIA must be silent on a point or not have dealt with a matter exhaustively; and
2. after balancing competing interests, the benefit of granting the relief must outweigh the relative prejudice to those affected by it.

In examining whether it was appropriate to exercise the Court's inherent jurisdiction in the Golfside matter, Nielsen ACJ observed that although the Trustee was aware of the ongoing litigation between Obcorp and Golfside at the time of its appointment, the pleadings and other documents filed in that proceeding did not clearly articulate the existence of the Obcorp Lien. Rather, the Trustee was faced with a situation in which it had made inquiries about the state of Golfside's finances in advance of its appointment. Then, after being appointed, it was alerted to Obcorop's additional secured claim. His Lordship held that these circumstances were not exhaustively addressed by the BIA, and as a result, the first step of the test articulated in Residential Warranty was satisfied.

Next, Nielsen ACJ balanced the competing interests to determine whether the relief sought by the Trustee outweighs the relative prejudice to those affected. His Lordship noted, among other things, that:

1. Trustees are fundamental parts of the bankruptcy system. Trustees assist the Court and the parties in determining the validity and priority of trust claims;
2. Determining the validity and priority of claims has a real cost. Trustees are entitled to receive reasonable compensation for their problem solving and exercise of judgment; and
3. There may be a chilling effect on Trustees if this Order were not granted. Trustees would not be able to trust that they would be reasonably compensated in a situation where a secured creditor's claim arrived post-appointment.

Ultimately, the Court determined that the relevant factors weighed in favour of the Trustee's position and noted that there was not much else the Trustee could or ought to have done to protect its interests in the circumstances. As a result, the Court granted a charge on Golfside's assets as security for payment of the Trustee's Fees in priority to the Obcorp Lien.

Conclusion

This case provides a useful reminder of the importance for insolvency professionals to conduct due diligence at the outset of an insolvency proceeding to determine, to the extent possible, the nature of the claims against a bankrupt's estate. Not only will this approach help ensure that sufficient equity will remain to cover the trustee's administrative fees (although a retainer, if available, would also protect the trustee), but it may also assist a Trustee in the event an unforeseen claim surfaces subsequent to its appointment that primes the Trustee's priority provided by BIA s. 136(1)(b).

It is also a further illustration of the recent use of courts' powers under "the important but sparingly used tool" of inherent jurisdiction, as opposed to residual statutory jurisdiction. This power has been employed to resolve novel legal issues in cases such as Petrowest Corporation v. Peace River Hydro Partners (2019 BCSC 2221; aff'd 2020 BCCA 339; aff'd 2022 SCC 41). That said, as was the case in Golfside, courts have always been careful to emphasize the limited availability of inherent jurisdiction as a gap-filling measure. While inherent jurisdiction remains a tool in the insolvency practitioner's tool box, it is not one we should expect to see often.

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.