Will the court enforce a contractual provision that eliminates property from the estate if it is commercially reasonable?
Chandos, a general construction contractor, entered into a Subcontract with Capital Steel. A provision of the Subcontract would award Chandos a sum of money in the event of Capital Steel’s bankruptcy. At the time that Capital Steel filed for bankruptcy, Chandos owed $126,818.39 to it under the Subcontract. Chandos argued that, pursuant to the impugned provision in the Subcontract, it was entitled to set off 10 percent of the Subcontract price ($137,330.05). If this provision was enforceable, it would mean Chandos had a $10,511.66 claim provable in the bankruptcy proceedings rather than a debt to Capital Steel of $126,818.39.
The Trustee applied for advice and directions from the Court of Queen’s Bench as to whether the impugned provision was valid or violated the anti-deprivation rule. The anti-deprivation rule prevents parties from agreeing to remove property from a bankrupt’s estate that would otherwise have vested in the trustee. It invalidates provisions that are “engaged by a debtor’s insolvency and remove value from the debtor’s estate to the prejudice of creditors”.
The application judge found the provision to be valid and concluded that Chandos had not attempted to avoid the effect of bankruptcy laws. On appeal, the majority of the Alberta Court of Appeal reversed the decision, finding the provision invalid. On further appeal to the Supreme Court of Canada, Chandos alleged that the majority of the Court of Appeal made several errors, including:
- finding an anti-deprivation rule exists at common law;
- applying an effects-based anti-deprivation rule; and
- failing to consider the effect of set off.
The SCC confirmed that the anti-deprivation rule has existed in Canadian common law and has not been eliminated by either the SCC or Parliament. The test to determine a breach of the anti-deprivation rule has two parts: first, the relevant clause must be triggered by an event of insolvency or bankruptcy; and second, the effect of the clause must be to remove value from the insolvent’s estate.
Chandos submitted that this Court should change the anti-deprivation rule to adopt an intention-based test. Under this test, the anti-deprivation rule would not invalidate provisions of “bona fide commercial transactions which do not have as their predominant purpose, or one of their main purposes, the deprivation of the property of one of the parties on bankruptcy”. According to Chandos, upholding bona fide commercial agreements would strike the best balance of public policy considerations and contribute to commercial certainty.
A majority of the SCC disagreed that adopting an intention-based test would create commercial certainty. To the contrary, applying such a test would require courts to determine the intention of contracting parties long after the fact and it would detract from the efficient administration of corporate bankruptcies. Moreover, an intention-based test would encourage parties who can plausibly pretend to have bona fide intentions to create a preference over other creditors by inserting such clauses. An intention-based test would render the rule ineffectual, save in the most flagrant cases of deliberate circumvention of insolvency law. This would threaten to undermine the statutory scheme of the BIA.
The majority held that the effects-based rule, as it stands, is clear. Courts and commercial parties do not need to look to anything other than the trigger for the clause and its effect. The effect of a clause can be far more readily determined in the event of bankruptcy than the intention of contracting parties. An effects-based approach also provides parties with the confidence that contractual agreements, absent a provision providing for the withdrawal of assets upon bankruptcy or insolvency, will generally be upheld.
The majority upheld the decision of the Court of Appeal and dismissed the appeal. The impugned clause violated the anti-deprivation rule and was thus void. The effect of the provision was to create a debt from Capital Steel to Chandos that would not exist but for the insolvency. This was a direct and blatant violation of the anti-deprivation rule.
Justice Côté dissented, finding that the anti-deprivation rule should not apply to transactions or contractual provisions which serve a bona fide commercial purpose on the basis that, among other things, there is a principled legal basis for retaining a bona fide commercial purpose test. According to Justice Côté, the anti‑deprivation rule is based on the common law public policy against agreements entered into for the unlawful purpose of defrauding or otherwise injuring third parties. Therefore, the rule requires an objective assessment of the parties’ intentions.
Justice Côté also found that the purely effects‑based test endorsed by the majority “gives too little weight to freedom of contract, party autonomy, and the elbow‑room which the common law traditionally accords for the aggressive pursuit of self‑interest”. Justice Côté also expressed concern that the effects-based test may create significant uncertainty by introducing a vague standard which unduly restricts the scope of the anti‑deprivation rule”. As a result, Justice Côté would have allowed the appeal and restored the order made at first instance.
Counsel: Darren Bieganek, Q.C. and Ryan Quinlan of Duncan Craig LLP for Chandos; Shauna N. Finlay of Reynolds Mirth Richards & Farmer LLP and Victoria Merritt of Kent Employment Law for Deloitte as Trustee in Bankruptcy; Zoe Oxaal for the intervener the Attorney General of Canada; Ashley Taylor and Sinziana R. Hennig of Stikeman Elliott LLP for the intervener the Canadian Association of Insolvency and Restructuring Professionals; Sean F. Collins, Brandon Kain and Cassidy Thomson of McCarthy Tétrault LLP for the intervener the Insolvency Institute of Canada.
Judges: Wagner C.J. and Abella, Moldaver, Karakatsanis, Brown, Rowe, Martin and Kasirer JJ.; Côté J. dissenting