Montreal (City) v. Deloitte Restructuring Inc.

December 22, 2021

What is the law on pre-post compensation under the CCAA?

SM Group, a consulting engineering firm, performed a variety of contracts for the City of Montreal over a period of several years. SM Group subsequently became insolvent and two of its former officers were charged with criminal offences in relation to certain collusion schemes. In August 2018, the Quebec Superior Court made an initial order by which SM Group became subject to proceedings under the CCAA. Following that order, SM Group continued to perform work for the City, but the City refused to pay for that work.

The City subsequently invoked its right to effect compensation between its debt to SM Group for the work done after the initial order and two claims against SM Group that arose before the initial order and resulted from fraud on SM Group’s part. The first claim arose from a settlement agreement entered into under the Voluntary Reimbursement Program that resulted from Bill 26 (“VRP claim”). The second claim was based on a proceeding brought by the City against SM Group, in which it claimed money from SM Group for allegedly having participated in collusion in relation to a call for tenders for a water meter contract.

In response, the Monitor for SM Group applied for a declaratory judgment stating that compensation could not be effected with respect to the amounts owed by the City to SM Group. The supervising judge granted the Monitor’s application for a declaratory judgment and held that pre‑post compensation (i.e. compensation between debts arising before and after an initial order) could not be effected in favour of the City. The majority of the Court of Appeal reached the same conclusion.

Before the Supreme Court of Canada, the City argued that the VRP claim related to a debt resulting from fraud pursuant to s. 19(2)(d) of the CCAA, and such a claim fell outside the absolute prohibition against pre‑post compensation. The Supreme Court noted that to discharge its burden that the debt resulted from fraud, a creditor must establish, on a balance of probabilities, the following four elements:

  1. the debtor made a representation to the creditor;

  2. the representation was false;

  3. the debtor knew that the representation was false; and

  4. the false representation was made to obtain property or a service.

Once these elements have been established, the creditor of a claim to which s. 19(2)(d) of the CCAA applies is in a better position than other ordinary creditors, insofar as such a claim, while not conferring secured creditor status, cannot be dealt with by a compromise or arrangement. However, the Supreme Court cautioned that this exception to the general scheme established by s. 19(1) of the CCAA must be interpreted narrowly.

The City had to prove that SM Group had knowingly made a false representation that led to the VRP claim. Evidence that a natural person or enterprise participated in the VRP cloud not, on its own, justify characterizing a claim as being related to a debt resulting from fraud pursuant to s. 19(2)(d) of the CCAA.

The Court then considered the second question raised by this appeal – whether a court’s discretion allows it to stay a right to pre‑post compensation invoked by a creditor under the civil law or the common law and, by extension, to authorize pre‑post compensation in appropriate cases. The Court held that the broad discretion conferred by ss. 11 and 11.02 of the CCAA allows courts to stay rights held by creditors if the exercise of those rights could jeopardize the restructuring process. This includes a creditor’s right to effect pre-post compensation.

In the vast majority of cases, an initial order will, and should, stay a creditor’s right to set up pre‑post compensation against the debtor. The instances in which a court should not stay the right to effect pre‑post compensation in an initial order will be rare. Such discretion must be exercised in furtherance of the CCAA’s remedial objectives. If a creditor could rely on compensation to refuse to pay for goods or services supplied by the debtor during the status quo period, the restructuring could be torpedoed. The debtor would have a disincentive to provide its creditors with goods and services because it would fear not being paid for them; it would then be deprived of the funds needed to continue operating.

Section 21 of the CCAA does not grant creditors a right to pre-post compensation that would be shielded from a supervising judge’s power to order a stay under ss. 11 and 11.02 of the CCAA. Although s. 21 indicates that there is a right to effect compensation in proceedings under that statute, it applies only to compensation between debts that arise before an initial order is made (in other words, “pre-pre compensation”). Viewing s. 21 as allowing pre-post compensation would undermine the effectiveness of the status quo period, would jeopardize the survival of the debtor company or the business it operates and could derail the restructuring process.

The Supreme Court found that the City had failed to prove the alleged fraud. Proof of the fraud could not be inferred solely from the fact that the City’s claim was related to an agreement entered into under the VRP. The City’s argument that the objective of protecting the public interest favoured pre-post compensation was rejected. To the contrary, the work performed by SM Group for the City was in the public interest, as it involved continuing to carry out major projects. The City did not rely on any of the CCAA’s other remedial objectives in support of its position. It failed to discharge its burden of proving that the order being sought was appropriate. The considerations that guide the exercise of a court’s discretion did not justify lifting the stay of the City’s right to pre‑post compensation.

Accordingly, the Supreme Court dismissed the City’s appeal with costs.

Judges: Wagner C.J. and Moldaver, Karakatsanis, Côté, Brown, Rowe and Martin JJ.

Counsel: IMK, Montréal for the appellant; Stikeman Elliott for the respondent; McCarthy Tétrault for the interveners the Alaris Royalty Corp. and the Integrated Private Debt Fund V LP; Fasken Martineau DuMoulin for the intervener Thornhill Investments Inc.; Service des affaires juridiques de la Ville de Laval for the intervener Ville de Laval; BLG for the intervener Union des municipalités du Québec