Subordinating a creditor to a debtor in an AVO?

Business Development Bank of Canada v. 170 Willowdale Investments Corp., 2025 ONCA 251
Can an approval and vesting order subordinate a creditor's rights?

Summary: In this case, a debtor company in receivership appealed the distribution of $900,000 of the proceeds of the sale of its primary asset — real property on which it had operated a hotel. The funds were released to the bank, which was unsecured vis-a-vis the real property. The debtor argued that a provision of the approval and vesting order denied the bank any portion of the net proceeds of the sale because, although a creditor, the bank did not hold security over the real property before it was sold. The court disagreed, finding that the relevant provision of the AVO simply said that secured creditors were entitled to be paid from the net proceeds before the bank was paid anything, and that had occurred. The provision did not say that a creditor with an unsecured claim receives nothing even when net proceeds remain after payment of secured creditors. Nor did it say that the debtor has priority in relation to the net proceeds over a creditor with an unsecured claim. As a result, the court dismissed the appeal.

In 2023, the respondent, The Fuller Landau Group Inc. (“FLG”), was appointed as receiver of the assets and undertakings of the appellant, 170 Willowdale Investments Corp. (the “Debtor”). The Debtor’s primary asset was real property on which it had operated a hotel. In 2024, with court authorization, FLG sold the real property and related assets for $8 million.

An approval and vesting order was granted in connection with the sale of the real property, among other assets of the receivership. Paragraph 2 of the AVO vested title in the purchaser free of any claims, secured or unsecured, of the Debtor’s creditors. Paragraph 4 dealt with priority among creditors in relation to the proceeds of the sale.

A portion of the proceeds were used to fully pay creditors who had security on the real property, and to pay transaction costs. FLG sought approval to distribute the balance of the proceeds, first to satisfy the claims of the Debtor’s remaining creditors, and then to the Debtor itself (as a surplus had been realized). FLG also sought its own discharge.

This appeal concerned the one aspect of the motion judge’s order that the Debtor contested, namely the authorization of distributions by FLG of about $900,000 to the respondent Royal Bank of Canada (“RBC”). The motion judge found that all of the claimed indebtedness to RBC was due and payable. He rejected the Debtor’s argument that the AVO precluded any distribution to RBC sourced from the sale of assets over which RBC had no security interest, namely the real property that comprised part of the assets sold by FLG. He gave several reasons for this conclusion.

First, under the Appointment Order, FLG was appointed over all “Property” of the Debtor, “including the [r]eal [p]roperty, and all the proceeds thereof”. As a result, the net proceeds of the sale were within the scope of the receivership. Although RBC had no security over the real property, it was clear that given the terms of its GSA, RBC had a security interest in any money of the Debtor which would include the net proceeds of the sale.

Second, the motion judge considered it antithetical to the entire concept of the receivership if significant assets of the Debtor were sold by FLG for the specific purpose of satisfying creditor claims, only to have the proceeds of such sales, net of amounts owing to those with specific registered security against the real property, vest in the Debtor thus requiring creditors to commence new proceedings to recover those debts.

Third, the motion judge noted that when an asset is sold by a receiver, the proceeds do not automatically fall outside scope of a receivership such that the Debtor is entitled to take them notwithstanding proven claims of creditors.

On appeal, the Debtor argued that it should receive the amount authorized to be paid to RBC because RBC’s right to any distribution was foreclosed. On the Debtor’s theory, the motion judge erred by proceeding on the basis that RBC had security over money held by the Debtor, such as proceeds of sale, since that security interest only could attach after the sale was made and the determination of RBC’s claim was to be made “as if the [hotel] assets had not been sold”.

Provisions such as para. 4 of the AVO determine the priority of creditor claims, as among the holders of those claims, to a fund generated by a sale, and specify the manner in which that is done. For that purpose, two related questions to be answered: (i) what is the nature of the creditor’s claim (for example, is it secured or unsecured) and (ii) what is the claim’s priority as against other creditors (for example, is it a first ranking security, a subsequent ranking security, or is it unsecured). The text of the provision requires those questions to be answered by reference to what the answers would be immediately before the real property was sold and as if it had not been sold.

As it applies to RBC, the nature of its claim was as an unsecured creditor in relation to the net proceeds of the sale of the real property, because regardless of any other security it held, it held no security over that property before it was sold. It thus ranked, in terms of priority to the net proceeds, behind those creditors who had security over the real property before it was sold. Under para. 4 of the AVO, creditors who held security over the real property were entitled to be paid from the net proceeds before RBC was paid anything. That occurred.

Paragraph 4 of the AVO did not say that a creditor with an unsecured claim receives nothing even when net proceeds remain after those with prior secured claims have been paid. Nor did it say that the Debtor has priority in relation to the net proceeds over a creditor with an unsecured claim. It only ranked creditors who had no security over the real property before it was sold behind those creditors who did. It did not subordinate creditors with unsecured claims to the Debtor or cancel and release unsecured claims.

A debtor placed in receivership under the BIA cannot reasonably expect any surplus available to it to be enhanced by bypassing proven claims of creditors. The Court dismissed the appeal and awarded costs of the appeal to FLG in the amount of $27,969.76 out of the funds under its control in the receivership. There were no costs of the appeal to RBC.

Judges: Zarnett, Sossin and Copeland JJ.A.

Professionals involved:

• Tony Van Klink of Miller Thomson for Fuller Landau as receiver

• Tim Hogan of Harrison Pensa for RBC

• David Trafford of Morse Trafford for the appellant