Preferential Payment, Unenforceable Against the Trustee and Creditor?
In the context of a professional relationship, one of your clients declares bankruptcy. You learn, during the examination of the bankrupt, that the latter chose to pay a friend before you, even though your claim was liquid and exigible.
As a reminder, in the context of a bankruptcy or proposal, as soon as a notice of intention (bankruptcy or proposal) is filed, creditors have no recourse against the insolvent person or their property and may not commence or continue any action, execution, or other proceeding for the recovery of provable claims in bankruptcy[1].
Since the creditor frustrated by the debtor’s preferential payment has one (1) year to act from the creditor’s knowledge of said preferential payment[2], they must immediately notify the trustee so that judicial proceedings may be initiated to recover the amount paid in preference to the bankrupt debtor’s friend.
Trustee’s Recourse
If the action in unenforceability is brought by a bankruptcy trustee on behalf of the creditors collectively, the one-year period runs from the day of the trustee’s appointment[3].
Indeed, the trustee, with the permission of the inspectors, must declare to the court that they are ready to institute proceedings for the benefit of the creditors, the court order must prescribe the time allowed for doing so, and in such case the profit resulting from the proceedings, if they are instituted within the time so prescribed, belongs to the estate of the creditors[4].
From the outset, any transaction made by the bankrupt debtor in the three (3) months preceding the bankruptcy in favor of a creditor with whom they have no relationship of dependency, with a view to giving them a preference, is unenforceable against the trustee[5].
Similarly, a transaction made by the bankrupt debtor to an unrelated creditor is presumed to have been made with a view to giving them a preference, even if the debtor did so under duress, proof of such duress not being admissible in this case[6].
Also, any transaction made by the bankrupt debtor in the year, one (1) year, preceding the bankruptcy in favor of a creditor with whom they have a relationship of dependency and having the effect of giving the latter a preference is unenforceable against the trustee[7].
In the event that the transaction challenged by the trustee is an “undervalued transaction or one made below market value,” in addition to the rules specific to the action in unenforceability provided for in the Civil Code of Québec[8], any transaction made by the bankrupt debtor will be unenforceable against the trustee if said trustee demonstrates:
In the case of a creditor with no relationship of dependency with the debtor[9]
- The transaction took place in the year preceding the bankruptcy;
- The debtor was insolvent or became insolvent due to the act;
- The debtor intended to defraud or frustrate a creditor or delay their payment
In the case of a creditor with a relationship of dependency with the debtor[10]
- The transaction in question must have been made in the year preceding the opening of the bankruptcy; or
- within the five years preceding the bankruptcy if the debtor was insolvent or became so because of the transaction or intended to defraud or frustrate a creditor or delay payment;
A person described as “interested” in the context of an undervalued transaction refers to any person who is partly connected to the transaction, and who, directly or indirectly, either benefits from it themselves or causes another to benefit from it.
A person who is related to a creditor is defined under the Civil Code as “a person with whom they are in collusion or who is related to them, including a spouse, a relative or person connected by marriage or civil union up to the second degree, a person living under their roof, or a partner or legal person of which they are a director or which they control.”[11]
Creditor’s Recourse
In the event that a creditor requests the trustee to institute proceedings which, in their opinion, would be to the advantage of the bankrupt’s estate, and the trustee refuses or neglects to institute such proceedings, the creditor may obtain from the court an order authorizing them to institute proceedings in their own name and at their own expense and risk, by giving the other creditors notice of the proposed proceedings, and subject to such other conditions as the court may order[12].
In such case, the “ordinary” one (1) year limitation period for individual action applies and the creditor must institute their recourse within one year of becoming aware of the “preferential payment”[13].
Similarly, since the presumptions of the Bankruptcy Act no longer apply, the creditor must satisfy the conditions established by case law to establish that there was a preference by the debtor in the choice of creditor paid.
Indeed, when this order is made, the trustee assigns and transfers to the creditor all their rights, titles, and interests in the property and rights that are the subject of these proceedings, including any supporting documents[14].
Consequently, any profit arising from proceedings exercised pursuant to the proceedings initiated by the frustrated creditor, up to the amount of their claim and costs, belongs exclusively to them, and any surplus, if any, shall be remitted to the estate of the creditors[15].
Conclusion
In conclusion, here are the time limits that a creditor or bankrupt debtor must keep in mind when proceeding with a transaction before assigning their property to a trustee:
Time limit prescribed to the creditor to initiate an action in unenforceability under article 1635 C.C.Q.:
- The creditor has one (1) year from knowledge of the act made in preference to their rights;
Time limit applicable to the trustee under the Bankruptcy and Insolvency Act for any transaction made by the bankrupt debtor with a:
Unrelated person:
- The trustee may challenge any transaction made in the three (3) months preceding the opening of the bankruptcy;
- If the transaction is undervalued, the trustee may challenge the transaction made in the year preceding the opening of the bankruptcy;
Related person:
- The trustee may challenge any transaction in the one (1) year preceding the opening of the bankruptcy;
- If the transaction is undervalued, but moreover, made with the intention to defraud, the trustee may challenge the transaction in the five (5) years preceding the opening of the bankruptcy;
In a future article, we will examine the conditions for applying the exceptional recourse that is the action in unenforceability[16].
References
[1] Sections 69 to 69.3 Bankruptcy and Insolvency Act, RSC 1985, c B-3;
[2] Section 1635, Civil Code of Québec, CQLR c CCQ-1991;
[3] Id. in fine;
[4] Section 38(4) BIA;
[5] Section 95(1)(a) BIA;
[6] Section 95(2) BIA;
[7] Section 95(1)(b) BIA;
[8] Sections 1631 to 1636 C.C.Q.; Berthiaume v. Ginsberg, 2007 QCCA 38;
[9] Section 96(1)(a) BIA;
[10] Section 96(1)(b) BIA;
[11] Section 1696 C.C.Q.;
[12] Section 38(1) BIA;
[13] Stone (Trustee of) 2007 QCCA 534;
[14] Section 38(2) BIA;
[15] Section 38 BIA;
[16] Gérard Nolin ltée (Trustee of) J.E. 79235 (C.A.)
