Earlier this fall, the Supreme Court of Canada (“SCC”) released its decision in Chandos Construction Ltd. v. Deloitte Restructuring Inc.  (“Chandos”) . The SCC agreed with the Alberta Court of Appeal in holding that a price-reduction clause in a subcontract between Chandos and the bankrupt subcontractor violated the common law anti-deprivation rule.

Chandos, a general construction contractor, was subcontracted to perform work with Capital Steele on a project. The subcontract contained a clause which stipulated that 10% of the price would be forfeited if the subcontractor became insolvent, bankrupt, or ceased operating “as a fee for the inconvenience of completing the work using alternate means and/or for monitoring the work during the warranty period.” Capital Steele became bankrupt, and its assets vested in Deloitte Restructuring Inc., as trustee, for distribution to creditors. The Trustee applied to the courts to determine whether the price reduction clause was rendered invalid due to the application of the common law anti-deprivation rule.

The SCC conferred that the wording contained in the subcontract conflicted with the operation of the Bankruptcy and Insolvency  Act (“BIA”) regime by removing assets that would otherwise form part of the bankrupt's estate and was therefore unenforceable.

SCC Decision and its Significance

The SCC held that the problematic clause violated the anti-deprivation rule as it's effect was to create a debt from Capital Steel to Chandos that would not exist but for the bankruptcy. In this respect, the SCC confirmed that any contractual provision which is triggered on the insolvency or bankruptcy of a party, and which purports to remove value that would otherwise be available to the bankrupt's estate, is unenforceable.

In its decision, the SCC provided clarity regarding the existence and application of the anti-deprivation rule at common law by providing the following key insights:

Co-Existence with Federal Bankruptcy Legislation: The SCC clarified that the anti-deprivation rule does not contradict federal BIA provisions. While subsections 65, 66 and 84 of the BIA regulates the enforceability of contracts in bankruptcy, these provisions aim to protect the debtor. The common-law anti-deprivation rule protects unsecured creditors. Further, section 71 of the BIA stipulates that property of a bankrupt “passes to and vests in the trustee”, and the anti-deprivation rule works in harmony with this provision as it voids contractual clauses that would prevent property from passing to the trustee As such, the SCC determined that the BIA  and common-law anti-deprivation rule are not in conflict and can exist simultaneously in Canadian law.

Application: The SCC also confirmed the proper application when considering the anti-deprivation rule. First, the relevant clause must be triggered by an event of insolvency or bankruptcy; and secondly, the effect of the clause must be to remove value from the insolvent's estate. This simple application creates certainty as parties need only assess the trigger and effect of questionable clauses.

Protection of Creditors: The SCC reiterates that the protection of creditors is a key aspect of the bankruptcy regime and that the anti-deprivation rule works to help maximize the assets that are available to the trustee. Additionally, the SCC noted the importance of having an effects-based rule, as an intention-based rule could lead to frustration of the BIA if parties were to allege to have had bona fide intentions in order to give themselves advantages over the bankrupt's other creditors.

Lessons for Contractors

The Chandos decision affirms the anti-deprivation rule to be an effects-based test, stipulating that intentions of the parties are not taken into consideration in the analysis.

The SCC does, however, provide guidance relating to circumstances in which the anti-deprivation rule would not be offended. Rowe J., writing for the majority, indicated that the anti-deprivation rule would not be offended by:

  1. A contractual provision that:

i) Removes property from the bankrupt's estate but does not eliminate value; or
ii) Is triggered by some event other than insolvency or bankruptcy

2. Taking security, acquiring insurance, or requiring a third-party guarantee.

Parties wishing to protect themselves against a contracting counterparty's insolvency or bankruptcy should therefore consider modifying these clauses in their contracting agreements, to conform to one of these potential exceptions to the anti-deprivation rule, in order to avoid having the clause rendered unenforceable and void altogether.

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.