In its March 20, 2023 ruling Syndic de Société de vélo en libre-service, 2023 QCCA 368, the Québec Court of Appeal addressed the trustee's review of a proof of claim submitted under the Bankruptcy and Insolvency Act (BIA), asserting a claim for restitution arising from a secured loan previously declared null by the courts. In addition to ruling that the nullity of the transaction did not relieve the trustee of its duty to consider the circumstances of the transaction, the Court of Appeal postponed the claim on the basis that it is in fact an equity claim and ruled that a claim arising from a transaction entered into in violation of a law of public order can be postponed by the trustee under subsection 137(1) BIA.

Background: the City's Secured Loan to Bixi Declared Null by the Court of Appeal

In 2019, the Court of Appeal ruled that a loan made by Ville de Montréal in 2011 to Public Bike System Company (Bixi) and the hypothec securing it were null, as they were made in violation of the prohibition on lending money to a commercial establishment for municipalities set out in the Municipal Aid Prohibition Act (the 2019 Decision). Therefore, the City had to return to Bixi's trustee the value of the Bixi assets that it took in payment. In return, the Court stated in its judgment that the City "[our translation] is a creditor for the balance due as of the date of the taking in payment [...] and may file a claim with the trustee in bankruptcy".

The City subsequently filed a proof of claim (the Claim) with the trustee based on the 2019 Decision. Further to its review of the Claim, the trustee postponed it on the grounds that:

  • the Claim is an equity claim that must be postponed pursuant to section 140.1 of the BIA because, amongst other things, the City stepped in to finance Bixi's operations at a time when Bixi could not find other sources of financing and the City had no reasonable expectation of repayment; and
  • the City was not dealing at arm's length with Bixi when it entered into the transactions giving rise to the Claim, and such transactions cannot be considered to be proper within the meaning of subsection 137(1) of the BIA as they are entered into in violation of a public order provision.

Dissatisfied with the trustee's decision, the City appealed to the Superior Court, which granted the appeal. The Superior Court accepted two of the City's arguments. First, since the effect of the nullity of the loan and the hypothec is that these acts are deemed to have never existed, the trustee could not rely on the circumstances surrounding these acts to postpone the claim. Second, the Court of Appeal had already decided the rank of the Claim in the 2019 Decision, as it mentioned in its reasons that the Claim "[our translation] will be treated pari passu with the other creditors in the bankruptcy".

The trustee appealed the decision of the Superior Court and sought de benne esse leave to appeal. In its March 20, 2023 ruling, the Court of Appeal allowed the trustee's appeal and confirmed the postponement of the Claim. This decision is interesting for several reasons.

Reviewing a Proof of Claim is a Fundamental Duty of the Trustee

While the City made two arguments on appeal to support its contention that the trustee could not postpone the claim, the Court of Appeal upheld the fundamental duty of a trustee to rule on the validity, amount, and rank of proofs of claim under section 135(1) BIA. This section provides that "[t]he trustee shall examine each proof of claim or proof of security filed and the grounds therefor."

First, according to the City, the trustee could not postpone the claim since the Court of Appeal, in the 2019 Decision, mentioned in its reasons that any such claim "[our translation] will be treated pari passu with the other creditors in the bankruptcy". The City argued that the Court of Appeal had therefore already ruled on the rank of the claim.

The Court of Appeal did not accept this argument in its 2023 decision. At the time of the 2019 Decision, no proof of claim had been filed. Therefore, the Court of Appeal could not have ruled on the rank of a proof of claim that did not exist. Further, the Court of Appeal's use of the words pari passu meant that the City would be treated like any other creditor and could file a proof of claim in Bixi's bankruptcy, as it no longer had a preference given the nullity of its hypothec.

Second, the City argued that since the effect of the nullity of the loan and hypothec is that these deeds are deemed to have never existed, the trustee could not rely on the circumstances surrounding these deeds to postpone the Claim. The Court of Appeal disagreed: although null deeds are deemed to have never existed, they remain legal facts that the trustee must consider in the analysis of a proof of claim.

Postponement of an Equity Claim

Section 140.1 of the BIA provides that a creditor is not entitled to a dividend in respect of an equity claim until all claims that are not equity claims have been satisfied. The Court of Appeal stated that in determining whether a transaction is a capital contribution rather than a loan, and therefore whether the resulting claim is an equity claim, the analysis must focus on the circumstances surrounding the alleged loan and the actual intent of the parties rather than the express terms of a contract, particularly where the parties are not dealing at arm's length.

In this case, the circumstances surrounding the 2011 $37 million loan agreement between the City and Bixi are sufficient for the trustee and the Court of Appeal to conclude that this alleged loan has all the characteristics of a capital contribution by Bixi's sole shareholder or alter ego:

  • Bixi carried out the City's bike share project on its behalf;
  • Bixi's project was developed by the City;
  • the City admitted before the Superior Court that it was not dealing at arm's length with Bixi;
  • the City did not expect that Bixi would ever be able to repay the money it had advanced;
  • the City treasurer was also a member of the Bixi board of directors from 2001 to 2013 and was heavily involved in its funding; and
  • the City's consolidated financial statements included Bixi as an entity under control of the City.

Furthermore, the Court of Appeal saw in the fact that no other lender was willing to finance Bixi's operations in 2011 a telling indicator that the alleged loan was instead a capital contribution.

The Court of Appeal recognized that the mere fact that a sole shareholder advances funds to a subsidiary or corporation of which it is the alter ego does not in itself constitute a capital contribution. However, the circumstances described above, taken together, demonstrated the reasonableness of the trustee's conclusion that the loan was in substance a capital contribution.

Postponement of a Claim Arising From an Improper Transaction

Subsection 137(1) of the BIA provides that a creditor who, at any time before the bankruptcy of a debtor, entered into a transaction with the debtor and who was not at arm's length with the debtor at that time is not entitled to claim a dividend in respect of a claim arising out of that transaction until all claims of the other creditors have been satisfied, unless the transaction was in the opinion of the trustee or of the court a proper transaction. The Court of Appeal accepted the trustee's interpretation that a claim arising from a transaction entered into in violation of a law of public order, in this case the Municipal Aid Prohibition Act, was not proper within the meaning of this provision.

The second criterion under subsection 137(1) BIA is that the creditor must have entered into a transaction with the bankrupt while not dealing at arm's length. Based on the evidence described above, the Court of Appeal agreed with the trustee that such a relationship existed between Bixi and the City at the time of the 2011 transaction.

The Trustee's Right of Appeal

The Court of Appeal dismissed the trustee's application for leave to appeal under subsection 193(e) of the BIA and instead decided that the trustee had right to appeal under subsection 193(c) BIA, namely where the value of the property at issue in the appeal exceeds $10,000. The Court of Appeal held that if the postponement or disallowance of a proof of claim had an effect on either party of more than $10,000 in value, the party had a right to appeal.

Conclusion

This decision is a reminder of the fundamental obligation of trustees to review every proof of claim under the BIA. Moreover, the Court of Appeal's decision makes it clear that the facts underlying a claim based on null contracts must be examined. Finally, the Court of Appeal confirmed the well-established principles guiding trustees in evaluating an equity proof of claim under section 140.1 BIA.

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