The anti-deprivation rule in Canadian law: removing value from the insolvent’s estate
In the matter of Chandos Construction Ltd v Restructuring Deloitte Inc, the Supreme Court of Canada issued a judgment on the anti-deprivation rule, which is intended to prevent contracts from frustrating statutory and common law rules relating to insolvency. The Court established that a clause triggered by an event of insolvency or bankruptcy and which has the effect of removing value from the insolvent’s estate is void and unenforceable.
Background: validity of a clause that has the effect of forfeiture by the subcontractor to part of the contract price to the general contractor in the event of insolvency
Chandos Construction (“Chandos”) is a general contractor who entered into a subcontract agreement with Capital Steel. A provision of the contract provided that in the event of Capital Steel’s bankruptcy or insolvency, the latter forfeits, among other things, 10 percent of the contract price in favor of Chandos, as a fee for the inconvenience and/or for monitoring the work.
The trustee to the bankruptcy of Capital Steele applied for advice and directions from the Court of Queen’s Bench of Alberta as to whether the clause was valid. Chandos sought to set off 10 percent of the subcontract price from the amount it owed to Capital Steel, by application of the provision.
While the Court of Queen’s Bench found the clause to be valid based on its finding that the provision constitutes a liquidated damages clause, both the Court of Appeal of Alberta and the Supreme Court of Canada held that it was invalid on the basis that it violates the anti-deprivation rule.
The anti-deprivation rule in Canadian law
The Supreme Court of Canada held that there are no cases where the anti-deprivation rule has been eliminated. In addition, it held that certain amendments to the Bankruptcy and Insolvency Act (the “BIA”) from 2009 that mandate that contractual provisions triggered by insolvency are unenforceable did not have the effect of precluding the application of the anti-deprivation rule, which was adopted from England and continues to apply in Canada.
The relevant statutory provision in the analysis of the anti-deprivation rule in Canada is section 71 of the BIA, which provides that upon bankruptcy the property of the bankrupt shall “immediately pass to and vest in the trustee named in the bankruptcy order or assignment”. The purpose of such provision is to maximize the assets that are available for the trustee to pass to creditors, in accordance with the priorities set out in the BIA.
Similarly, the anti-deprivation rule renders void contractual provisions that, upon bankruptcy or insolvency, would prevent property from passing to the trustee. To determine whether a contractual provision violates the rule, the Court explained that a two-step test must be applied: first, the application of the provision in question must be triggered by bankruptcy or insolvency. Second, the clause must have the effect of removing value from the insolvent's estate. Thus, contractual provisions that eliminate property from the estate, but do not eliminate value, or whose effect is triggered by an event other than insolvency or bankruptcy may not offend the anti-deprivation rule.
The anti-deprivation rule is an effects-based test, not a purpose-based test
The Court rejected Chandos’ argument that a purpose-based test that protects bona fide commercial transactions which do not have as their predominant purpose, or one of their main purposes, the deprivation of the property of one of the parties, would strike the best balance of public policy considerations and contribute to commercial certainty, as the United Kingdom Supreme Court has held.
In rejecting this submission, the Supreme Court of Canada held that a purpose-based test would create commercial uncertainty, since it would require courts to determine the intention of the parties long after the fact, which would be detrimental to the efficient administration of corporate bankruptcies.
Compatibility of the anti-deprivation rule with the BIA’s affirmation of set-off
The Court noted Chandos’ argument that the BIA expressly permits set-off, such that the anti-deprivation is incompatible with the BIA. In the Court’s view, while set-off indeed results in a reduction in the value of the assets transferred to the trustee for distribution, it is not incompatible with the anti-deprivation rule. Indeed, the anti-deprivation rule renders deprivations triggered by insolvency unenforceable. Set-off, on the other hand, applies only to the bankrupt's debts that were not triggered by the bankruptcy.
In this case, the Court held that the clause expressly provides that its application is triggered in the event of bankruptcy or insolvency. The impugned clause therefore created a debt owed to Chandos that would not have existed but for Capital Steel’s insolvency. By seeking to set-off this debt by deducting it from the amount it owes to Capital Steel, Chandos is in direct violation of the anti-deprivation rule.
Justice Côté’s dissent
Justice Côté dissented from the majority and asserted that the anti-deprivation rule should not apply where the contractual provisions in question serve a bona fide commercial purpose. In Justice Côté’s view, the impugned provision furthered a bona fide commercial purpose. A fee for the inconvenience of the general contractor in completing the work upon the event of the subcontractor’s bankruptcy is a bona fide risk management tool to attenuate costly delays caused by the bankruptcy of a sub-contractor.
anti-deprivation rule Supreme Court of Canada Alberta Court of Appeal Alberta Court of Queen's Bench Bankruptcy and Insolvency Act Bankruptcy and Insolvency