Montreal (City) v Deloitte Restructuring Inc: the court’s discretion to stay compensation in CCAA proceedings
In the matter of the Companies' Creditors Arrangement Act ("CCAA") of SM Group, the Supreme Court of Canada rendered a decision regarding compensation in CCAA proceedings. The court ruled that a creditor's right to pre-post compensation under civil or common law may be stayed by a court pursuant to sections 11 and 11.02 of the CCAA. In an 8-1 ruling, the Court held that the discretion to refuse to stay or lift the stay of the right to pre-post compensation should only be exercised in exceptional circumstances, given the strong disruptive potential of pre-post compensation.
Background: claims arising out of the debtors’ fraudulent acts?
The City of Montréal (the “City”) claims to be owed two debts by the debtors, the SM Group, which are subject to an initial order issued under the CCAA on August 24, 2018.
The first alleged debt results from a settlement agreement between the Minister of Justice acting on behalf of the City and the SM Group in connection with the Voluntary Reimbursement Program (the “VRP”), established under the Act to ensure mainly the recovery of amounts improperly paid as a result of fraud or fraudulent tactics in connection with public contracts (“Bill 26”). The second alleged debt is based on an action brought by the City under the same act against four companies of S.M. Group claiming $14M from them for participating in collusion in connection with a request for proposals for a service contract involving the installation of water meters.
In addition, the City is indebted to the SM Group for work performed by the latter. It claims to be able to set-off, on the one hand, the two debts resulting from the alleged fraudulent acts committed by the SM Group before the initial order was issued on August 24, 2018 and, on the other hand, the debt that it owes to the SM Group for the work that the latter carried out after that date. With respect to the debt related to its action against the SM Group, the City claims that, although that debt is not due, it would be entitled to retain the amounts on which it claims to be able to operate set-off until the judicial liquidation of its claim.
A declaratory judgment concluding that the amounts owed to S. M. Group by the City are not subject to compensation is then sought by Deloitte in its capacity as monitor.
Decisions of the Superior Court and the Quebec Court of Appeal
In March 2019, the application for declaratory judgment was granted by the Superior Court of Québec, which concluded that the City could not effect compensation. In the judge's opinion, the debt arising from the VRP was related to an unrefuted allegation of fraud and the debt arising from the lawsuit was not liquid and exigible. Based on the principles set out in Métaux Kitco, the Superior Court reiterated that compensation cannot be effected between, on the one hand, a debt owed by the debtor to a creditor that arose prior to the issuance of an initial order and, on the other hand, a claim held by the debtor against that creditor that arose after the issuance of that order (“pre-post compensation”). The Court of Appeal subsequently confirmed these conclusions in March 2020, and the City appealed to the Supreme Court.
The rules of compensation during a restructuring under the CCAA
The Supreme Court dismissed the City’s appeal, reviewing the rules of compensation in a restructuring under the CCAA. Sections 11 and 11.02 of the CCAA provide for the power of the supervising judge to stay any action, suit or other proceeding that may be brought against the debtor. The range of the rights and remedies that may be included in a stay order, interpreted in a broad and liberal manner by the case law, may include the right to operate a pre-post compensation.
Generally, the initial order will stay de facto the creditor's right to operate pre-post compensation against the debtor. However, for the Court, the supervising judge has the discretion to refuse to stay or lift the stay of the right to pre-post compensation in exceptional circumstances, given the strong disruptive potential of such an authorization. Accordingly, the absolute prohibition set out by the Court of Appeal in Métaux Kitco is tempered by the Supreme Court.
Moreover, the Supreme Court clarified that section 21 CCAA is limited to authorizing compensation between debts arising prior to the issuance of the initial order and therefore does not have the effect of authorizing pre-post compensation, but neither does it have the effect of prohibiting it. It is within the discretion of the court to stay or authorize the exercise of the pre-post compensation invoked by a creditor.
To guide the interpretation of the supervising judge's discretion regarding pre-post compensation, the Supreme Court referred to the three baseline considerations that the court must keep in mind when exercising its discretion: (1) the appropriateness of the order being sought, assessed against the remedial purposes of the CCAA including public interest, (2) due diligence, and (3) the good faith of the applicant.
In this case, the Supreme Court refused to allow the City to exercise pre-post compensation on two grounds. First, the City has not demonstrated that the exercise of pre-post compensation is justified in the public interest, which should not be confused with the City's own interest as a public body. Second, the Court concluded that the City had not diligently raised pre-post compensation by waiting at least 47 days to do so.
Debts arising from fraud and compensation
Under subsection 19(2)(d) of the CCAA, claims arising from fraud cannot be compromised in a compromise or arrangement. The City, which argued that the VRP debt arose from fraud, took the position that a debt arising from fraud may, in all cases, be subject to pre-post compensation. Thus, the characterization of the VRP debt as being a claim relating to a debt or obligation arising out of fraudulent conduct is at the heart of the dispute before the Supreme Court.
In order to establish that a debt results from fraud, the creditor has the burden of establishing, on a balance of probabilities, four elements: (i) the debtor made a representation to the creditor; (ii) the representation was false; (iii) the debtor knew the representation was false; (iv) the false representation was made to obtain property or a service. Since the City did not even allege any of these four elements, and since the content of the VRP agreement, Bill 26 and its regulations do not give rise to any presumption that SM Group admitted to having committed a fraudulent act, the City did not establish that the VRP claim fell within the scope of subsection 19(2)(d) CCAA.
In addition, the Supreme Court rejected the City's contention that a debt arising from fraud may, in all cases, be subject to pre-post compensation. The Court however noted that, “[i]n very specific circumstances, a court could [...] conclude that protection of the public interest and the CCAA’s other remedial objectives justify authorizing pre‑post compensation in favour of a creditor that has proved that it was a victim of fraud within the meaning of s. 19(2)(d) of the CCAA”.
Brown J., dissenting, considered that the discretion of the supervising judge to refuse to stay or lift the stay of the right to pre-post compensation should not be limited to exceptional circumstances. Given the absence of a prohibition against pre-post compensation in section 21 CCAA, such a type of compensation should not be limited other than by the exercise of the judge's discretion.