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Set-off and claims that may not be compromised by a CCAA plan of arrangement

In the matter of the Companies’ Creditors Arrangement Act (“CCAA”) of the S.M. Group, the Québec Court of Appeal rendered a ruling on the effect of the law of set-off on debts arising out of alleged fraud and the application of the same Court’s ruling in Kitco to this type of debts. The Court held that the rule prohibiting a creditor from setting-off a post-filing debt owed to the debtor against a pre-filing debt due by that debtor applies even if the latter debt cannot be compromised by a transaction or an arrangement.

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 S.M. Group and entities related to it (the “S.M. 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 S.M. 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 related to the 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 S.M. 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 S.M. Group before the initial order was issued on August 24, 2018 and, on the other hand, the debt that it owes to the S.M. Group for the work that the latter carried out after that date. With respect to the debt related to its action against the S.M. 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.

The effect of the law of set-off on claims arising out of fraud

Section 21 CCAA provides that the law of set-off applies to claims made against a debtor company that is involved in CCAA proceedings. In addition, subsection 19(1) CCAA identifies the claims that may be considered, and eventually compromised, by an arrangement reached pursuant to that act. In particular, paragraph 19(2)(d) CCAA excludes from these claims those which result “from obtaining property or services by false pretences or fraudulent misrepresentation”.

The Court of Appeal notes that the wording of paragraph 19(2)(d) CCAA is virtually identical to that of paragraph 178(1)(e) of the Bankruptcy and Insolvency Act (“BIA”), which applies to the bankruptcy of a natural person and identifies the debts in respect of which a bankrupt cannot be discharged. The Court infers from this analogy that the burden of proof applicable under paragraph 178(1)(e) BIA must be met by the creditor invoking paragraph 19(2)(d) CCAA. That burden requires proof, on a balance of probabilities, that the debtor knowingly made a false statement to the creditor for the purpose of obtaining a good or service.

Noting that the purpose of the VRP is to enable the recovery of sums unjustly paid as a result of fraud in the awarding of public contracts, the Court emphasizes that this does not give rise to a presumption or admission of fraud against the companies engaged under that program. Indeed, section 3 of Bill 26 provides that the VRP allows a company to reimburse amounts paid in connection with the awarding of a public contract for which there simply “may have been fraud or fraudulent tactics”. Section 7 of the VRP further states that “[t]he fact that a natural person or an enterprise participates in the Program does not constitute an admission of liability or of a fault committed by the natural person or enterprise.”

Relying on the wording of Bill 26 and the VRP established pursuant to it, the Court of Appeal holds that participation in the VRP does not constitute an admission of liability or fault. Accordingly, it considers that the transaction entered into by the S.M. Group under the VRP does not, in and of itself, provide the City with a claim arising out of fraud within the meaning of subsection 19(2) CCAA. The Court, finding that the City had not met the burden of proof required by paragraph 19(2)(d), determines that the claim resulting from the VRP agreement is an ordinary claim and that it can be compromised under subsection 19(1) CCAA. In sum, the Court finds that the fraudulent nature of a debt does not grant it priority.

Secondly, the Court of Appeal is of the opinion that no set-off can be made with respect to the claim relating to the water meters contract, since it is neither certain, liquid nor exigible. The Court further observes that an action alleging fraud does not constitute sufficient grounds to give effect to subsection 19(2) CCAA and indefinitely delay arrangement proceedings instituted under that act.

The application of the Court of Appeal’s ruling in Kitco to claims that may not be compromised under a plan of arrangement

The Court reiterates that, according to its holding in Kitco, set-off cannot take place between a debt arising before the CCAA proceedings and another arising after those proceedings. However, it acknowledges that it did not address the interaction between subsection 19(2) and section 21 CCAA in that case.

According to the Court, the fact that a claim cannot be dealt with in the context of an arrangement cannot defeat the interpretation of section 21 that was upheld in Kitco. This section must be interpreted in accordance with the primary purpose of the CCAA, which is to promote the restructuring of large, financially distressed companies to ensure their survival. In the Court's view, the interpretation of section 21 supported by the City would impede the status quo period during which the insolvent company can prepare a plan of arrangement to be submitted to its creditors without being hindered by the individual recourses of its creditors.

The Court of Appeal concludes that the fact that a claim cannot be compromised does not justify interference with the stay of proceedings during the restructuring. The principles set out in Kitco must therefore be applied despite the presence of a claim allegedly arising out of fraud.

Case information

Re Consultants SM inc, 2020 QCCA 438, under appeal before the SCC



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