Bankruptcy issues in construction

The construction industry has one of the highest rates of bankruptcies and insolvencies of any industry in Canada.  According to statistics tabulated by the Office of the Superintendent of Bankruptcy, in 2013 in British Columbia alone, there was a shortfall of over $36,000,000 between the reported assets and liabilities of bankrupt and insolvent companies.  Whether it occurs during litigation, or after its conclusion, a bankruptcy of one party to litigation can profoundly impact the position of the remaining solvent parties.

Insolvency is a narrow and technical area of the law which is largely governed by the Bankruptcy and Insolvency Act, R.S.C., 1985, c. B-3 (the “BIA”) and the Companies’ Creditors Arrangement Act, R.S.C., 1985, c. C-36 (the “CCAA”).  Insolvency simply describes the situation where a debtor is unable to pay its debts.  The BIA and the CCAA provide the framework for different types of insolvency proceedings.  The details of these Acts are beyond the scope of this article, but it is useful to briefly review the different types of insolvency proceedings.

When insolvent, a debtor faces several possible scenarios.  Where the debts are secured (i.e., the debtor has entered into a security agreement with the creditor), a receiver may be appointed over the debtor’s assets for the purpose of realizing sufficient funds to pay the secured claim.  A receivership can happen at the same time as a bankruptcy, or without a formal bankruptcy filing.  Once the secured creditor is paid, the receivership ends.

Another scenario is restructuring, often referred to as a bankruptcy proposal to creditors.  Such proposals may occur under either the BIA or the CCAA.  The debtor presents a proposal to its creditors, under supervision of the Court, on how to address its debts with its available assets.  The creditors are provided the opportunity to vote on the proposal.  If the proposal passes the vote, then the debts are all dealt with in the manner set out in the proposal and the debtor can carry on in business.

A third scenario for an insolvent debtor is bankruptcy.  When a debtor enters into bankruptcy (either voluntarily or at the behest of a creditor), all of its assets are assigned to a trustee in bankruptcy who is then tasked with paying out any creditor claims in a fair and orderly manner.  A corporate debtor may not obtain a discharge from bankruptcy unless all of its debts are paid in full.

Receivership, restructuring, or bankruptcy can happen at any time with little or no warning to other concerned parties.  When an insolvency scenario occurs during the course of litigation, it can dramatically impact the remaining parties’ litigation strategy.

The starting point is that any ongoing litigation, or contemplated new litigation, will be stayed against an insolvent party who is under receivership, restructuring under the BIA and CCAA, or bankrupt.  A stay of proceedings suspends all further legal processes.  It prevents the remaining parties from proceeding with discoveries, obtaining evidence, or obtaining settlement contributions from the insolvent party.  Essentially, the insolvent party is no longer obliged to participate as a party in the litigation in any manner.

The BIA and the CCAA contain statutory provisions that govern stays.  While most stays are similar, it is important to review the applicable legislation and to obtain a copy of the Court order which operates to create the stay of proceedings.   The stay may be time limited, it may apply to all current and future proceedings, or it may apply only to current proceedings.

Where the insolvent party is a defendant, proceeding with the litigation creates risks for both the plaintiff and the co-defendants.  A plaintiff will be unable to recover any judgment against an insolvent party.  Any remaining defendants may find themselves facing exposure for the entirety of the plaintiff’s claim, even if the insolvent defendant was responsible for only a portion of the plaintiff’s loss.  In many negligence cases, at the conclusion of trial the judge will apportion liability between the defendants.  Unless the plaintiff is found contributorily negligent, in most cases in British Columbia liability between the defendants for a tort is considered to be “joint”.  The effect of this is that even if the Court determines that the insolvent defendant is 50% at fault, because the plaintiff will not be able to recover against the insolvent defendant, it will be able to proceed against the remaining defendants for 100% of the judgment.

If circumstances arise where it is the plaintiff who is insolvent, this does not bring the action to a conclusion.  Instead, the litigation can continue with the receiver or trustee continuing to prosecute the claim.  This scenario also creates risks for the defendants.  Usually if a plaintiff loses its case at trial, the Court will award costs to the defendants.  Where a plaintiff is bankrupt, it has no ability to pay costs. Therefore, even if the defendants have a very strong defence, it may not be worth proceeding to a trial knowing that it will not be able to collect full costs if successful.  Defendants involved in a case against a bankrupt plaintiff may be able to obtain a security for costs order, where a portion of the estimated costs are put into trust and held as security for a possible costs award, but usually security is not granted for the full amount of the costs that will be payable.

In very limited circumstances, it is possible to have the stay of proceedings lifted.  The most common reason that a stay of proceedings is lifted is if the debtor has insurance available for the claim.  In that case, the parties to the litigation may obtain a court order lifting the stay up to the amount of available insurance and the litigation will proceed in its usual course.

Given the frequency of insolvencies in the construction industry, it is important when involved in litigation to consider whether the parties to the action are solvent, whether they are likely to remain solvent, and whether if there is an insolvency, the parties are insured.  These issues are best dealt with as soon as insolvency occurs so that an appropriate litigation strategy can be adopted given the risks to the remaining parties to the litigation.

 

Originally published in Construction Business magazine.

Rebecca J. Cleary is a member of the Construction + Engineering practice at Alexander Holburn Beaudin + Lang LLP.