Facing Insolvency: Do Directors Owe a Fiduciary Duty to Creditors During a Bankruptcy? If Not, How Can Creditors Protect Themselves?

Written by Jack Kuzyk
JD Candidate 2023 | UCalgary Law

Bankruptcy is a difficult process that can be overwhelming for both individuals and businesses. Provisions in the federal Bankruptcy and Insolvency Act (“BIA”) and the provincial Personal Property Security Acts make it difficult for creditors to seize and retain their assets for materially less than their fair market value.[1] Upon bankruptcy, the BIA provides a distribution scheme to determine creditor priority when administering the bankrupt’s estate (i.e., the debtor company assets).[2] The estate, however, generally holds an insufficient amount of assets for creditors to fully recover. Further, a stay of proceedings is automatically imposed on all claims against the bankrupt and their property.[3] As a means to maintain control over the distribution of the assets and property of the bankrupt, the stay operates to prohibit creditors from commencing any further legal action against the debtor.[4] From a creditor perspective, this mechanism severely limits repayment by inhibiting enforcement of debt collection.
 
In Canada, however, directors of a corporation are subject to potential personal liability – e.g., unpaid taxes, environmental damage and unpaid employment wages. Director liability provides a legal tool for creditors to increase their reimbursements. Under the Canadian Business Corporations Act (“CBCA”), director duties include both the duty of loyalty, and duty of care.[5] There is, however, growing recognition that directors of an insolvent corporation owe a duty of care to the corporation’s creditors. Although this duty does not rise to the level of a fiduciary duty,[6] the directors, in discharging their fiduciary duty of loyalty and determining the best interests of the corporation,[7] may need to consider the interests of shareholders, employees, suppliers, creditors, consumers, governments and other stakeholders.[8] The interests of these different constituencies may conflict (e.g., debtholders versus equity holders where the corporation is in the vicinity of bankruptcy[9]) and the directors, in fulfilling their fiduciary obligation to act in the best interest of the corporation, are required to balance these competing interests. With very little guidance on how to perform this balancing act, this blog post will provide a brief discussion on whether directors are required to shift their primary focus to the creditors once the corporation approaches the possibility of insolvency.  
 
Creditors of a Corporation under the BIA:
As a preliminary matter, section of 2 of the BIA defines “creditor” as a person having a “claim provable as a claim”.[10] Sections 121 to 123 of the BIA define what constitutes “claims provable”, including certain debts and liabilities incurred by the bankrupt corporation.[11] To be granted creditor status, including the right to participate in the distribution scheme prescribed under the BIA, onus is on the creditor to prove its status under the BIA. Moreover, creditors are separated into different constituencies reflecting various levels of priority under the bankruptcy regime. For purposes of this blog, the ensuing discussion assumes all creditors are unsecured and collecting inside the bankruptcy process. Notably, however, there are instances where creditors may strategically force a corporation into bankruptcy as their status inside bankruptcy results in them receiving a greater return than they would otherwise receive outside of bankruptcy.[12] From both debtor and creditor perspective, it is imperative to understand creditor status and priority ranking.
 
Peoples: Fiduciary Duty Not Owed To Creditors
Pursuant to the Supreme Court of Canada (the “Court”) in Peoples Department Stores Inc. (Trustee of) v Wise,[13] the directors of a corporation, even when facing insolvency, do not owe a fiduciary duty to the creditors of a company.[14] In Peoples, the trustee in bankruptcy, representing the creditors of the bankrupt company (here, Peoples), commenced an action against the directors of Peoples, alleging that its directors breached their fiduciary obligations to its creditors. The claim against the directors was not pursued under the oppression remedy nor a derivative action. In examining the nature of a director’s duties under Canadian law in the context of an insolvency proceeding, the Court in Peoples held that “the various shifts in interest that naturally occur as a corporation’s fortunes rise and fall do not, however, affect the content of the fiduciary duty under s. 122(1)(a) [CCBA – i.e., duty of loyalty]… At all times, directors and officers owe their fiduciary obligation to the corporation. The interests of the corporation are not to be confused with the interests of the creditors or those of any other stakeholders… In using their skills for the benefit of the corporation when it is in troubled waters financially, the directors must be careful to attempt to act in its best interest by creating a “better” corporation, and not to favour the interests of any one group of stakeholders.”[15] In other words, while broadly describing the duty of care, the Court, while limiting the duty of loyalty to the corporation itself, specifically excluded creditors from the scope of a director’s fiduciary duties and found director fiduciary duties do not change when a corporation is in the nebulous “vicinity of insolvency”.[16] Notably, the Court reasoned that creditors have the broad oppression remedy available to protect their interests against prejudicial conduct of director(s) under s.241 of the CBCA. Thus, the Court found no need to extend the fiduciary duty of loyalty imposed on directors to include creditors.[17]
 
Further, the Court in Peoples,[18] and later re-affirmed in BCE Inc v 1976 Debentureholders,[19] severely restricted director liability by affirming the business judgment rule. Effectively, the courts will not intervene in the substantive decisions of directors and impose director liability where directors’ decisions satisfy their procedural requirements under the duty of care.  
 
If Not, How Can Creditors Contractually Protect Themselves?
Therefore, if not owed a fiduciary duty, unpaid creditors, or the trustee in bankruptcy, may use the oppression remedy to obtain judgment against the directors of a corporation under the Canadian Business Corporation Act.[20]  However, as an equitable remedy, receiving standing as a “complainant” to pursue an oppression action is based on the circumstances of each case.[21] For instance, the oppression remedy may not be used by a creditor solely as a tool for debt collection. The policy rationale for its limited use is that creditors are not contractually obligated to enter into agreements with the corporation. Moreover, freedom of contract enables creditors to price the risk of the corporation’s failure into the price (e.g., higher interest on a loan or higher cost for supply of services), use a debt instrument,[22] or impose conditions that withstand bankruptcy and provide the creditor with priority protection. For example, the creditor may require a charge against property of the debtor as security for the debt due to the creditor. Consequently, the creditor has a secured interest that ranks above unsecured creditors in the distribution scheme.[23] Moreover, it may not be affected by the stay of proceeding.[24]
 
Conclusion:
While the pendulum does not swing entirely to the creditors, directors of a corporation experiencing financial difficulties should, and should be seen to, maintain a high degree of diligence and care regarding the dealings of the corporation. While there is no bright-line test in this regard, the interests of creditors is a factor. In particular, when the threat of insolvency looms over the company’s future. The foregoing only touches the surface of this issue. For further information, please contact the BLG Business Venture Clinic.



[1] Bryce C. Tingle, Start-up and Growth Companies in Canada: A Guide to Legal and Business Practice, 3rd ed (Toronto: LexisNexis Canada Inc., 2018) at 79 [Tingle]. See also, Bankruptcy and Insolvency Act, RSC 1985, c B-3, s 247 [BIA] and Personal Property Security Act, RSA 2000, c P-7, ss 60,62.
[2] Supra note 1, s 136.
[3] BIA, supra note 1, s 69.
[4] BIA, supra note 1, s 69.3(1)
[5] Canadian Business Corporations Act, RSC 1985, c C-33, ss 121(1)(a) and (b), respectively [CBCA].
[6] Peoples Department Stores Inc (Trustee of) v Wise, [2004] SCJ 64, [2004] SCR 68 [Peoples].
[7] CBCA, supra note 5, s 122(1).
[8] CBCA, supra note 5, s.122(1.1); Peoples, supra note 6, at para 42.
[9] Tingle, supra note 1 at 79.
[10] Supra note 1.
[11] Supra note 1.
[12] Stephanie Ben-Ishai & Thomas G.W. Telfer, Bankruptcy and Insolvency Law in Canada: Cases, Materials, and Problems, (Toronto: Irvin Law, 2019) at 321.
[13] Supra note 6.
[14] Peoples, supra note 6 at para 1.
[15]Supra note 6 at paras 43-47.
[16] Peoples, supra note 6 at para 46.
[17] Peoples, supra note 6 at paras 48-53.
[18] Peoples, supra note 6, at para 67.
[19] [2008] SCJ No 37, [2008] 3 SCR 560 at para 112 [BCE].
[20]Olympia and York (2001), 28 CBR (4th) 294; CBCA, supra note 5, s 2(d).
[21] First Edmonton Place Ltd v 31588 Alberta Ltd (1989), 45 BLR 110 (Alta CA); Sidaplex-Plastic v Elta Group Inc (1998), 111 OAC 106 (CA). 
[22] Tingle, supra note 1 at p 79.
[23] BIA, supra note 1, ss 136 and 2 “secured creditor”.
[24] BIA, supra note 1, s 69.3(2).