Factoring transactions, in which a buyer purchases outright or acquires an interest in a seller’s accounts receivable, are becoming increasingly common. Initially, the buyer must determine whether the transaction is to be recourse or non-recourse to the seller. In other words, can the buyer seek a remedy against the seller if the receivable is bad, or doesn’t pay, or does the buyer bear the entire credit risk of the deal, irrespective of whether the receivable is good? Both recourse and non-recourse transactions raise a handful of interesting considerations in bankruptcy situations. What happens if the seller in a factoring transaction goes bankrupt? Can creditors of the seller look to the third party purchaser for recovery? Factors are at risk under the Bankruptcy and Insolvency Act (BIA) and the Companies’ Creditors Arrangement Act (CCAA), which allow for such recovery in certain circumstances. 

Canadian legislation empowers courts to declare a “transfer-at-undervalue” void during specific “look-back periods”. As well, a trustee in bankruptcy may apply to a court for payment by a transferee of the difference between the actual consideration given and the fair market value of the assets transferred. 

A transfer-at-undervalue is defined as a disposition of property for which no consideration is received or for which the consideration received is conspicuously less than the fair market value. 

Where a transfer-at-undervalue occurs between parties dealing at arm’s length, a transfer may be set aside if (1) it occurred in the year prior to the date of the initial bankruptcy; (2) the debtor was insolvent at the time or rendered insolvent by it; and (3) the debtor intended to defraud, defeat or delay a creditor. 

Where a transfer-at-undervalue occurs between parties not dealing at arm’s length, a transfer may be set aside if (1) the transfer occurred in the 12 months prior to the initial bankruptcy event; or (2) the transfer occurred within the five years prior to the initial bankruptcy event and the debtor was: (i) insolvent at the time, or rendered insolvent by it and (ii) the debtor intended to defraud, defeat or delay a creditor. 

What does “conspicuously less” mean? 

The phrase “conspicuously less” is not defined in either the BIA or the CCAA. Canadian jurisprudence, while providing some guidance, does not explicitly set out the percentage at which a discount will render the consideration received to be “conspicuously less” than fair market value. 

The Supreme Court of Canada in Peoples Department Stores Inc. (Trustee of) v Wise, commenting on s. 100 of the BIA as it was written at the time, stated that the “conspicuously less” test is not “whether the [difference] is conspicuous to the parties at the time of the transaction, but whether it is conspicuous to the court having regard to all the relevant factors.” It went on to say that “there is no particular percentage that definitively sets the threshold for a conspicuous difference, [but that] the percentage difference is a factor [to be taken into consideration].” In that case, the SCC held that a disparity of slightly more than six percent between the fair-market value and the consideration received by the bankrupt corporation did not constitute a conspicuous difference within the meaning of the BIA. Similarly, in Re Mendenhall, which involved a disparity of 6.67 percent, the Ontario Superior Court (Bankruptcy and Insolvency Division) held that the conspicuous difference threshold was not met. 

Canadian courts have, in some cases, held discounts to be conspicuous. The British Columbia Court of Appeal inSkalbania (Trustee of) v Wedgewood Village Estates Ltd. held that a discount of 17.5 percent resulted in a conspicuous difference. The Court explained that a decision as to whether a difference is conspicuous should be made in light of an examination of the particular circumstances in the case. It went on the say that the word “conspicuous” should be considered in its plain and ordinary meaning, namely, “plainly evident, attracting notice; hence eminent, remarkable, [or] noteworthy.” In 2013, the Alberta Court of Queens Bench in Re Mihalich held that discounts of 55 percent, 71 percent, 77 percent and 82 percent on the transfer of certain chattels between common law spouses did result in a conspicuous discount. 

What should factors be aware of? 

Due diligence of potential sellers and transactions should result in a detailed understanding of a seller’s corporate structure and who is originating the receivable. 

A buyer’s underwriting team needs to be sensitive to the seller’s financial condition and its corporate-related parties, other creditors and the seller’s overall ability to pay its obligations as they fall due. In particular, buyers should be aware of the definition of “insolvency” as it may be applied to a seller or its related parties. Buyers should not merely rely on the business condition of the seller, where affiliates and related parties may affect any potential claw back. 

Finally, buyers of accounts receivable dealing with Canadian businesses should avoid discounts that are disproportionate to the fair-market value of the receivables being acquired, or market practice generally. To avoid negative consequences, factors should use a discount rate that is generally accepted as standard practice in the industry.