This article has been contributed by Martin Desrosiers and Julien Morissettepartner and associate respectively, in the Insolvency & Restructuring Group of Osler, Hoskin & Harcourt LLP.

The Bankruptcy and Insolvency Act permits creditors to file an application in bankruptcy against a debtor if certain conditions are met. While these applications are relatively rare (most debtors voluntarily file for protection) they may be used as a last-ditch effort to collect a debt. The conventional wisdom is that a company which has publicly admitted to insolvency can never successfully defend such an application. In a recent judgment, an Ontario court refused to bankrupt a company precisely in that situation. 

Background Litigation

In early 2011, Darryl Stretch and a company he controlled entered into an Executive Consulting Agreement with Solid Gold Resources Corp., a junior mining exploration and development company. Stretch was Chief Executive Officer of Solid Gold for a time. In late 2012, Solid Gold terminated the Agreement.

Stretch and his company sued Solid Gold for damages, claiming approximately half a million dollars. Solid Gold filed a defence counterclaim for about $2.2 million. While it denied liability in its defence, Solid Gold stated therein that it was insolvent and provisioned the amount of the claim in its financial statements. The action was still pending in the fall of 2014.

The Bankruptcy Application

At that point, Stretch and his company (the Applicants) filed an application in bankruptcy before the Ontario Superior Court of Justice against Solid Gold under section 43(1) of the Bankruptcy and Insolvency Act (BIA):

… [O]ne or more creditors may file in court an application for a bankruptcy order against a debtor if it is alleged in the application that

(a) the debt or debts owing to the applicant creditor or creditors amount to one thousand dollars; and

(b) the debtor has committed an act of bankruptcy within the six months preceding the filing of the application.

Unlike ordinary civil claims, bankruptcy applications are often heard in an expedited manner and with a limited record.

The Court’s Rebuke

In his judgment rendered in January (Stretch v Solid Gold, 2015 ONSC 82), Justice Pattillo denied the bankruptcy application. He dealt with three points. First, given the contingent nature of their claim and the substantially larger counterclaim, were the Applicants actually creditors? Perhaps unsurprisingly, he concluded that the claim was too contingent for the Applicants to have creditor status. Little weight was given to the note in the financial statements given Solid Gold’s denial of liability in its defence. This finding may have been sufficient to deny the application, but the Court considered two additional points.

Did Solid Gold commit an act of bankruptcy? At first glance, an unambiguous statement that the company is insolvent in a court filing should lead to an incontrovertible result. The Court applied the doctrine of “absolute privilege”, i.e. that no statement in a court filing may be the basis of a lawsuit, to shield Solid Gold from any consequences of the admission. Justice Pattillo also mentioned that the most recent financial statements showed assets in excess of liabilities and that there was little evidence that actual creditors were not getting paid. This is a fact-specific result which may not often be replicated. In addition the doctrine of absolute privilege does not exist in every Canadian province.

The Court should also have noted that, without more evidence or unless it is made in writing at a creditors’ meeting, a sheer admission of insolvency is not an act of bankruptcy. Under the BIA, failing to make payments when due is an act of bankruptcy but having greater liabilities than assets is not. Persons who are “balance sheet insolvent”, without more, may voluntarily avail themselves of the protection of the Act but cannot be forced into bankruptcy. This should be kept in mind by anyone considering filing an application to bankrupt a company which has insufficient assets but is nonetheless meeting its current obligations.

Finally, the BIA permits the Court to deny a bankruptcy application for “a sufficient cause.” The Court found that this was such a case and that the Applicants had an improper purpose. In Justice Pattillo’s view, the Applicants were using the process as a tactic to short circuit the ongoing litigation against Solid Gold by attempting to snuff out its counterclaim. He also found that one of the Applicants’ goals was to acquire Solid Gold’s assets (presumably at a large discount) in the bankruptcy. The Court held that this was an improper purpose and was grounds to dismiss the application.

The Need for a Sober Second Thought

A judgment such as this should give pause to any creditor considering a hostile bankruptcy application. The BIA’s requirements are not always easy to satisfy. This is particularly true for an applicant having a contingent or unliquidated claim. This may prolong litigation, even if one party may never be able to satisfy a judgment against it. As well, when a creditor has ulterior motives, the rule against improper purpose may be problematic even if all other requirements are met.

Martin Desrosiers

Julien Morissette