In the recent decision of Re WorkGroup Designs Inc.,1 the Ontario Court of Appeal considered the provisions of the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3 (the "BIA") which relate to valuing and determining the claims of secured creditors in proposal proceedings under the BIA.

Background

The Royal Bank of Canada ("RBC") appealed from the Order of Justice Wilton- Siegel which set aside an Order made by the Deputy Registrar in Bankruptcy which found that RBC was a secured creditor of WorkGroup Designs Inc. ("WorkGroup"). The Court of Appeal allowed the appeal and restored the Order of the Deputy Registrar in Bankruptcy.

RBC held a general security agreement over all of the assets, property and undertaking of WorkGroup. WorkGroup filed a proposal to its creditors pursuant to the provisions of the BIA. The proposal treated RBC as an Affected Secured Creditor and also required the trustee to determine the value of all "Proven Affected Secured Claims", which was defined in the proposal to mean the value of any proven claim to the extent of the value of the secured property, as determined by the trustee in relation to that claim, subject to appeal rights. RBC filed a Proof of Claim as a secured creditor of WorkGroup in the amount of approximately $125,000 and voted against the proposal.

Relying on section 135(3) of the BIA, the proposal trustee disallowed RBC’s secured claim. Section 135(3) of the BIA provides as follows:

Notice of determination of disallowance

135 (3) Where the trustee makes a determination under subsection (1.1) or, pursuant to subsection (2), disallows, in whole or in part, any claim, any right to a priority or any security, the trustee shall forthwith provide, in the prescribed manner, to the person whose claim was subject to a determination under subsection (1.1) or whose claim, right to a priority or security was disallowed under subsection (2), a notice in the prescribed form setting out the reasons for the determination or disallowance.

The disallowance of the RBC secured claim was based on the proposal trustee’s view that there were no assets over which RBC held any security. All of WorkGroup’s assets were encumbered by the Canada Revenue Agency ("CRA") in priority to RBC for employee withholdings that WorkGroup failed to remit. Applying a liquidation analysis, the proposal trustee determined that the CRA’s prior claim exceeded the value of WorkGroup’s assets. Since there would be insufficient assets to satisfy the CRA’s claim, there could be no assets over which RBC could hold any security. Accordingly, the proposal trustee admitted the RBC claim as an unsecured claim.

The Decision of the Deputy Registrar in Bankruptcy

RBC appealed the proposal trustee’s disallowance of its claim as a secured creditor to the Deputy Registrar in Bankruptcy.2 Deputy Registrar Diamond allowed the appeal and restored RBC’s secured creditor status. He found that while the proposal and section 50.1(2) of the BIA specifically provided the proposal trustee with an opportunity to value the RBC claim, the proposal trustee did not do so. Rather, the approach taken by the proposal trustee was to disallow the claim pursuant to section 135(3) of the BIA on the basis that all the assets were encumbered by the super-priority claim of the CRA.

The Decision of Justice Wilton-Siegel

WorkGroup appealed the decision of Deputy Registrar Diamond to the Ontario Superior Court of Justice.3 Justice Wilton-Siegel allowed the appeal, finding the proposal had not complied with section 50.1 of the BIA. He went on to state that a proposal is intended to be a flexible proceeding under the BIA and, to permit this, sections 135(3) and 60(2) of the BIA collectively create a structure for a claims process administered by the proposal trustee that can be adapted to the specific circumstances of any particular proposal.

Justice Wilton-Siegel held that those provisions provided the proposal trustee with the authority to determine the quantum, if any, of RBC's secured claim under the proposal and subsequently disallow RBC’s claim as a secured creditor. He also noted that there was no prejudice to RBC if the trustee's disallowance necessitated an appeal under section 135(3) rather than under section 50.1(4) of the BIA. In either case, the nature of the appeal would be the same.

The Decision of the Court of Appeal

The Court of Appeal found that the appeal by RBC should be allowed having regard to the proper interpretation of the provisions of the BIA. In particular, Justice Rouleau phrased the issue to be determined on appeal as follows: whether in a bankruptcy proposal, a proposal trustee can invoke the general statutory power set out in section 135 of the BIA to assess the value of a secured creditor’s claim and disallow that claim, thereby eliminating the secured creditor’s vote as a secured creditor on the proposal.

The Court of Appeal held that the statutory interpretation issue was dispositive of the appeal and the valuation issues did not need to be addressed. On a proper interpretation of the provisions of the BIA, Justice Rouleau stated that section 135 of the BIA cannot be used by a proposal trustee for the purpose of valuing and disallowing a secured claim. Rather, the proposal trustee should have adopted the procedure set out in section 50.1 of the BIA, which specifically addresses the proper approach to be applied where a proposal has been made.

The relevant subsections 50.1 of the BIA provides as follows:

50.1 (1) Subject to subsections (2) to (4), a secured creditor to whom a proposal has been made in respect of a particular secured claim may respond to the proposal by filing with the trustee a proof of secured claim in the prescribed form, and may vote, on all questions relating to the proposal, in respect of that entire claim, and sections 124 to 126 apply, in so far as they are applicable, with such modifications as the circumstances require, to proofs of secured claim.

(2) Where a proposal made to a secured creditor in respect of a claim includes a proposed assessed value of the security in respect of the claim, the secured creditor may file with the trustee a proof of secured claim in the prescribed form, and may vote as a secured creditor on all questions relating to the proposal in respect of an amount equal to the lesser of

(a) the amount of the claim, and (b) the proposed assessed value of the security.

(4) Where a secured creditor is dissatisfied with the proposed assessed value of his security, the secured creditor may apply to the court, within fifteen days after the proposal is sent to the creditors, to have the proposed assessed value revised, and the court may revise the proposed assessed value, in which case the revised value henceforth applies for the purposes of this Part.

RBC submitted that the proposal trustee is under an obligation to follow the procedure set out in section 50.1 of the BIA because the section specifically addresses the valuation of secured creditors’ claims in the context of proposal proceedings. Accordingly, a general section such as section 135 of the BIA should not be relied upon in circumstances where the BIA specifically addresses a particular situation with a specific provision.

Conversely, WorkGroup argued that it was appropriate for the proposal trustee to rely upon section 135 of the BIA as section 50.1 need only be resorted to where, as set out in section 50.1(2), a proposal "includes a proposed assessed value of the security in respect of the claim." According to WorkGroup, since its proposal did not contain a proposed assessed value of RBC’s secured claim, section 50.1 did not apply in the circumstances such that it was open to the proposal trustee to resort to section 135 to disallow RBC’s secured claim. Interestingly enough, WorkGroup did concede that to the extent that a specific section in the proposal provisions of the BIA was applicable to the matter under consideration, then it would not be appropriate to resort to a section of more general application contained in another part of the BIA.

In allowing the appeal, Justice Rouleau made the following observations with respect to the procedure set out in section 50.1 of the BIA:

I agree with the appellant on this issue. Properly interpreted, 50.1 of the BIA provides direction for the determination of the value of the secured creditor’s claim that the secured creditor may vote in respect of a proposal. Section 50.1(1) sets out the general rule. It provides that, subject to subsections (2) to (4), the secured creditor has the right to vote the claim as a secured creditor for the entire amount once it has filed proof of security. Section 50.1(2) provides that, where the proposal ascribes an assessed value to the claim, the secured creditor is only allowed to vote for the lesser of the amount of the claim or the proposed assessed value…

The Court of Appeal noted that the WorkGroup proposal did not include a proposed assessed value for RBC’s claim as provided for in section 50.1(2) of the BIA, therefore section 50.1(1) of the BIA applied to the WorkGroup proposal: "Therefore, when RBC responded to the proposal by filing a proof of $125,000 secured claim in prescribed form, RBC became entitled to vote ‘on all questions relating to the proposal in respect of that entire claim’."

In connection with the procedure set out in section 135 of the BIA, Justice Rouleau stated that section 135 is concerned with the allowance or disallowance of the security itself for the purposes of a distribution of dividends from a bankrupt’s estate.

Justice Rouleau concluded that section 50.1, which "specifically applies in this fact situation" must prevail over the more general section 135.

In allowing the appeal and restoring the Order of the Deputy Registrar in Bankruptcy, Justice Rouleau made the following concluding remarks:

As a result, since no proposed assessed value was contained in the proposal, RBC, holding a general security agreement in WGD’s assets, was entitled to vote the full amount of its $125,000 claim as a secured creditor in accordance with s.50.1(1). Taking the vote of this $125,000 secured claim into account results in the rejection of the proposal by the secured creditors’ class.

The effect of this decision would be to restore the order of the Deputy Registrar in Bankruptcy. That was the order in effect when the parties sought and obtained court approval of the proposal. My understanding, therefore, is that the proposal as accepted by the court would remain in effect and RBC would regain the status it had when the proposal was approved.

This decision of the Court of Appeal serves to clarify the procedure to be applied by a proposal trustee for evaluating and determining secured creditors’ claims in the context of Division I proposals under the BIA.