On March 9, 2017, the Supreme Court of Canada granted leave to appeal from the Ontario Court of Appeal’s ruling that there was no jurisdiction to grant equitable subordination under Canada’s Company Creditors and Arrangement Act (“CCAA“) which is often compared to Chapter 11 proceedings in the U.S.

Equitable subordination is a well-known American doctrine that permits a court to determine that a secured creditor is not entitled to the benefit of its normal priority position in an insolvency. Some consider it to be a tool for US bankruptcy courts to ensure that a debtor’s assets are distributed fairly. When the question last reached Canada’s Supreme Court in 1992, the Court declined to consider whether equitable subordination was available under Canadian law stating that that it was a question “for another day.” That day has now come.

Equitable Subordination

Equitable subordination is codified in section 510(c) of the US Bankruptcy Code. Typically, the doctrine is applied in cases where a creditor exercises control over the debtor and there is evidence that transactions were not conducted at arm’s length. In order for a secured creditor’s claim to be equitably subordinated, three conditions must be satisfied:

  1. the claimant must have engaged in some type of inequitable conduct;
  2. the misconduct must have resulted in injury to creditors of the bankrupt or conferred an unfair advantage on the claimant; and
  3. equitable subordination of the claim must not be inconsistent with the provisions of the bankruptcy statute.

U.S. Steel Canada (Re)

In U.S. Steel Canada (Re), 2016 ONCA 662, the steel producer US Steel Canada was under CCAA protection. The former unionized employees argued on appeal that the doctrine of equitable subordination should be applied to the $2.2 billion in inter-company debt claims filed by the US parent. The Ontario Court of Appeal held that while the CCAA gives courts broad and flexible powers, they are not limitless and it does not give express or implied authority to apply the doctrine of equitable subordination. The decision emphasized that the purpose of the CCAA is to facilitate compromises and arrangements between debtors and creditors and that the CCAA did not provide an “at-large equitable jurisdiction to reorder priorities or to grant remedies as between creditors.”

The Court of Appeal distinguished between the potential availability of the equitable subordination doctrine under the CCAA and Canada’s Bankruptcy and Insolvency Act (“BIA“) which is the primary insolvency statute for smaller companies and individuals. A provision of the BIA, which has no CCAA equivalent, invests the bankruptcy court with “such jurisdiction at law and in equity” and therefore it may have jurisdiction to grant equitable subordination under that regime. One of the arguments of the former unionized employees is the potential availability of the equitable subordination doctrine under the BIA as compared to the CCAA requires clarification and guidance from the Supreme Court.

With the leave application granted, the Supreme Court appears ready to conclusively answer the question about the applicability of the equitable subordination remedy under Canadian law. The appeal hearing is scheduled for November 9, 2017, and will be watched closely by Canadian insolvency practitioners.