2007 BCSC 267 (B.C. Supreme Court, Feb. 28, 2007)

Trustee in bankruptcy must affirm swap contracts to take advantage of them but is not personally liable if the contracts end up being out of the money - While contract gave buyer a termination right on bankruptcy, it could choose not to exercise this option and leave it to the trustee to decide whether or not to affirm the swap and take the risk that the estate will end up out of the money

Even though one was decided in British Columbia and the other in England, the two cases discussed in this issue of the Structured Finance Update each relate to the insolvency of North America Steamships Ltd. (NASL) of Vancouver. In the Canadian proceeding, Mr. Justice Tysoe was asked by NASL's Trustee in Bankruptcy for declarations that (i) it was not required to affirm certain swap agreements in order to take the benefit of them and (ii) that it would not be personally liable if it did affirm those swap agreements.

The facts were as follows. Beginning in 2005, NASL had entered into a number of freight forward swap agreements (FFA Contracts) in a standard form written confirmation incorporating the 1992 ISDA Master Agreement (Multicurrency-Cross-Border), which makes payment obligations conditional on the non-occurrence of an "event of default". One such event is bankruptcy, broadly defined to encompass insolvency, administration, arrangements etc.

On the evidence, NASL's trading strategy was none too successful. The company ran up significant trading losses and ended up in bankruptcy. Because of a shift in the market, the outlook was much brighter for one group of FFA Contracts - "the AWB Geneva/Pioneer swaps" - that mature at the end of 2007. This group of FFA Contracts would be in the money by a total of $18.3 million if the settlement rate at the time of the hearing held up until December 31. Naturally, the Trustee wanted the benefit of the AWB Geneva/Pioneer swaps - if at all possible without actually "affirming" the contracts. But it did not want to incur potential personal liability should the contracts end up being out of the money.

In case it is not clear, the reason that the counterparties did not terminate the contracts was that they would then have been required to make the termination payment called for under the contract. To avoid this, they relied on their rights under section 2 of the ISDA Master Agreement to suspend performance obligations upon NASL's event of default (namely, the bankruptcy). In response, the Trustee took the unusual step of attempting to turn the bankruptcy proceeding into a CCAA proceeding in order (it hoped) to avail NASL of a CCAA stay of those rights - an aspect of the proceeding that is discussed at more length in our brief of the English sequel to this ruling. As a first step, however, the Trustee needed to obtain a ruling from the B.C. court with respect to whether it had to affirm the contracts and to whether it faced any possible personal liability.

Necessity to affirm

At least since Re Thomson Knitting Co. Ltd. (1925), 5 C.B.R. 489 (Ont. C.A.), it has been the law in Canada that a trustee in bankruptcy must affirm the bankrupt's contracts if it does not wish the counterparties to treat them as repudiated. Tysoe J. observed that this rule makes commercial sense, as it assures the solvent party that it will not be treated merely as an unsecured creditor with respect to its post-bankruptcy performance.

The Trustee argued that things were different here, since the AWB Geneva/Pioneer swaps included a termination right exercisable upon NASL's bankruptcy. Obviously the exercise of this right would have suited the Trustee quite well, since the swaps were massively in the money at the time of bankruptcy. But Tysoe J. held that the fact that the counterparties held this option did not mean that they weren't entitled to the benefit of the usual operation of the law in the event that they chose not to exercise it. So the Trustee could either affirm (and hope for the best) or disclaim (and realize nothing). If it did neither, it would never collect because of the clause in the ISDA Master Agreement suspending payments during an event of default.

Tysoe J. also rejected the argument that because (supposedly) the obligation to affirm or disclaim applies only to executory contracts, it did not apply in the case of a swap, where the only remaining obligation was payment. He held that it did not matter what the remaining obligation was.

Personal liability

As s. 31(4) of the Bankruptcy and Insolvency Act is commonly understood, there is a rebuttable presumption that debts arising post bankruptcy fall upon the estate in bankruptcy rather than personally upon the trustee. As Tysoe J. noted, it is not as clear that this is the case with liabilities (e.g. in tort) that cannot be classed as "debts", but in this case what was at issue was a potential debt.

Cases in which personal liability has been found include where a trustee has pledged his personal credit in exchange for the supply of goods or has agreed to act as agent for a secured creditor in realizing its security.

While Tysoe J. agreed that he could not issue a blanket declaration that the Trustee was not personally liable, he was willing to issue a more limited declaration, as follows:

The affirmation of the Geneva/Pioneer Swap Agreements by the Trustee will not itself make the Trustee personally liable in respect of the obligations of the buyer under the Swap Agreements as long as the Trustee affirms the Swap Agreements on behalf of the bankruptcy estate and not in its personal capacity. He declined to make a further declaration limiting the Trustee's personal liability to the realizable value of the property of the bankrupt less the Trustee's own fees. He could find no authority for giving the Trustee's fees this kind of special priority. In addition, as noted above, Tysoe J. declared that the Trustee had to affirm in order to take the benefit of the AWB Geneva/Pioneer swaps.