For the first time ever in Canada, super-priority rights have been given to employees which will take priority over existing secured creditors.

The super-priority arises out of the Wage Earner Protection Program Act (the "WEPPA") and amendments to the Bankruptcy and Insolvency Act (the "BIA") which took effect on July 7th 2008. The WEPPA and the BIA establish a new regime to give employees claims for wages and pension contributions in the event of the bankruptcy or receivership (court and privately appointed) of their employer that will outrank claims of existing secured creditors.

Wage and Pension Priorities

A wage arrears super-priority up to a maximum of $2,000 per employee has been created over the current assets (essentially, accounts receivable and inventory) of the business which will have priority even over creditors with security on those assets. The wage arrears super-priority does not apply to equipment and thus, lenders/lessors of fixed assets may not be directly affected by these particular provisions.

A further super-priority has been created for unpaid pension contributions and unremitted employee pension deductions (although not deficiencies in pension plan assets). There is no maximum amount for this priority and these claims will have priority over all secured creditors in both bankruptcies and receiverships. It may be possible to use title retention instruments such as leases and conditional sales contracts to defeat the pension super-priority.

Wage Earner Protection Program

In the custom of modern legislative reform, a new bureaucratic agency will be established to administer a Wage Earner Protection Program (the "Program"). The Program guarantees payment of arrears of wages up to $3,000 per employee during the six month period preceding the bankruptcy or receivership. Payments made under the Program will be reduced by applicable income taxes and other deductions so the government is protecting itself as well as employees. When the Program pays an employee's claim, the Program is subrogated to the employee's claim which means it becomes entitled to the super-priority over secured creditors outlined above.

Trustees and receivers are obligated by the WEPPA to help administer the Program by identifying employees who are owed wages, to notify employees of their entitlement and to provide the Program administrators with information pertaining to the wage arrears owing to the employees. The WEPPA imposes penalties on trustees and receivers for non-compliance.

Protecting Your Collateral Position 

To varying degrees, this new employee-friendly regime will cause issues for secured lenders. In order to protect themselves, lenders and financiers may wish to:

  • reduce the percentage of leverage or margining allowed under a facility;
  • require additional security to account for the risks presented by the WEPPA and BIA amendments;
  • reduce the overall amount of financing;
  • require a prospective lessee or borrower to undertake operational changes such as using a payroll service to limit wage claims in the event of a bankruptcy or receivership;
  • enter into intercreditor arrangements with other secured lenders in order to ensure a fair sharing of the burden of any super-priority claims; and
  • increase monitoring activities of their borrowers to ensure that they are not surprised by a significant super-priority claim.

Unfairness

The insolvency amendments do not set out a mechanism to determine whose secured assets should fund the wage and pension claims. Situations may arise where one secured creditor will be forced to disgorge the proceeds of a security realization to pay for such claims with little recourse other than asserting a preferred claim under the amended preferred priority provisions contained in the BIA. Preferred claims rank below secured claims so the aggrieved secured creditor will be involuntarily placed in a much worse position than it had contractually bargained and expected.

Impact

It is regrettable that our policy makers and government officials could not design a system that would protect employees while at the same time protecting the integrity of the Canadian credit markets. These new provisions will have serious and unknown consequences to our credit markets at a time of particular distress by reducing credit availability, particularly to small and medium sized businesses. A more effective and less distortionary solution would have been to establish an employee protection fund similar to what currently exists as employment insurance.

Conclusion

The WEPPA and BIA amendments pertaining to employee claims contain serious deficiencies that will need to be addressed in order to restore fairness to the credit system. In the meantime, it is important to be aware of the new legislation and its impact on lenders, borrowers and trustees and for lenders and credit grantors, to protect themselves as much as possible from its impact.

The WEPPA and the new BIA provisions are not retroactive and will only apply to bankruptcies and receiverships that occur on or after July 7, 2008