The U.S. doctrine of equitable subordination (as now set out in the U.S. Bankruptcy Code) allows a U.S. court to subordinate all or part of a creditor's claim to the claims of other creditors if the creditor has engaged in inequitable conduct that gives the creditor an unfair advantage or is injurious to the other creditors. Will the Canadian courts apply the doctrine?

The U.S. doctrine of equitable subordination allows a court to subordinate all or part of a creditor’s claim if the creditor engages in inequitable conduct that results in an unfair advantage, or is injurious to other creditors. The doctrine has been codified in the U.S. in section 510(c) of the U.S. Bankruptcy Code and has been applied by way of a three pronged test.

This test was discussed by the Supreme Court of Canada ("SCC") in Canada Deposit Insurance Corp. v. Canadian Commercial Bank ("CCB"). In CCB, the SCC stated that the criteria for applying the U.S. doctrine of equitable subordination are:

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

The SCC in CCB did not, however, accept that a comparable doctrine of equitable subordination should exist in Canadian law. Rather the SCC found that the question of whether equitable subordination is available under Canadian law is a question left open for another day.

Prior to CCB, it seemed like the equitable subordination door was closed in Canada by virtue of the decision of the Ontario Court of Justice in AEVO Co. v. D & A MacLeod Co. ("AEVO"). In AEVO, the Court stated that "to incorporate the doctrine of equitable subordination into the Bankruptcy Act would create chaos and lead to challenges of security agreements based on the conduct of the secured creditor."

Subsequent to CCB, Canadian courts have either avoided applying the U.S. doctrine in Canada, refused to apply it, or applied the test but found the criteria not met based on the facts of those cases.

Most recently in Re I Waxman & Sons Ltd. the Ontario Superior Court of Justice (Commercial List) considered once again whether the doctrine was applicable in Canada. It found that the doctrine has developed based on the U.S. legal system, hence, uprooting the doctrine from its "legal home" and applying it to Canada’s statutory bankruptcy regime without further considerations for the development of that doctrine would be problematic. The Court found that the doctrine is based on many of the same principles as found in the Bankruptcy and Insolvency Act ("BIA") and therefore there currently does not seem to be a need to import such a doctrine in Canada. The Court ultimately found that, based on the facts of the case, there was no need to apply the doctrine to the case at bar.

Unfortunately, many courts continue to evade the issue of whether the doctrine of equitable subordination is applicable in Canada. Court decisions have fallen across the spectrum in applying the doctrine. Some courts have simply recognized it and others have flatly refused to import it into Canadian law. Most recently, however, it seems that courts are shutting the door on equitable subordination in Canada, at least until legislative authority steps in to address this issue.