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The reorganization of insolvent business : a functional comparison of the Canadian and American models Yamauchi, Keith D. 1994

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THE REORGANIZATION OF INSOLVENT BUSINESSES:A FUNCTIONAL COMPARISON OF THE CANADIAN AND AMERICAN MODELSbyKEITH DENNIS YAMAUCHIB.A., The University of Calgary, 1977LL.B., The University of Saskatchewan, 1981A THESIS SUBMIEfED IN PARTIAL FULFILLMENT OFTHE REQUIREMENTS FOR THE DEGREE OFMASTER OF LAWSinTHE FACULTY OF GRADUATE STUDIES(Faculty of Law)We accept this thesis as conformingto the required standardTHE UNPIERSITY OF BRITISH COLUMBIASeptember 1994© Keith Dennis YarnauchiIn presenting this thesis in partial fulfilment of the requirements for an advanceddegree , I agree that the library shall make itfreely available for reference and study. I further agree that permission for extensivecopying of this thesis for scholarly purposes may be granted by the head of mydepartment or by his or her representatives. It is understood that copying orpublication of this thesis for financial gain not be allowed without my writtenpermission.Department of Li.’The University of British ColumbiaVancouver, CanadaDate ‘DE-6 (2/88)11ABSUACEThe business reorganization systems available to fmancially-distressed businesses in Canadaare evolving into a system similar to that employed in the United States under Bankruptcy Reform Actof 1978 (Code). Business reorganizations have been an integral part of American commercial culturefor almost a century. In Canada, business debtors may resort to the Companies’ CeditoiA nwgemeni’ Act (CCAA) or the Bankruptcy and Insolvency Act (BIA), when seeking to reorganizetheir affairs. However, Canadian debtors use those systems sparingly.A primary objective of a business reorganization system is to balance the debtor’s rehabilitationefforts with the rights of creditors. This paper examines the Code and conducts a functionalcomparative analysis of certain aspects of the Canadian and American systems. The purpose of thisexamination is to detemiine whether the systems accomplish that objective and whether the Canadiansystems could accomplish that objective more effectively by examining and incorporating aspects ofother systems.This paper argues that the BL& neither encourages the debtor’s rehabilitation efforts nor treatscreditors equitably. The primary reason for this shortcoming was the failure of the policymakers toconsider the objectives of a business reorganization system. These policy objectives formed thefoundation of the Code. As a result, the Code contains concepts that attempt to balance the interestsof debtors and creditors and gives the courts the necessary flexibility to mould the concepts to achievethat balance. The CCAA provides little procedural or substantive guidance concerning its policyobjectives. Accordingly, the courts have significant flexibility in applying its provisions. However,that flexibility also results in a lack predictability.The proposal provisions of the BIA must undergo significant changes before it becomes aworkable business reorganization model. Further efforts at bankruptcy reform must include a thoroughstudy of legislative and doctrinal aspects of systems other than those used domestically. This paper111argues that Canadian policymakers could create a fair and equitable business reorganization system byusing the concepts in the Code and those developed under the CCAA and by attempting to resolveshortcomings of those systems identified by the courts and commentators.vTABLE OF CONTENTSABSTRACT iiTABLE OF CONTENTS ivGLOSSARY viiCHAPTER I INTRODUCTION 1A. CONCEPTUAL FRAMEWORKAM) ISSUES 1B. LITERATURE REVIEW 6C. METHODOLOGY 9D. “BUSII.1ESS REORGANIZATION” 14CHAPTER II LEGISLATIVE HISTORY 16A. BIA 16B. CCAA 21C. CODE 22CHAPTER ifi ELIGIBILITY TO REORGANIZE 29A. DEFINITIONAL DIFFERENCES 29B. TECHNICAL REQUIREMENTS UNDERTHE CCAA 36C. GOOD FAITH IN COMMENCINGREORGANIZATION PROCEEDINGS 391. The Concept ofGood Faith in a BusinessReorganization 402. Legislative History and Evolution ofthe Concept of Good Faith inReorganization Proceedings 423. Should Good Faith Be a Consideration? 51D. CONCLUSION 53VCHAPTER 1V CUSTODY OF THE ESTATE OF THE DEBTOR 55A. DEBTOR IN POSSESSION (DIP) 561. Legislative History and Conceptual Basis 562. Fiduciary Duty ofthe DIP 613. External Control ofthe DIP 634. Appointment of a Trustee or Examiner 66B. THE CANADIAN APPROACH 69C. FULFILMENT OF OBJECTIVES AND PROPOSALSFOR REFORM 72CHAPTER V CERTAIN ADMINISTRATiVE POWERS 76A. ADEQUATE PROTECTION DURINGTHE STAY OF PROCEEDINGS 771. Terminology 80(a) Secured Creditor 80(b) Adequate Protection 842. Nature ofthe Stay ofProceedings 953. Scope ofthe Stay ofProceedings 1034. Lifting the Stay / Dismissingthe Case 114(a) CCAA 116(b) Code 121(c) BIA 1275. Analysis ofthe BIA and Proposals for Reform 132B. REPUDIATION OR REJECTION OF REALPROPERTY LEASES 1401. Legislative History 140vi2. Repudiation / Rejection 1453. Rejection or Repudiation ofUnexpired Leasesto Facilitate Reorganization 152(a) The Necessity for the Existence of aLease 153(b) Ipso Facto or Bankruptcy Clauses 155(c) Time Limit for Electionto Reject or Repudiate 159(d) Performance of Obligations Duringthe Stay ofProceedings 162(e) The Landlords Claim or Compensationfor Breach 168(f) Standards for Rejection or Repudiation 1714. Considerations for Reform 173C. FINANCING THE PROCEEDING 1751. Use ofCash Collateral 1772. Obtaining Credit 1863. Conclusion 200CHAPTER VI MOVING TOWARD CONFIRMATION OF A PLANOF REORGANIZATION 201A. STEPS PRECEDING CONFIRMATION 202B. TIME WITHIN WHICH THE PLAN MUST BE FILED 210C. CLASSIFICATION AN]) VOTING ON THE PLAN 2231. Voting on the Plan and Required Majorities 2252. Classification of Claims and Interests 234D. CRAM DOWN 254CHAPTER VII CONCLUSION 270VuGLOSSARY77B: Act ofJune 7, 1934, ch. 424, 48 Stat. 911 at 912 (1934).1898 U.S. Act: Banknq,tcy Act of 1898, ch. 541, 30 Stat 544 (1898).1984 Amendments: Bankruptcy Amendments and Fedeivi Judgesh4’ Act of 1984, Pub. L. No. 98-353,98 Stat. 333 (1984).BIA: Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3, as am. by S.C. 1992, c. 27.Bkr-L Ed: J. Lee, Consultant, Bankruptcy Service Lawyers Edition (Deerfield: Clark BoardmanCallaghan, 1993).CCAA: Companies’ Creditors Arrangement Act, RS.C. 1985, c. C-36.Chandler Act: Chandler Act of 1938, ch. 575, 52 Stat. 840 (1938).Chapter 11: Code, ss. 1101-1174.Chapter X Chandler Act, ss. 101-276.Chapter XI: Chandler Act, ss. 301-399.Code: Bankruptcy Refonn Act of 1978, Pub. L. No. 95-598, 92 Stat. 2549 (codified as amended at 11U.S.C. ss. 101-1329 (1988)).Colter Committee Report: Advisory Committee on Bankruptcy and Insolvency, Repoil (Ottawa:Consumer and Corporate Affairs Canada, 1986) (Chair: G. Colter).former Canadian Act: Bankruptcy Act, RS.C. 1985, c. B-3, as am. up to but not including S.C. 1992,c. 27.House Report: House Repon’, HR No. 95-595, 95th Cong., 1st Sess (1977), reprinted in 1978U.S.C.C.A.N. (598 Stat.) 5963.Norton Bankruptcy Law & Practice: W.L. Norton, Jr., Non’on Bankruptcy Law and Prc4tice, 2d ed.(Deerfield: Clark Boardman Callaghan, 1994).Senate Report: Senate Repon’, S.R No. 95-989, 95th Cong., 2d Sess. (1978), reprinted in 1978U.S.C.C.A.N. (598 Stat.) 5787.Tassé Report: Study Committee on Bankruptcy and Insolvency Legislation, Repon’ (Ottawa:Inforniation Canada, 1970) (Chair: R Tassé).1CHAI7EERIN1RODUCHONA. CONCEPTUAL HAMEM)RKAND ISSUESTn 1947, in the seminal article on the CCAA, Stanley E. Edwards wrote the following, whenspeaking about the development of business reorganization law in Canath:Canadians are fortunately in a position to adopt the portions they choose from the solutions,both statutory and judicial, which have been worked out in the United States and Great Britain.The wisdom of the procedures and rules worked out there will be examined in the light ofCanadian conditions in an effort to devise the fairest and most feasible scheme possible forapplication of the C.C.A.A.1From the time of Edwards’ article to the early 1980s, there were few business reorganizations inCanada. There were two reasons for this. First, there was the notion that the CCAA was intended forlarge companies with complex capital structures.2 Few companies met these criteria. The secondreason was that the former Canadian Act did not allow the debtor to bind secured creditors to theproposal provisions or the ancillary provisions of the act that were enacted to facilitate proposals.Debtors started using the CCAA in the early 1980s and since then, it has become the “remedyof choice”3 of debtors seeking to reorganize their fmancial affairs. However, the structure of theCCAA requires the debtor to make numerous court applications to accomplish the objectives of theact. Thus, companies that use the CCAA must have the necessary fmancial backing to withstand thesignificant costs attendant on such a proceeding. The former Canadian Act continued to be of littleuse to debtors with significant secured debt.Bill C-22,4 which received Royal Assent on June 23, 1992, resulted in significant amendments1 S.E. Edwards, “Reorganizations Under the Companies’ Creditors Arrangement Act” (1947), 25Caii Bar Rev. 587 at 592.2 For a discussion of this issue, see chapter ffl(B), below.F.J.C. Newbould, Q.C. “The Companies’ Creditors Arrangement Act” (1992) 7 B.F.L.R 51.‘ Bill C-22, An Act to Amend the Bankmptcy Act and to Amend the Income Tccc Act inconsequence thereof, 3d Sess., 34th Parl., 1991 (assented to 23 June 1992).2to the former Canadian Act. The amendments changed the name of the former Canadian Act to theBankruptcy and Insvlvency Act5 and they were proclaimed in force on November 30, 1992.6 The BIAcompletely changed substantive and procedural aspects of the proposal provisions of the formerCanadian Act. The most significant change was to the rights and duties of secured creditors. Thedebtor now has the ability to stay proceedings of secured creditors and to bind a minority of securedcreditors should a majority accept the proposal. The BIA did not repeal the CCAA and, as a result,debtors in Canada presently have a choice of reorganization regimes under which to proceed.By its terms, the provisions and the operation of the BIA are to be reviewed by aparliamentary committee established for that purpose.7 Parliament has formed the committee and itspurpose is to:provide a forum to discuss and determine priorities for insolvency reform for the nextseveral years and to allow for the development of a consensus on policy recommendations invarious areas of concern.8The parliamentary committee has established a number of working groups. The object of eachworking group is to focus on a specific area of concern.9 Working Group #2 is to focus on, inter alia,commercial reorganization issues. The Superintendent of Bankruptcy views the provision requiring theS.C. 1992, c. 27, s. 2.6 P.C. 1992-2180, ST192-194, C. Gaz. 1992.11.4079. Certain administrative provisions wereproclaimed in force prior to that time [P.C. 1992-1665, SJJ92-135, C. Gaz. 1992.11.3300]. Thoseprovisions will not be addressed in this paper.S.C. 1992, c. 27, s. 92 provides:“After the expiration of three years after this section comes into force, this Act shall standreferred to such committee of the House of Commons, of the Senate or of both Houses ofParliament as may be designated or established for that purpose and the committee shall, assoon as practicable thereafter, undertake a comprehensive review of the provisions andoperation of this Act and shall, within one year after the review is undertaken or within suchfurther time as the House of Commons authorize, submit a report to Parliament thereon.”8 S.J. Kershman, “Working Groups of the Bankruptcy and Insolvency Committee” (1993) 13:3Insolv. Bulletin 342 at 343.9lbid3review by the parliamentary committee as continuing the momentum started by the enactment of theHe goes on to state:The opportunity presented by that review will only be meaningful if interested parties keep theprocess alive by making the Government aware of the need for ongoing reform. The[parliamentary committee] provides a unique forum through which to set the agenda forresearch and reform and to shape the future direction of the insolvency process.”This paper is intended to contribute to that discourse.During that review, the parliamentary committee must examine whether the amendments meetthe broader objectives of a business reorganization regime. This paper will show that the committeecannot undertake this task without taking advantage of the methodology suggested by Stanley E.Edwards, over four decades ago.In considering the CCAA, a number of courts and writers use American case law in theirarguments and discussion and they have alluded to the fact that the CCAA is evolving in a way thatprovides the parties to the proceeding with rights similar to those contained expressly in the Code.’2The few cases that have considered the BIA appear to be taking an approach similar to that takenunder the CCAA.The Colter Committee Report specifically rejected the wholesale adoption of the reorganizationprovisions contained in Chapter 11 and the administrative provisions contained in chapter 3 of theCode.13 Parliament appeared to have taken this advice, although there may be sufficient flexibility inthe BIA to allow some of the Code’s more desirable concepts to be used in a Canadian business10 G.F. Redling, “The First Year of the Bankruptcy and Insolvency Act: The Policy andRegulatory Perspective” (1993) 13:4 Insolv. Bulletin 381 at 391.‘ Ibid12 See e.g., Quintette Coal Ltd v. Nippon Steel Corp. (1990), 80 C.B.R. (N.S.) 98 (B.C.S.C.);Meridian Developments Inc. v. Toronto Dominion Bank (1984), 52 C.B.R. (N.S.) 109 (Alta. Q.B.);Re UnitedMaritime Mshennen Co-op. (1988), 69 C.B.R. (N.S.) 161 at 169 (N.B.C.A.); Re PerkinsHoldings (1991), 6 C.B.R. (3d) 299 at 301 (Ont. Gen. Div.); Edwards, supra note 1; L.J. Crozier,“Good Faith and the Companies’ Creditors Arrangement Act” (1989) 15 Can. Bus. L.J. 89.13 Colter Committee Report at 53-54.4reorganization. It is not clear wi’y the Colter Committee Report and Parliament were determined toreject all aspects of the American model. There are aspects of the American model that are less thandesirable, such as the time necessary to complete most proceedings under Chapter 11 and the fact thatfew debtors emerge from the proceedings as viable entities.’4 However, this should not havediscouraged Parliament from incorporating some of the Code’s more equitable provisions and thenotions developed by the American courts that balance the interests of debtors and their creditors.Parliament should not have rejected the American model without a thorough examination of the andthe practical effects flowing from it.This paper will illustrate the utility of conducting such an examination, to show that certainconcepts developed in the United States could more effectively deal with Canadian businessreorganizations. While it is acknowledged that Parliament incorporated certain mechanisms similar tothose used in the Code, considerable litigation will be necessary to resolve the uncertainties created bysuch piecemeal incorporation. This shortcoming could have been avoided in the original drafting ofthe BIA.A further concern is the suggestion’5that Parliament will repeal the CCAA sometimefollowing the presentation of the parliamentary committee report.’6 The CCAA is a flexiblereorganization tool that the courts have generally athpted to fit the circumstances of the particularcase. Should Parliament repeal the CCAA, without incorporating some of the principles developedunder it into the BIA, a debtor seeking relief must reestablish those principles to obtain equivalentrelief. This is not an efficient way of proceeding, given that the CCAA and the American statutoryand judicial solutions are at the disposal of the policymakers.‘ See generally, D.G. Baird “The Dark Side Of Chapter 11: A Comment on Professor Triantis’Article” (1992), 20 Can. Bus. L.J. 261.‘ S.L. Robinson Burns, “The New Bankruptcy and Insolvency Act: Commercial Reorganizations”in The New Bankriq,tcy and Insolvency Act (Toronto: Canadian Institute, 1992) at 42.16 Supra note 7.5With respect, the BIA is not a useful reorganization tool. A reason for this shortcoming is thatthe legislators failed to determine the “spirit and intent” of the legislation and, in particular, they failedto consider the broader objectives of the legislation or how the legislation would actually work inpractice.’7 A primary objective of a business reorganization statute is to provide the debtor with astructure within which to rehabilitate, while ensuring the equitable treatment of creditors. This paperwill examine whether the structure of the proposal provisions of the BIA serves to accomplish thatobjective or whether the American model or the model established under the CCAA is more conduciveto accomplishing that objective.In exploring these issues, this paper will pay special attention to the rights and duties ofsecured creditors. In the United States, the Code tends to restrict the rights of secured creditors in tofacilitate the object of achieving equity and fairness in the distribution of the assets comprising theestate and affording the debtor a fresh start.’8 However, in restricting those rights, the Code attemptsto preserve the relative positions of secured creditors by providing certain protective measures.The former Canadian Act placed few restrictions on the rights of secured creditors. The TasséReport suggested that, when Parliament passed the first Canadian bankruptcy statute, secured creditorsheld such a small proportion of the total debt that giving them special treatment was not justified.’9That report and the Colter Committee Report suggested that any bankruptcy reform should includeprovisions for at least monitoring and perhaps placing restrictions on the rights of secured creditors?°The BIA includes certain restrictions on the rights of secured creditors and places certain duties onthem. One of the purposes of this paper is to explore whether the amendments are conceptuallyeffective to alleviate the inefficiencies and inadequacies perceived by the Tassé Report and the Colter17 G.C. Thornton, Legislative Drq/ting, 2d ed. (London: Butterworth, 1979) at 106.18 F.R Kennedy, “Secured Creditors Under the Bankruptcy Reform Act” (1982) 15 Ind. L. Rev.477 at 482.19 Tassé Report at 56.20 Colter Committee Report at 56-58; Tassé Report at 96-98.6Committee Report.B. LITERATURE REVIEWMost of the articles and treatises written on business reorganizations have dealt with issuesarising out of domestic legislation, with very little attention being paid to the legislation or case law ofother jurisdictions. Several excellent articles have been written that describe and synthesize the caselaw decided under the CCAA21 and there are numerous American textbooks and services that describein detail the policies and procedures involved in a Chapter 11 proceeding.22 The reader may obtainbackground information from those works, as it is not the intent of this paper to describe theprocedures and case law, other than to assist in resolving the issues at hand.The BIA has received little scholarly attention to date. Most of the articles have been preparedfor continuing legal education panels that, for the most part, describe the amendments, with possibleramifications.23Three articles have taken a more general approach to the policy issues arising out of a businessreorganization system by looking to Canadian and American legislation and case law. ELward&24article is important and frequently-cited, as it sets forth the policy objectives of a business21 See e.g., J.D. Honsberger, Debt Restructuring (Aurora: Canada Law Book, 1994); Newbouldsupra note 3; A. Zimmerman and D. Knowles, “Developments and Trends in the Companies’Creditors Arrangement Act” in Insolvency Institute of Canada Second Annual Meeting and ConferenceMaterials, October 20-22, 1991 at 40; D.H Goldman, D.E. Baird, Q.C. and MA. Weinczok,“Arrangements Under the Companies’ Creditors Arrangement Act” (1990), 1 C.B.R. (3d) 135; FR.Foran and T.M Warner, “Reorganizing the Insolvent Oil and Gas Corporation” (1990) 28 Alta. L.R.132.22 See e.g. Norton Bankruptcy Law & Practice, vol. 4; MJ. Bienenstock, BankruptcyReorganization (New York: Practicing Law Institute, 1987).23 One exception is RA. Klotz, “Protection of Unpaid Suppliers Under the New Bankruptcy andInsolvency Act” (1993) 21 Can. Bus. L.J. 161, where the author undertakes an examination and acomparative analysis of the right of repossession under the BIA and refers to similar rights under theQuebec Civil Code, the American Uniform Commercial Code and the Code. This issue will not beexamined in this paper. See also Honsberger, supra note 21.24 Edwards, supra note 1.7reorganization system. While recognizing the “great potential importance” of the CCAA, Edwardsexpressed the limitation of his work by stating that the CCAA “has received little attention in eitherCanadian legal literature or the decisions of the courts.”25 He proposed a methodology for the study ofCanadian reorganization law by recommending that the student consider the reorganization laws ofother countries.26 Edwards abides by that advice and illustrates his points by reference to Americanand English cases. In reviewing his article, one must remember that he was considering a previousversion of the American reorganization regime and therefore, its present use for interpreting particularprovisions may be limited. However, the valuable insight that Edwards provided into the policy ofbusiness reorganization systems is as valid today as in 1947 and therefore, this paper will refer to hiswork, from time to time.An article by Professor George Triantis 27 examined the effectiveness of the draft BIA inquelling the desire of creditors in a reorganization proceeding to hold out for a greater proportion ofthe “going concern surplus.” Professor Triantis sees the objective of bankruptcy reorganization law asa solution to this “collective action problem” which results in the liquidation of a debtor that is worthmore as a going concern than the aggregate liquidation value of its assets. He discusses the stay ofproceedings and the voting and acceptance of proposals and concludes that neither mechanismaddresses the collective action problem. He proposes a simpler, albeit hypothetical, model thataddresses the problem and incorporates certain features of the Code, such as the cram down and theprepackaged plan. He does not conduct a comparative doctrinal analysis of these concepts but merelyuses them for illustrative purposes. Professor Triantis also points to certain difficulties arising out ofthe wholesale adoption of the extensively regulated system of Chapter 11.25 Ibid at 587.26 Supra note 1 and accompanying text.27 G.G. Triantis, “Mitigating the Collective Action Problem of Debt Enforcement ThroughBankruptcy Law: Bill C-22 and its Shadow” (1992), 20 Can. Bus. L.J. 242. This article, althoughpublished in 1992, was written in 1991, prior to the passage of the BIA.8Professor Douglas G. Baird questioned the wisdom of Professor Triantis’ suggestion thatCanada move along the reorganization spectrum toward a Chapter 11 model.28 Professor Baird’sarticle does not analyze the doctrinal or normative bases of the Canadian and American businessreorganization provisions. Rather, he provides a critique or, more accurately, a criticism of Chapter11. We must temper any suggestion of adopting certain features of another system with the concernsraised by those living under the system. Accordingly, this paper will refer to Professor Baird’s thesisthroughout the discussion that follows.This paper will expand upon the notion put forth by Triantis and Edwards that certain featuresof the Code be incorporated into the Canadian business reorganization regime. However, rather thanlooking at a business reorganization system as a rationale for the mitigation of the collective actionproblem, this paper will treat the distributional objective of balancing debtor and creditor rights, alongwith the objective of rehabilitation of the debtor, as the primary objectives of a business reorganizationsystem.29 These objectives provide the normative platform upon which to build a businessreorganization system. One may take the position that business reorganizations are desirable and thatthe rights of the debtor (and hence, the reorganization itself) should take precedence over the rights ofthe creditors. However, one can hardly make an argument that business reorganizations are desirablein every situation. Conversely, it is equally eoneous to suggest that business reorganizations shouldnot be a part of a commercial system, as certain businesses should have the opportunity to adapt to thechanging circumstances in the marketplace. To that extent, the system may modify the strict rights ofcreditors. A system that favours neither the debtor nor its creditors but attempts to balance theinterests of each is one that we should seek to attain. In attempting to strike such a balance, therespective positions of the parties that have the least to gain should not be sacrificed. Conversely,28 Baird, supra note 14. This article was prepared and published at the same time as theforegoing article by Professor Triantis.29 Professor Triantis considers bankruptcy law as attempting to achieve efficiency rather thanbalancing the rights of debtor and creditor, given that the parties consider the distributional impact ofbankruptcy rules long before the rules become operative.9those that may prosper from a successful reorganization should be made to incur the risks of thereorganization proceeding.3°C MKIIIODOLOGYThis work will use, in a very general way, the methodology suggested by Edwards, although itwill not stress the public policy objectives upon which Edwards based his work. Since his article, theCanadian and American systems have developed sufficiently to justify a doctrinal analysis of theconcepts that have evolved. This type of analysis will allow us to determine whether we have realizedthe “great potential importance” of the CCAA and business reorganization laws, foreshadowed byEdwards.31It would however, be naive to think that one could study a topic dealing with businessreorganizations, insolvent business debtors and potential loss of jobs, through a purely doctrinalanalysis, without some type of policy analysis. The normative values underlying a businessreorganization system will significantly affect the nature of this analysis. This will be an importantaspect of this discussion, as it appears that the Parliament of Canada left the development of abusiness reorganization system to the courts. With respect, the courts should not be required to bearthis burden. The legislation should have reflected the broad policies sought to be accomplished.Courts face only the very narrow issues that come before them and must resolve those issues withoutbeing required or permitted to establish broad, seemingly unrelated policies. Furthermore, the courtshave limited sources of information from which to draw, compared to the vast resources available tothe policymakers.32 Without clearly articulated policies, as reflected in the legislation, it may take° See D.G. Baird and T.H Jackson, “Corporate Reorganizations and the Treatment of DiverseOwnership Interests: A Comment on Adequate Protection of Secured Creditors in Bankruptcy” (1984)51 U. Chi. L. Rev. 97.31 Edwards, supra note 1 at 587.32 RA. Heineman, ed., The World of the Policy Analyst (Chatham: Chatham House, 1990) at141-169.10years to realize those policies or they may never be realized, should the precise issue not come beforethe courts.33The specific methodology to be undertaken will be one of comparative analysis of the proposalprovisions of the BIA, the reorganization and certain administrative provisions of the Code and theCCAA. This methodology raises several issues that must be dealt with before embarking on theexamination. Given the differences in the structures of the respective regimes it is difficult to overlayone system on another. Therefore, this paper will undertake functional comparisons of similarmechanisms to illustrate the necessity of conducting a comprehensive review of the Canadian system.A purely descriptive approach will be avoided, although some description will be necessary. Rather,an “applied comparative law”34 approach will be undertaken. Such an approach does not merelydescribe the laws being considered or their differences, but is a functional comparison of themechanisms and concepts used in each system.35 As part of this examination, a brief review of thelegislative histories of the statutes under consideration will be made. This may give us some insightas to the legal and social causes underlying the differences in the reorganization regimes.There are several reasons for employing this methodology, at this time. First, the provisionsof the Code have been operative for over fifteen years, which has resulted in a body of case law.This case law may assist us in determining whether the objectives of the American policymakers inenacting Chapter 11 have been realized in practice. Furthermore, this approach may point to positiveand negative aspects of the Code and may assist us in formulating proposals for reform that are lucidand accomplish the desired objectives.36 As well, because of the perception that the CanadianE.L. Rubin, “The Concept of Law and the New Public Law Scholarship” (1991) 89 MIch. L.Rev. 792 at 804-805.I{C. Gutteridge, Comparative Law (Cambridge: Cambridge University Press, 1946) at 9.Ibid36 It has been said of this type of methodology that:“To study the way other systems at comparable stages of development deal with problems that11reorganization regimes are evolving into a system similar to the American model,37 examining theAmerican model may assist us in interpreting and understanding the current Canadian systems.Finally, the United States continues to be the major trading partner of Canada and the level of tradewill undoubtedly continue or escalate under the Canada-U.S. Free Trade Agreement38 and the NorthAmerican Free Trade Agreement.39 If both countries reexamine their respective businessreorganization regimes with a view to harmonizing the provisions, the expectations of creditorsinvolved in cross-border insolvency proceedings may be more expeditiously and equitably realized.While each of the statutes that will be considered in this paper may be traced back to Englishstatutes and case law,4° this paper will make only passing reference to those laws. Alan Watsondescribed the importation of rules or systems of law from one country to another as a “legaltransplant”41 and developed an analogy to describe the level of acceptance of the transplant:A successful legal transplant - like that of a human organ - will grow in its new body, andbecome part of that body just as the rule or institution would have continued to develop in itsparent system. Subsequent development in the host system should not be confused withrejection.42An interesting question is why business reorganization law continued to develop in the United Statesour own system either does not handle very well or to which we have not yet worked outsatisfactory solutions, is often extremely enlightening. Comparatists do not ordinarily viewthis sort of study as preliminary to wholesale transplantation of a foreign institution, but ratheras a source of inspiration, and an indication of the problems, as well as the benefits, to beanticipated with using alternative models. [MA. Glendon, MW. Gordon and C. Osakwe,Comparative Legd Trcditions (St. Paul: West, 1985) at 14].Supra note 12.38 Ottawa: Department of External Affairs Canada, 1987.Ottawa: Minister of Supply and Services Canada, 1992.° See generally J.A. MacL.achlan, Law ofBankniptcy (St. Paul: West, 1956) at 20-21; L.W.Houlden and C.H Morawetz, Bankruptcy and Insolvency Law of Canixla, 3d ed. (Toronto: Carswell,1993) at 1OA-l.41 A. Watson, Legal Transplants (Charlottesville: University Press of Virginia, 1974).42 Ibid at 27.12whereas in Canada, neither the former Canadian Act nor the CCAA were used to any great extentprior to the early 1980s. Tn 1947, Edwards attributed the lack of Canadian reorganization law toCanada’s relatively immature economic development.43 This however, does not explain why, since thattime, business reorganizations in Canada continued to lie dormant while American reorganization lawwas flourishing. Certainly, it did not take Canada to the early 1980s to reach the economicdevelopment of the United States in the 1940s.A comparative analysis approach is also fraught with the danger of ethnocentricity or asuggestion that one law is a superior or exemplary regime. Hopefully, a paper which suggests thatnone of the systems is entirely satisfactory may not be accused of either.This brings us to perhaps the most vexing problem in undertaking a comparative analysisinvolving foreign legislation. In the first instance, one must familiarize oneself with the legislation.This requires not only a review of the legislation, but also a review of certain cases and commentariesinterpreting that legislation. It is dangerous to assume that the approaches taken by scholars and thejudiciary are completely objective and as such, there is some difficulty in exercising autonomy in theinterpretation of the legislation. In combatting this difficulty however, the reader must remember thatthe object of this paper is not to provide a critique of the American system, but to use Americanmaterials as a benchmark from which to determine whether the Canadian courts and legislators wouldbenefit from adopting a similar approach. In this manner, the commentaries on the Americanlegislation will be invaluable. This paper will also refer to the Senate Report and the House Report,where appropriate, in an attempt to determine the legislative intent of the Code. This not only willassist in interpreting the provision being considered, but also may be useful in giving us insight intothe social objectives that the legislation sought to accomplish. The aim in reviewing the American lawis not to determine whether the system is inherently good or bad, but whether aspects of it help toaccomplish the broader objectives of a business reorganization system.“There was little reorganization law in America when its economic development was at a stagecomparable to Canada’s present condition.” [Edwards, supra note 1 at 592).13This approach is not meant to suggest that a uniformity of business reorganization laws ispossible or advisable. To make such a suggestion, it would be necessary to examine broadernonbankruptcy matters such as regimes involving real and personal property security andmacroeconomic factors. This broader examination is beyond the scope of this paper.One final issue concerning the approach to be taken in conducting research on a topic thataffects a broad range of individuals and entities in the business conmiunity must be addressed. Asmentioned above, one purpose of insolvency legislation is to attempt to balance the interests of thevarious parties involved in the proceeding. An attempt has been made to attain scholarly objectivityin conducting the research. However, depending on the position of the reader, the results of theresearch may be seen as biased in favour of one or more parties. For example, in discussing theconcept of adequate protection under the Code, it has been said that:In resolving the conflict, many bankruptcy courts appear to give undue deference to thesecured creditor’s rights, leading them to impose standards of adequate protection that seriouslyimpede and often arrest the debtor’ reorganization.45On the other hand, some ‘witers see the concept of adequate protection as one which favours thedebtor such that “the balance is usually in favour of the debtor so as to effectuate the underlyingbankruptcy policy of rehabi1itation.”This merely illustrates the danger in assuming that the research will be seen as objective,despite the lofty aim of objectivity. In fact, the legislation itself may be value-laden as it may nottruly reflect the best interests of the business community as a wiole. The committee that prepared theTassé Report stated that it was not a committee of inquiry or investigation,47although it solicitedSupra note 29 and accompanying text.Comment, “Adequate Protection and the Automatic Stay Under the Bankruptcy Code: EasingRetraints on Debtor Reorganization” (1982) U. Pa. L. Rev. 423 at 426.D. Price, “Adequate Protection Under the Bankruptcy Act of 1978” (1982-83) 71 Ky. L.J. 727at 742.Tassé Report at xi.14information from registrars and official receivers and interviewed judges, registrars, official receivers,trustees, lawyers and law teachers. In addition, a number of parties, a partial list of which appeared asan appendix to the Tassé Report, made written submissions. Only one party specifically representeddebtors.48 One must question whether the Tassé Report fairly represented the position of debtor andaccordingly, whether the legislation that resulted serves the needs of society as a whole.C ‘BUSINESS REORGAMZATION”This paper is concerned with business reorganizations under Chapter 11, compromises andarrangements under the CCAA and proposals under division I of part ifi of the BIA.. The term“reorganization” or “business reorganization” will be used to designate these procedures. This paperspecifically avoids use of the term “corporate reorganization,” as the Code and the BIA also apply toindividuals and partherships that are carrying on business. Excluded from the term are consumerproposals or arrangements,49arrangements involving farmers and farm corporations,5°plans foradjustment of a municipality5’and raifroad reorganizations or schemes of arrangement.52Although one may define a business reorganization in terms of the objectives that it seeks toaccomplish, it may be more appropriate to defme it by its intiinsic nature. For the purposes of thispaper, “reorganization” or “business reorganization” means a judicially-supervised53settlement betweena debtor and its creditors and among the debtor’s creditors concerning the fmancial affairs of the48 It is acknowledged that submissions were made by organizations such as the Canadian BarAssociation and La Chambre de Commerce du District de Montréal, wiuich may have addressed theinterests of debtors but overwhelmingly, the written submissions were from interest groupsrepresenting creditors.Division II of part ifi of the BIA and chapter 13 of the Code.50 Fann Debt Review Act, RS.C. 1985, c. 25 (2d Supp.) and chapter 12 of the Code.51 Chapter 9 of the Code.52 Railway Act, R.S.C. 1985, c. R-3, ss. 99-103 and subchapter IV of chapter 11 of the Code.Honsberger, supra note 21 at 1-2 1.15debtor. The reorganization seeks to solve the problem of how to make a debtor in failingcircumstances economically sound, while at the same time preserving or modifying the legal rights ofits creditors and shareholders.MCollier on Bcinkniptcy, vol. 1, 14th ed. (New York: Matthew Bender, 1974) s. 0.01.16CHAPTER IILEGISIATWE HISTORYThis chapter will provide a brief legislative history of each system being considered in thispaper.’ Placing the provisions within a historical context may provide an indication of the interestssought to be protected at the time of their enactment. It may also assist a contemporary law reformerin determining whether those interests continue to require protection or alternatively, whether currentvalues require protection of different interests.A. BIAThe first bankruptcy legislation enacted by the Parliament of Canada2was the Insolvent Act ofThis chapter will deal with the legislative history of business reorganization legislationgenerally. Throughout this paper, reference will be made to the legislative history of the particularprovisions under consideration.2 Bankruptcy laws and specifically, business reorganization laws, are promulgated pursuant to therespective jurisdictions granted to the federal governments of the United States and Canada under theirconstitutions. Subsection 91(21) of Constitution Act, 1867, (U.K.), 30 & 31 Vict., c. 3 [hereinafterthe Canadian Constitution], delegates to the Parliament of Canada legislative authority over bankruptcyand insolvency. Similarly, the Constitution of the United States ofAmerica, 1 Stat. 10 (1845)[hereinafter the U.S. Constitution], grants Congress the power to establish “uniform Laws in thesubject of Bankruptcies throughout the United States” [art. I, s. 8, cl. 3].The courts have placed few limits on the extent of the bankruptcy power. The District Courtof Missouri stated:“I hold it extends to all cases where the law causes to be distributed the property of the debtoramong his creditors; this is its least limit. Its greatest is a discharge of the debtor from hiscontracts. And all intermediate legislation, affecting substance and form, but tending to furtherthe great end of the subject - distribution and discharge - are in the competency and discretionof congress.” [In re Klein, [1843] Fed. Cas. 716 at 718 (D. Mo.)].If there are inconsistent or conflicting federal and provincial or state laws, the federal laws willprevail or pre-empt the provincial or state law. This is based, in Canada, on the federal paramountcydoctrine [Tennant v. Union Bank, [1804] A.C. 31 (P.C.)] and, in the United States, on the “supremacyclause” in the U.S. Constitution, that provides:“This Constitution, and the Laws of the United States which shall be made in Pursuancethereof ... shall be the supreme Law of the Land; and the Judges in every State shall be boundthereby, any Thing in the Constitution or Laws of any State to the Contrary notwithstanding.”[art. VI, s. 2]171869. That act contained provisions allowing an insolvent debtor to make a composition4with itsThese doctrines are applicable when the federal law and the provincial or state law are valid andenacted within each government’s delegated or residual authority, but they yield inconsistent orconflicting results [P.W. Hogg, Constitutional Law of Canada, 3d ed. (Toronto: Carswell, 1992) at418]. A recent challenge to the commercial tenancy provisions in Part ifi of the BIA was undertakenin Re Janpar Inc. (1993), 20 C.B.R (3d) 8 (C.S. Qué.), where the court upheld those provisions on thebasis of the federal paramountcy doctrine.The Canadian and American courts have upheld the jurisdictions of the Parliament of Canadaand Congress to enact legislation providing for compositions, extensions and reorganizations undertheir respective bankruptcy powers. The constitutionality of a provision permitting the debtor to effecta compromise of its debts with its creditors was upheld on the basis that the bankruptcy power wasnothing less than “the subject of the relations between an insolvent or non-paying or fraudulent debtorand his creditors, extending to his and their relief.” [In re Reiman, 20 Fed. Cas. 490 at 496-497 (No.11, 673) (S.D.N.Y. 1874)]. The constitutional validity of the rehabilitative methods from compositionof unsecured claims to reorganization and adjustment of secured claims has also been upheld.The CCAA was upheld in a reference case to determine its constitutional validity. In ReCompanies’ Creditors Arrangement Act, [1934] S.C.R 659 [hereinafler CCAA Reference], Duff C.J.stated that:“The history of the law seems to show clearly enough that legislation in respect ofcompositions and arrangements is a natural and ordinary component of a system of bankruptcyand insolvency law.” [at 660]The Alberta Court of Queen’s Bench recently had occasion to consider the constitutionality ofthe CCAA in Norcen Energy Resources Ltd v. Oakwood Petroleums Ltd (1988) 72 C.B.R. (N.S.) 1(Alta. Q.B.). The court made certain comments that may foreclose any challenges to theconstitutionality of reorganization statutes generally. In discussing the CCAA Reference case, ForsythJ. said:“The C.C.A.A. is an Act designed to continue, rather than liquidate, companies. In upholdingthe C.C.A.A., the Supreme Court of Canada must be taken as having extended the meaning ofthe term “insolvency” to include dealing with insolvent companies outside of a liquidationsetting. The critical part of the decision is that federal legislation pertaining to assisting in thecontinuing operation of companies is constitutionally valid. In effect the Supreme Court ofCanada has given the term “insolvency” a broad meaning in the constitutional sense bybringing within that term an Act designed to promote the continuation of an insolventcompany.” [at 15-16].S.C. 1869, c. 16.Although the term business reorganizations, as used in this paper, includes compositions,extensions and schemes or plans of arrangement, early legislation referred only to compositions. Acomposition is an arrangement between the debtor and its creditors where the creditors agree with thedebtor and among themselves to take less than the full amount of their respective claims on a pro ratabasis in full satisfaction of the debts due or accruing due to them from the debtor [Blxk’s LawDictionaiy, 6th ed. (St. Paul: West, 1990) at 286]. It is important to note the difference betweencommon law compositions and compositions created by statute. In the case of a statutorycomposition, the statute allows the majority to bind the minority to the composition. For example,section 94 of the Insolvent Act of 1869, ibid, provided:18creditors.5 The Insolvent Act of 18756 repealed the Insolvent Act of 1869. The Insolvent Act of1875 contained provisions similar to those repealed.8 These acts applied only to insolvent traders.9Because of the number commercial failures resulting from the depression in Canada between 1874 and“A deed of composition and discharge, executed by the majority in number of those of thecreditors of an Insolvent who are respectively creditors for the sums of one hundred dollarsand upwards, and who represent at least three fourths in value of the liabilities of the Insolventsubject to be computed in ascertaining such proportion, shall have the same effect with regardto the remainder of his creditors, and be binding to the same extent upon him and upon them,as if they were also parties to it;”Conversely, in a common law composition, a non-assenting creditor need not be bound by theagreement of others.In the context of a business reorganization, an extension is an agreement between the debtorand its creditors where, in consideration of the creditors agreeing not to enforce their rights to collectthe debts owing by the debtor for a period of time after the debts are due, the debtor agrees to pay thedebts in full within that period [Tassé Report at 93].Finally, a scheme of arrangement, in strict terms, includes any arrangement where the propertyor income of a debtor is proportionately applied to its debts {R. Bird, Osboum’s Concise LawDictionary, 7th ed. (London: Sweet & Maxwell, 1983) at 297]. The assets of the debtor aretransferred or assigned to a trustee who administers the scheme [M Crystal and B. Nicholson,Baiikmptey and Deeds ofA irangement Law arid Prtice (London: Oyez, 1978) at 59; L. Duncan andJ.D. Honsberger, Bankntptcy in Canada, 3d ed. (Toronto: Canada Law Book, 1961) at 261]. Otherthan the distinguishing feature of the third party intermediary, it appears that a scheme of arrangementcould have the substantive features of an extension or composition.Although the definition of “proposal” in the BIA includes a proposal “for a composition, for anextension of time or for a scheme of arrangement” [BIA s. 2 “proposal”] and the CCAA allows thedebtor company to make a “compromise or an arrangement”[CCAA ss. 4 and 5] with its creditors,these terms are of historical significance only, as “in actual practice the court is not greatly concernedwhether the proposal falls into one of these. . . headings or is a combination of them” [L.W. Houldenand C.H Morawetz, Bankruptcy and Insolvency Law of Canada, 3d ed. (Toronto: Carswell, 1994) at2-74]. This paper has chosen to use the words “business reorganization” to denote one or all of thesetypes of arrangements. This term is broader than the three terms used in the BIA, as it encompassesthe potential of there being fundamental changes to both the debt and the equity structures of thedebtor, including the elimination of some interests. The current practice of the courts appears to treatproceedings under all of the legislative schemes being examined in this broad manner. However,when the terms composition, extension and scheme of arrangement are used in this chapter, they shallhave the strict, narrow meanings described above.Insolvent Act of 1869, supra note 3 ss. 94-108.6 S.C. 1875, c. 16.‘‘ Ibid ss. 149 and 151.8 Ibid ss. 49-66.Section 1 of both acts.191878, public discontent with legislation that permitted “dishonest and designing debtors” to escapetheir liabilities,10 led to the passage ofAn Act to repeal the Acts Respecting Insolvency now in forcein Canzki.’ A further reason for the repeal was the “constant irritation caused by ill-consideredlegislative tinkering with so important a piece of legislation.”2 Canada was without bankruptcylegislation until 1919, when the Bankruptcy Act’3 was passed. The 1919 Act enlarged the scope ofproposals that an insolvent debtor could make to its creditors to include, not only compositions, butalso extensions and schemes of arrangement.14 In 1923, Parliament passed The Bankruptcy ActAmenthnent Act, 1923.’ Section 15 of that act repealed section 13 of the 1919 Act and replaced itwith a provision allowing only a bankrupt to make a proposal. This amendment resulted fromallegations that debtors were avoiding bankruptcy by securing creditor consent to a proposal throughbribes and other fraudulent means.’6Parliament repealed the 1919 Act in 1949’ and replaced it with the 1949 Act.’8 It appears thatParliament intended to clarify bankruptcy legislation by the passage of the 1949 Act. When the billwas introduced to the Senate, the Honourable J. Gordon Fogo said “[t]he bill provides a more orderlyarrangement of subjects and the language in many sections of the Act has been simplified.”9 For our10 House of Commons Debates (19 February 1880) at 102.“ S.C. 1880, c. 1.12 Duncan and Honsberger, supra note 4 at 17.13 S.C. 1919, c. 36 [hereinafter the 1919 Act].14 1919 Act s. 13(1).15 S.C. 1923, c. 31.16 Tassé Report at 19.‘ Bankruptcy Act, 1949, S.C. 1949, c. 7 [hereinafter the 1949 Act], s. 173.18 Ibid‘ Debates of the Senate [6 October 1949] at 98.20purposes, the most notable change was the reinstatement of the provision allowing an insolvent personto make a proposal, without being bankrupt. The 1949 Act was criticized as inefficient, obsolete andincapable of dealing with fraudulent bankruptcies?° Thus, in 1966, Parliament made significantamendments to the 1949 Act by the Act to amend the Bankniptcy Act.2’ Among other things, theamendments gave the court the right to appoint an interim receiver22 and provided that the insolventperson would be considered bankmpt on the refusal of the creditors or the court to accept or approvethe proposal?In 1966, steps were also taken toward the process of amending Canada’s bankruptcy regime,with the formation of the Study Committee on Bankruptcy and Insolvency Legislation. The committeepresented the Tassé Report to the Minister of Consumer and Corporate Affairs in June of 1970 andrecommended the adoption of a new bankruptcy and insolvency statute.24 Since the presentation of theTassé Report, Parliament made no fewer than six attempts to repeal and replace the former CanadianAct prior to the passage of the amendments that resulted in the BIA.In 1984, following the sixth failure of Parliament to adopt a new bankruptcy statute, theMinister of Consumer and Corporate Affairs at that time, suggested that it may be more expedient toamend the former Canadian Act.25 The Minister struck the Committee on Bankruptcy and Insolvencythat presented the Colter Committee Report in 1986. The Tassé Report and the Colter CommitteeReport recommended the retention of a system allowing for the reorganization and rehabilitation of20 Colter Committee Report at 18.21 S.C. 1966-67, c. 32.22 Ibid s. 5.23 Ibid ss.7and824 Tassé Report at 81.Colter Committee Report at 18.22statements to induce them to accept the proposal being put forth.3’ As a result, Parliament enactedamendments to the CCAA in 195332 that required the debtor company to have issued bonds,debentures or other evidences of indebtedness under a trust deed or other instrument running in favourof a trustee?3 However, in recent years, the courts have allowed less than complex debtors to use theCCAA, by permitting them to gain access to its provisions by issuing “instant trust deeds.” Therefore,the the CCAA is not meeting the legislative intent, although court supervision of proceedings under itmay serve to quell any abuses of the legislation.34C CODEThe debtor’s right to make a composition with its creditors first appeared in the 1874amendments35to the Bankruptcy Act of 1867.36 A debtor could effect a composition without beingadjudicated a bankrupt.37 Tn 1878, Congress repealed the Bankruptcy Act of 186738 because of abuseson the part of the courts and excessive fees.39 The United States was without bankruptcy legislationfor twenty years until the passage of the 1898 U.S. Act.4° The composition provisions of the 1898‘ Ibid32 An Act to amend The Companies’ Creditoic Arrangement Act, 1933, S.C. 1952-53, c. 3.This provision is now CCAA s. 3(a). The types of debtors to whom the CCAA was intendedto have application were “companies that have complex financial structures, and a large number ofinvestor creditors.” [House of Commons Debates (23 January 1953) at 12691.“ For a discussion of this issue, see chapter ffl(B), below.Ch. 390, 18 Stat. 178 (1874).36 Ch. 176, 14 Stat. 517 (1867) (repealed 1878).Collier on Bankruptcy, vol. 1, 14th ed. (New York: Matthew Bender, 1974), s. 0.05.38 Ch. 160, 20 Stat. 99 (1878).Collier on Bankruptcy, supra note 37.4° The 1898 U.S. Act was repealed by Pub. L. 95-598, 92 Stat. 2549 (1978), s. 401(a).23U.S. Act were similar to those included in the amendments to the Bankruptcy Act of 1867. A debtorcould only make a composition with its unsecured creditors.4’ This limitation curtailed the use of thecomposition provisions. However, the 1898 U.S. Act did not require the debtor to be insolvent to beeligible to make a composition.42 Provided the composition met the necessary prerequisites, it couldbe confirmed by the court’ and the debtor would be discharged from its debts, following itscompliance with the provisions of the composition.Congress enacted minor amendments to the composition provisions of the 1898 U.S. Act inl910 and 1922.46 However, major amendments were not made until the onset of the depression thattook place in the 1930s. The depression resulted in a significant increase in the number ofbankruptcies.47 As a result, Congress saw a need to amend the provisions of the bankruptcy regime toprotect the integrity of the system and allow honest but unfortunate debtors easier access to the system41 Collier on Bankruptcy, supra note 37, vol. 6, s. 0.03.42 1898 U.S. Act s. 4 provided that “[amy person who owes debts. . . shall be entitled to thebenefits of this Act as a voluntary bankrupt”, cf First National Bank of Cincinnati v. Flershem, 290U.S. 504 (1934), where the court found that insolvency was neither present nor imminent and,although the court acknowledged that the plan was formulated to provide future benefit to thebusiness, it found that the course of action proposed by the debtor was in “deliberate disregard” of therights of the affected creditors [at 517]. The court went further however, and found that the purposesought to be effected by the debtor was “fraudulent in law.” [at 519].1898 U.S. Act ss. 12 and 13.1898 U.S. Act s. 14.‘ Cli. 412, 36 Stat. 838 (1910), which amended the time at which an offer of composition couldbe made.Ch. 22, 42 Stat. 354 (1922), which added the necessity of an indemnity for any losses sufferedas a result of the delay in adjudication resulting from the presentation of a composition.In his address to Congress in 1932, President Hoover outlined the following staggeringstatistics:“The number of cases in bankruptcy has steadily increased from 23,000 in the fiscal year 1921to 53,000 in 1928 and to 65,000 in 1931. The liabilities involved have increased from$171,000,000 in 1921 to $830,000,000 in 1929 and to $1,008,000,000 in 1931, and the lossesto creditors have increased from $144,000,000 in 1921 to $740,000,000 in 1928 and to$911,000,000 in 1931.” [reprinted in, Collier on Bankruptcy, supra note 48 at s. 0.06]24and more expeditious relief.48 Unfortunately, the time required to study the existing system and makerecommendations necessitated the passage of “emergency” legislation in the mid-1930s.The legislation that preceded the enactment of the emergency legislation, permitted onlycompositions. It did not permit a comprehensive reorganization of the debt and capital structures ofthe debtor to facilitate its ongoing operation.49 Among other things, the emergency legislationattempted to accomplish this. For our purposes, the addition of section 7713 was the most significantamendment effected by the emergency legislation, as it was the first comprehensive code for thereorganization of corporate debtors.Section 7Th laid the groundwork for the reorganization provisions that evolved into Chapter11. It provided that on acceptance of a plan by special majorities of creditors and stockholders, the48 IbidW.J. Blum and S.A. Kaplan, Corporate Re4ustments and Reoigazizations (Mineola:Foundation Press, 1976) at 185. Prior to the enactment of section 7713, corporate reorganizations wereaccomplished through a device known as the equity receivership. An equity receivership wascommenced by a creditor whose execution had been returned unsatisfied. The creditor would seek thecourt’s assistance in having a receiver appointed to take control of and, ostensibly, sell the debtor’sassets to satisfy the creditors. However, once a receiver was appointed, the debtor and the creditorscould formulate a plan that would see the debtor’s assets sold and the rights and obligations of theparties adjusted with a view to having the former business of the debtor continue, as reorganized [for afull discussion of equity receiverships, see Collier on Bankruptcy, supra note 37, vol. 6, s. 0.04].Although equity receivership was an adequate device for reorganization, it possessed manyinadequacies that section 7Th attempted to rectify. The inadequacies were summed up by the UnitedStates Supreme Court, where Goldberg J. said:“Before passage, in 1934, of s. 7Th of the Bankruptcy Act, 48 Stat. 912, bankruptcyprocedures offered no facilities for corporate rehabilitation, which, therefore, was left to equityreceiverships, with their attendant paraphernalia of creditors’ and security holders’ committees,and of rival plans of reorganization. Lack ofjudicial control of the conditions attendingformulation of the plans, inadequate protection of widely scattered security holders, frequentadoption of plans which favoured management at the expense of other interests and whichafforded the corporation only temporary respite from fmancial collapse, so often characteristicof equity receivership reorganizations, led to the enactment of s. 7Th. ... As does thepresent Chapter X, s. 7Th perniitted the adjustment of all interests in the debtor, securedcreditors, unsecured creditors, and stockholders.” [Securities and Exchange Commission v.American Trailer Rentals Co., 379 U.S. 594 at 603-604 (1965) [hereinafter American TrailerRentals]].25plan would be binding on the dissenting minority.50 It also provided for the classification of claims,5’the stay of proceedings,52the continuation of the debtor in possession in the absence of theappointment of a trustee53 and allowed the court to make an independent detennination concerning thefairness of the plan.54However, section 7Th lacked provisions for the protection of creditors and investors andsupervision of the business of the debtor during the reorganization procedure.55 Accordingly, Congresspassed the Chandler Act in 1938. Section 7Th essentially became Chapter X which governedcorporate reorganizations. The theory underlying Chapter X was that the actual parties in interest,being the creditors and the stockholders, would control the reorganization process.56 It also providedfor the mandatory appointment of an independent trustee to monitor the affairs of a large debtor duringthe reorganization57and a more comprehensive means of control by the courts during thereorganization process.58 One of Chapter Xs strengths was in permitting the debtor to reorganize andcompromise the interests of unsecured and secured creditors, and stockholders. However, the° 77B(e).51 77B(c)(6).52 7Th(c)(10)77B(c)(1).77B(f)(1).Senate Repon’ No. 1916 on House Report 8046, 75th Cong., 3d Sess. (1938) 21-22.56 J.I. Weinstein, The Bankniptcy Law of 1938 (New York: National Association of Credit Men1938) at 192.Chandler Act s. 156 provided:“Where the liquidated and non-contingent indebtedness of a debtor is $250,000 or over, thejudge shall, upon the approval of the petition, appoint one or more disinterested trustees, whoshall be qualified, except as to residence and location of office, as prescribed in section 45 ofthe Act. Where such indebtedness is less than $250,000, the judge may appoint one or moretrustees or may continue the debtor in possession.”58 American Trailer Rentals, supra note 49 at 604.26provisions were intended for large publicly-held corporations that needed readjustment of secureddebt.59The Chandler Act also created a new procedure under Chapter XI, known as an “arrangement.”Chapter XE was designed for use by individuals and corporations other than those to whom theprovisions of Chapter X applied.60 As Chapter XI permitted a debtor to reorganize its affairs onlywith its unsecured creditors,61 it suffered the same weakness as the former Canadian Act. The plancould not affect secured creditors.62 One commentator explained the rationale for excluding securedcreditors from the provisions of Chapter XE as follows:The policy of dealing with secured debts was unsound; it was soon recognized that theinterference with the free exercise by secured creditors of their remedies was bound ultimatelyto impair the liberal extension of credit upon collateral. Besides, its provisions wereineffective; in the majority of cases ... the secured indebtedness wss a single debt held by asingle person and in an amount sufficient to constitute a substantial, if not the major, part ofthe indebtedness. Such a secured creditor held and frequently exercised a virtual veto powerover the proceeding.63Collier on Bankruptcy, supra note 37 at s. 0.09. Tn this manner, the focus of Chapter X wasthe same as the intended focus of the CCAA. Under Chapter X, public investors were protected bythe intervention of the Securities and Exchange Commission. See e.g., Chandler Act s. 172 whichprovided:“After hearing and before approval of any plan, the judge may, in cases in which thescheduled indebtedness does not exceed $3,000,000 and shall, in cases in which the scheduledindebtedness exceeds $3,000,000, refer to the Securities and Exchange Commission forexamination and report the plan or plans deemed by him worthy of consideration. Such reportshall be advisory only.”60 Chandler Act s. 147, provided:“A petition improperly filed under this chapter, because adequate relief can be obtained by thedebtor under chapter XE, may upon the debtor’s application, be amended to comply with therequirements for a petition under chapter XE, and thereupon shall be regarded as if originallyfiled thereunder.”See also Chandler Act ss. 146(2) and 141 which together, provided that a court may dismiss a petitionthat is filed under Chapter X if adequate relief would be obtainable by the debtor under Chapter XE.61 Weinstein, supra note 56 at 259.62 Ibid63 Ibid at 260.27The provisions of Chapter Xl were much less stringent than those of Chapter X given theinterests to be served by Chapter X Despite the intent of Congress, it appeared that a corporation hada choice of regimes under which it could attempt to effect a reorganization. The United StatesSupreme Court held that the consideration controlling the choice of regime was not the character ofthe debtor, the nature of its capital structure or its size, but the nature of the interests and the needs tobe served in the rehabilitation of the debtor.M Although generally, Chapter X was intended foradjustment of publicly-held debt,65 the courts allowed larger, publicly-held corporations to use ChapterXL However, on application of the Securities and Exchange Commission, the court had thediscretion to dismiss a Chapter XI proceeding, unless the debtor complied with the more stringentrequirements of a Chapter X proceeding.67 Despite these procedures, fewer that 10 percent of allreorganizations were commenced under Chapter X Debtors used the the less rigorous provisions ofChapter XI more frequently.68The House Report69 referred extensively to the shortcomings of having two reorganizationchapters and summarized its position as follows:In sum, any justification that existed in 1938 for two reorganization chapters has disappeared.Chapter X has become an unworkable procedure, and chapter XE is inadequate to fill the void.Chapter X needs to be made more flexible, both in terms of procedure and fmancial standards64 General Stores Corp. v. Shlenky, 350 U.S. 462 (1956).65 American Trailer Rentals, supra note 49 at 613.See e.g, In re Transvision, Inc., 217 F.2d 243 (2d Cir. 1954), cen’. denied, 348 U.S. 952(1955).67 11 U.S.C. 728 (1970). See e.g, In m Lea Fabrics, Inc., 272 F.2d 769 (3d Cir. 1959), where, indescribing the scope of the discretion to be exercised by the courts in such a case, Goodrich J. said:“That discretion, it is to be observed, is not one limited greatly by settled legal niles. ... Butthe criterion by which the district judge’s discretion is to be exercised has to do with the bestarrangement for all parties concerned under the circumstances confronting the particularcorporation.” [at 771].House Report at 222.69 Ibid28for confirmation. Chapter XI needs to be expanded to pemiit adjustment of secured debt andequity, and needs to have added certain public protections not now found in chapter XI. Asthese changes are integrated into the two chapters, the differences between them begin todisappear, and a consolidated business reorganization chapter begins to appear. [The Code]adopts a consolidated chapter for all business reorganizations.7°Thus, Congress adopted the consolidated version of the reorganization chapters as Chapter 11.Ibid at 223 [citations omitted].29CHAPTER ifiE[IGIBILHY TO REORGANIZEAt first blush, the eligibility of an entity to take advantage of a statute allowing it toreorganize its fmancial affairs may seem like a simple matter. However, the Code, because of itspermissive eligibility description, has been creatively used in a way that may seem unusual toCanadian insolvency practitioners. The CCAA and the BIA use more restrictive descriptions.This chapter will examine the definitional requirements of the legislative schemes with a viewto determining whether those requirements encourage or restrict certain entities from using thereorganization opportunities offered by the legislation. Should the conclusion resulting from suchexamination be that only certain types of entities can take advantage of the opportunity to reorganize,one is confronted with the issue of whether that result meets with the broader objectives of thelegislation.Any enactment that gives one party an advantage over other parties may be subject to abuse.Thus, because the Code and the CCAA give a debtor extensive rights on the commencement of areorganization proceeding, such as the stay of proceedings,’ the courts consider whether the debtormust act in good faith in commencing the proceeding. This chapter will examine whether good faithshould be considered by the courts and whether the concept supports the objectives of a reorganizationproceeding.A. DEFINiTIONALDIFFERENCFSSubsection 109(a) of the Code allows a person2 that resides, is domiciled or has a place ofbusiness or property in the United States to be a debtor under the Code. Section 109 then providesSee discussion in chapter V(A), below.2 Code s. 101(4 1) defmes “person” as including an individual, a partnership and a corporation.The defmition excludes governmental units, under certain circumstances.30that all persons, other than stock and commodity brokers and certain donstic and foreign insurancecompanies and banking institutions may be debtors under Chapter 11. The exclusions exist because,in the case of stock and commodity brokers, Congress viewed customer accounts, which are theessence of such entities, as unprotected in a Chapter 11 proceeding.4 Separate state and federal laws,that contain detailed provisions concerning the insolvency and liquidation of insurance companies andbanking institutions, comprehensively supervise and regulate those entities.5The CCAA pemiits a “debtor company” to propose a compromise or arrangement with itscreditors. A company, under the CCAA, includes any federally or provincially incorporated companyor any incorporated company having assets or doing business in Canada, wherever incorporated.6 Itexcludes certain companies such as banking institutions, railway companies and insurance companies,as applicable federal or provincial law governs their insolvency and liquidation.7 A debtor company isone that is or is deemed to be insolvent, has committed an act of bankruptcy under the BIA or isbankrupt.8 Section 3 sets forth the further precondition that there be outstanding bonds issued by thedebtor under a trust deed or other instrument running in favour of a trustee.9Subsection 50(1) of the BIA allows a proposal to be made by, inter alia, a bankrupt or aninsolvent person. “Insolvent person” is, in turn, defmed as a person1°who resides or canies onCode ss. 109(b) and (d).House Report at 319.House Report at 318; Senate Report at 31.6 CCAA s. 2 “company”.7lbid.8 CCAA s. 2 “debtor company”.Use by the debtor company of an “instant trust deed” to permit its use of the CCAA has beenthe subject matter of a number of cases and commentaries. This issue will be examined in chapterffl(B), below.‘° BIA s. 2 defmes a “person” as including a corporation, partnership or unincorporatedassociation.31business in Canada,1’whose liabilities amount to one thousand dollars and who has ceased paying oris unable to meet its obligations as they become due or whose assets would not be sufficient to pay allobligations that are due and accruing)2The most striking difference between the Canadian and American reorganization regimes is theabsence of a requirement in the Code that the debtor be insolvent or bankrupt at the time the voluntaryproceeding is commenced.’3 The Code, therefore, permits seemingly solvent debtors to take advantageof the protective aspects of the Code. Before the enactment of the Code, either the courts or thelegislation required the petitioning creditor or debtor to show that the debtor was insolvent at the timeof the commencement of the case. The 1898 U.S. Act did not require the debtor to be insolvent, onlythat it owed debts)4 However, the United States Supreme Court held that it would be “fraudulent” fora debtor to attempt to take advantage of provisions permitting reorganization if the debtor was solvent‘ All of the statutory schemes being considered permit an entity that carries on business in therespective country to seek the relief being offered by the legislation. The CCAA and Code furtherprovide that an entity that merely has assets in that country may use the provisions of the statute. Thisbroad jurisdictional base has caused difficulties in multinational insolvencies. These difficulties willnot be considered in this paper but the reader is referred to various treatises and commentaries thatconsider this issue such as the Tassé Report at 60-62; J.D. Honsberger, Debt Restructuring (Aurora:Canada Law Book, 1994); and the many articles written over a period of approximately five decadesby Professor Kurt Nadehnann, commencing with “The Recognition of American ArrangementsAbroad” (1941-42) U. Pa. L. Rev. 780 and “Compositions - Reorganizations and Arrangements - in theConflict of Laws” (1948) 61 Harv. L. Rev. 804.12 BIA s. 2 “insolvent person”.‘ A voluntary case is commenced under section 301 of the Code by the debtor filing a petitionwith the bankruptcy court. An involuntary case is commenced under section 303 of the Code by therequisite number of creditors as provided in subsection 303(b). Tn order to grant the relief requested inthe involuntary petition, the court must be satisfied either that the debtor is generally not paying itsdebts as they become due or that a trustee, receiver or agent was appointed to take possession of all orsubstantially all of the property of the debtor for the purpose of enforcing a lien against such property,within 120 days before the filing of the petition. Similarly, a creditor may make the initial applicationunder the CCAA for an order that a meeting of creditors be summoned. The BIA however, does notpermit a creditor to commence the proposal proceedings, other than indirectly through a bankruptcytrustee, liquidator or receiver.14 1898 U.S. Act s. 4, provided that “any person who owes debts. . . shall be entitled to thebenefits of this Act as a voluntary bankrupt.”32or where insolvency was not imminent or certain.15 Section 77B, which was added to the 1898 U.s.Act in 1934, required that the debtor set forth in its petition “facts showing the need for relief underthis section; and that the corporation is insolvent or unable to meet its debts as they mature and that itdesires to effect a plan of reorganization.”6 Insolvency was also a requirement under Chapter X andChapter )j17The legislative history of the Code does not suggest the reason for removal of the insolvencyrequirement, in the case of a voluntaiy petition. One whter suggested that Congress may have felt thata solvent debtor that was facing fmancial distress could lose the opportunity to reorganize if it waitedtoo long to commence proceedings.18Also, the removal of the insolvency requirement alleviates apreliminary objection requiring a hearing to determine the financial condition of the debtor. Unlessthe debtor is clearly insolvent, a hearing to determine the debtor’s fmancial condition could be alengthy and costly procedure, as it would require the debtor and the objecting party to retain thirdparties to provide valuations of the debtor’s assets and opinions concerning its solvency. Should thedebtor be in a tenuous fmancial condition, the fmancial and other resources expended on such a15 Plist National Bank of Cincinnati v. Plendiem, 290 U.S. 504 (1934) [hereinafter Plerchem] at517, 519.16 77B(a); see In re Piccdilly Realty Co., 78 F.2d 257 (7th Cir. 1935), where the court held that,as a result of the definition of “claim” in section 77B which excluded the claims of stockholders, thedebtor was solvent, as the only significant liabilities were those owing to stockholders on account ofdividends and amounts owing upon maturity of the stock. Accordingly, the court held that the debtorwas not permitted to use section 77B; cf In re Kelly-Springfield Tire Co., 10 F. Supp. 414 (D. Md.1935), where the court allowed a solvent debtor to use the provisions of section 77B to help the debtorremain viable and avoid eventual fmancial demise. In so doing, the court felt that “it is very, veryclear that in applying the substance or intention of this Act we do not have to wait until a corporationis absolutely insolvent.” [at 417].17 Chandler Act ss. 106(3) and 306(3), respectively. See e.g, Tucker v. Texas AmericanSyndicate, 170 F.2d 939 (5th Cir. 1948), where the court held that the petition was not filed in goodfaith as the debtor, although “cash poor” was “asset rich” and made no effort to borrow money toymaturing obligations. In other words, the debtor was not insolvent and accordingly, it could not usethe provisions of Chapter X See also In ir Southwest Enteiprises, Inc., 261 F.Supp. 721 (W.D. Ark.1966).18 MS. Bever, “Manville Corporation and the ‘Good Faith’ Standard for Reorganization Under theBankruptcy Code” (1983) 14 U. Toledo L. Rev. 1467 at 1495-1497.33procedure could be better allocated to maintaining operations.To temper the possibility of abuse resulting from the removal of the insolvency requirement,Congress provided the courts with the ability to scrutinize a Chapter 11 proceeding to determinewhether to permit it to continue. Paragraph 305(a)(1) of the Code allows the court to dismiss orsuspend the reorganization proceeding if the interests of the debtor and the creditors would be betterserved by a dismissal or suspension. The court also has the ability to permit a party to commence orcontinue any action that it has against the debtor or debtor’s the property by granting relief from theautomatic stay.’9 Finally, under subsection 1112(b) of the Code, a case may be dismissed or convertedfrom a reorganization case to a liquidation case, whichever is in the best interests of the creditors andthe estate.In the case of relief from the automatic stay and conversion or dismissal, the court may grantsuch relief “for cause.” Although the Code does not list the debtor’s insolvency or good faith2° as aprerequisite to commencing proceedings under Chapter 11, several courts have concluded that the“causes listed in those sections are not exhaustive and that other causes, such as lack of good faith orthe fmancial condition of the debtor could be examined.”2’A case that raised the concern over the use by solvent entities of the reorganization provisionsof the Code and that established the right of such entities to use the protective measures contained inthe Code was the case involving Johns-Manville Corporation.22 When it filed its voluntary petition‘ Code s. 362(d); see discussion chapter V(A)(4)(b), below.20 The issue of whether good faith is a prerequisite to commencing and maintaining areorganization proceeding will be discussed in chapter ffl(C), below.21 See e.g., In re Pappas, 17 B.R. 662 at 666 (Bankr. D. Mass. 1982); In re Victoiy ConstructionCo., 9 B.R 549 (Bankr. C.D. Cal. 1981) [hereinafter Victoiy], modified, 9 B.R. 570, vccated as moot,37 B.R 222 (9th Cir. 1984), where the court held that “the debtor’s lack of ‘good faith’ in filing a caseunder Chapter 11 is ‘cause’, independent of the existence or lack of adequate protection. . .“ [at 560122 Johns-Manville Corporation is hereinafter referred to as Manville. See, In re Johns-ManvilleCoiporation, 36 B.R. 743 (Bankr. S.D.N.Y. 1984); In re Johns-Manville Coiporation, 36 B.R 727(Bankr. S.D.N.Y. 1984), cppeal denied 42 B.R. 651 (S.D.N.Y. 1984), reh’g denied 41 B.R 654(S.D.N.Y. 1984).34under Chapter 11, Manville’s net worth exceeded $1.1 billion and its total sales for the immediatelypreceding year were more than $2 billion.23 Although there were many reasons for its filing, Manvillefiled primarily to control and quantify existing and anticipated toxic tort liability claims of victimssuffering from asbestos-related diseases. Although solvent at the time of the filing, Manville submittedthat the time and expense of litigation and the quantum of the awards would, in the opinion ofcompany officials, leave Manville with no alternative but to liquidate or otherwise dispose of its assetsand dismember its business.24 Commentators have criticized and defended the Manville filing.25However, it must remembered that the court upheld the filing. The Bankruptcy Court specifically heldthat insolvency was not a precondition to filing a voluntary petition under Chapter 11 •26 Moreover, thecourt upheld the policy “that a fmancially beleaguered debtor with real debt and real creditors shouldnot be required to wait until the economic situation is beyond repair in order to file a reorganizationpetition. “27We must contrast the Code’s eligibility requirements with the Canadian eligibilityrequirements. Given the restrictive descriptions in the Canadian reorganization statutes, it is unlikely23 L.A. Flyer, “Will Financially Sound Corporate Debtors Succeed in Using Chapter 11 of theBankruptcy Act as a Shield Against Massive Tort Liability?” (1983) 56 Temple L.Q. 539 at 541-542(f. 11).24 JJ,jd (f. 13).25 See e.g., Flyer, ibid at 566-567, where the author said “. . . courts should conclude that afinancially healthy corporation which has filed for reorganization for the purpose of escaping tortliability has not filed in good faith. . . . To allow a stable corporate debtor to cloak itself in theprotective provisions of chapter 11 would render the chapter a sham.”; M Kunlder, “The ManvilleCorporation Bankruptcy: An Abuse of Judicial Process?” (1983/84) 11 Pepperdine L. Rev. 151, wherethe author argues that the filing by Manville was an abuse of the federal bankruptcy law; cf S.Friedman, “Manville: Good Faith Reorganization or ‘Insulated’ Bankruptcy” (1983/84) 12 Hofstra L.Rev. 121, where the author argues that because of the future prospect of fmancial distress and theattempt by Manville to account and provide for the victims whose health problems had yet to manifestthemselves, the filing was indeed within the contemplation of the Code and accords with the spirit andintent of Chapter 11.26 In re Johns-Manville Coiporation, 36 B.R. 727 at 732 (Bankr. S.D.N.Y. 1984).27 Ibid at 736.35that a solvent debtor could seek the protection of reorganization. Both statutes require the debtor to beinsolvent or bankrupt and it would appear the debtor must be insolvent at the time it commences theproceeding. However, a debtor may be able to devise its eligibility to commence proceedings underthe CCAA or the BIA. For example, a debtor company under the CCAA is one that, inter alia, “hascommitted an act of bankruptcy within the meaning of the Bankruptcy and Insolvency Act”.28 One actof bankruptcy under paragraph 42(l)(h) of the BIA is the debtor giving notice to any of its creditorsthat it is about to suspend payment of its debts. Under the BIA, a debtor could fall within thedefinition of “insolvent person” by merely ceasing to pay its current obligations in the ordinary courseof business as they generally become due.29 The BIA says nothing concerning the inability of thedebtor to make such payments, only that the payments have ceased. Whether devising its eligibility topropose a compromise or arrangement under the CCAA or to file a proposal or a notice of intention tofile a proposal under the BIA breaches any good faith requirement3°does not derogate from the factthat, on a strict reading of the statutes, the debtor is qualified to use the provisions.Although one may attempt to argue that the possibility of massive tort liability in Canada isremote, given the size of awards made by Canadian courts or the fact that Canadian industry is simplynot as large as that carried on in the United States, the possibility of such liability exists in Canada.Furthermore, debtors are using the CCAA for purposes that were likely not contemplated by thepolicymakers, such as the downsizing of operations by disdaining leases of unprofitable locations.3’In appropriate circumstances, other strategic advantages could be gained by using the CCAA, such28 CCAA s. 2 “debtor company”(b).29 BIA s. 2 “insolvent person”(b).° See discussion infra notes 71-89 and accompanying text.31 E.g., the case involving Silcorp Ltd. involved a substantial downsizing wiiere the courtpennitted the debtor to repudiate a substantial number of leases of unprofitable premises. The issueconcerning repudiation of real property leases is discussed in chapter V(B), below.36disclaiming other onerous types of contracts.32Is an insolvency requirement necessary or desirable in a business reorganization regime? Theprobability or even possibility33 of financial demise is within the contemplation of the objectives of abusiness reorganization system. Thus, if an entity is facing financial distress, it should be able to takeadvantage of a reorganization regime, whether or not it is insolvent. However, removal of arequirement of insolvency could present an opportunity for abuse of the system. If removed, thecourts should be given the power to scrutinize all of the circumstances of the case to detenninewhether the proceeding meets objectives of the legislation. It is arguable that despite the solvency ofManville, its filing fell within the intent and spirit of a business reorganization system. Had it notfiled, the claims of existing victims could have taken precedence over those victims whose damageshad yet to manifest themselves, in the sense that the claims of existing victims may have resulted inManville’s liquidation and dismemberment. By allowing the filing to stand, all of the victims, bothexisting and future, would be treated equally. However, a debtor that is merely attempting to gainsome strategic advantage over its creditors or is seeking the protection of a reorganization statute forsome purpose that does not further the objectives of the legislation should not be able to takeadvantage of its provisions. In such a case, the legislation should be sufficiently flexible to allow forthe dismissal of the case. The Code provides that flexibility. The Canadian statutes have yet to betested in this regard.B. TEQINICAL REQUIREMFNIS IJNDER ThE CCAAThe CCAA is unique among the reorganization statutes being considered, as it sets forth a32 For example, in the United States, Chapter 11 has been used by debtors to extricate themselvesfrom obligations under collective bargaining agreements. See e.g., In te Continental Airlines Coip., 38B.R 67 (Bankr. S.D. Tex. 1984).It was held in In re US.A. Motel Corp., 450 F.2d 499 (9th Cir. 1971), relying on Flerthem,supra note 15, that the debtor’s inability to pay its liabilities had to be more than a mere possibility;such inability had to be proved imminent and certain.37precondition to its application. When Parliament first enacted the CCAA, any company incorporatedby or under any federal or provincial act or any company having assets or doing business in Canadacould use it.35 The 1953 amendment6 attempted to limit the use of the CCAA to widely-heldcompanies with complex fmancial structures. When the amendment was introduced in the House ofCommons for second reading on January 23, 1953, the Honourable Stuart S. Garson, provided theHouse with a brief rationale for the amendment.With the passage of this bill it will leave companies that have complex fmancial structures,and a large number of investor creditors, able to use the Companies’ Creditors ArrangementAct for the purpose of reorganization. Moreover, they will be able to use it efficiently;because as a nile, the terms of their o trust deed provide for a trustee of the creditors whosebusiness it will be to look after their interests properly, a provision which is ahnost invariablyabsent in the case of the mercantile creditors. The mercantile companies will be able to usethe provision of part ifi of the new revised Bankruptcy Act, which, unlike the Bankruptcy Actin force in 1933, has a provision whereby companies may apply for an extension to work outtheir affairs without incurring the stigma of bankruptcy.37Companies made little use of the CCAA during the first four decades of its existence. One maysurmise that the trust deed requirement had the intended effect of limiting its use to certain types ofcompanies.The 1980s saw a significant increase in the use of the CCAA, although the trust deedrequirement did not limit its use to entities with complex fmancial structures or many investorcreditors. Debtors met the precondition by issuing bonds or debentures under trust deeds createdimmediately before the commencement of the proceeding. The courts allow debtors to use these“instant trust deeds” to meet the condition imposed by section 3. Tn Re UnitedMaritime FishennenRe Ccmiian Bed& Biakfact Reg. Ltd (1986), 65 C.B.R. (N.S.) 115 at 116 (B.C.S.C.).S.C. 1933, c. 36, s. 2(b). The defmition of “company” excluded banks, raily or telegraphcompanies, insurance companies, trust companies and loan companies.An Act to amend the Companies’ Creditoi Airangement Act, 1933, S.c. 1952-53, c. 3, s. 2[now CCAA s. 3].House of Commons Debca’es (23 January 1953) at 1269.38Co-op,38 the New Brunswick Court of Queen’s Bench specifically held that:the words “bona fide” do not appear in section 3 of the Act and that the Court, uponhearing such an application, had no obligation and indeed no rights to raise the issue anddetermine the validity of the trust deeds.39With respect, one must question the court’s rationale in this case. The New Brunswick Court ofQueen’s Bench, as a court of equity,4°has the jurisdiction to question the bonafides of any matterbefore it, whether or not the statute specifically allows for that examination. Despite this criticism, thecourts have permitted debtors to seek relief under the CCAA following the issuance of an instant trustdeed.4’Thus, section 3 merely constitutes a procedural hurdle. Although other reasons exist that maydissuade a debtor from seeking the protection afforded by the CCAA, section 3 does not impose aserious impediment. The effect of this impediment is lessened by the doctrine of reasonable demandand section 244 of the BIA that requires a secured creditor to give the debtor notice of the creditor’s38 (1988), 67 C.B.R. (N.S.) 22 (N.B.Q.B.), rev’d on other grounds 67 C.B.R. (KS.) 161(N.B.C.A.) [hereinafter UnitedMaritime Rshennen].Thid at 54 (N.B.Q.B.).° Judicature Act, RS.N.B. 1973, c. J-2, s. 26.41 See e.g. Elan Corporation v. Cominskey (Trustee of) (1991), 1 C.B.R. (3d) 101, per DohertyJ.A. (dissenting in part); Hongkong Bank of Cancth v. ChefRec4’ Foods Ltd (1991), 4 C.B.R. (3d)307 (B.C.S.C.), affd (1991), 4 C.B.R. (3d) 311 (B.C.C.A.), where the British Columbia Court ofAppeal affirmed an order of the British Columbia Supreme Court allowing an application of the debtorfor a stay of proceedings under the CCAA notwithstanding the creation of an instant trust deed. TheCourt of Appeal specifically recognized that the debtor created the trust deed “so as to qualify” underthe CCAA [at 313]. Cf Re Nonnc Hauling Ltd (1991), 6 C.B.R. (3d) 16 (Sask. Q.B.), where thecourt refused to follow the courts of the other jurisdictions in sanctioning the use of instant trust deeds.In so doing, Wimmer J. stated:“It is the duty of the court to give effect to legislation, not to emasculate it. The plainlanguage of s. 3 offers no other conclusion than that it was enacted to exclude certaincompanies from the benefits of the Act. No company is excluded if all that is required is an“entrance fee” in the form of a trust deed created not to raise capital but simply to gain accessto a legal remedy not otherwise available. I cannot think that the legislation was intended tobe interpreted in a way that permits this. In my opinion, s. 3 contemplated the existence ofsecurities characterized by genuineness in the sense that they were issued to raise capital orsecure existing indebtedness and not, as here, to achieve an oblique purpose. To holdotherwise would fail to give effect to the spirit and intent of the legislation.” [at 19]39intention to enforce its security. These time periods provide a debtor with ample opportunity to createa trust deed and issue bonds or debentures thereunder. Any reform should remove the requirement ofthe trust deed. The requirement was originally intended to protect investor creditors by having atrustee monitor the debtor’s affairs. A more comprehensive reorganization regime that requiresextensive reporting by a debtor in possession or the appointment of a trustee or interim receiver withbroad investigative powers could provide this protection. Another alternative may be to create a two-tiered reorganization system; one that deals with more complex entities, the other to deal with the lesscomplex ones. Although this was attempted under the Chandler Act with Chapter X and Chapter XI,it may be workable in a manner similar to that being done in Canada with the BIA and the CCAA.Like the Code, the flexibility of the CCAA spawns litigation to deal with substantive andprocedural matters. This flexibility and the costs attendant on such a proceeding results in the CCAAbeing used by the larger, more complex entities, in any event.C GOOD FAiTHN COMMENCING REORGANIZATION PROCEEDINGSNone of the statutory schemes expressly requires the debtor to be acting in good faith, whencommencing a reorganization proceeding. However, the good faith issue arises in a number ofsituations under the Code and at least one Canadian commentator has suggested that good faith shouldconsidered by the courts under the CCAA and the BIA.42This section will examine the concept of good faith in a business reorganization proceeding. Itwill then, briefly examine the history of the concept under the American enactments and analyzewhether a debtor should be acting in good faith in commencing a reorganization proceeding.42 J.D. Honsberger, “The Companies’ Creditors Arrangement Act: How to Use It and Not Use Itand a Critical Comparison with Part ifi of the Bankruptcy Act, Chapter 11 of the U.S. BankruptcyCode and Administration Proceedings in England” in Canadian Insolvency Association 1991 NationalSemincc (Toronto: Canadian Insolvency Association, 1991) Tab 2 at 23.401. The Concept of Good Faith in a Business Reoiganizafion PoceedingBlack’s Law Dictionary43 defmes “good faith” as follows:Good faith is an intangible and abstract quality with no technical meaning or statutorydefmition, and it encompasses, among other things, an honest belief, the absence of malice andthe absence of design to defraud or seek unconscionable advantage, and an individual’spersonal good faith is concept of his own mind and inner spirit and, therefore, may notconclusively be determined by his protestations alone.Honesty of intention and freedom from knowledge of circumstances which ought to put theholder upon inquiry. An honest intention to abstain from taldng an unconscientious advantageof another, even through technicalities of law, together with absence of all information, notice,or benefit or belief of facts which render transaction unconscientious. In common usage thisterm is ordinarily used to describe that state of mind denoting honesty of purpose, freedomfrom intention to defraud, and, generally speaking, means being faithful to one’s duty orobligation.A Canadian law dictionary45adds a further element to the definition of good faith that isrelevant to the issue at hand. It states that good faith implies an “absence of ulterior motive.” Thiselement is crucial to any determination of good faith of the debtor in commencing reorganizationproceedings and requires an examination of the objectives or purposes of a business reorganizationregime against the actual, subjective motives of the debtor. In other words, for the debtor to have anulterior motive, the proper objectives must be manifest. As good faith is a “state of mind,” a debtormust be aware of the policies which it is attempting to circumvent, to find that it is lacking good faith.As none of the statutes censures the commencement of a reorganization proceeding based on theabsence of good faith, a debtor may examine the statute and conclude that it falls within itsjurisdictional ambit. To fmd that the debtor lacks good faith, one must go the extra step and fmd that,although the debtor falls within the jurisdictional ambit of the legislation, it is using that legislation for‘ Blcrk’s Law Dictionary, 6th ed. (St. Paul: West 1990) [citations omitted] [hereinafter Black’s].‘‘ Ibid at 693. Black’s goes on to provide a specific defmition of good faith in the context of areorganization proceeding of an individual. However, the defmition refers to a provision of the Codethat expressly requires good faith as part of the confirmation process and accordingly, it is inapplicableto the issue at hand.J.A. Yogis, Q.C., Cancdian Law Dictionary (New York: Barron’s, 1990).41“inappropriate purposes.”The analysis must focus on the debtor’s honesty, as the concept speaks of honest intention.47 Itmust not be based on some objective criteria that would suggest whether there is a reasonablepossibility of reorganization The circumstances may point to factors that would allow the court toglean the subjective intention of the debtor despite its “protestations,” but these factors must notderogate from the primary thrust of the examination, which is to determine the debtor’s motives.48A primary purpose of a business reorganization statute is to allow the debtor to reorganize itsfinancial affairs to facilitate its rehabilitation, while treating creditors in an evenhanded, fair andequitable manner. If there is no realistic hope of reorganization and the debtor commences theproceeding merely to delay, defeat or defraud creditors, then there is an absence of good faith.49However, one must question whether such an analysis truly examines the state of mind of the debtoror whether it is an objective examination of the circumstances of the case to arrive at a conclusion asto the prospects of reorganization or the future viability of the debtor. The timing of such anD.L. GaIThey, “Bankruptcy Petitions Filed in Bad Faith: What Actions Can Creditor’s CounselTake?” (1979-80) 12 U.C.C.L.J. 205 at 210.Black’s, supra note 43.48 But see discussion concerning the good faith standard under Chapter X infra notes 54-59 andaccompanying text.‘ Eg., much has been witten on the single-asset cases in the United States, where a debtortransfers a single asset, in which it holds no equity, to an entity that has no other assets, liabilities,employees or active business. This entity subsequently files a Chapter 11 petition. The intent ineffecting the transfer is to shield the debtor’s active and profitable operations and to delay anyforeclosure proceedings through the use of Chapter 11, in the hopes that the property will appreciate invalue. It is submitted that a petition filed for this purpose is one that lacks good faith. See e.g., In rePhoenix Piccdilly, Ltd, 849 F.2d 1393 (11th Cir. 1988) [hereinafter Phoenix Piccdilly]; In re LittleCreek Development Coip., 779 F.2d 1068 (5th Cir. 1986) [hereinafter Little Creek], in which the courtcharacterized this type of arrangement as the “new debtor syndrome” and observed that it “exemplifies,although it does not uniquely categorize bad faith cases.” [at 1073]; In re Nancant, Inc., 8 B.R. 1005(Bankr. D. Mass. 1981), where the court similarly granted a motion to dismiss the petition However,the court refused to hold that all new debtor cases would necessarily be dismissed on the grounds ofbad faith. [at 1008]; cf In re Becrh Club, 22 B.R. 597 (Bankr. N.D. Cal. 1982), where the court foundno bad faith in the filing of the petition on the grounds that there was a legitimate business purpose inthe debtor effecting a transfer of the assets to the “new debtor” and the creditors were adequatelyprotected notwithstanding the transfer.42examination is crucial. If the court conducts the examination very early in the proceedings under theCCAA or Code, there may not be sufficient evidence before the court concerning the future prospectsof the debtor, such as the possibility of securing additional debt fmancing or equity capital. Under theBIA, the policakers have made provision for the filing of a projected cash-flow statement within 10days after the filing of a notice of intention to make a proposal.5° This is presumably intended to givethe creditors some idea of the debtor’s bonajides in filing the notice of intention. However, one mustremember that the debtor prepares the projected cash-flow statement and, although a trustee reviewsthe statement for its reasonableness, the trustee’s report is based on assumptions and informationprovided by management of the debtor and contains language sufficient to exonerate the trustee fromany liability other than errors resulting from gross negligence or fraud.51It may be difficult to argue that the courts should sanction the commencement ofreorganization proceedings when there is an absence of good faith by the debtor. However, a plainreading of the statutes does not mandate this type of examination.We now turn to the issue of whether the policymakers deliberately excluded an expressmandate to make a determination of good faith from the Code and whether the courts have thestatutory or inherent authority to examine this issue at the outset of a reorganization proceeding.2. Legislative Ilistoiy and Evolution of the Concept of Good Faith in Reoiganizafion PmceedingsThe 1898 U.S. Act required good faith as a condition of the court approving a compositionfollowing acceptance by the creditors.52 However, it did not make good faith a prerequisite to the50 BIA s. 50.4(2).‘ See BIA Form 42.2.52 1898 U.S. Act s. 12(d) provided:“The judge shall confirm a composition if satisfied that. . . [the composition has been offered]and its acceptance are in good faith and have not been made or procured. . . by any means,promises or acts herein forbidden.”43commencement’ of a composition proceeding. Tn 1933, Congress enacted section 7Th wiuich madegood faith a prerequisite to the commencement of the proceeding. Subsection 77B(a) provided:Upon the filing of such petition or answer the judge shall enter an order either approving it asproperly filed under this section if satisfied that such petition or answer complies with thissection and has beenflied in goodfaith, or dismissing.53The Chandler Act repealed section 7Th and created Chapter X and Chapter XE to governbusiness reorganizations. Only a petition filed under Chapter X had to be filed in good faith.Chapter X provided the following nonexclusive defmition of “good faith”:146. Without limiting the generality of the meaning of ‘good faith,’ a petition shall bedeemed not to be filed in good faith if -(1) the petitioning creditors have acquired their claims for the purpose of filing thepetition; or(2) adequate relief would be obtainable by a debtor’s petition under chapter Xl ofthe Act; or(3) it is unreasonable to expect that a plan can be effected; or(4) it appears that in a prior proceeding pending in any court, the interests ofcreditors and stockholders would be best subserved thereby.”For our purposes, subsections 146(3) and (4) are of interest. Subsection 146(4) allowed the court todismiss the petition in a two-party dispute between the debtor and one of its creditors. As bankruptcyonly deals with problems involving the collective interests of all or substantially all of the debtor’screditors, subsection 146(4) would protect the debtor from a petition filed by one of its creditors55 foran improper purpose,56 such as collection proceedings of the creditor.57 It also protected the creditorsCh. 204, 47 Stat 1467 at 1474 (1933) [emphasis added].Chandler Act s. 144 provided:“Upon the filing of a debtor’s petition, the judge shall enter an approval order if satisfied thatthe petition complies with the requirements of this chapter and has beenflied in goodfaith;otherwise, he shall dismiss it.” [emphasis added]Chandler Act ss. 106(8) and (9) allowed a petition to be filed against a debtor by a creditor ortrustee under a trust deed, indenture or mortgage.56 See e.g., In re South Cocch Co., 8 F. Supp. 43 (D. Del. 1934).A petition under the BIA may similarly be dismissed if it is filed for some improper purpose,such as an attempt by the creditor to use the bankruptcy system as a collection mechanism. See e.g.Re Wells (1944), 25 C.B.R. 291 (Ont. S.C.).44and stockholders from a debtor that was merely attempting to obtain some strategic advantage byseeking protection through bankruptcy legislation when state court proceedings were pending.58Subsection 146(3) of the Chandler Act provided that a petition was deemed not to be filed ingood faith if it was “unreasonable to expect that a plan can be effected.” This appeared to address thesituation of a petition being filed when there was little objective hope that a plan could be effected.As mentioned previously,59a court, in attempting to determine whether the petitioner commenced theproceeding in good faith, must inquire into the petitioner’s state of mind. By using the word “expect”in subsection 146(3) of the Chandler Act Congress was seeking to deal with the state of mind of thepetitioner. However, by requiring the court to determine whether the expectation was “unreasonable,”the court had to examine objective criteria that would lead to conclusions concerning, not the state ofmind of the petitioner, but the state of mind of a reasonable petitioner. Although this type of inquiryderogates from the “pure” concept of good faith that deals with subjective intention, Congress mayhave been attempting to address the unreasonable expectations and optimism of entrepreneurs infinancial difficulty.Unlike Chapter X Chapter Xl had no good faith filing requirement. It has been argued,however, that the courts implied a requirement of good faith for the filing of a petition under ChapterX1.6° Victoiy went further, however, and held that, as the good faith filing requirement was impliedinto Chapter XI, despite an absence of an express requirement, so too should it be implied into theCode.6’ Professor Flaccus has recently argued that this conclusion is ong on the basis that the cases58 In re Willicimsport Wire Rope Co., 10 F.Supp. 481 (D. Pa. 1935); In re Phelps Manor RedlyCo., 73 F.2d 1010 (3d Cir. 1934).See Chapter ffl(C)(1), above.60 See e.g., Victoiy, supra note 21 at 557, where the court observed “[a]s we have seen, ChapterXI, X[I and XIII contained no ‘good faith’ filing requirement. This’gap’ was filled by the courts!!”; L.Ponoroff and F.S. Knippenberg, “The Implied Good Faith Filing Requirement: Sentinel of an EvolvingBankruptcy Policy” (1991) 85 Nw. U.L. Rev. 919 at 922-923 (ii. 10); RM Cohn, “Good Faith and theSingle-Asset Debtor” (1988) 62 Am. Bankr. L.J. 131 at 132.61 Victoiy, ibid at 557.45upon which Victoiy relied to support the conclusion, were based on faulty reasoning.62 She concludesthat all of the cases cited by Victoiy were considering statutory provisions that made good faith anexpress filing requirement, such as Chapter X, an express requirement for confirmation of the plan, orother factors listed in section 146. Accordingly, she concludes that a good faith filing requirementshould not have been implied as part of Chapter XI in the cases preceding Victoiy. It followstherefore, that if the decision in Victoty was incorrectly grounded, its conclusion is likely not strongauthority. That is, it may be improper to imply a good faith filing requirement into Chapter Xl or theCode.The legislative history also refutes any argument that there is a good faith filing requirementunder the Code. The Report of the Commission on the Bankruptcy Laws of the United States63recommended the elimination of the good faith filing requirement.TM The footnote explaining thisrecommendation stated:The proposed Act ... allows any party in interest to move the court for an order ofdismissal or conversion to liquidation if it is unreasonable to expect that a plan can beeffectuated, rather than requiring the court to determine whether good faith exists at an oftenpremature stage and without adequate evidence.65In adopting this recommendation, Congress intended to delete a finding of good faith as a preconditionto the filing of a petition. It also enacted paragraph 11 12(a)(1) which allows a court to convert aChapter 11 case to a liquidation or dismiss the Chapter 11 case for cause, including, “continuing lossto or diminution of the estate and absence of a reasonable likelihood of rehabilitation” [emphasisadded]. The “state of mind” element has been deleted. That is, the paragraph speaks of the absence62 J.A. Flaccus, “Have Eight Circuits Shorted? Good Faith and Chapter 11 Banlcruptcy Petitions”(1993) 67 Ani Bankr. L.J. 401 at 412-413.63 House Doc. No. 93-137, Part I, 93d Cong., 1st Sess., reprinted in A.N. Resnick and E.MWypyski, eds., Bankntptcy Refonn Act of 1978: A Legislative Histoiy, vol. 2, doe. 21 (Buffalo:William S. Hem, 1979).64 Ibid at 183.65 Ibid at 222-223.46of a reasonable “likelihood” of rehabilitation rather than a reasonable “expectation.” It is submittedthat the courts, in analyzing this element, must look at all of the circumstances to determine,objectively, whether rehabilitation is likely, rather than attempt to glean the state of mind of thepetitioner. In other words, it appears that the Congressional intent was not to have the courtsdetermine the good or bad faith of the petitioner in filing the case. The courts are to make anobjective determination of the likelihood of a successful reorganization, quite apart from the motivesof the petitioner. Accordingly, good faith of the petitioner is not necessary in the filing of a petitionunder Chapter 11. The important issue for the courts to consider is not whether the petitioner wasacting in good faith, but whether the objectives of the legislation may be achieved through areorganization. Even if the petitioner had ulterior motives in filing the Chapter 11 case, areorganization may be the most appropriate means of treating creditors equitably.Although the list of “causes” that would result in conversion or dismissal is not exhaustiveand the court possesses equitable powers to carry out the provisions of the Code,67 the court should notbe permitted to base its reasoning on a ground that was specifically removed by Congress in enactingthe legislation Such an approach subverts the legislative grant and allows the court to go beyond itsjurisdiction, which is to decide whether a reorganization proceeding may be beneficial for allconcerned, whatever the state of mind of the debtor.Good faith, as a requirement for filing a petition under Chapter 11, has also been impliedunder paragraph 362(dXl), which allows the court to grant relief from the automatic stay ofHouse Report at 406, where it was said that the court “vill be able to consider other factors asthey arise, and to use its equitable powers to reach an appropriate result in individual cases.” See alsoIn r I-JBA East, Inc., 87 B.R 248 at 258-259 (Bankr. E.D.N.Y. 1988); In r G-2 Realty Trust, 6 B.R.549 (D. Mass. 1980), where the court dismissed an involuntary petition of three “ffiendly” creditors onthe basis that the debtor lacked good faith in changing its structure to make it eligible for Chapter 11relief.. A lack of good faith in filing the petition on the part of the debtor has been held to be anequitable ground which would justify dismissal of the case [Phoenix Piccdilly, supra note 49].67 Code s. 105(a). See In re Hartford Run Apartments ofBuford, Ltd, 102 BR. 130 at 132(Bankr. S.D. Oh. 1989).68 Flaccus, supra note 62 at 416.47proceedings, “for cause, including the lack of adequate protection of an interest in property “69The courts have granted creditors relief from the automatic stay of proceedings when it appears thatthe debtor lacks good faith in filing the petition. Paragraph 362(dXl) does not allow for the dismissalof the case but it provides an effective means of enforcement of the concept of good faith,7°especiallyin the case of a creditor holding security on all or a substantial portion of the assets of the debtor.Unlike the United States, which has a rich history underlying the current statutory provisions,Canada has little to draw upon with respect to the absence of the concept of good faith in thelegislative schemes being considered. As mentioned previously, the New Brunswick Court of Queen’sBench refused to read an element of good faith into the provisions of the CCAA based on a plainreading of the act.71 The court found, however, that the debtor was not acting in bad faith in creatingthe instant trust deeds.Although the New Brunswick Court of Queen’s Bench rejected the argument that the debtormust be acting in good faith in commencing proceedings under the CCAA. Canadian courts have sinceimplied a concept that appears to approach a notion of good faith. The approach taken by the courtsin this regard is similar to the approach taken by some courts in the United States when consideringwhether a Chapter 11 case should be converted to a liquidation or dismissed on the basis that there is69 See e.g, Victoiy, supra note 21 at 560; cf In re Beach Club, supra note 49, where the courtfound that the creditors were adequately protected. See also In re Lotus Investments, Inc., 16 B.R 592(Bankr. S.D. Fla. 1981) where the court said:“While s. 362(d)(1) does not specifically incorporate s. 1112(b), it is reasonable to concludethat a creditor should be granted relief from the stay if the case is one which the court shoulddismiss if a motion to dismiss under s. 1112(b) were presented.” [at 595]Although this logic makes practical sense, the coiut, with respect, assumes that good faith is anelement of s. 1112(b) that justified conversion or dismissal. Neither section expressly so provides.For a full discussion of section 362 of the Code, see chapter V(A), below.70 E. Di Donato, “Good Faith Reorganization Petitions: The Back Door Lets the Stranger In”(1983) 16 Conn. L. Rev. 1 at 7.71 UnitedMaritime shennen, supra notes 38 and 39 at 54 (N.B.Q.B.).48an absence of a reasonable likelthood of rehabilitation under paragraph 11 12(b)(1) of the CodeYUnder the CCAA, a challenge to the debtor’s ability to successfully rehabilitate itself isgenerally taken as a challenge to the stay of proceedings. If a creditor that holds security on all orsubstantially all of the property of the debtor succeeds in its challenge, the proceeding will beeffectively dismissed, as the debtor will no longer have assets with which to attempt to reorganize.Tht Treaswy Fincincid Inc. v. Congo Petroleums Inc74 illustrates the approach. In that case, a securedcreditor of the debtor brought an application for the appointment of a receiver and manager pursuantto its debenture. Secured creditors holding approximately 60 percent of the amount owing to allsecured creditors and an unsecured creditor whose claim constituted “well over half of the unsecuredclaims” of the debtor supported the application.75 The debtor brought a cross-application for reliefunder the CCAA.The court allowed the application of the secured creditor and dismissed the application of thedebtor on several bases, including the fact that “any plan Cango could put forward would dmostcertainly be turned down by both the secured and the unsecured creditors.”76 The court did not discussthe motives of the debtor in seeking relief under the provisions of the CCAA in terms of its good or72 Paragraph 11 12(b)(l) of the Code requires an additional element to be proved when a courtdismisses or converts a case under that provision, viz., the “continuing loss to or diminution of theestate.” Despite this additional requirement, some courts have considered the likelthood of asuccessful reorganization as a separate element and have dismissed or converted the case on that basisalone. See e.g., In ie Canion, 129 B.R 465 (Bankr. S.D. Tex. 1989); In re Mogul, 17 BR. 680(Bankr. MD. Fla. 1982); In re Dutch Flat Investment Co., 6 BR. 470 (Bankr. N.D. Cal. 1980); In rePappas, supra note 21 where the court applied both arms of the test. The diminution of the estatewould result from the fact that the debtor had no equity in its assets and the debts would continue toincrease as a result of accruing interest and taxes.This issue will be fully discussed in Chapter V(A)(4)(a), below.‘ (1991), 3 C.B.R.. (3d) 232 (Ont. Gen. Div.) [hereinafter Congo].Ibid at 238. In order to succeed, a compromise or arrangement must be accepted by a majorityin number, representing three-fourths in value of the creditors, or class of creditors, voting at themeeting directed by the court. [CCAA s. 6].76 Ibid at 240 [emphasis added].49bad faith. However, one might infer from the reasons for the decision that the court may have beeninfluenced by certain factors that pointed to the lack of bonafides of the debtor or its principals. Thecourt observed that:(a) the debtor had “deliberately qualified itself’ to seek relief under the CCAA by issuingan “instant debenture” so as to bring itself within the requirements of section 3 of the CCAA;77(b) the family that controlled the debtor had “enhanced its o position vis-a-vis [theunsecured creditors] by taking security to the extent of $5 million.., from the company tothat value”;78(c) the objective of any plan would not be to continue the business of the debtor but tosell it off in whole or in part and that a merchant banker retained by the debtor to assist thedebtor with its fmancial difficulties “was concerned with the agenda” of the family thatcontrolled the debtor;79 and(d) “. . . Cango is simply asking the Court to stay the hands of creditors in the hope that,in whatever period of grace is granted, something more will happen than has occurred duringthe past 9 months, and that something will permit the company to be salvaged.”80We must contrast the approach taken in Congo with the approach taken by the same court inRe Perkins Holdings.8’ In that case, the court recognized that proceedings under the CCAA should bediscontinued if the situation is “totally hopeless,” since the plan would have no hope of succeedinggiven the creditors’ strong opposition to it. However, the court allowed the debtor’s application underthe CCAA on the basis, inter alia, that the debtor “recognized its fmancial problems and retainedoutside help in an attempt to resolve theni”83 Again, the court did not allude to the motives of thedebtor in seeking relief under the CCAA. However, the basis on which the court allowed theIbid at 235, 236.78 Ibid at 238.‘ Ibid at 240.80 Ibid at 238.81 (1991), 6 C.B.R. (3d) 299 (Ont. Gen. Div.) [hereinafter Perkins].82 Ibid at 303.83 Ibid at 306.50application certainly points to the “state of mind” of the debtor.Reported cases considering the BIA have not addressed the issue of good faith in commencingproposal proceedings. However, one commentator suggested that good faith may be an issue to beconsidered under subsection 50.4(11) in a motion by a trustee, interim receiver or a creditor for thetermination of the period during which the debtor may file a proposal.8 This does not directly addressthe issue of whether the debtor must be acting in good faith in commencing proposal proceedings, asthe issue is not considered at the outset of the case. It is considered as part of an application that isheard once the court has accepted jurisdiction of the matter.An absence of a requirement or specific exclusion of good faith may prove to be beneficial forCanadian practitioners seeking to challenge the commencement of reorganization proceedings by adebtor on that ground. Unlike the Code, where it is at least arguable that good faith should not be anelement to be considered as a filing requirement, given its specific exclusion, in Canada, the courtshave the right to consider the concept under their equitable jurisdiction.85 Under the BIA, the courtslisted in section 183 “are invested with such jurisdiction at law and in equity as will enable them toexercise original, auxiliary and ancillary jurisdiction in bankruptcy and in other proceedings authorizedby this Act” [emphasis added]. The CCAA provides certain courts with jurisdiction to hearapplications and make orders thereunder.86 The various courts listed in the CCAA, by their enablingprovincial statutes, are invested with legal and equitable jurisdiction within their respective tenitorialjurisdictions. Accordingly, the various courts hearing applications under either the BIA or the CCAA‘ K Han,, “Corporate Restructuring Under Part ifi of the Bankruptcy and Insolvency Act” inCoiporate Restructuring (Toronto: Canadian Institute, 1992) Tab ifi at 32. See chapter VI(B), below,for a general discussion on the time within which a plan proponent must file a plan.85 Honsberger, supra note 42 at 23.86 CCAA s. 2 “court”.87 See e.g., Judicature Act, R.S.A. 1980, c. J-l, s. 5(l)(a); Supreme Court Act, R.S.B.C. 1979, c.397, s. 3, Law and Equity Act, R.S.B.C. 1979, c. 224, s. 4.51may apply the doctrine of good faith, apart the holding in UnitedMaritime Fishennen.88 This isillustrated by the following quotation from a leading text on equity:These three maxims may be viewed as together illustrating that great distinctive and governingprinciple of equity, that nothing can call forth a court of equity into activity but conscience,good faith, and personal diligence.89Having established that the courts in Canada may have the jurisdiction to consider the “state ofmind” of the debtor in commencing reorganization proceedings, we now turn our attention to whetherthe courts should consider good faith in determining whether to allow a debtor to commence orcontinue reorganization proceedings.3. Should Good Faith Be a Consideiufion?The commentators who suggest that there is or should be a good faith standard forcommencing reorganization proceedings under the Code cite the legislative history and generalprinciples of equity in support of that position.9° Conversely, those who argue that there is not orshould not be such a standard cite the legislative history and the plain meaning of the statute in88 Supra note 38.89 E.HT. Snell, The Princ4,les ofEquity (London: Steven and Haynes, 1868) at 33. The threemaxims referred to by the author are:(a) He who seeks equity must do equity.(b) He who comes into equity must come with clean hands.(c) Equity aids the vigilant, not the indolent.9° See e.g, J. Moss, “Consecutive Chapter 11 Filings: Use or Abuse?” (1991/92) 19 FordhamUrban L.J. 111; Cohn, supra note 60; D.B. McColl, “Good Faith in Chapter Eleven Reorganizations”(1984) 35 S.C.L. Rev. 333; RL. Ordin, “The Good Faith Principle in the Bankruptcy Code: A CaseStudy” (1983) Bus. Law. 1795; D.M Zavagno, “Tort Claims Against Business Debtor Filings ForReorganization and a Fresh Start” (1983) 52 U. Cin. L. Rev. 791.52support of that position.9’It is difficult to argue that good faith should not be present when a debtor commences areorganization proceeding. Said another way, should a business reorganization statute allow a debtorwith improper or fraudulent motives the benefit of its protections? One’s visceral reaction to such aproposition is to reject it outright. After all, it seems logical and proper that to take the benefit of areorganization statute, the debtor should have an honesty of intent to use the legislation to attempt toreorganizeY In addition, the good faith standard prevents the debtor from abusing the bankruptcyprocess for illegitimate or reprehensible purposes and maintains the jurisdictional integrity of thebankruptcy courts.93While these arguments are compelling, the difficulty in requiring good faith as a preconditionto allowing a reorganization proceeding to be commenced or continued is its abstract and intangiblequality, as described in the definition set forth earlier.94 To be of assistance in the commercialenvironment, standards governing conduct must have predictability of result. Without suchpredictability, transaction costs will increase and forum shopping may result. One commentatorexpressed this concern over lack of predictability by noting that “the major problem with the goodfaith standard [is that] it is so vague that there will always be conflicting case law.”9591 See e.g., Flaccus, supra note 62; MJ. Bienenstock, Bankniptcy Reoiganization (New York:Practising Law Institute, 1987) at 28-34; D.J. Tyukody, “Good Faith Inquiries Under the BankruptcyCode: Treating the Symptom, Not the Cause” (1985) 52 U. Chi. L. Rev. 795; Di Donato, supra note70.cohn, supra note 60 at 134.Little Creek, supra note 49 at 1072.‘ Supra note 44 and accompanying text.Flaccus, supra note 62 at 434-435; see also, Phoenix Piccr]illy, supra note 49, where the courtsaid:there is no particular test for determining whether a debtor has filed a petition in badfaith. Instead, the courts may consider any factors which evidence an intent to abuse thejudicial process and the purposes of the reorganization provisions or, in particular, factorswhich evidence that the petition was filed to delay or frustrate the legitimate efforts of secured53While there may be reasons for attempting to determine the motives of the debtor inconmiencing the proceedings, there are adequate statutory protections afforded disgruntled parties,which may be invoked very early in the proceedings. A party may apply to have the automatic staylifted under the Code for cause, including a lack of adequate protection. Under the BIA, the partymay apply for relief from the stay if it determines that it is being materially prejudiced?6 In addition,the niles of court in the various jurisdictions in Canath provide that a proceeding that is frivolous orvexatious may be dismissed.97if the normative basis of a business reorganization proceeding is evident, the motives of thedebtor should be irrelevant. That is, the court would merely be asked to consider whether theproceeding meets the objectives of the legislation. One writer suggested that dismissing a case basedon bad faith may adversely affect creditors and the public interest by thwarting a reorganization andequitable distribution of the assets of the debtor based on the “mental sin of the debtor’s proprietor orcorporate officer.”98 In other words, the courts should not focus on the “state of mind” of the debtor.They should consider the objectives of the legislation to determine whether reorganization ll benefitcreditors through an equitable distribution, whether there is a benefit to society as a whole bysalvaging the business and having it continue as an ongoing entity and whether, through areorganization, the debtor may be rehabilitated?9D. CONCLUSIONThe character and motives of the debtor should not be considered by the courts in decidingcreditors to enforce their rights.” [at 1394, citations omitted].See discussion in chapter V(A)(4Xc), below.See e.g. Alberta Rules of Court, r. 129(1)(b).98 Bienenstock, supra note 91 at 30-31.cf Phoenix Piccdilly, supra note 49 at 1395 where the court said “[t]he possibility of asuccessful reorganization cannot transfer a bad faith filing into one undertaken in good faitK”54whether to allow a reorganization proceeding to be commenced or to continue. The focus of theexamination should be whether the proceeding will accomplish the objectives of the legislativescheme. Whether the debtor is insolvent, has issued bonds or debentures under a trust deed or isacting in good faith in commencing the proceeding should not be the focus of the court’s inquiry.There are alternate means of suppressing an abuse of the bankruptcy process without compromisingthe interests of the parties to the proceeding. The court could, for example, lift the automatic stay ofproceedings or dismiss the proceeding on the grounds that it is ffivolous or vexatious, If there arelegitimate reasons for maintaining the proceedings, irrespective of the character, conduct or motives ofthe debtor, the proceeding should be maintained.55CHAFFER IVCUSTODY OF ThE FSTAFE OF ThE DEBTORReorganization proceedings commenced under the BIA require the intervention of a trustee,’inter alia, to nxnitor and investigate the debtor’s assets, business and financial affairs and to evaluatethe cause of its financial difficulties.2 Section 47.1 of the BIA gives the court discretion to appoint aninterim receiver, in addition to the trustee appointed under the proposal or named in the notice ofintention to make a proposal. The court will appoint an interim receiver if it is considered necessaryfor the protection of the debtor’s estate or the interests of one or more creditors or the creditorsgenerally.3 Under the CCAA,, although there is no express provision allowing for the appointment of atrustee or interim receiver, the orders promulgated at the outset of a proceeding under the CCAA“typically include provision for the appointment of a ‘monitor’.”4We must contrast this virtual automatic appointment of an independent entity having powersranging from overseeing the debtor’s operations and financial affairs to ousting its management, withthe approach taken under the Code that maintains the debtor in possession5of the business and itsaffairs. The ouster of the debtor’s management by the appointment of a trustee under the Code6 hasBJA ss. 50(2) and 50.4(1).2 BIA ss. 50(5) and (10) and 50.4(7).BIA s. 47.1(3).D.H Goldman, D.E. Baird and MA Weinczolç “Arrangements Under the Companies’ CreditorsArrangement Act” (1990), 1 C.B.R. (3d) 135 at 200.Code s. 1101(1) defmes “debtor in possession” as the “debtor except when a person that hasqualified under section 322 of this title is serving as trustee in the case”. In this chapter, the acronymDIP will be used to denote the debtor in possession.6 Code s. 1104(a).56been described as an “extraordinary remedy”7that will be allowed only on the basis of clear andconvincing evidence.8 In other words, the debtor’s right to remain in possession and control itsfinancial and business affairs is a strong presumption.9This chapter will examine the concept of the DIP, its rights and duties and the checks andbalances imposed by the Code and the courts which ensure that the DIP is fulfilling its duties. It willthen examine the circumstances under and standards by which the courts determine whether theappointment of a trustee or an examiner is appropriate.10The purpose of this examination is to determine whether maintaining the DIP or, alternatively,whether the virtual automatic appointment of an independent third party is more likely to result in thefulfilment of the objectives of a business reorganization system. In so doing, this chapter will examinethe advantages and disadvantages of appointing a trustee or examiner.A. DEBTOR IN POSSFSSION (DIP)1. legislative Ilistoty and Conceptual BasisThe legislative history of the Code and the structure of Chapter 11 make it clear that theIn re Ionosphere Clubs, Inc., 113 B.R. 164 at 167 (Bankr. S.D.N.Y. 1990) [hereinafterIonosphere]; In re Microwave Products ofAmerica, 102 B.R. 666 at 670 (Bankr. W.D. Tenn. 1989)[hereinafter Microwave]; In re Sharon Steel Coip., 86 B.R 455 at 457 (Bankr. W.D. Pa. 1988), afJ’d871 F.2d 1217 at 1225 (3d Cir. 1989) [hereinafter Sharon Steel]; In re Hotel Associates, Inc., 3 B.R.343 at 345 (Bankr. E.D. Pa. 1980) [hereinafter Hotel Assocs.].8 C.W. Frost, “Running the Asylum: Governance Problems in Bankruptcy Reorganizations” (1992)34 Az. L. Rev. 89 at 121. See also Sharon Steel, ibid at 1226 (3d Cir.), ibid. at 457 (Bankr.);Microwave, ibid at 670.Committee ofDalkon Shield Claimants v. A.H Robins Co., 828 F.2d 239 (4th Cir. 1987) wherethe court affirmed the fmding that the debtor was in civil contempt, but held that such fmding was notto be equated with fraud or mismanagement sufficient to justify the appointment of a trustee [at 240].10 Code s. 1104(b). The appointment of an examiner is a less drastic remedy. An examiner hasinvestigative and reporting duties under paragraphs 1 106(a)(3) and (4) but it does not have the samemanagerial and supervisory rights and duties as a trustee, such as the right to carry on the business ofthe debtor pursuant to section 1108 [D.W. Given, “When and Why Courts Appoint Trustees inBankruptcy” (1988) 34:6 Prac. Law. 29 at 35].57debtor’s prepetition management is to remain in possession and control of the debtor’s fmancial andbusiness affairs following commencement of the proceedings. Section 1107 provides that the DIPshall have all the rights and powers and shall perform all the duties of a trustee, other than certainobvious exceptions, such as the duty to investigate itself and report thereon. Section 1108 of the Codeallows a trustee, unless the court orders otherwise, to operate the debtor’s business. Thus, the DIP isentitled, inter dia, to carry on the debtor’s business.1The concept of the DIP first appeared in section 77B.’2 Chapter X retained the concept,’3butonly with respect to entities that owed less than a prescribed amount. In all other cases, Chapter Xrequired the appointment of an independent trustee.14 Chapter X included the requirement for theappointment of an independent trustee, in large cases, at the instance of the Securities and ExchangeCommission,15to protect public investors and the public interest. The trustee’s role was not merely toinvestigate or supervise, but to take a very active role in the reorganization process. Besidesinvestigative and supervisory powers, the trustee would supervise the negotiations leading to areorganization plan, assist in the formulation of the plan and, ultimately, present the plan to the court)6“ The legislative history reflects this intention. The House Report at 404, stated that section 1107“places the debtor in possession in the shoes of a trustee in every way” and that section 1108 “doesnot presume that a trustee will be appointed to operate the business of the debtor. Rather, the powergranted to trustee under this section is one of the powers that a debtor in possession acquires by virtueof proposed [section 11071.”12 77B(c)(1).13 Chandler Act s. 156 provided, inter dia“Where the liquidated and non-contingent indebtedness of a debtor is $250,000 or over, thejudge shall, upon the approval of the petition, appoint one or more disinterested trustees, whoshall be qualified, except as to residence and location of office, as prescribed in section 45 ofthe Act. Where such indebtedness is less than $250,000, the judge may appoint one or moresuch trustees or may continue the debtor in possession.”14 Ibid15 J.I. Weinstein, The Bankriçtcy Law of 1938 - Chandler Act (New York: National Associationof Credit Men, 1938) at 212.16 RJ. McAfee, “Business Rehabilitation - Chapter 11” (1979) 48 U. Cin. L. Rev. 392 at 393.58Chapter XI provided, in substance, that the debtor was to remain in possession and authorizedthe debtor to operate the business, unless a trustee was appointed.’7 This was very similar to theCode’s provisions. This issue of the appointment of a trustee was the subject of a “substantialdebate”8prior to the Code’s passage. The resulting legislation is a composite of the Senate and Houseversions.Chapter X required the appointment of a trustee in cases involving large, widely-heldcompanies. The Senate Report felt that it was necessary to differentiate between a case involving apublic company and one involving a private company and sought to retain a requirement forappointment of a trustee in the case of public companies, whatever their size.’9 The Senate Reportexpressed the necessity of this protective mechanism as follows:In a large public company, whose interests are diverse and complex, the most vulnerable todayare public investors who own subordinated debt or equity securities. The bill, like chapter )çis designed to counteract the natural tendency of a debtor in distress to pacify large creditors,with whom the debtor would expect to do business, at the expense of small and scatteredpublic investors.20In other words, a trustee would protect the interests of the subordinated debt holders and investors“i’ Chandler Act ss. 342 and 343 provide:“342. Where there is no receiver or trustee, the debtor shall continue in possession of hisproperty and shall have the title and exercise the powers of a bankruptcy trustee, subject,however, to the control of the court and to the limitations, restrictions, terms and conditionswhich the court may, from time to time, prescribe.343. The receiver or trustee or the debtor in possession, when authorized by the court andsubject to its control, shall have the power to operate the debtor’s business and manage itsproperty during such limited or indefmite period as the court may, from time to time, fix, andshall report thereon to the court at such intervals as the court may designate.”‘ Frost, supra note 8 at 113. The extent and nature of the debate is discussed in RJ. Berdan andB.G. Arnold, “Displacing the Debtor in Possession: The Requisites for and Advantages of theAppointment of a Trustee in Chapter 11 Proceedings” (1984) 67 Marquette L. Rev. 457 at 460-469.Illustrative of the extent of the debate, the writers of the latter article noted “. . . very few issues dealtwith by Congress in connection with the drafting of the Code produced a greater divergence of viewsthan the standards for the appointment of trustees.” [at 461].‘ Senate Report at 9-11.20 Ibid at 10.59whereas, it was the Senate’s perception that a DIP would only be concerned with self-interest.The House Report spurned the public versus private company distinction. The reportspecifically referred to the fact that the securities laws and the vigorous enforcement by the Securitiesand Exchange Conmiission provide sufficient public protection.2’ The House Report felt that “[t]hepublic and the creditors will not necessarily be harmed if the debtor is continued in possession in areorganization case.”22 The court, in considering whether a trustee would be appointed, wouldconsider all factors and determine, in each case, whether there is a need for a trustee.23The major divergence between the recommendations of the House Report and the resultingCode provisions was in the method of selecting the trustee. The House Report recommended that theUnited States truste&4make the appointment of the trustee, following consultation with the parties ininterest and su1ject to approval of the court, which, in most cases, would be perfunctory.25 The Coderejected this notion and provided that the court appoint the trustee “on request of a party in interest orthe United States trustee.”26The DIP is the prepetition management of the debtor and practically, there is no change in or21 House Report at 233.22 Ibid23 Ibid24 The United States trustee is a government official appointed the Attorney General, see 28U.S.C. 581 (1988). In creating the office of the United States trustee, the House Report explained theduties of the office as follows:“Some of the servisory functions removed from the judge will be transferred to a newsystem of United States trustees who will act as bankruptcy watchdogs, overseeing thequalifications and appointments of private trustees in bankruptcy cases, servising theirperformance, monitoring their fees, and serving as trustees in cases where a private trusteecannot be found to serve.” [House Report at 4]The United States trustee is not mlike the &qeiintendent of Bankruptcy in Canadi See BIA ss. 5and 6.25 House Report at 234.26 Code s. 1104(a).60replacement of the personnel of preexisting management.27 However, conceptually, because the DIPhas powers and assumes duties that, before the filing of the petition, the debtor did not have,28 the DIPdoes not appear to be one and the same as the debtor. This has resulted in some courts describing theDIP as a “new entity.”29 The analysis of the DIP as a new entity is useful conceptually. It is difficult,for example, without such analysis, to understand how the law may sanction a breach of a validcontract. However, if one proceeds on the basis that the DIP is a different entity from the debtor andthat the DIP is not a party to the contract, such analysis is more palatable.3°The courts have not universally accepted the new entity concept, however.31 For example, theUnited States Supreme Court in National Labor Relations Board v. Bildisco and Bildisco,32 held thatthe debtor and the DIP were the same entity but that the Code conferred on the DIP certain powers27 In re DeLuca Distributing Co., 38 BR. 588 (Bankr. N.D. Oh 1984).28 The DIP, postpetition, has the power, for example, to recover preferences or fraudulent transferspursuant to sections 547 and 548 of the Code, respectively or it may reject or assume and assignexecutory contracts or unexpired leases pursuant to section 365 of the Code. This latter power isdiscussed at chapter V(B), below. Prior to the filing of the petition, the debtor did not have thesepowers. Conversely, the DIP has additional duties such as the filing of lists, schedules and statementsrequired by subsection 521(1).29 See e.g., Re Baldwin United Coip., 43 B.R 443 (Bankr. S.D. Oh. 1984) [hereinafter Baldwin];Shopman’s Local Union No. 455 v. Kevin Steel Products, Inc., 519 F.2d 698 (2d Cir. 1975)[hereinafter Kevin Steel], where the court said “[a] debtor-in-possession under chapter XI or underchapter X a trustee under the latter chapter, or a trustee in a straight bankruptcy proceeding is not thesame entity as the pre-bankruptcy company.” [at 704, emphasis original].° See e.g., Kevin Steel, ibid This type of analysis is also useful for determining the priority ofclaims. Sections 503 and 507 of the Code give a first priority to administrative expenses which are“the actual, necessary costs and expenses of preserving the estate.” Second in priority are allowedunsecured claims. If the DIP incurred the expense, the claim would be given an administrativeexpense priority. On the other hand, if the expense was incurred by the debtor, it would merely be anunsecured claim. See Baldwin, ibid. See also Re Wil-Low Cqfeterios, Inc., 35 F. Supp. 965 at 968(S.D.N.Y. 1940).31 See e.g. Cle-Ware Industries, Inc. v. Sokolsky, 493 F.2d 863 (6th Cir. 1974) where, in rejectingthe notion of appointing separate counsel for the debtor and for the DIP, the court said “[t]he debtorand the debtor-in-possession is one and the same person, although ‘wearing two hats’.” [at 870-871].32 465 U.S. 513 (1984).61and duties that the prepetition debtor did not have.33 This type of analysis is in keeping with thenotion that legislation, if it is clear and unambiguous, may effect an object that, at first blush, appearsto be contrary to our notions of fair play. The Code is clear in providing the DIP the right, forexample, to reject a valid and enforceable executory contract or unexpired lease in circumstanceswhere the debtor could not do so. The United States Supreme Court merely interpreted the plain andunambiguous language of the Code without seeing the necessity of attempting to draw a conceptualdistinction between the DIP and the debtor. One witei characterizes this distinction between thedebtor and the DIP as nothing more than a distinction in roles. That is, the DIP exercises its dutiesand powers for the benefit of “diverse constituencies,”35including creditors and shareholders, whereasthe debtor’s duties are limited to benefitting the equity holders.362. Hduciaiy Duty of the DIPAlthough the structure of the Code makes the duties of the DIP and the trustee coextensive,37with certain exceptions, the following examination will focus on the DIPs fiduciary duty, as thetrustee, usually, will not exercise its duties in a biased manner.38Ibid at 528T.G. Kelch, “The Phantom Fiduciary: A Debtor in Possession in Chapter 11” (1992) 38 WayneL. Rev. 1323 at 1334.Ibid at 1323.36 MJ. Bienenstock, “Conflicts Between Management and the Debtor in Possession’s FiduciaryDuties” (1992) 61 U. Cm. L. Rev. 543 at 553.Codes. 1107.38 Subsection 324 of the Code penriits the removal of a trustee “for cause.” The legislativehistory makes it very clear that removal may be made in a summary fashion if the trustee isfI.inctioning “improperly, poorly or even illegally” [House Repon, HR. No. 99-764, 99th Cong., 2dSess. (1986) at 27, repHnted in 1986 U.S.C.C.A.N. (554 Stat.) 52271.62The DIP has the duty to act as a fiduciary of the estate and the estate’s creditors.39 The UnitedStates Supreme Court outlined this duty as follows:[T]he willingness of courts to leave debtors in possession is premised upon an assurance thatthe officers and managing employees can be depended upon to carry out the fiduciary duties ofa trustee.4°This duty does not extend to the debtor itself or the debtor’s principals unless the principals are alsocreditors.4’ In acting in its fiduciary capacity, the DIP must maintain a level of impartiality and treatall parties fairly and equitably.42 In addition, it must exercise the care and skill that a reasonableperson would exercise in similar circumstances43and must avoid profiting at the expense of creditorsand the debtor’s shareholders.With the fiduciary duty imposed on the DIP comes liability for its breach. Negligence in theperformance of its fiduciary duty may result in liability of the estate45 or personal liability.4° However,House Report at 404; Senate Report at 116. See also In re Johns-Manville Coip., 52 B.R 879(Bankr. S.D.N.Y. 1985), where the court said:“Thus, Manville’s directors, in negotiating any plan of reorganization, and indeed for as longas Manville remains in Chapter 11, are required by the Code to act as fiduciaries of the estate.[Amy directors would have to act not for the narrow interests of shareholders, but asfiduciaries of the estate.” [at 8851For an extensive discussion of the fiduciary duties of the DIP, see Kelch, supra note 34.4° Commodity Futures Trcriing Commission v. Weintrc&b, 471 U.S. 343 at 355 (1985) [citationsomitted], on remand 776 F.2d 1049 (7th Cir. 1986).‘ In ie L & S Industries, Inc., 122 B.R. 987 at 993-994 (Bankr. N.D. 111. 1991), qtj’d 989 F.2d929 (7th Cir. 1993).42 Kelcl supra note 34 at 1344. See also In re Cochise College Park, Inc., 703 F.2d 1339 (9thCir. 1983) at 1357 [hereinafter Cochise College Patic].Cochise College Park, ibidMicrowave, supra note 7, where the court held that “any attempt by the individual boardmembers [of the DIP] to structure deals that would benefit them privately to the detriment of othercreditors would contravene the fiduciary relationship.” [at 672].“i Ford Motor Credit Co. v. Weaver, 680 F.2d 451 at 461 (6th Cir. 1982) [hereinafter Weaver].See also In re Johnson, 518 F.2d 246 at 251 (10th Cir. 1975), cert. denied (sub nom. Clark v.Johnson) 423 U.S. 893 (1975).63personal liability will certainly result from intentional violation of the fiduciary duty.47 As there areonly finite resources available for distribution among the debtor’s creditors, the DIP must makedecisions concerning the allocation of those s.’ Accordingly, what one party sees as a breach ofthe DIP’s fiduciary duty, others may see as completely fair dealing. In clear cases of intentional‘wongdoing the DIP will be held strictly accountable.49 On the other hand, the courts will upholddecisions based on reasonable business judgment.5° The DIP must exercise caution in making suchdecisions and be able to justify the basis of its decision, from a practical and documentary point ofview.The DIP may be put in the unenviable position of having to make decisions detrimental toboth the debtor and the prospects of reorganization in the interests of “impartiality,” if to do otherwisemay be seen as a breach of its fiduciary duty.3. External Contrnl of the DIPBesides the appointment of a trustee5’or examiner52 and the imposition of disclosureMosser v. Darrow, 341 U.S. 267 at 272, 274 (1951).Weaver, supra note 45; In re George Schumann Tire and Batteiy Co., 145 B.R. 104 at 108(Bankr. MD. Fla. 1992), which was a chapter 7 case. In that case a trustee was found to haveintentionally breached court orders requiring the payment of surplus funds to the debtor. The courtgranted personal judgment against the trustee. See also In re Weber, 99 B.R. 1001 (Bankr. D. Utah1989), where the court “pierced the corporate veil” and held the sole shareholder and director of theDIP personally liable for a breach of fiduciary duty [at 1011].48 Microwave, supra note 7 at 671.See e.g. In re Weber, supra note 47 at 1013.5° See e.g, In ie Johns-Manville, 60 B.R. 612 at 615-616 (Bankr S.D.N.Y. 1986). In this case,the court approved the DIP’s retention of lobbyists to monitor and express the views of the debtor onall legislative and regulatory matters with respect to, inter alia, asbestos compensation legislation onthe basis that there was a “reasonable basis for its business decision.”Code s. 1104(a). See discussion infra notes 61-75 and accompanying text.52 Code s. 1104(b). See discussion infra notes 76-79 and accompanying text.64requirements,53the Code provides mechanisms for overseeing the powers exercised by the DIP. Thelegislative history suggests that Congress, while recognizing that creditor control in bankruptcy casescould be beneficial and is “theoretically sound,M also recognized that most creditors are simpiy notinterested in pursuing the debtor or participating in the bankruptcy process.55 This seems logicalwhether one is examining a Canadian proceeding or an American one. To continue its pursuit of adebtor once the debtor commences bankruptcy proceedings, a creditor will incur expenses that mayresult in a judgment against a person from whom the creditor will not recover anything. Should thecreditor choose to participate in the proceeding directly as either an inspector (in a Canadianbankruptcy proceeding) or as a member of a creditors’ committee (in an American reorganizationproceeding), there may be significant time commitments involved in attending meetings and instructingoutside advisors. Not surprisingly, Congress observed that “[c]reditor control in bankruptcy cases is amyth.”56 Congress diminished certain functions of the creditors’ committee in an attempt to make thecreditors’ committee procedure less onerous on the participants.57 The creditors’ committee mayconsult with the DIP, investigate the debtor’s affairs, participate in the formulation of the plan andrequest the appointment of a trustee or examiner.58 In reality however, creditors are still reluctant toparticipate directly in monitoring the debtor’s affairs.Creditors’ committees were appointed in only a minority of cases. They usually failed toobtain assistance from an attorney, accountant, or other person familiar with the reorganizationReference has afready been made to the filing of lists, schedules and statements undersubsections 1106 and 52 1(1) of the Code [See discussion supra note 281. Other examples ofdisclosure during the reorganization proceeding is the duty to disclose the identity and affiliations ofindividuals that the plan proposes to serve as directors or officers postconfirmation [Code s.1 129(a)(5)(A)(i)] and the compensation payable to trustees during the chapter 11 case [Code s. 326(a)].House Report at 92.Ibid56 IbidHouse Report at 104.Codes. 1103.65process. They seldom conducted investigations of the cause of business failure or providedserious opposition to any course the debtor chose to follow. In those cases where they didoppose the debtor, they were unsuccessful.59Thus, it appears that, with the level of creditor apathy in reorganization proceedings, creditors’committees do not provide an effective mode of controlling the debtor. The more powerful weapon inthearsenal ofacreditor is thecdhocpowertoraiseandbeheardonanyissue inacaseunderChapter 1 1.60 Under subsection 1109(b), a party may raise issues that affect it directly, though it isnot involved in the case in any general supervisory capacity. The court may also limit the powers ofthe DIP under subsection 1109(b), acting sua sponte. Subsection 105(a) of the Code provides:The court may issue any order, process, or judgment that is necessary or appropriate to canyout the provisions of this title. No provision of this title providing for the raising of an issueby a party in interest shall be construed to preclude the court from, sua sponte, taking anyaction or making any determination necessary or appropriate to enforce or implement courtorders or niles, or to prevent an abuse of process.Under subsection 1107(a), the court may circumscribe the powers of the DIP. This rightpoints to the broad power of the court to control the operation of the business and the transactionsentered into by the debtor, as well as the entire procedure contemplated by Chapter 11. The court mayexercise the powers on a transactional basis, such as through hearings for relief from the automaticstay of proceedings or the rejection or assumption of executory contracts or unexpired leases.The foregoing illustrates some external controls imposed on a DIP. However, parties take lessthan full advantage of these controls because of creditor apathy, which may be the result of theperception that the system is working adequately or, conversely, that the system is a complete failureand participating in it is a waste of time and resources. This paper will not examine that issue butL.M LoPucki, “The Debtor in Full Control - Systems Failure Under Chapter 11 of theBankruptcy Code?” (2d Install) (1983) 57 Am. Bankr. L.J. 247 at 272. Professor LoPucki’s study isone of the few quantitative analyses conducted in the field of business reorganizations.60 Code s. 1109(b). This right must be contrasted with the section 34 of the BIA which permitsonly the trustee to apply for directions and does not permit any other party to apply. Creditors aregiven very little recourse to the courts and only in limited circumstances, see e.g. the right undersection 69.4 of the BIA to apply to the court for a declaration that the stay of proceedings no longeroperates in respect of that creditor.66merely observes that creditor participation in Chapter 11 cases is minimal. Provided that creditors areadequately protected and their positions are not eroding during the pendency of the case, one wonderswhether the mandatory appointment of an independent third party is necessary or advisable.4. AppoinUnent of a Tiustee or ExaminerThe appointment of a trustee is an extraordinary remedy that the courts use sparingly.6’ Onecourt stated that, absent fraud, a trustee should not displace the debtor.62 The practical reason for thisreluctance is that the DIP is usually more experienced and more familiar with the debto?s business andoperations than the trustee. As well, the decision has financial aspects, as a trustee will uadoubtedlyconsume the debtor’s scarce financial resources in its attempt to familiarize itself with the debtor’sbusiness and the operation of the business.63 While courts recognize that, in most reorganization cases,some mismanagement or imprudent decision-making has taken place, they are sceptical that a trustee isin any better position to manage a business, properly and pnidently, with which it has little or nofamiliarity.TM Thus, as complexity of the debtor’s business or industry increases, the applicant’s onusbecomes heavier and there is an increased likelthood of the application failing.65 Generally, the courtsrequire the applicant to establish a clear and convincing case for the appointment of a trustee,61 Supra note 7 and accompanying text.62 In re Columbia Motor Express, Inc., 33 B.R 389 at 393 (MD. Tenn. 1983).63 In re Anchorage Boat Sdes, Inc., 4 B.R 635 at 644 (Bankr. E.D.N.Y. 1980), where the courtfelt it appropriate to conduct a cost-benefit analysis in order to detem,ine whether the appointment of atrustee was appropriate in the circumstances; Microwave, supra note 7 at 676.64 In re Anchorage Boat Sdes Inc., ibid at 645; In re Queen Kon&iratos Lines, Ltd, 10 B.R 609(Bankr. D. Me. 1981), where the court observed that “[ut is reasonable to expect that no [sic] everybusiness decision of a reorganization debtor will reflect exemplary business acumen. . . it being theexceptional reorganization case that does not come into this court at least in part because of someimperfect managerial decisionmaking.” [at 610].65 D.W. Given, “When and Why Courts Appoint Trustees in Bankruptcy” (1988) 34:6 Prac. Law.29 at 31-32.Supra note 8 and accompanying text.67although the Code does not require such a standard.Subsection 1104(a) sets out the standards governing the appointment of a trustee. It provides:At any time alter the commencement of the case but before confirmation of a plan, on requestof a party in interest or the United States trustee, and after notice and a hearing, the court shallorder the appointment of a trustee -(1) for cause, including fraud, dishonesty, incompetence, or gross mismanagement ofthe affairs of the debtor by current management, either before or alter thecommencement of the case, or similar cause, but not including the number of holdersof securities of the debtor or the amount of assets or liabilities of the debtor; or(2) if such appointment is in the interests of creditors, any equity security holders, andother interests of the estate, without regard to the number of holders of securities ofthe debtor or the amount of assets or liabilities of the debtor.Although the courts draw a distinction between the “for cause” standard in paragraph 1 104(a)(1) andthe “best interests” standard in paragraph 1104(a)(2),67 a “cause” under paragraph (1) that would notjustify the appointment of a trustee under that paragraph would likely be an element considered in ananalysis under paragraph (2).The causes listed in paragraph (1) are not exclusive but are merely illustrative of causes thatmay justify the appointment of a trustee, as Congress listed the factors as “included”68 in thedescription of “cause.” Also, the applicant need not prove all of the factors listed in paragraph (1) tohave a trustee appointed but the listed factors are alternatives. For example, incompetent managementis not necessarily dishonest.69 Improper conduct by prepetition management involving fraud7°orbreach of fiduciary duty7’ will justify the appointment of a trustee. Cases involving prepetitionnegligence, incompetence or errors of judgment of management are less clear. The courts examine67 Berdan and Arnold, supra note 18 at 472.68 Code s. 102(3) provides “includes’ and ‘including’ are not limiting.”69 In re Warwick Park, Inc., 100 B.R 179 at 180 (Bankr. D. Del. 1989).7° See e.g. In , New Haven Rcdio, Inc., 23 BR. 762 at 767 (S.D.N.Y. 1982); In ir BondedMailings, Inc., 20 BR. 781 at 786 (Bankr. E.D.N.Y. 1982).71 See e.g, In , Fiesta Homes of Georgic Inc., 125 BR. 321 at 325-326 (Bankr. S.D. Ga. 1990),where the court displaced the DIP because of the presence of a conflict of interest that could lead to abreach of fiduciary duty; In n McCorhill Publishing Inc., 73 B.R 1013 at 1017 (Bankr. S.D.N.Y.).68these cases on a case by case basis to decide whether the conduct or omission is sufficient to justifythe appointment of a trustee.72 These types of cases require the applicant to show cause by clear andconvincing evidence.73Paragraph 1 104(a)(2) provides the second basis for the appointment of a trustee. Inconsidering the “best interests” standard, the court balances the respective interests at stake and, inparticular, it examines the advantages and disadvantages of appointing a trustee. The court willconsider the following factors in such a case:(a) the trustworthiness of the debtor;(b) the debtor in possession’s past and present performance and prospects for the debtor’srehabilitation;(c) the confidence - or lack thereof - of the business community and of the creditors in presentmanagement; and(d) the benefits derived by the appointment of a trustee, balanced against the cost of theappointment.74The court must consider the additional costs imposed on the estate by the trustee’s appointment and theavailability of a trustee that is capable and willing to act. However, at the heart of the inquiry iswhether the DIP or a trustee will more likely facilitate a confirmed plan of arrangement expeditiously.For example, if the creditors refuse to deal with the DIP under any circumstances, the court may bejustified in appointing a trustee.75The court or the parties may consider the appointment of an examiner under subsection1104(b) if there are concerns regarding the DIP or the conduct of prepetition management that are notSharon Steel, supra note 7 at 1226 (3d Cir).Berdan and Arnold, supra note 18 at 472.Ionosphere, supra note 7 at 168 [citations omitted].Ibid See also In re Scwino Oil & Heating Co., 99 B.R 518 at 527 n. 11 (Bankr. E.D.N.Y.1979); In re Advanced Electronics, Inc., 99 B.R 249 (Bankr. MD. Pa. 1989).69serious enough to justify the appointment of a trustee.76 The examiner’s primary role is to investigateand report to the court and not to manage the debtor’s business and affairs.77The limited role of the examiner and its report has been described as follows:His fmdings do not have binding effect on the court or parties of those of a special master,arbitrator or magistrate; nor do they have the evidentiary character of an opinion by a courtexpert ... An Examiner performs the investigative duties of the trustee, and may performother investigative duties as the Court directs, but he stands on a different legal footing than atrustee.78The examiner’s reduced role results in a corresponding reduction in the onus on the party seeking theappointment. All that appears necessary to justify the appointment of an examiner is an allegation andevidence of mismanagement.B. ThE CANADIAN APPROACHThe Colter Committee Report recommended that in all cases where a secured creditor has notappointed a receiver, the debtor should appoint a trustee to act as interim receiver.80 The role of the76 Code s. 1104(b) provides:If the court does not order the appointment of a trustee under this section, then at any timebefore the confirmation of a plan, on request of a party in interest or the United States trustee,and after notice and a hearing, the court shall order the appointment of an examiner to conductsuch an investigation of the debtor as is appropriate, including an investigation of anyallegations of fraud, dishonesty, incompetence, misconduct, mismanagement, or irregularity inthe management of the affairs of the debtor of or by current or former management of thedebtor, if -(1) such appointment is in the interests of creditors, any equity security holders, andother interests of the estate; or(2) the debtor’s fixed, liquidated, unsecured debts, other than debts for goods, services,or taxes, or owing to an insider, exceed $5,000,000.In re Boileau, 736 F.2d 503 at 506 (9th Cir. 1984); In re International Distribution Centei,Inc., 74 B.R 221 at 224 (S.D.N.Y. 1987). One court held that it is proper to appoint an examiner forthe express purpose of investigating the issue of whether a trustee should be appointed [In re Hainiel& Sons, Inc., 20 B.R 830 (Bankr. S.D. Oh. 1982)].78 Bddwin, supra note 29 at 316.McAfee, supra note 16 at 397.80 Colter Committee Report at 56.70trustee or interim receiver, as contemplated by the report, was similar to the role assigned to theproposal trustee under the BIA, as the trustee or interim receiver would have been required to reviewthe books and records of the debtor and maintain control and account for the disposition of thedebtor’s property during the interim period.8’However, the Colter Committee Report went further andprovided the court the discretion to grant additional powers to the trustee or interim receiver, includingthe right to take possession and sell all or part of the debtor’s property or manage the debtor’sbusiness. The BIA gives the proposal trustee relatively noninvasive duties, such as to report on thereasonableness of the debtor’s projected cash-flow statement,83 notify the creditors of the filing of thenotice of intention to make a proposal, monitor and report on the debtor’s business and affairs85 andadvise on and participate in the preparation of the proposal.The court may give an interim receiver appointed pursuant to section 47.1 more invasivepowers. Subsection 47.1(2) gives the court very broad discretion in determining the powers that maybe given to the interim receiver, including the powers to take control over the debtor’s business orproperty and to “take such other action as the court considers advisable.” Although case law under theBIA has yet to establish the contours of the role of an interim receiver, the legislative grant appears tocontemplate a broad and potentially invasive role.8781 Ibid82 Ibid at 56-57.83 BIA s. 50.4(2).BIA s. 50.4(6).85 BIA s. 50.4(7).86 BIA s. 50.5.One must be cautious in attempting to analogize the interim receiver’s role on the filing of apetition for a receiving order (a liquidation proceeding). It has been held that the interim receiver, inthose circumstances, is to take only conservatory measures to protect the debtor’s estate and is not todivest the debtor of its property [Re Soren (1926), 7 C.B.R 545 (Ont. S.C.); Re Stuan’-Sutterby(1930), 12 C.B.R. 267 (Ont. C.A.)]. It should be noted however, that the BIA specifically states that,in such circumstances, “the interim receiver shall not unduly interfere with the debtor in the carrying71The recent case of Re NT. W. Management Group Ltd88 illustrates the separation of the rolesof the proposal trustee and an interim receiver. In that case, the court appointed an interim receiver onthe basis that the debtor, after filing the notice of intention to make a proposal, opened a new bankaccount and deposited funds into that account that were subject to a security interest. Rather thanappointing a separate entity as the interim receiver, the court appointed the proposal trustee, to reducecosts.89 The court further held that the proposal trustee need not relinquish its duties as proposaltrustee but thereafter, it must fuffil the duties of proposal trustee and also, comply with the courtordered duties of an interim receiver.The BIA does not provide a list of persons who may apply for the appointment of an interimreceiver. It has been suggested that the proposal trustee or any creditor or creditors may make theapplication.90 In such an application, the applicant has the onus of showing that the appointment of aninterim receiver is necessary for the protection of the estate or the interests of one or more creditors orthe creditors generally.9’ The courts have held that they must act cautiously in considering whether toappoint an interim receiver. The reason for this cautious approach is their desire to avoid precipitousaction that could not only prejudice the hopes of the debtor for its recovery, but also the interests ofcreditors.92 The applicant must adduce evidence of an actual danger of dissipation of assets; mereon of his business except as may be necessary for the conservatory purposes or to comply with theorder of the court.” [BIA s. 46(2)1.88 (1993), 19 C.B.R (3d) 162 (Ont. Gen. Div.).89 Tn Dufferin-Custom Concrete v. CarlinWMaplehuis’t Developments Inc. (1993), 22 C.B.R (3d)67 (Ont. Gen Div.), the court held that the “crucial consideration” in the appointment of an interimreceiver is “to reduce or control costs as much as possible.”9° L.W. Houlden and C.R Morawetz, The Annotated Bankniptcy and Insolvency ACt 1993(Scarborough: Carswell, 1992) at 92.91 BIA s. 47.1(3).92 156190 Cancda Ltd v. Ba,coum Drugs Ltd (1993), 19 C.B.R. (3d) 129 at 135 (N.W.T.S.C.).72suspected or feared dissipation will not be sufficient.93A monitor appointed in an order under the CCAA must assess and review the debtor’s businessand affairs on an ongoing basis.94 The court has the discretion to grant powers in excess of theseduties. In Canadian Imperial Bank of Commerce v. Quintette Coal Ltd, the court refused to expandthe role of the monitor to include the right to prepare, negotiate and file the plan with the court,coordinate the approval process and call and chair all meetings. The court felt that the objectives ofthe CCAA would be best accomplished through the limited role of the monitor, who would besubject to the court’s supervision.C FULFILMENT OF OBJECIIVFS A1NI) PROPOSALS FORREFORMAlthough the primary objective of a business reorganization proceeding is the confirmation ofa plan of reorganization, there will be a period between the commencement of the proceeding andconfirmation of the plan, during which many interim decisions and interlocutory proceedings will takeplace. Those interim steps will affect the rights of the parties to the proceeding.The appointment of an independent third party, in addition to or in substitution of formermanagement, will inject elements of objectivity and impartiality into the proceedingY7 This has theadvantage of easing the minds of the creditors, should there be a suspicion of wrongdoing ornegligence on the part of the former management of the debtor. The independent party will take anobjective look at the business operations to determine the most cost-effective manner of proceeding,Re L.A.T McrcáonddEnteiprises Ltd (1982), 42 C.B.R. (N.S.) 17 (Ont. S.C.); 156190 CanadaLtd v. Barsoum Dntgs Ltd, ibid.“ Goldman, Baird and Weinczok supra note 4 at 199.(1991), 1 C.B.R. (3d) 253 (B.C.S.C.).The court felt that the objectives are “to permit a corporation, through reorganization, tocontinue its business and thereby prevent its organization from being disrupted and its goodwill lost.”[ibid at 260, emphasis added].Hotel Assocs., supra note 7. See also Berdan and Arnold, supra note 18 at 385-386.73henceforth, unencumbered by previous loyalties and relationships that may have clouded the judgmentof former management. Following its review, the independent party may decide to liquidate ordispose of unproductive assets or divisions of the business and dismissal of long-term employees.More importantly, it can assess the fmancial viability of the debtor to determine whether areorganization is a feasible alternative. The independent party will also undertake examinations andinvestigations that former management may be unwilling or unable to undertake, such as the review ofinsider transactions.Conversely, the appointment of an independent third person will result in additional, oftensignificant, costs that the creditors will bearY8 In addition, because the trustee or interim receiver maylack the experience of former management in the debtor’s business operations and industry practices,there may be significant delay while the trustee or interim receiver familiarizes itself with thesemattersY9 This delay may result in loss to the debtor in terms of time, customers and suppliers. Amore practical concern is that the independent person may not have the time or incentive to maintainthe business in a way that will result in a confimed plan of reorganization. This proposition has twoaspects. First, the independent person may not have the necessary human resources to dedicate to thedebtor’s business. In times of severe macroeconomic difficulty, the independent person may beworking at full capacity, with no personnel to dedicate to the debtor’s affairs. Although this mayresult in a loss to the debtor’s business, the more serious consequence is that the independent thirdperson may view the most expeditious solution as the best solution in the circumstances, viz.,liquidation. A related concern is the perception in the insolvency conummity that, if the third partycan deal with and conclude the matter expeditiously, the appointing creditors may be more inclined toprovide the trustee or monitor with replacement work. Although this is a valid consideration for thefree-market mentality of the insolvency practitioners, it hardly encourages support of the debtor’s98 House Report at 233.99Ibid.74reorganization efforts.In a broader sense, the virtual automatic appointment of a trustee or monitor may provide adisincentive for management to seek the protection of a reorganization statute, even if a reorganizationis the most effective means of solving the debtor’s problems.10° Management may feel that a total orpartial loss of control may spell the demise of the business because of the lack of knowledge oftrustees and monitors and the costs resulting from their appointment. This type of approach defeatsthe purpose of a business reorganization regime, as it results in debtors waiting until the last possiblemoment before seeking the protection that may have saved them some months previously.To fashion proposals for reform, it is necessary, in first instance, to determine whether thebusiness community wants a business reorganization regime. If that inquiry leads to an affirmativeresponse, we must determine the best method of accomplishing that objective, If we accept ProfessorLoPucki’s observation that creditors take little active interest in the affairs of their debtors,’°1we mustquestion the role of the independent person appointed to protect the creditor’s interests.The virtual automatic appointment of a proposal trustee to investigate the debtor’s affairs or amonitor to supervise the debtor’s business may not encourage a debtor to seek the protection of abusiness reorganization regime and may not serve the interests of all those concerned with the process,not the least of which are the creditors. Because the reorganization process is generally a “zerosum”102 game, where there is a limited amount for distribution among the parties, with some partiesgaining and others losing, the effective deployment of assets is of primary concern to the parties. Theappointment of an independent third person will erode the resources available for the creditors andequity holders and accordingly, the decision to appoint an independent person to protect those interestsshould be left to the parties that will be paying for the benefit of that person’s advice. Should the100 House Report at 233-234; see also Frost, supra note 8 at 136.101 LoPucki, supra note 59 and accompanying text.102 Frost, supra note 8 at 119.75parties have confidence in existing management or see no need in “throwing good money after bad,”they should not be forced to pay for a resource that they do not want in the first place. Thus, in allcases, the presumption should be that the debtor remains in possession and control of the business andoperations, but that the creditors be permitted to apply summarily to the court for the appointment of atrustee or monitor. The parties or the court, if the parties are unable to agree, will be determine therights and duties of the trustee or monitor. In this manner, the stakeholders are making the decisionconcerning the disposition of “their” money.In analyzing the creditors who are supporting the application, the court must be cognizant ofthe actual creditors that will bear the costs of the trustee or monitor. An undersecured creditor withsecurity on all or substantially all of the debtor’s assets will bear those costs, as any furtherexpenditures will further erode its security, if the secured creditor is frilly secured, the unsecuredassets will bear the costs. In such a situation, the court must pay special attention to the interests ofpreferred and unsecured creditors.if the policymakers put this type of system into place, sufficient checks and balances mustexist for the courts and creditors to monitor and control the debtor’s affairs. The debtor may see thisas a small price to pay for the opportunity to attempt a reorganization. The legislation couldimplement provisions for adequate disclosure requirements, the possibility of having the reorganizationproceeding converted to a liquidation, requirement for court approval and easy access to the courts bythe DIP and other parties in interest for advice and direction.These proposals do not derogate from the objective of a business reorganization system butenhance it. If the checks and balances and the debtor remaining in possession are satisfactory to theparties, there is no reason why the debtor should not remain in possession. The system should servethe constituents whose interests it seeks to protect. Providing flexibility to allow the parties tostructure the proceeding in a way that serves their respective needs, while always providing the courtsthe opportunity to supervise the proceedings, attains this objective.76CHAPTER VCEREAN ADIIMSThAT1VE PORSThe title of Chapter 11 is “Reorganization” which may lead the reader to conclude that thefocus of this paper would be on that chapter. However, chapters 1, 3 and 51 are general provisionsapplicable to all proceedings under the Code. The “administrative powers” in subchapter IV of chapter3 of the Code are the essence of a business reorganization proceeding, as those powers will determinewhether the debtor will have an opportunity to attempt to formulate a plan of reorganization.Subchapter IV of chapter 3 of the Code consists of six relatively short and, facially, simplesections. However, there is a very rich history underlying each section and they have each engendereda significant body of case law. This chapter will examine whether the administrative powers assist theAmerican courts in defming and attaining the objectives of a business reorganization system.The CCAA, through its loosely-worded provisions or through case law, has developedadministrative powers similar to those outlined in subchapter IV of chapter 3 of the Code. Thischapter will examine the development of those powers under the CCAA to determine whether theyhave enhanced or hindered the debtor in its reorganization efforts.The BIA also has incorporated mechanisms similar to most of the administrative powerscontained in the Code. However, the differences have a significant impact on whether the insolventperson will be able to put forth an acceptable proposal. This chapter will contrast the administrativepowers contained in the Code with the mechanisms contained in the BIA to determine which systemwill better attain the objectives of the legislation.This chapter will examine the concept of adequate protection and the automatic stay ofproceedings that the Code imposes at the outset of a case. It will also review the discretionary stay ofproceedings under the CCAA and the automatic stay of proceedings under the BIA and will consider1 They are, respectively, entitled “General Provisions”, “Case Administration” and “Creditors,Debtor and Estate”.77whether importation of the concept of adequate protection during the stay would assist a Canadiandebtor in its attempts to reorganize its fmancial affairs.We will then examine of the issue of repudiation of real property leases. The Code and theBJA specifically give the debtor the right to repudiate, reject or disclaim real property leases. Incertain circumstances, the courts allow debtors a similar right under the CCAA. Again, this chapterwill examine this power to determine which system fosters the objectives of the legislation.The fmal section of this chapter will review the statutory schemes available to the debtor tofmance the proceeding and its operations during the proceeding. The Code has a comprehensive andcomplex scheme for fmancing during the proceeding. Neither of the Canadian legislative schemesappears to have addressed this specific issue, although out of necessity, creditors who allege materialprejudice to their interests by the absence of such provisions have raised the issue.These issues have very practical and serious ramifications for the parties in interest. From thedebtor’s perspective, a determination adverse to its interests on any of these issues may destroy thepossibility of its effecting a reorganization of its fmancial affairs. A creditor may find itselffmancially unable to cope with the consequences of the exercise of an administrative power and mayface the possibility of its own insolvency.A. ADEQUATE PROTECHON DURING THE STAY OF PROCEEDINGSThis section will examine certain changes to the rights and duties of secured creditors thatresulted from the passage of the BIA.2 Tn particular, this section will examine the stay of proceedings2 The relationship between a debtor and its secured creditors and the validity and enforceability ofsecurity are generally governed by law promulgated by the provinces pursuant to subsection 92(13) ofthe Canadian constitution. That subsection delegates authority to the provincial legislatures to enactlegislation governing “property and civil rights in the provinces.” However, when bankruptcyintervenes, the federal bankruptcy and insolvency laws govern the relationships between the debtor andits creditors and among the creditors. In the case of Cushing v. Dtpuy (1880), 5 App. Cas. 409(P.C.), the Judicial Committee of the Privy Council provided the rationale for this shift as follows:“It would be impossible to advance a step in the construction of a scheme for the78administration of insolvent estates without interfering with and modifying some of theordinary rights of property, and other civil rights, or without providing some mode of specialprocedure for vesting, realization, and distribution of the estate, and the settlement of theliabilities of the insolvent. . . It is therefore to be presumed, indeed it is a necessaryimplication, that the Imperial Statute, in assigning to the Dominion Parliament the subjects ofbankruptcy and insolvency, intended to confer on it legislative power to interfere withproperty, civil rights, and procedure within the Provinces, so far as a general law relating tothose subjects might affect them” [at 416].The courts in the United States have come to a similar conclusion. Chief Justice Fuller of the UnitedState Supreme Court expressly recognized this right of Congress in Hanover National Bank of the CityofNew York v. Moyses, 186 U.S. 181 (1902):“The subject of ‘bankruptcies’ includes the power to discharge the debtor from his contractsand legal liabilities, as well as to distribute his property. The grant to Congress involves thepower to impair the obligation of contracts, and this the states were forbidden to do.”[at 188].Notwithstanding the right of Congress and the Parliament of Canada to abrogate the rights of securedcreditors pursuant to their jurisdiction over bankruptcy and insolvency, the courts jealously guard theproperty rights of secured creditors. In the United States, constitutional challenges to federalbankruptcy laws take place primarily under the “due process” and the “unlawful taking” clauses of theFifth Amendment. The relevant provisions of the Fifth Amendment provide that “[nb person shall bedeprived of life, liberty or property, without due process of law, nor shall private property betaken for public use, without just compensation.”The concept of “due process of law,” as that term is used in the Fifth Amendment, requiresthat a particular law not be unreasonable, arbitrary or capricious and that the law and its means ofenforcement shall have a reasonable and substantial relation to the results being sought [US. v. Smith,249 F.Supp 515 at 516 (S.D. Iowa 1966)]. Along with this general requirement, the courts require“substantive due process” and “procedural due process” in any case to which the Fifth Amendmentapplies. Substantive due process is the doctrine that a person shall not be deprived of life, liberty orproperty arbitrarily, and legislation that results in such deprivation must have a rational basis [Jeffriesv. Turkey Run Consolidated School District, 492 F.2d 1 (7th Cir. 1974)]. Procedural due process, onthe other hand, requires procedural fairness prior to depriving a person of life, liberty or property. Ata minimum, the applicant must provide notification of the proceedings to the party being deprived,who must be given an opportunity to be heard at the proceeding. The proceeding must be held at ameaningful time and in a meaningful manner [Fuentes v. Shevin, Attorney-General of Florida, 407U.S. 67 (1972)].The 1935 United States Supreme Court decision in Louisville Joint Stock Land Bank v.Rcdford, 295 U.S. 555 (1935) [hereinafter Rcdfordj is seen by many commentators and courts as thedecision that entrenched the Fifth Amendment principles into the bankruptcy power [See e.g., L.S.Jayson, ed., The Constitution of the United States ofAmerica - Analysis and Inteipretation(Washington: United States Government Printing Office, 1973); In re Gfford, 669 F.2d 468 (7th Cir.1982); US. v. Security Industrial Bank, 459 U.S. 70(1982)]. The court in Rcdford was consideringcertain amendments to the 1898 U.S. Act that added provisions designed to save family-owned farmsfrom foreclosure.The court held the amendments to be unconstitutional as a violation of the principles containedin the Fifth Amendment and stated that “The bankruptcy power, like the other great substantive powersof Congress, is subject to the Fifth Amendment.”[Rc4’ord, supra at 589]. The court noted that despite79imposed on secured creditors at the outset of a reorganization proceeding and the protection affordedto secured creditors as a result of the imposition of the stay of proceedings. The fmal part of thissection will consider the issue of whether stay provisions further the objectives of a businessreorganization proceeding.The Colter Committee Report advised the policymakers that “[amy proposed change to ourbankruptcy legislation should be assessed in terms of how well it contributes to meeting the basicthe dire economic conditions and the importance of agriculture to the economy of the United States “.private property shall not be thus taken even for a wholly public use without justcompensation.”[Rcdford, supra at 602].Rcdford uses the wording of the unconstitutional “taking” provision of the Fifth Amendmentand not the deprivation of life, liberty or property without due process of law. However, subsequentdecisions cite Rcdford as authority for the due process proposition [Wright v. Vinton Branch of theMountain Trust Bank ofRoanoke, 300 U.S. 440 at 457 (1937)], as well as for the unconstitutionaltaking proposition. Although there is some dispute among commentators and courts as to the nature ofthe Rc4dford decision, it is clear that both concepts have been applied and followed in subsequentdecisions [For a discussion of the debate, see In re Gfford, supra]. Thus, it can be said generally, thatthe bankruptcy power is limited by the Fifth Amendment.In Canada, there is a common law limitation on the legislative power to take property withoutcompensation. The lack of constitutional protection places the interests of secured creditors injeopardy should the Parliament of Canada choose to exercise its broad legislative powers to deprivesecured creditors of their interests in the bankrupt’s property [J.M Ferron, “The ConstitutionalImpairment of the Rights of Secured Creditors in Canada and the United States” (1986), 60 C.B.R(N.S.) 146].To date however, the Anglo-Canadian courts have consistently held that, in the absence of aclear intention to the contrary, legislation which takes private property or impairs a vested interest inprivate property for public use or the use of third parties must provide compensation for that which istaken. The courts have gone so far as to require not just reasonable compensation for the propertytaken but full compensation [Belfast Coip. v. O.D. Cai Ltd, [1960] A.C. 490 (HL.)]. The generalprinciple was recently applied in the case of Lloyds Bank Ccinala v. International Wairanty Co.(1990), 76 C.B.R (KS.) 54 (Aita. C.A.), leave to appeal to the Supreme Court of Canada refused(1990), 76 C.B.R. (KS.) xxix [hereinafter Internationd Watronty]. In that case the Alberta Court ofAppeal held:“For Revenue Canada to succeed, the plain and unambiguous meaning of the section must bethat it deprives a properly secured creditor. . . of all or part of its security withoutcompensation, for the purpose of paying another debt entirely unrelated to the security. It issurely equivalent to the transfer of proprietary rights without compensation.” [at 58]Practically, the rights of secured creditors in Canada are similar to those of theirAmerican counterparts, notwithstanding the lack of constitutional protection of property rights. Thisfunctional similarity however, may be shattered by Parliament at any time by the utilization of “plainand unambiguous” [International Wanvnty, supra] language.80goals or objectives of the law.”3 Laws facilitating business reorganizations must attempt to strike adelicate balance between “the desire to achieve equity and fairness in the distribution of the bankrupt’sfunds”4 and assets, on the one hand, and the contractual rights of secured creditors, on the other hand.The Code and the CCAA tend to restrict the rights of secured creditors in a business reorganizationproceeding to facilitate the object of achieving equity and fairness in the distribution of the assetscomprising the estate and affording the debtor a fresh start.5 The former Canadian Act placed fewrestrictions on the rights of secured creditors. The Tassé Report recognized the significant increase insecured credit in Canada and the inadequacy of the former Canadian Act to adjust, efficiently andfairly, the relationship between debtors and creditors.6 It recommended changes to the legislation thatwould monitor and place certain restrictions on the rights of secured creditors. This chapter willconsider whether the BIA is conceptually effective to resolve the inefficiencies and inadequaciesperceived by the Tassé Report.1. Temnnology(a) Secured CreditorThe Code does not defme “secured creditor.” Rather, it describes the claimant according tothe nature of its allowed claim. Thus, whereas the 1898 U.S. Act referred to a creditor holding asecurity interest in the assets of the debtor as a “secured creditor,” the Code now describes it as a“creditor secured by a lien on property in which the estate has an interest.”7 That is, it classifiesColter Committee Report at 20.4 BankofMann v.Englond, 385 U.S. 99 at 103(1966).F.R. Kennedy, “Secured Creditors Under the Banlcruptcy Reform Act” (1982) 15 md. L. Rev.477 at 482.6 Tassé Report at 62.Code s. 506(a).81claims, not creditors, as secured or unsecured.8 The Code made this change to obviate the vaguenessof the 1898 U.S. Act, where it was necessary to determine whether a creditor with a security interestin collateral of a value less than the amount secured was to be treated as a secured creditor or as acreditor that was partly secured and partly unsecured.9 Subsection 506(a) resolves this apparentproblem by bifurcating the claim of the creditor into a secured portion and an unsecured portion.’°The claim is secured to the extent of the value of the collateral and is unsecured for the balance. Thisis a very important concept, as certain provisions of the Code define the interest or limit the claims ofsuch creditors on basis of the amount of the secured claim and not by the full amount owed to thecreditor.1’As mentioned above, the creditor’s claim is secured to the extent that the creditor has a “lienon property in which the estate has an interest.” The Code provides a very broad defmition of “lien,”2which includes inchoate liens.’3 The Code then defmes three categories of liens being judicial liens,security interests and statutory liens.’4 This section shall concern itself only with liens created by wayof security agreement and not with nonconsensual liens created by statute or judicial process. Liens8 See Barash v. Public Finance Coiporation, 658 F.2d 504 (7th Cir. 1981); In re Glenn, 796 F.2d1144 (9th Cir. 1986).Bkr-L Ed, Code Commentary and Analysis s. 21:25 1. Under the Code, such a creditor iscommonly known as an “undersecured creditor”. The distinction between oversecured creditors andundersecured creditors is important for determining the extent of their entitlement to “adequateprotection”. See discussion, infra notes 49-77 and accompanying text.10 See In re Glenn, supra note 8.‘ A plan of reorganization under Chapter 11 will be considered fair and equitable with respect toa class of creditors secured by liens on property in which the estate has an interest, only if the plan toprovides, inter dia, that the claimants retain their liens on the collateral and that they receive deferredcash payments, each totalling the allowed amount of the secured claims and not the full amount ofsuch creditors’ claims [Code s. 1 129(b)(2)(A), emphasis added].12 Code s. 10 1(37) “lien” means charge against or interest in property to secure payment of adebt or performance of an obligation;13 House Report at 312.14 Code ss. 101(36), 101(51) and 101(52), respectively.82created by way of security agreement include real property mortgages and liens on personal propertyor fixtures created pursuant to appropriate state law.Generally, nonbankruptcy state law detemiines the validity of the lien.’5 However, even thoughvalid under state law, the trustee or the debtor may avoid or subordinate the lien pursuant to the Code.The BIA and the CCAA each defme “secured creditor,” but only the CCAA defmes“unsecured creditor.”16 Most of the case law considering these defmitions involves determinations ofwhether a particular type of claim or interest makes the claimant a secured creditor. The vagueness ofan in personain defmition of the temi has not yet caused any difficulty in practice. However, the BIAoscillates between references to secured creditors and “secured claims,” which is an undefmed term.For example, subsection 50(1.2) of the BIA provides:A proposal must be made to the creditors generally, either as a mass or separated into classesas provided in the proposal, and may also be made to secured creditors in respect of any class15 Butnerv. US., 440 U.S. 48 (1979).16 BIAs. 2:“secured creditor” means a person holding a mortgage, hypothec, pledge, charge, lien orprivilege on or against the property of the debtor or any part thereof as security for a debt dueor accruing due to him from the debtor, or a person whose claim is based on, or secured by, anegotiable instrument held as collateral security and on which the debtor is only indirectly orsecondarily liable;CCAA s.2:“secured creditor” means a holder of a mortgage, hypothec, pledge, charge, lien or privilege onor against, or any assignment, cession or transfer of, all or any property of a debtor companyas security for indebtedness of the debtor company, or a holder of any bond of a debtorcompany secured by a mortgage, hypothec, pledge, charge, lien or privilege on or against, orany assignment, cession or transfer of, or a trust in respect of, all or any property of the debtorcompany, whether the holder or beneficiary is resident or domiciled within or outside Canada,and a trustee under any trust deed or other instrument securing any of those bonds shall bedeemed to be a secured creditor for all purposes of this Act except for the purpose of voting ata creditor’s meeting in respect of any of those bonds;“unsecured creditor” means any creditor of a company who is not a secured creditor, whetherresident or domiciled within or outside Canada, and a trustee for the holders of any unsecuredbonds issue under a trust deed or other instrument running in favour of the trustee shall bedeemed to be an unsecured creditor for all purposes of this Act except for the purpose ofvoting at a creditors’ meeting in respect of any of those bonds.83or classes of secured claim, subject to subsection (1.3). [Emphasis added]This subsection, if read in isolation, exhibits the vagueness of the 1898 U.S. Act. As the BIA doesnot defme “secured claim,” we must assume that it is a claim by a person whose security has beenproved and appropriately validated by the trustee. This subsection, furthenriore, does not recognize thepossibly bifurcated nature of a secured creditor’s claim and specifically does not place the unsecuredportion of the creditor’s claim within the body of general creditors. These problems are, to a certainextent, addressed in subsection 50.1(3) of the BIA that states:Where the proposed assessed value is less than the amount of the secured creditor’s claim, thesecured creditor may file with the trustee a proof of claim in the prescribed form, and mayvote as an unsecured creditor on all questions relating to the proposal in respect of an amountequal to the difference between the amount of the claim and the proposed assessed value.That subsection states that the secured creditor “may vote as an unsecured creditor,” whereas thesection prescribing the voting procedure specifies that “all unsecured claims constitute one class” andthat the proposal will be accepted only if “all classes of unsecured creditors” vote for its acceptance.’7The BIA provides that the secured creditors may vote as unsecured creditors (the inperonamdescription) for the shortfall amount but does not state that their shortfall claim would rank as anunsecured claim (the in rem description). Although one may argue that this is merely semanticdiscussion that has no practical consequence, in a proper case, it may prove to be problematic. Forexample, must unsecured creditors, simpliciter, or unsecured creditors and secured creditors voting asunsecured creditors accept the proposal?This problem is magnified by the CCAA which neither sets forth the detailed procedure of theBIA nor provides specifically for the bifurcation of an undersecured credito?s claim. In fact, thedecision in Re Northland Properties Ltd’8 questioned the notion of bifurcation under the CCAA, byholding that the same debt cannot give rise to separate classes.Despite the foregoing discussion, “secured creditor,” in this section, refers to a creditor having17 Emphasis, in both cases, added.18 (1988), 73 C.B.R. (N.S.) 166 (B.C.S.C.).84a valid security interest in an asset or assets of the debtor. This defmition applies to references underthe American or Canadian legislation.(b) Adequate ProtectionThe Code does not defme adequate protection although it refers to the concept in the sectionsdescribing an application for relief from an automatic stay,19 use, sale or lease of property of the estatewhen such property is subject to a lien in favour of a secured party2°and the obtaining of credit.21 Wemay garner an understanding of the concept from its objective, which is to ensure that the creditorreceives “essentially what he bargained for”22 unless of course, receipt of that benefit frustrates orseriously interferes with the purposes of the Code’s reorganization provisions. In the latter event, thecreditors will receive the benefit of the bargain by alternate means.23Section 361 sets forth the three means of providing adequate protection as follo:When adequate protection is required under section 362, 363, or 364 of this title of an interestof an entity in property, such adequate protection may be provided by -(1) requiring the trustee to make a cash payment or periodic cash payments tosuch entity, to the extent that the stay under section 362 of this title, use, sale, or leaseunder section 363 of this title, or any grant of a lien under section 364 of this titleresults in a decrease in the value of such entity’s interest in such property;(2) providing to such entity an additional or replacement lien to the extent thatsuch stay, use, sale, lease or grant results in a decrease in the value of such entity’sinterest in such property; or(3) granting such other relief, other than entitling such entity to compensationallowable under section 503(b)( 1) of this title as an administrative expense, as willresult in the realization by such entity of the indubitable equivalent of such entity’sinterest in such property.19 Code s. 362(d).20 Code s. 363(e).21 Code s. 364(d).22 House Report at 339.23Ibid.85These means are neither exclusive nor exhaustive.24 However, they are all intended to protect thecreditor’s interest in the property. With respect to secured creditors, the protection applies only to the“interest of an entity in property” and not to the amount of the debt or the value of the property, bothof which may be more or less than the interest in the property. This appears to be reasonable. Forexample, in the absence of the stay, the secured creditor could recover only the amount of the debt orthe value of the collateral, whichever is less.26 It follows then, that if the interest of the securedcreditor has no value, there is nothing to protect.27The Fifth Amendment that protects a creditor from being deprived of its property without dueprocess of law or just compensation28is the source of the concept of adequate protection. Adequateprotection seeks to address both of the issues raised by the Fifth Amendment. While acknowledgingthe constitutional basis of the concept, the legislative history indicates that public policy played asignificant role in the development of the concept and the drafting of section 361? The constitutionalbasis protects the rights of the creditors. Public policy, on the other hand, focuses primarily on debtorrehabilitation or reorganization by the preservation of businesses and employment, the continuation of24 House Report at 339.25 In re Alyucan Interstate Corp., 12 B.R 803 (Bankr. Utah 1981); In re Pine Lake VillageApartment Co., 19 B.R 819 (Bankr. S.D.N.Y. 1982).26 As to whether a component of the secured creditor’s bargain is compensation for lostopportunity cost has been the subject-matter of much debate. This topic will be examined infra notes49-77 and the accompanying text.27 See e.g. In re 620 Church Street Building Corp., 299 U.S. 24 (1936), which held that, if aparcel of land on which there are a number of mortgages has an appraised value of less than theamount of the first mortgage, the subordinate mortgagees have no interest in that property whichrequires adequate protection.28 Continental Illinois National Bank & Trust Co. v. Chicago, Rock Island & Pcrjfic Railway Co.,294 U.S. 648 (1935); Radford, supra note 2.29 House Report at 339.86credit3°and the protection of investment. It also protects macroeconomic interests by preservingessential and viable industries. The concept of adequate protection requires the courts in the UnitedStates to attempt to balance those interests.3’Negotiation and agreement on a method and procedure for providing adequate protection arethe most economical ways of dealing with it.32 One writer suggested that the requirement of adequateprotection should foster cooperation between the debtor and its creditors.33Once the creditor requests adequate protection of its interest, the onus is on the debtor or thetrustee to propose a method of adequately protecting the creditor. The debtor will propose a methodof adequate protection that will be acceptable to the creditor while minimizing the effect on its effortsto reorganize.34 If the secured creditor objects to the method of protection, the court detennines theadequacy of the protection. The court will not, in the first instance, suggest the method of protection,as this would place the court in an administrative role.3530 J.L. Smaha, “Automatic Stay Under the 1978 Bankruptcy Code: An Equitable Roadblock toSecured Creditor Relief’ (1980) 17 San Diego L. Rev. 1113 at 1123.31 See e.g., Radford supra note 2.32 U.S. Bankruptcy Rules s. 4001(d) prescribes a procedure for the approval by the court of asettlement agreement between the debtor and its creditors concerning adequate protection. Althoughthe U.S. Bankruptcy Rules do not mandate apriori approval, it has been held to be the preferredapproach [In re Blehm Land & Cattle Co., 859 F.2d 137 at 140 (10th Cir. 1988)1. Otherwise, thecreditor is at risk that the court will refuse to sanction the agreement postfcrto, as being inequitable orcontrary to the intent and purpose of the Code. U.S. Bankruptcy Rules s. 4001(d) seeks to preservethe due process rights of third party creditors who are entitled to notice of an application for approvalof such an agreement.A.N. Karlen, Adequate Protection Under the Bankruptcy Code, Its Role in BusinessReorganizations” (1982) 2 Pace L. Rev. 1 at 33 where he states:“Adequate protection may encourage a spirit of cooperation and negotiation between the debtorand its secured creditor, since it is to both parts advantage to confirm a plan to revitalize thedebtor’s business, and to provide adequate protection in the interim.”H R Miller and MR Bienenstock “Adequate Protection for Property in Bankruptcy” (1983)8:1 ALl-ABA Course Materials J. 31.House Report at 338.87Subsection 361(1), allowing periodic cash payments, and subsection 361(2), allowingadditional or replacement liens, compensate the creditor for the “decrease in the vdue of such entity cinterest in such property” [emphasis added], not an interest in specific collateral. Consequently, ifthere will be no decrease in the value of the interest, there is no entitlement to adequate protection.For example, periodic cash payments may be appropriate to compensate for depreciation of property ata relatively fixed rate.Similarly, an additional or replacement lien protects the creditor’s value in the originalproperty, should it decline during the pendency of the case. The additional or replacement lien givesthe secured creditor alternate or additional property upon which to realize the decreased value of thecollateral.37Most of the case law attempting to defme the concept of adequate protection deals with theextent of the protection necessary to result in the creditor realizing the “indubitable equivalent” of itsinterest in the collateral. Congress borrowed the concept of “indubitable equivalent” from thefrequently-quoted statement of Judge Learned Hand in In re Murel Holding Coiporation38where, indiscussing the power given to a judge to provide a creditor with adequate protection, he stated:li construing so vague a grant, we are to remember not only the underlying purposes of thesection, but the constitutional limitations to which it must conform. It is plain that “adequateprotection” must be completely compensatory; and that payment ten years hence is notgenerally the equivalent of payment now. Interest is indeed the common measure of thedifference, but a creditor who fears the safety of his principal will scarcely be content withthat; he wishes to get his money or at least the property. We see no reason to suppose that thestatute was intended to deprive him of that in the interest ofjunior holders, unless by a36 House Report at 339. See e.g, In e Bermec Coiporation, 445 F.2d 369 (2d Cir. 1971), whichoriginated the periodic cash payment method [Bkr-L Ed, Code Commentary and Analysis s. 15:5]. Inthat case, the debtor was in the business of leasing trucks and tractor-trailers. A number of securedcreditors provided fmancing on security of the vehicles and opposed the reorganization petition. Thecourt found that the secured creditors were adequately protected by the trustee’s proposal to pay the”‘economic depreciation’ on the secured creditor’s equipment so as approximately to preserve their statusquo” [at 3691.Ibid75 F.2d 941 (2d Cir. 1935) [hereinafter Mwel].88substitute of the niost indubitable equivalence.39The legislative history indicates that the concept of indubitable equivalence was a general categoryintended to provide the courts with the necessary flexibility to fashion “new methods of fmancing.”4°However, with a few exceptions, the protection awarded conforms to traditional methods of fmancingsuch as government mortgage guaranties,4’a combination of equity in the property, current paymentsand insurance coverage42 or curing defaults under a security agreement or lease and undertaking tomeet payments as they fall due or providing the creditor with a security deposit.43More novel however, is the use by the courts of an “equity” or “value” cushion as adequateprotection. As a secured creditor must be adequately protected for the value of its interest in thecollateral and not for the amount of the debt, when the amount of the debt is greater than the value ofits interest in the collateral, the secured creditor is “undersecured.” The amount of the debt thatexceeds the value of the secured creditor’s interest in the collateral should not be adequately protected.The debtor, in other words, has no “equity” in the collateral.Conversely, when the amount of the debt is less than the secured creditor’s interest in thecollateral, the secured creditor is “oversecured.” Accordingly, the full value of its interest in thecollateral should be adequately protected and the courts hold, in some cases, that the “equity cushion”provides sufficient adequate protection.”’Ibid at 942.40Ibid41 Pennsylvania State Employee’s Retirement Fund v. Roane, 14 B.R. 542 (Bankr. E.D. Pa. 1981);contmRe Heath, 9 B.R. 665 (Bankr. E.D. Pa. 1981).42 Re Rose, 21 B.R 272 (Bankr. D.C.N.J. 1982).Re Wdker, 3 B.R. 213 (Bankr. WE. Va. 1980).The first case to incorporate this concept was In re Blazon Flexible Flyer, Inc., 407 F.Supp.861 (D.C.N.D. Ohio 1976) [hereinafter Blazon]. In that case, debtor owed the secured creditorapproximately $1,340,000 for which it held security valued at $5,731,000. The secured creditor’sconcern was that by allowing the debtor to use the accounts receivable and inventory, which werevalued in aggregate at $3,700,000, its Fifth Amendment rights were being violated. The court held89Several writers are critical of the evolution of the equity cushion concept45 where the“collateral cusHon” is eroding through depreciation, accruing interest and costs, such as when thecourt holds the equity cushion in real estate to be adequate protection, without more.47 These writersdo not dismiss the notion of an equity cushion as a component of adequate protection in a proper case,so long as the debtor provides the creditor with additional forms of adequate protection, such asperiodic payments or replacement liens. One form of adequate protection that they suggest isthat in view of the value of the assets of the debtor and the amount owed to the secured creditor, thesecured creditor’s interests were adequately protected [at 864-865]. There were four factors that mustbe noted with respect to this case:1. the amount owed to the secured creditor s approximately 23% of the value of thecollateral;2. there would be no detrimental effect on the security of the secured creditor as long as theaccounts receivable and inventory were maintained at a level sufficiently in excess of thesecured interest of the secured creditor;3. the court ordered the debtor to provide fmancial reporting to it and to the secured creditoron a regular basis; and4. the court allowed revision of its orders to be made on short notice in light of any changesin circumstance which would be detrimental to the secured creditor [Ibid 1.In other words, the court required, in addition to the equity cushion, regular reporting and maintenanceof the equity cushion.J. McCafferty, “‘Value Cushion’ Reexamined: A Critical Review of Value Cushion as AdequateProtection in Chapter 11 Real Estate Cases” (1984) 89 Comm. L.J. 31; E.D. Flaschen, “AdequateProtection for Oversecured Creditors” (1987) 61 Am. Bankr. L.J. 341; J.L. Fellows, “In re AlyucanInterstate Corporation: Determining Adequate Protection in Actions for Relief From the AutomaticStay” (1982) Utah L. Rev. 393.Flaschen, ibid at 348 defines “collateral cushion” as the amount by which the value of thecollateral exceeds the amount loaned by an asset-based lender.‘ McCafferty, note 45 at 33. See e.g in i Mellor, 734 F.2d 1396 (9th Cir. 1984) where the courtheld that an equity cushion of approximately 2O% was sufficient adequate protection. These types ofcases prompted McCafferty to state:“[the equity cushion as adequate protection] has now been applied to frustrate completely therights of creditors secured by sluggishly illiquid real property in the hands of speculators,where the margins of value in excess of liens have been so narrowed as to make the Blazonfinancing arrangement look like the best loan Citicorp ever made!” [at 32].90providing the oversecured creditor with compensation for iost opportunity cost.48 Although suchcompensation usually concerns undersecured creditors,49 secured creditors that are provided adequateprotection by the equity cushion alone, with no current interest being paid, will also seek thatcompensation.Opportunity cost is defmed as the loss incuiTed by a secured creditor by not being permitted toforeclose its lien, sell the collateral and reinvest the proceeds.5° Subsection 506(b) of the Codeprovides:To the extent that an allowed secured claim is secured by property the value of which, afterany recovery under subsection (c) of this section, is greater than the cimowit of such claim,there shall be allowed to the holder of such claim, interest on such claim, and any reasonablefees, costs, or charges providedfor under the agreement under which such claim arose.[Emphasis added]While subsection 506(b) allows an oversecured creditor to recover postpetition interest, fees and coststo the extent of the value of the collateral exceeding the amount of its secured claim, it still loses thetime value of those amounts and thereby suffers a loss. An award of periodic payments to cover itsopportunity cost51 would fully compensate the secured creditor in such circumstances. However, whileit may be arguable that compensation for opportunity cost,52 should be awarded to an oversecuredcreditor, there is no statutory authority for awarding it to an undersecured creditor.53Compensation for opportunity cost has more importance to undersecured creditors. Unlike anoversecured creditor which may recover postpetition interest, fees and costs from the value of the48 Flaschen, supra note 45 at 353; McCafferty, supra note 45 at 35.Defmed, supra note 9 and accompanying text.° In re Timbery of Inwood Forest Associates Ltd. 793 F.2d 1380 at 1382 (5th Cir. 1986), afi’d484 U.S. 365, 98 L Ed 740 [hereinafter Timbers, cited to L Ed].51 Flaschen, supra note 45 at 354.52 A secured creditor would be well-advised to include a provision in its security agreement forlost opportunity cost to at least allow the argument to be made that such cost was contemplated by theagreement.Timbers, supra note 50.91collateral that exceeds its claim, the Code has no provision entitling an undersecured creditor to suchamounts. Before the decision in Timbers, there was some uncertainty as to an undersecured creditor’sentitlement to compensation for its opportunity cost.54To understand the uncertainty, we must refer to Judge Learned Hand’s notion that adequateprotection should be “completely compensatory” and that “payment ten years hence is not generaliythe equivalent of payment now.”55 Many Bankruptcy and District Courts in the early 1980s held thatthe right of a secured creditor to repossess, sell and reinvest the proceeds is a valuable right worthy ofprotection and, following Judge Hand’s opinion in Murel, awarded compensation for the present valueof that right.56 Tn 1984, the court in In re American Mc,inerIndustries Inc.57 upheld this position.The court held that the central issue in the case was not to determine how to provide adequateprotection but whether58 the value of the collateral or the present value of the interest of theundersecured creditor in the collateral is an interest that must be protected. It was then necessary todetermine the nature of that interest. While the court acknowledged that neither the legislative historynor the Code expressly mentioned protection of the secured creditor’s right to foreclose, sell andreinvest the proceeds of sale of the collateral, it held that, “[u]nquestionably, however, these arevaluable rights of secured creditors, and nothing in the reports suggests that they are not among thoseImmediately following the decision in Timbers’, numerous law review articles praised theSupreme Court’s decision as being strictly in accordance with statutory interpretation and providedundersecured creditors with strategies to assist them in coping or circumventing the Timbers’ decision.These articles pointed to the possible narrowness of the decision and criticized previous decisions thatwere contrary to the approach in the Timbers’ case as being ill-conceived. If the Timbers’ decision wasso obviously correct, one wonders why there was any uncertainty in the first place.See supra note 39 and accompanying text.In re Anchorage Boat Sales, Inc., 4 B.R. 635 (Bankr. E.D.N.Y. 1980); In ir Viiginia FounthyCo. Inc., 9 B.R493 (D.C.W.D. Va. 1981); Metmpolitan Life Insurance Co. v. Monme Park, 17 B.R934 (D.C.D. Del. 1982).734 F.2d 426 (9th Cir. 1984) [hereinafter American Mariner].58 Ibid at 430.92equitable and legal interests entitled to protection.”59 The court therefore concluded that opportunitycost was an interest that required protection for the secured creditor to realize the benefit of itsbargain.60 The court acknowledged that it was being “guided by equitable principles.”61 It held thatthe award was consistent with Judge Hand’s wording that Congress adopted in enacting section361(3),62 which “at least encourages if not requires a present value analysis.”63 The courtacknowledged several times that it was standing on less than firm ground. However, from a purepublic policy perspective, the decision is defensible.M The policy underlying the decision is obviousfrom the following:To the extent that the debtor in bankruptcy can prevent the secured creditor from enforcing itsrights against collateral while the debtor benefits from the creditor’s money, the debtor and hisunsecured creditors receive a windfall at the expense of the secured creditor.65Meanwhile, Bankruptcy Courts in a number of other circuits concluded that neither Murel norIbid at431.60 House Report at 339.61 American Mcriner, supra note 57 at 432.62 Ibid at 434.63 Ibid at 432.64 See, infra notes 69-76 and accompanying text.65 American Mariner, supra note 57 at 435. The Fourth Circuit Court of Appeals followed theAmerican Mariner reasoning in Gnmdy National Bank v. Tandem Mining Corporation, 754 F.2d 1436(4th Cir. 1985). The Eighth Circuit Court of Appeals in In re Briggs Transportation Co., 780 F.2d1339 (8th Cir. 1985), also accepted that in an appropriate case, interest payments for the delay inforeclosing, liquithting and reinvesting the proceeds may be awarded but refused to “hold as a matterof law that a creditor is always entitled to ‘such compensation’ .“ [at 13501. The result of this case,while recognizing compensation for lost opportunity cost, was to require each court to examine on acase by case basis whether such interest is worthy of such protection. This approach would haveresulted in considerable litigation and lack of predictability and accordingly, it was widely criticized.See e.g, Note, “Adequate Protection’ and the Availability of Postpetition Interest to UndersecuredCreditors in Bankruptcy” (1987) 100 Harv. L. Rev. 1106 at 1120.93the Code intended to protect the foreclosure, liquidation and reinvestment interest and thereforerefused to require compensation for loss of that “right.” This position ultimately prevailed. In acarefully reasoned decision, Mr. Justice Scalia, who wrote for a unanimous court in Timbers, deniedthe undersecured creditor compensation for its opportunity cost. The decision is an exercise instatutory interpretation and is therefore of limited value for our purposes.67The court did not accept any of the equitable arguments put forth by the creditor. It issubmitted that it could not accept those arguments as the Code, when read as a whole, presented thecourt with no ambiguity.68Given the care that Justice Scalia used in drafting his decision and his logical approach, it isdifficult to challenge the soundness of the decision and the law review articles bear witness to thatfact. However, the articles do not give credit to the soundness of the public policy concerns thatAmerican Mariner and subsequent decisions adopting that approach were attempting to address. Indiscussing an opinion that supported the public policy ofAmerican Mariner and was “notable for itsmisconceptions,” one author wrote that the judge”... was apparently unaware or chose to ignore thefact that the bankruptcy laws are designed specifically to help debtors “69 Another author,referring to the fact that awarding compensation for opportunity cost would have adverse consequencesSee e.g., In re Pine Lake Village Apartment Co., supra note 25; In re Alyucan Interstate Coip.,supra note 25; In re South Village, Inc. 25 B.R. 987 (Bankr. D. Utah 1982). As the conclusionsreached by these courts accord with the decision of the United States Supreme Court in Timbers, adiscussion of the reasoning in these cases will not be undertaken..67 For example, the court held that section 506(b) allows postpetition interest to oversecuredcreditors only and not to undersecured creditors. As to oversecured creditors, they are only entitled topostpetition interest to the extent of the value of the collateral. Undersecured creditors as to theunsecured portions of their claims, must share the benefits and losses of a business reorganization withother unsecured creditors. They should not be given the benefit of interest on their secured claimsbefore unsecured creditors receive any principal payments. Furthermore, section 502(b) of the Codeprohibits the payment of unmatured interest.Timbers, siqIv note 50.T.T. Shepard ifi “The Plight of Secured Creditors After In re Timbers of Inwood ForestAssociates, Ltd.” (1989) Comm. L.J. 26 at 39.94on corporate reorganizations and would result in more liquidations said “accordingly, grantingundersecured creditors lost opportunity costs would be poor public policy.”70While decision in Timberc is sound, based on the wording of the Code, awardingcompensation for opportunity cost is not necessarily poor public policy, for the reasons set forth by thecourt in American Mariner.71 Bankruptcy law is not designed exclusively for debtors or unsecuredcreditors. It seeks to balance the interests of all parties in interest. Is it poor public policy to allow asecured creditor the benefit of its bargain, which is finite (ie. a secured creditor can only recover, atmost; its principal, interest and costs) while allowing the parties that have the most to gain from areorganization and the least to lose from its failure, to use part of the assets upon which the securedcreditor based its bargain? Several authors eqressed the concern that Timbers would result in securedcreditors requiring increased marglns or alternatively, higher borrowing costs which could result infewer out of court settlements and increased bankruptcies7 One wonders if this is sound publicpolicy.As the courts are moving away from fully compensatory adequate protection, several writershave suggested that creditors will be moving more quickly to seek relief from the automatic stay ofproceedings and requiring the debtor to show that it has a reasonable possibility of successfullyreorganizing within a reasonable time.73 The result will be dismissal of the case or conversion toliquidation cases at an earlier stage in the proceedings.74 It appears, therefore, that American° C.J. Cuevas “Lost Compensation Costs and the Undersecured Creditor: A Journey Into theInwood Forest” (1988) 33 N.Y.L. School Rev. 1 at 40.71 Supra note 57.P. Mable “The Resolution: United States v. Timbers of Jnwood Forest Associates” (1989-90) 41Ala. L. Rev. 503 at 522; J.U. Schorer “The Right of the Undersecured Creditor to Postpetition Interestin Bankruptcy on the Value of its Collateral: Implications of Recent Cases” (1988) 21 U.C.C.L.J. 61at 70.Timbe,, supra note 50 at 751.P.R Scanlon “Adequate Protection and Secured Creditors’ Strategies After Timbers” (1989-90)Miss. Coll. L. Rev. 59 at 76.95jurisprudence is moving toward the CCAA approach of questioning the feasibility of reorganization atthe outset of the proceeding and forcing the court to look at the debtor’s chances of success rather thanthe creditor’s right to protection Unfortunately, there have been few reported cases that test thishypothesis.75 As one writer noted, “[flew undersecured creditors waste time filing early motions forstay relief, and few bankruptcy courts are willing to write extensive opinions on a matter that has beenclearly decided against the creditor’s position”76To avoid the risk of leaving the reader with the idea that the concept of adequate protection isillusory, it may be useful to summarize the concept. The court must grant adequate protection to acreditor on the creditor’s request or when the Code requires it. Adequate protection protects thecreditor from a decrease in the value of its collateral and it may assure the creditor that it willultimately receive the value of its collateral at the dismissal or conclusion of the case. It also requiresthe debtor to maintain the property and not to expose the property to noncompensable loss through alack of insurance. Finally, it is arguable that adequate protection would protect the “collateralcushion” or lending margin of an oversecured creditor.However, it does not protect an undersecured creditor for its opportunity cost and, to thatextent, it is not completely compensatory, as it deprives the undersecured creditor of the right toforeclose, sell and reinvest the proceeds, which is the “essence of secured lending.”2. Natme of the Stay of PioceedingsThe BIA and the Code impose an automatic stay of proceedings upon the commencement ofThe reported cases to date merely confirm Timbei. See e.g., In r Reddington/SwaiwwLimited Pciflne,s’h4, 119 B.R. 809 (Bankr. D.NM 1990).76 Shepard, supra note 69 at 43.L.R Molbert “Adequate Protection for the Undersecured Creditor in a Chapter 11Reorganization: Compensation for the Delay in Enforcing Foreclosure Rights” (1984) 60 N. Dakota L.Rev. 515 at 517.96business reorganization proceedings.78 The BIA imposes the stay upon the filing of the notice ofintention to file a proposal or the proposal itself. Under the Code, the filing of a petition underChapter 11 results in the commencement of the stay. Unlike the BIA and the Code, a stay ofproceedings under the CCAA is not automatic. It is a discretionary remedy79 granted by the court onapplication.80 In keeping with the philosophy that a business reorganization will be beneficial to allcreditors, the CCAA allows “any person interested in the matter’ to make the application, althoughusually it will be the debtor who seeks the stay. In considering whether to grant a stay of proceedingsunder the CCAA, the current trend is for the courts to examine the bonafides exhibited by the debtorand the feasibility of a successful reorganization, from the perspective of the creditors and from aneconomic perspective.8’ The analysis conducted by the courts in these cases is not unlike the analysisconducted by United States courts when considering whether to grant a secured creditor relief from theautomatic stay imposed by the Code.The former Canadian Act contained no provision for automatically staying the rights ofsecured creditors upon the filing of a proposal. This severely restricted the use of the proposalprovisions contained in the fonner Canadian Act. Until the revitalization of use of the CCAA in theearly 1980s, this limitation resulted in there being no effective method under which to structure abusiness reorganization in Canada. The imposition of the automatic stay under the BIA is perhapsthe most serious intrusion of the amendments into the rights of secured creditors.78 Code s. 362(a); BIA s. 69 and 69.1.Non’hlarzdPmperties Limitedv. Guardian T,ust Co. (1989), 73 C.B.R. (N.S.) 163 (B.C.C.A.).80 CCAAs. 11.e.g., Re Philip’s Manufacturing Ltd (1992), 9 C.B.R. (3d) 25 (B.C.C.A.), leave to appealdenied (1993), 15 C.B.R. (3d) 57 (S.C.C.) [hereinafter Philzp’s]; Ba,gain Haivid’s Discount Ltd v.Paribas Bank of Canada (1992), 10 C.B.R (3d) 23 (Ont. Gen. Div.) [hereinafter Bargain Harold’s].82 See discussion, chapter V(A)(4)(b), below.83 BIA ss. 69(b) and 69.1(b).97The specific policies addressed by the stay of proceedings are common to the statutes beinganalyzed. However, the broader purposes of the legislation are reflected in the American version ofthe automatic stay, which seeks to attain the public policy objective of balancing the interests ofdebtors and creditors.85 This broader perspective requires the American courts to determine whetherthe stay is beneficial to all those concerned.The Canadian courts, in considering the stay provisions of the CCAA, focus on the rights ofthe debtor only and the public policies involved in a reorganization proceeding, which usually resultsin the balance tipping in favour of the debtor. Furthermore, neither the CCAA nor the BIA containthe significant provisions of the Code that seek to protect creditors during the business reorganizationproceeding. In the CCAA cases, this has led to an imposition of the stay with no provision for interimprotection other than in some cases, the appointment of a monitor, or a complete dismissal of thecase.87Smaha, siq’ra note 30 at 1116.85 MA. Frey, W.L. McConnico and P.R Frey, An Introduction to Bankruptcy Law (St. Paul:West, 1990) at 16.86 It is acknowledged that this generalized proposition does not take into account a number ofother factors that the judiciary considers in an application by a secured creditor for relief from thestay. One such factor may be the relative shortness of time to complete a CCAA proceeding ascompared to a Chapter 11 proceeding. However, in the case involving Quintette Coal Limited, thecourt granted the debtor a period of six months within which to effect a plan of arrangement. Whilethe stay period may not appear inordinate, it must be remembered that the companies seeking relieffrom the stay were owed in excess of $36,000,000. It is submitted that a six month stay with noprotection of the claims of the creditors could hardly be considered equitable from the creditors’ pointof view.87 The Quebec Superior Court hinted at the possibility of “carving out” a secured creditor whichconsidered its security to be in jeopardy. M le juge Gervais in the case of Tcrhé Construction Ltée.v. Banque Lloyds du Canada (1991), 5 C.B.R (3d) 151 at 162, stated:“L’intervenante n’a démontré a la Cour que ladite machinerie était plus en danger maintenantqti’auparavant et, tout comme lea garanties de l’intervenante, la Banque Lloyds, celles de laBanque nationale du Canada doivent demeureur en suspens durant le moratoire.”[headnote translation, at 152:“As for the creditor who held securities on the machinery, it did not establish that themachinery was now in greater danger than it had been before. Its securities, like that of the98The Colter Committee Report88 suggested a means of staying proceedings by secured creditorsthat recognized their need to be adequately protected while the debtor considered whether areorganization was feasible. The recommendations allowed the secured creditor to collect accountsreceivable, sell rapidly depreciating or perishable property, cany on the business of the debtor, solicitbut not accept offers to purchase the collateral and take possession of but not remove property. Inaddition, the recommendations gave the courts a wide discretion to determine whether to lift the stayagainst the applicant secured creditor, based on whether the creditor was “adequately secured.”Although the BIA incorporated the recommendation of imposing the stay against secured creditors, itgave secured creditors none of the rights, other than to apply to the court to seek relief from the stayon the grounds that the secured creditor is “materially prejudiced” or on other grounds.9°Prior to the enactment of the Code, the policymakers recognized that the stay provisions underthe 1898 U.S. Act and the rules promulgated thereunder were inadequate from the perspectives of thedebtor, who required the protection of the stay, and the creditor against whom the stay applied andwho needed relief from the stay when the collateral was deteriorating in value.9’ The followingfrequently-cited excerpt from the House Report reflects the rationale and objectives of the automaticstay provisions of the Code:The automatic stay is one of the fundamental debtor protections provided by the bankruptcylaws. It gives the debtor a breathing spell from his creditors. It stops all collection efforts, allharassment, and all foreclosure actions. It permits the debtor to attempt a repayment orreorganization plan, or simply to be relieved of the fmancial pressures that drove him intoprincipal creditor, should remain on hold during the moratorium.”]Had the secured creditor been in a position to show that it was in greater danger, the court may havebeen willing to allow the creditor to have the stay lifted against it alone and allow it to realize on themachinery.Colter Committee Report at 56.Ibid at 57.9° BIA s. 69.4.9° House Report at 174.99bankruptcy.The automatic stay also provides creditor protection. Without it, certain creditors could pursuetheir own remedies against the debtor’s property. Those who acted first would obtain paymentof the claims in preference to and to the detriment of other creditors. Bankruptcy is designedto provide an orderly liquidation procedure under which all creditors are treated equally. Arace of diligence by creditors for the debtor’s assets prevents that.92The foregoing policy statement reflects the culmination of the evolution of the concept of the stay ofproceedings93 since the passage of section 77B.Canadian courts, in describing the purpose of the stay provisions in the CCAA, use similarlanguage. The courts describe the purpose as being to maintain the status quo for a period while thedebtor attempts to gain the approval of its creditors for a proposed arrangement that will enable thedebtor to remain in operation for the future benefit and well-being of the debtor and its creditors.94The courts see the stay as a mechanism for “holding the creditors at bay”95 until the compromise orarrangement is approved by the court and the creditors or it is obvious that the attempt is “doomed tofailure.” For policy reasons that tend to favour the debtor, the courts are inclined to allow the debtorthe opportunity to attempt a reorganization, even in circumstances where secured creditors have madeit clear that they will not sanction a plan under any circumstances. The basis on which the courts holdthat the stay should remain in place is that it is possible that the debtor could formulate some type ofplan that would see the secured creditor paid out in full. The creditor would clearly accept this typeHouse Report at 340.See e.g. In re Maler Brewing Co., 38 F.Supp. 806 at 817 (S.D. Cal. 1941).Meridian Developments Inc. v. Toronto Dominion Bank (1984), 52 C.B.R (N.S.) 109 (Alta.Q.B.) [hereinafter Meridian]; Re Non’hla.ndPmperties Ltd (1988), 73 C.B.R. (N.S.) 146 (B.C.S.C.).Hongkong Bank of Canada v. ChefRecidy Foods Ltd (1991), 4 C.B.R (3d) 311 at 315(B.C.C.A.) [hereinafter ChefReady].Ibid.100of plan.97 That is, the courts seem to grant the stay based on the “interest of the public in thecontinuation of the enterprise,”98 such as by the number of people that the business employs or thenature or necessity of the commodities or services supplied by the enterprise.This structure of the CCAA requires the courts to take this type of approach. The initialapplication under the CCAA must seek an order for a meeting of creditors, shareholders or both.’°° Itdoes not give any direction concerning the proceedings or substance of the meeting but we mayassume that the purpose of the meeting is to consider the plan of compromise or arrangement. Section11 allows the court to grant a stay of proceedings “whenever an application has been made under” theCCAA. The only application that the debtor can make is the initial application seeldng an order for ameeting. In this manner, the court must consider some of the merits of the case when agreeing togrant the stay.10’ Given the limited information provided to the court at that stage by the applicant, thefact that most initial applications are ex porte and faced with the general objectives of the CCAA, thecourts seem to rely on the general policy and objectives of the CCAA in granting the stay. The courtshave been reluctant to “carve out” certain creditors and allow them to realize on their security.’02 ThisSee e.g., Timber Lodge Ltd v. Timber Lodge Ltd (Creditors of) (1992), 15 C.B.R. (3d) 244 at252 (P.E.I.S.C.) [hereinafter Timber Lodge]; Icor Oil & Gas Ltd v. Cancdiaii Imperial Bank ofCommerce (No. 1) (1990), 102 A.R. 161 (Alta. Q.B.) [hereinafter Icon; contra; Elan Coiporation v.Cominskey (Trustee of) (1990), 1 C.B.R. (3d) 101 (Ont. C.A.) [hereinafter Elan]; Baigain Harold’s,supra note 81.98 S.E. Edwards, “Reorganizations Under the Companies’ Creditors Arrangement Act” (1947) 25Can. Bar Rev. 587 at 593.Ibid However, one case denied an application for a stay on the basis that the public did nothave an interest in the continuation of the enterprise [Re Unsel Investments Ltd (1991), 2 C.B.R. (3d)260 at 279 (Sask. Q.B.), rev’d on other grounds (1992), 10 C.B.R. (3d) 61 (Sask. C.A.)J. This caseappears to be an anomaly however, and is not indicative of the general trend.100 CCAAss.4and5.101 It is therefore more appropriate to discuss the exercise of the court’s discretion in the contextof a creditor seeking relief from the stay. See discussion, chapter V(AX4)(b), below.102 Quintette Coal Ltd v. Nzpon Steel Coip. (1991), 2 C.B.R. (3d) 291 at 297 (B.C.S.C.)[hereinafter Quintette].101has resulted in applications to lift the stay entirely and to have the CCAA proceedings vacated. Thisapproach clearly favours the debtor, as the only alternative to reorganization is liquidation, which iscontrary to the intent of the legislation. This situation has prompted one writer to note, “[tjhis createsa heavy onus on the creditor seeking to vary stay orders or oppose the reorganization and technicalarguments are rarely likely to succeed in the face of ‘economic reality’ - the ends will invariably justifythe nans.”°3In the United States, on the other hand, the stay is automatic, which obviates the necessity ofjustifying the stay. The courts first face the issue of the necessity of the automatic stay on anapplication by a disgruntled creditor to have the stay lifted. The Code gives the court some directionconcerning alternate remedies that it may grant on such an application. Specifically, the court may“carve out” a creditor’s interest on proof of certain facts or may provide “adequate protection”°4to acreditor. As the court need not deprive the debtor of the opportunity to reorganize and as the securedcreditor will be entitled to have its interest “adequately protected,” the court balances the interests ofthe debtor and the secured creditor in determining whether to lift or continue the stay.Adequate protection may take a number of fomis.’°5 Canadian legislation does not give thecourts authority to grant adequate protection and accordingly, they have simply denied securedcreditors the ability to realize on their security, without providing any interim protection orcompensation for loss during the stay period.’06In summary, although the specific objectives of the stay of proceedings are common to all of103 MA. Fitch, “The Reorganization of Quintette Coal Limited: An Unsecured Creditor’sPerspective” in Insolvency Institute of Cancda SecondAnnual Meeting and Conference Materials,October 20-22, 1991, Horseshoe Valley Inn, Orillia, Ontario 99 at 107.104 Code s. 362(d)-(g).‘° See discussion, chapter V(A)(1)(b), below.106 e.g., Re Phil4is Manufirturing Ltd (1992), 12 C.B.R (3d) 133 at 138 (B.C.S.C.), wherethe court denied payment to a secured creditor of interest during the period of the stay as it would be“unfair” to “prefer” the bank as to interest when no other creditor will receive it.102the statutory schemes, the statutory schemes have detennined, to a great extent, the way in which thestay will operate. The courts, in considering the CCAA, with its “all or nothing” approach to the staylook favourably at allowing the debtor the opportunity to reorganize. Unless the plan is “doomed tofailure,” the courts allow the debtor time within which to formulate the plan. The creditor has theonus of showing why the court should not grant the order.’°7 The courts in the United States, on theother hand, look at whether the creditor’s interests are protected..’°8 Other than with respect to the issueas to whether the debtor has any equity in the property, the debtor has the burden of proof on all otherissues.109Although the structure of the BIA allows the courts to consider relief from the stay on acreditor by creditor basis, the wording of section 69.4110 appears to place the burden of proof on thecreditor seeking relief. That section provides:A creditor who is affected by the operation of sections 69 and 69.3 may apply to the court fora declaration that those sections no longer operate in respect of that creditor, and the courtmay make such declaration, subject to any qualifications that the court considers proper, if it issatisfied(a) that the creditor is likely to be materially prejudiced by the continued operationof those sections; or(b) that is is equitable on other grounds to make such declaration.With no statutory mechanism for providing secured creditors with interim protection, this sectionplaces a burdensome onus on the creditors. The courts, in considering cases under the CCAA, choosenot to exercise their equitable jurisdiction to allow such interim relief or protection and, in fact, refuseto allow it.” It is open to the courts, in considering cases under the BIA, to exercise their specific107 Baigain Harold’s, supra note 81 at 30.108 Code s. 362(d).‘ Code s. 362(g).‘o BIA s. 69.4.111 Quintette, supra note 102. See also Re Alberta-Pxflc Tenninals Ltd (1991), 8 C.B.R. (3d)99 (B.C.S.C.), where the court denied paents to a creditor pursuant to operating agreementsnotwithstanding continued use of the secured property by the debtor.103equitable jurisdiction”2and grant interim protection to secured creditors.3. Scope of the Stay of PmceedingsSection 362(a) of the Code defmes the scope of the automatic stay.’13 The legislative historyintended the scope of the stay to be broad and to encompass not only judicial proceedings, but alsoarbitration, license revocation and administrative proceedings against the debtor, as well as civil112 BIA ss. 183(1) and (2); Re Gold (1927), 8 C.B.R. 39 (Ont. S.C.); Re Heron (1933), 15C.B.R. 39 (Ont. S.C.).113 Code, s. 362 (a):(a) Except as provided in subsection (b) of this section, a petition filed under section 301,302, or 303 of this title, or an application filed under section 5(a)(3) of the Securities InvestorProtection Act of 1070 (15 USC 78eee(a)(3)0, operates as a stay, applicable to all entities, of -(1) the commencement or continuation, including the issuance or emploent ofprocess, of a judicial, administrative, or other action or proceeding against the debtorthat was or could have been commenced before the commencement of the case underthis title, or to recover a claim against the debtor that arose before the commencementof the case under this title;(2) the enforcement, against the debtor or against property of the estate, of ajudgment obtained before the commencement of the case under this title;(3) any act to obtain possession of property of the estate or of property from theestate or to exercise control over property of the estate;(4) any act to create, perfect, or enforce any lien against property of the estate;(5) any act to create, perfect, or enforce against property of the debtor any lien tothe extent that such lien secures a claim that arose before the commencement of thecase under this title;(6) any act to collect, assess, or recover a claim against the debtor that arosebefore the commencement of the case under this title;(7) the setoff of any debt owing to the debtor that arose before the commencementof the case under this title against any claim against the debtor; and(8) the commencement or continuation of a proceeding before the United StatesTax Court concerning the debtor.104actions and all proceedings even if they are not before governmental tribunals.’14 The stay also enjoinsa secured creditor holding a security interest under article 9 of the Uniform Commercial Code fromrepossessing its collateral by self-help or judicial process.115 To appreciate the extent of the stay, oneonly need review the definition of the term “entities,”6to which the automatic stay is applicable. Anentity includes, inter dia a governmental unit and a person, which in turn, is defined”7as includingan individual, partnership and corporation. Although neither section 362(a) nor the definitions of“entity” or “person,” refer to creditors and specifically, secured creditors, section 362(a) is clearlyapplicable to secured creditors. We should also note that a “claim against the debtor” includes a claimagainst the debtor’s property”8and section 541 comprehensively defines “property of the estate.”The scope of the stay of proceedings that a court may order pursuant to section 11 of theCCAA is not as comprehensive as section 362(a) of the Code. Section 11 provides:Notwithstanding anything in the Bankniptcy and Insolvency Act or the Winding-up A ctwhenever an application has been made under this Act in respect of any company, the court,on the application of any person interested in the matter, may, on notice to any other person orwithout notice as it may see fit,(a) make an order staying, until such time as the court may prescribe or until anyfurther order, all proceedings taken or that might be taken in respect of the companyunder the Bankniptcy and Insolvency Act and the Winding-up Act or either of them;(b) restrain further proceedings in any action, suit or proceeding against thecompany on such terms as the court sees fit; and(c) make an order that no suit, action or other proceeding shall be proceeded withor commenced against the company except with the leave of the court and subject tosuch terms as the court imposes.Should a court choose not to make a comprehensive order incorporating subsections (a), (b) and (c),114 House Report at 340.115 RL. Jordan and W.D. Warren, Bankruptcy (Mineola: Founthtion Press, 1985) at 754; Code s.362(aX3).116 Code s. 101(15).117 Code s. 101(41).118 Code s. 102(2).105the extent of the stay will be limited accordingly. Two early CCAA cases serve to illustrate thisproposition. In Re Arthur Flint Company Limited,”9the court considered a provision in an order thatstayed all actions by unsecured creditors and a further order that stayed proceedings for the recoveryof debts. The court held that proceedings under the former Canadian Act were not proceedings for therecovery of debts. In allowing a petition under the former Canadian Act to stand, the court noted thatthe stay order did not correspond to the wording of the CCAA that allowed the staying of proceedingsunder the former Canadian ActGray v. Wentworth Canning Company Limited’2°further illustrates the strict interpretation of aprovision in a stay order. In that case, the court held that a provision in an order restrainingproceedings that may “be taken” against the debtor prohibited only future actions, suits or proceedingsagainst the debtor and that preexisting proceedings may continue.12’ Because ofArthur Flint andWeniworth Canning, orders under the CCAA incorporate the language of section 11, enjoining thecommencement or continuation of all present and future suits, actions and proceedings against thedebtor, including proceedings under the BIA and the Winding-up Act.’22 The courts have upheld thesebroad provisions.’23119 (1944), 25 C.B.R 156 (Ont. S.C.) [hereinafter Arthur Flint].120 (1950), 31 C.B.R. 182 (Man. KB.) [hereinafter Weniworth Canning].121 Ibid at 185.122 FR. Foran and T.M Warner, ‘Reorganizing the hisolvent Oil and Gas Corporation: TheCourts and Fairness” (1990) 28 Alta. L. Rev. 132 at 143. See e.g., the stay order in the Quintette CoalLimited case which read as follows:AND THIS COURT ORDERS that all proceedings taken or that might be taken in respect ofthe Petitioner under the Bankruptcy Act and the Winding-up Act or either of them be stayed;AND THIS COURT ORDERS that any further proceeding in any action, suit or proceedingagainst the Petitioner be restrained;AND IF11S COURT ORDERS that no suit, action or other proceeding shall be proceeded withor commenced against the Petitioner;123 See e.g., Quintette Cod Limited v. Nippon Steel Corp. (1991), 2 C.B.R. (3d) 303 (B.C.C.A.).106The term “proceeding” determines the breadth of the stay. While it may be difficult to arguethat an “action” or “suit” contemplates something other than a judicial proceeding, the term“proceeding” was the subject-matter of discussion in some of the earlier cases. The court inWentwon’h Canning, gave the term a very narrow meaning. Using ejusdem generis, Kelly J. held thatthe word “suit” governs the word “proceeding” and accordingly, the stay enjoins only proceedingsinstituted in a court)24 Such a narrow interpretation would not prevent extra-judicial proceedings suchas self-help remedies (where they are available under provincial law) or realizing on assigned orpledged property.An early case that saw the revitalization of the CCAA rejected this narrow approach. InMeridian,’25Wachowich J. gave section 11 a wide interpretation to accommodate the purposes of theCCAA. Specifically, His Lordship refused to restrict the term “proceedings” to those involving a courtor a court official. The courts have embraced this broad approach to abrogate the rights of securedcreditors, for example, to foreclose on a real property mortgage,’26 realize on security granted pursuantto section 427 (formerly section 178) of the Bank Act’27 and notify third party lessees pursuant to anassignment of rents given to the secured creditor.’28 The overriding principle, it seems, is that ifrealization on the security, regardless of its nature, prejudices the opportunity of the debtor to attempta reorganization of its fmancial or business affairs, the court will enjoin the secured creditor fromrealizing on its security.The stay provisions of the BIA are broad and appear to encompass most realizationproceedings that a secured creditor could take. For example, subsection 69(1) provides:124 Wentworth Canning supra note 120 at 185.125 Meridian, supra note 94.126 Re Non’hlandPropeilies Limited (1989), 73 C.B.R. (N.S.) 141 (B.C.S.C.).127 S.C. 1991, c. 46 [hereinafter Bank Act]; ChefRecdy, supra note 95.128 Timber Lodge, siqra note 97.107Subject to subsections (2) and (3) and sections 69.4 and 69.5 on the filing of a notice ofintention under section 50.4 by an insolvent person,(a) no creditor has any remedy against the insolvent person or the insolventperson’s property, or shall commence or continue any action, execution or otherproceedings, for the recovery of a claim provable in bankruptcy,(b) no provision of a security agreement between the insolvent person and asecured creditor that provides, in substance, that on(i) the insolvent person’s insolvency,(ii) the default by the insolvent person of an obligation under the securityagreement, or(iii) the filing by the insolvent person of a notice of intention under section50.4,the insolvent person ceases to have such rights to use or deal with assets secured underthe agreement as he would otherwise have, has any force or effect, and(c) Her Majesty in right of Canada may not exercise her rights under subsection224(1.2) of the Income Tav Act in respect of the insolvent person where the insolventperson is a tax debtor under that subsection, and Her Majesty in right of a provincemay not exercise her rights under provincial legislation substantially similar to thatsubsection in respect of the insolvent person where the insolvent person is a tax debtorunder provincial legislationuntil the filing of a proposal under subsection 62(1) in respect of the insolvent person or thebankruptcy of the insolvent person.Paragraph (a) of the stay provisions imposes a stay against creditors that, by defmition, includessecured creditors.129 The terminology appears, at first blush, to be straightforward and self-explanatory. However, on closer examination, the stay provisions of the BIA leave one with thefeeling that the policymakers were unaware of the concerns raised in the cases under the CCAA. Theterms “action” and “execution” should not be the subject-matter of debate. However, we again, mustface the term “other proceedings.” Although one would think that the courts will look to the decisionsunder the CCAA as a statute in pai materia to determine the scope of “other proceedings,” Parliamentcould have clarified that term at the outset.129 BIA s. 2:“creditor” means a person having a claim, preferred, secured or unsecured, provable as a claimunder this Act;108In the event that the courts give “other proceedings” a broad interpretation, as under theCCAA, then the opening words of paragraph (a) may be superfluous, as the word “remedy,” likelyincludes both judicial and self-help remedies. Should the courts give “other proceedings” a narrowinterpretation, then the term “remedy” is limited to self-help remedies, and “other proceedings”contemplates a limited defmition that cases as early as eight years prior to the BIiVs enactment appearto have settled.The stay of actions, executions or other proceedings in paragraph (a) concerns “the recovery ofa claim provable in bankruptcy.” A secured creditor may realize its security and prove the balancedue after deducting the realized amount or, surrender the security to the trustee, and prove for theentire claini13° Assuming, as often happens, that the secured creditor chooses to realize its securityand prove for the balance, the stay provision arguably only stays the secured creditor with respect tothe provable portion and not the secured portion. In that case, the first portion of paragraph (a)operates to enjoin the secured creditor from resorting to any remedy against the “insolvent person orthe insolvent person’s property.” This would, logically, apply to a mortgagee under a real propertymortgage or a secured party holding a security interest in the debtor’s equipment. However, does itprevent a secured creditor from realizing on property that the debtor absolutely assigned to it orproperty in which the secured creditor has an interst that is tantamount to ownership? For example, aproperly framed assignment of book debts conveys all of the right, title and interest in the book debtsto the assignee such that the book debts “were never more the property of the assignor.”3’ In such acase, it is arguable that the secured creditor is not seeking a remedy against either the insolvent personor the insolvent person’s property by requesting payment from the third party debtor. Similarly,security under section 427 of the BankAct132 gives the bank the same rights and powers as if the130 BIA s. 127.‘‘ Royd Bank of Caiicda v. R. (1985), 52 C.B.R (N.S.) 198 (F.C.C.).132 Siqra note 127.109bank had acquired a warehouse receipt or bill of lading in the secured property and consequently, allthe right and title to those documents and the goods, wares and merchandise secured thereby.’33 It istherefore arguable that the bank is realizing on what it already owns and it is seeking no remedyagainst the insolvent person or the insolvent person’s property.While one may raise arguments to counter the foregoing positions, they illustrate problems thatthe courts may face under the stay provisions. The policymakers could alleviate these arguments byclarifying the stay provisions to address the concerns of secured creditors and debtors.Paragraph (b) allows the debtor to “use or deal” with the collateral. From a secured creditor’spoint of view, this provision may be more troubling than the actual stay of proceedings, as the BIAprovides no protection to the secured creditor for the debtor’s use of “liquid” collateral such asinventory or accounts receivable (assuming that the stay prevents the secured creditor from realizingon those assets). A debtor could continue collecting accounts receivable or consuming inventorywithout having to protect or compensate the secured creditor. While the secured creditor may applyfor relief from the stay, in such circumstances, such an application will force the courts to choosebetween the interests of the secured creditor and those of the debtor or more broadly, the public policyinterests of allowing the debtor an opportunity to reorganize its affairs. The courts are placed in thedifficult position of determining the objectives of the legislation, with the wording of the BIAproviding little or no guidance.134 This provision is of even greater concern when one considers thatthe BIA deems such provision in a security agreement to be of no “force or effect.” This may providelegislative sanction to the debtor diverting funds from the creditor that previously held security onsuch funds, with no compensation being paid to such creditor. It is suggested that, in such a case, thejudiciary exercising its equitable jurisdiction, could inject the concept of adequate protection’35 in133 Ibid s. 435.134 See discussion, chapter V(5), below.135 See discussion, chapter V(A)(1)(b), below.110favour of a secured creditor without frustrating the business reorganization provisions of the BIA.The foregoing shows that the courts, under the statutes being considered, have very broadpowers to stay proceedings against the debtor. However, the inherent power of the court furtheraugments these powers. Under the Code, the courts use subsection 105(a) to issue injunctions againstparties or proceedings not otherwise stayed by subsection 362(a) or that subsection 362(b) specificallyexcepts from the scope of the stay. Subsection 105(a) of the Code provides:The court may issue any order, process, or judgment that is necessary or appropriate to canyout the provisions of this title. No provision of this title providing for the raising of an issueby a party in interest shall be construed to preclude the court from, sua sponte, talcing anyaction or making any determination necessary or appropriate to enforce or implement courtorders or rules, or to prevent an abuse of process.In In , Otem Mills, Inc., ‘ the creditor brought an action against the guarantor of obligations of OteroMills, Inc. that was subject to protection under subsection 362(a) of the Code. The debtor assertedthat the guarantor was going to contribute personal assets to it to effect the reorganization plan. Thecourt, pursuant to subsection 105(a), prohibited the creditor from enforcing its judgment against theguarantor. Enforcement against the guarantor would affect the debtor’s estate and adversely influenceand pressure the debtor through the guarantor.’37 The importance of this case lies in the formulationby the Bankruptcy Court of the test to determine wiiether the court would grant an injunction to enjoina creditor from pursuing a co-debtor or guarantor. In such a case, the debtor must show:1. irreparable harm to the debtor’s estate if the injunction does not issue;2. strong likelihood of a successful plan of reorganization; and3. no harm or minimal harm to the other party or parties.’38To this, the District Court added a fourth factor, which appeared to be the overriding and mostinfluential factor. The court held that “in the bankruptcy setting, the public interest lies in promoting136 25 B.R. 1018 (D.N.M 1982) [hereinafter Otero Mills].137 Ibid at 1019-1020.138 Ibid at 1021, quoting the Bankruptcy Court.111successful reorganizationtl39 The court reinforced this factor by stating:At the beginning of the reorganization process, a court must work with less evidence thanmight be desirable and should resolve issues in favour of reorganization. . Althoughreorganization by any bankrupt may be speculative early in the proceedings, [the creditor] isprotected in that if a reorganization plan is not approved, it may apply to the bankruptcy courtto lift the injunction. ‘4°Subsequent case law and legal scholars’4’have criticized the approach in Otero Mills as it”...would distort congressional purpose to hold that a third party solvent co-defendant should be shieldedagainst his creditors by a device intended for the protection of the insolvent debtor and creditorsthereof.”142 Despite the criticism, other courts have followed it in different contexts.143 Therefore, thestay provisions may apply to the secured creditor even though the creditor seeks a remedy for whichthe stay provisions appear inapplicable.The Canadian courts have recently begun explicitly recognizing their inherent jurisdiction incases under the CCAA.’’ The courts, however, do not require the increased burden of showingirreparable harm to the debtor’s estate or a strong likelthood of a successful plan of reorganization. In139 Ibid at 1021.“° Ibid.141 See e.g., Lynch v. Johns - Manville Sdes Coip., 710 F.2d 1194 (6th Cir. 1983) [hereinafterLynch]; D.R Kuney, “The Bank Guaranty Agreement: The Emerging Threat of the Bankruptcy Stay”(1985-86) Bus. Law. 77.142 Lynch, ibid at 1197.143 E.g., In re A.H Robins Co., Inc., 828 F.2d 1023 at 1026 (4th Cit 1987) [hereinafter A.HRobins], where the court enjoined the plaintiffs from pursuing products liability insurers of themanufacturer of the Dalkon Shield on the grounds that such an action would require the insurer toinvolve the debtor and such involvement would cause irreparable harm to the bankruptcy estate byplacing a burden on the officers, directors and employees of the debtor “which would exhaust theirenergies and thus interfere with the debtor’s reorganization”; In re Fussell, 928 F.2d 712 (5th Cir.1991), where the court held that it could enjoin state criminal proceedings premised on a debt owed bythe debtor. But see In re The Russell Coiporation, 156 B.R. 347 (Barikr. N.D. Ga. 1993), where thecourt held that the automatic stay “was not designed to benefit third parties, except to the extent thatthird parties benefit generally from the preservation of assets of the debtor.” (at 349).‘ See e.g. Re Westar Mining Ltd (1992), 14 C.B.R. (3d) 88 (B.C.S.C.), where the court granteda “super-priority” to suppliers who were prepared to keep the debtor operating.112Ccanpeau v. Olympia & York Ltd,’45 the court exercised its inherent jurisdiction to restrain theplaintiff from continuing an action against a co-defendant of the debtor. Implicit in the decision is arecognition that section 11 of the CCAA did not provide the court with jurisdiction to restrain actions,suits or proceedings against entities other than the debtor company. Using language that echoes thereasoning in similar cases in the United States) the court stated,”... the restraining power extendsas well to conduct which could seriously impair the debtor’s ability to focus and concentrate its effortson the business purpose of negotiating the compromise or arrangement.”47 The court then makes thevery curious statement that “[tlhe balance of convenience must weigh significantly in favour ofgranting the stay, as a party’s right to have access to the courts must not be lightly interfered with.”48The curiosity of this statement lies not in the proposition itself but the court’s failure to justifyinterference with the plaintiffs right of access to the courts.More recently, Mr. Justice Farley in Re Lehndoff General Pailner Ltd,’49 held that the court’sinherent power to grant stays “can be used to supplement s. 11 of the CCAA when it is just andreasonable to do so.”° In this manner, His Lordship stayed proceedings, not only against the debtorcompanies but also against the individual interests of limited partners, as the business of the debtorcompanies s significantly intertwined with that of the limited partnerships.15’Although the British Columbia Supreme Court, in the case involving Quintette Coal Limitedenjoined creditors from demanding payment from the guarantors of the obligations of the debtor, it145 (1992), 14 C.B.R. (3d) 303 (Ont. Gen. Div.) [hereinafter Cainpeau].‘ See e.g. A.H Robins, supra note 43.147 Campeau, supra note 145 at 309.Ibid at 309-310.149 (1993), 17 C.B.R. (3d) 24 (Ont. Gen. Div.) [hereinafter Lehndorfj].‘° Ibid at 38.151 Ibid at 35.113appears from the reported cases that that provision went unchallenged by the creditors. However, othercourts refuse to stay actions against guarantors, directors and officers.’52 In Philzp’s,’53 the debtorobtained the stay by an ex parte application. The stay prevented creditors from taking proceedingsagainst directors, officers, employees, agents or consultants of the debtor. The court refused toexercise its inherent jurisdiction to maintain the stay. It distinguished the American cases upholdingsuch a stay on the basis that “there is a specific provision under the United States Bankruptcy Code,11 U.S.C.S. (s. 105(a)), which empowers the court to issue ‘any order.., necessary or appropriate’ tocarry out the provisions of the Code.”54 However, the court granted liberty to reapply in the eventthat the lack of the stay significantly interfered with the preparation of the reorganization plan.’55The stay provisions under the BIA are limited to proceedings against the insolvent person orthe insolvent person’s property. As mentioned above, however,’56 the BIA gives the the courtsequitable jurisdiction. In addition, the court has inherent jurisdiction with respect to all matters underthe BIA.’ This gives the court a broad discretion to stay various actions that are in somey relatedto the insolvent person, the insolvent person’s property or, more generally, the broad purposes of the152 See e.g. Guardian Tiust Co. v. Gaglardi (1990), 64 D.L.R (4th) 351 (B.C.S.C.); Re KeddyMotor Inns Ltd (1991), 290 A.P.R. 419 (N.S.S.C.); Re Faüview Industries Ltd (1991), 11 C.B.R (3d)37 (N.S.S.C.)Philip’s, supra note 81.154 Ibid. at 9.Ibid156 See discussion, supra notes 110-112 and accompanying text.In Re Loxtave Buildings of Cancth Ltd (1943), 25 C.B.R 22 at 25 (Sask. KB.), the courtsaid:“1 realize that the bankruptcy law is statutory mainly and a Court should not go beyond theprovisions of the statute applicable. But, if the subject-matter is within the statute, the Courtmay draw on its inherent powers to give effect to the provisions of the statute.”114legislation. However, the stay of proceedings is in the nature of an injunction’58 and governed by thesame principles.’59 In particular, the three factors cited in Otero Mills reflect the general principles ina bankruptcy case 160 and the public policy of promoting business reorganizations should notsignificantly influence the courts, unless all other factors are equal.’61 The oveniding considerationshould not be the policy of encouraglng business reorganizations but the very special and extraordinarynature of the exercise of inherent jurisdiction. As stated by the Supreme Court of Canada, “[i]nherentjurisdiction cannot, of course, be exercised so as to conflict with a statute or Rule. Moreover, becauseit is a special and extraordinary power, it should be exercised only sparingly and in a clear ii1624. lifting the Stay! Dismissing the CaseA challenge to the granting or continuation of the stay is “one of the major battlegrounds”63of158 A.-G. Man. v. Metropolitan Stores (MTS) Ltd, [19871 1 S.C.R. 110 at 127 [hereinafter MTS].159 Ibid at 127-29, where Beetz J. set forth tests employed by the court in considering whether aninjunction should be granted, being:1. a preliminary and tentative assessment of whether there is a serious question to be tried,2. whether the litigant who seeks the interlocutory injunction would, unless the injunction isgranted, suffer irreparable harm, that is harm not susceptible or difficult to be compensated indamages; and3. a determination of which of the two parties will suffer the greater harm from the grantingor refusal of the interlocutory injunction, pending a decision on the merits.160 Supra note 138 and accompanying text.161 MTS, supra note 158 at 129-30. While the Supreme Court of Canada felt that the publicinterest should be a factor to be considered under its third test, it did so in the context of a challengeto the constitutionality of a statute promulgated by the Manitoba legislature. Although a businessreorganization affects certain sectors of the public and the economy, it is suggested, with respect, thatthe Supreme Court of Canada s contemplating public rights in the context of laws which are passed“for the common good” [at 135]. The court then cites numerous examples, none of which appear tofall within the purview of what the court referred to as “the interests of private litigants’ which in mostcases, will be the types of interests sought to be protected under the inherent or equitable jurisdictionof the court under the BIA.162 Baxter Student Housing Ltd v. College Co—opercdive Ltd, [1976] 2 S.C.R. 475 at 480.163 F.J.C. Newbould, Q.C. “The Companies Creditors Arrangement Act” (1992), 7 B.F.L.R 51.115business reorganization proceedings. One American writer stated that “stay relief is the main event inmany chapter 11 cases.lMThe difference in structure of the Code and the CCAA results in the parties seeking tochallenge the stay taking different approaches. The courts in Canada focus on aspects of the case orstages in the proceeding that differ from their American counterparts. A strict comparative analysis ofthe approaches taken is difficult to conduct, although the approaches intersect periodically. Thissection will analyze each scheme separately and then, consider those schemes in light of the BIA.Before embarking on the analysis however, we must address two matters. First, we cannotoverstate the importance of the concept of adequate protection in an American proceeding. The theoryunderlying American stay litigation is that, so long as the secured creditor is provided with adequateprotection or has an opportunity to repossess the collateral, there is no need for that creditor toquestion the right of the debtor to attempt to reorganize. The reorganization process is not harming thecreditor. In this way, the debtor may continue operating the business while formulating a plan.Conversely, the Canadian courts have not used the concept of adequate protection in dealingwith cases under the CCAA. Accordingly, secured creditors have no alternative but to challenge theentire proceeding based on the lack of bonajIdes of the debtor or the feasibility of a successfulreorganization. The burden placed on a secured creditor in taking such an approach is very heavy,given the inclination of the courts to afford the debtor an opportunity of exploring the reorganizationalternative. In other words, the courts must choose between the secured creditor, whose interests arecompromised, or the debtor, which is seeking to reorganize its affairs. Without the concept ofadequate protection, there is no mechanism for the courts to use to strike a compromise; one partywins, the other loses.A second matter that we must note is that, throughout the discussion that follo, passing164 MJ. Bienenstock, Bankmptcy Reorganization (New York: Practising Law Institute, 1987) at132.116reference will be made to the conduct of the parties. Although, generally, the courts do not expresslystate that their decisions are heavily influenced by the conduct of the parties, such conduct appears tohave some influence. One ‘.witer noted:while economic or financial factors are significant in automatic-stay litigation, thesefactors are not the only consideration that courts apply. Instead, litigation by creditors to liftthe stay is often reached in light of the creditor’s and debtor’s behavior before and during thebankruptcy case. The result is a general balancing of equitable factors, especially in businesscases, that is significantly more complex than the pure economic evaluation often suggested inthe literature.’65With the limited number of cases under the CCAA, the fact that few cases specifically refer tothe conduct of the parties and, most importantly, the fact that this aspect of the decision-maldngprocess is generally covert, it is difficult to gamer any general principles from the decisions.Hovever, the reader must be cognizant of this factor when reviewing the following.(a) CCAAA challenge to the stay generally takes place at the initial hearing, if the debtor applies onnotice to other parties, or soon after the creditors receive or become aware of the stay order, if thedebtor’s application was ex pan’e. As the court is reluctant to carve out certain creditors, it is forced toconsider the viability of the plan at a very early stage of the proceedings.’In the event that a single-class creditor or a group of creditors of a class sufficient to defeatthe compromise or arrangement advises the court that no compromise or arrangement will beacceptable,’67the court must face the issue of whether the compromise or arrangement is doomed to165 RT. Nimmer, “Real Estate Creditors and the Automatic Stay: A Study in BehavioralEconomics” (1983) Ariz. St. L.J. 281 at 281.‘ The issue concerning the dismissal of a proceeding based on the inability of the debtor tosecure the requisite statutory majorities is more appropriately discussed in the context of the creditors’voting on the plan. See discussion chapter VI(C), below. Hoever, as the challenge to the stay putsthe entire proceeding into question, there will necessarily be some overlap in the discussions.167 Tn order to succeed, a compromise or arrangement must be accepted by a majority in number,representing three-fourths in value of the creditors, or class of creditors, voting at the meeting directedby the court [CCAA s. 6]. There is no provision in the CCAA which allows the court to “cram down”117failure. In such a case, the court will dismiss the application for the stay of proceedings or lift thestay, if the court granted the stay order on the ex parte application of the debtor. The Ontario Court ofAppeal faced this issue Elan.’68 The majority of the court held that the appellant bank should beplaced in its own class and, as that class would reject a plan of arrangement, the plan could notsucceed.’69 As a result, the court lifted the stay of proceedings and dismissed the proceeding. InDiemc’ster Tool Inc. v. Skvotsoff (Trustee oj),17o the court reached a similar conclusion despitetestimony that the plan of compromise and arrangement would result in payment in full to the securedcreditor.’7’the plan on a class of creditors that has rejected the plan as contemplated by section 1129 (b) of theCode. A rejection of the plan by a class of creditors merely results in a failure of the plan withrespect to the rejecting class or, if a plan so provides, a failure of the plan in its entirety [CCAA s. 6;J.D. Honsberger, Debt Restructuring (Toronto: Canada Law Book, 1993) at 9-40].168 Elan, supra note 97.169 Ibid at 115. In reviewing the decision of the majority, one wonders whether the erosion of thecollateral was the major factor being considered by the court, ie. the lack of adequate protection. Oneof the primary securities held by the appellant was a first registered charge on accounts receivable.The court specifically referred to a previous order in the proceedings which stayed the appellant bankfrom acting on its security and allowing the debtor to spend up to $321,000 from accounts receivablecollected by it [at 109].170 (1991), 3 C.B.R (3d) 133 (Ont. Gen. Div.) [hereinafter Diemaster].171 The debtor required the stay period to seek new debt or equity fmancing. The court appearedconcerned with the fact that the debtor had been in fmancial difficulty and had been seeking debt orequity fmancing for almost two years prior to the application under the CCAA. Although notexpressed, it appears that the court had little confidence in the debtor finding sufficient debt or equityfmancing to pay the secured creditor in fill. This conclusion is implicit in the following statement:“The bank would hardly vote for a result that would go against its own interests. Since itopposes any proposals or arrangements now, the bank would be expected to vote against it,thereby assuring rejection of any proposal by that class of secured creditor.” [at 149]See also First Treaswy Pinancid Inc. v. Cango Petroleums Inc. (1991), 3 C.B.R. (3d) 232 at 238 (Ont.Gen. Div.) [hereinafter Cajigo] where Austin J., in dismissing an application for a stay order undersection 11, said:“In the present case, Cango is simply asking the Court to stay the hands of creditors in thehope that, in whatever period of grace is granted, something more will happen than hasoccurred in the past 9 months, and that that something will permit the company to besalvaged.”118The Ontario Court of Justice refmed the test more recently in Ba,gain Ha,vld’s.’72Whileaccepting the general proposition that the court will refuse an application for a stay if it is clear that noplan will be acceptable to the required percentages of creditors, the court held that the advice ofcertain secured creditors that they would not approve any plan put forth by the debtor does not put anend to the inquiry. The court felt that it must consider “all affected constituencies” including secured,preferred and unsecured creditors, shareholders, landlords, employees and the public generally.’ Thecourt ultimately held that there was no reasonable prospect that the debtor could devise a plan thatwould satisfy those voting constituencies under section 6 and therefore, refused to impose the stay.’74We must distinguish the foregoing cases from the cases that allow the debtor an opportunity toreorganize in the face of advice that a single-class secured creditor or a sufficient majority of a classwill reject any plan put forth by the debtor. All of the cases, save one, emanate from jurisdictionsoutside Ontario. The British Columbia Court of Appeal in Phi4ps175 and the Alberta Court of Queen’s172 Baigain Ha,old’s, supnr note 81.‘ Ibid at 30.174 Ibid at 32. This case is a clear example of the court’s concern with the conduct of the debtor.Austin J. referred to a number of “important elements” which were used in reaching the decision,including:1. the debtor did not know the precise nature of the problem which resulted in its fmancialdifficulties and that its auditors advised that the cause may never be known2. the debtor had no idea how to salvage the operation, other than to “dosize”;3. the debtor lacked operating capital and certain shareholders who were in a position to assistin refmancing had made no offer to so assist;4. the debtor failed or abandoned an attempt to raise equity to fmance expansion on the basisof its fmancial and accounting problems; and5. the debtor’s admissions of mismanagement, with no proposed solution.Cf Re Perkins (1991), 6 C.B.R. (3d) 299 (Ont. Gen. Div.) [hereinafter Perkins], where the courtdistinguished Cango, supra note 171, on the basis of the conduct of the debtor and the support of theunsecured creditors, the latter of which was absent in Cango. In Perkins, the debtor itself “hadrecognized its fmancial problems and had retained outside help in an attempt to resolve it [sic]” [at306].175 Phil4,’s, siq,n7 note 81.119Bench in 1cor76 imposed a stay of proceedings to allow the debtor an opportunity to negotiate andfonriulate a plan of reorganization and compromise. Each court further held that advice concerningthe unequivocal rejection of any plan at any stage of the proceedings was not a sufficient basis uponwhich to dismiss the case, as the plan could result in full payment of the objecting creditor’s claims orsome other satisfactory arrangement.’77Similar considerations appeared to have influenced the Prince Edward Island Supreme Court inTimber Lodge.178 The value in this case goes beyond the affirmation of those approaches, as the courtsuggested that there was evidence tendered which not only showed the objecting creditors to be“adequately protected”79but also intimates that the creditors may be able to recover compensation foropportunity cost.’8°The foregoing illustrates the difficulties faced by the courts in analyzing the use or continued176 Icor supra note 97.W7 The Alberta case is interesting, as the court briefly discusses the fmancial position of one ofthe creditors. Although the terminology used by the court does not make clear whether it was usingan appraised value of the collateral or the face value of the security, it is clear that the court felt thatthe creditor was “adequately secured”[at 164]. The debt was $2.2 million, the accounts receivable $1.4million and the creditor held “debenture security of 1.5 million dollars.” The creditor was complainingthat the accounts receivable were being used for continuing operations to which the court replied “It islikely however, that the use of some of accounts receivable for ongoing operations will ultimatelyimpinge upon unsecured creditors, rather than the [complaining creditor].” This indicates that thedebenture security together with some of the accounts receivable would pay out the complainingcreditor. The balance of the accounts receivable would be distributed among the unsecured creditors.178 Timber Lodge, supra note 97.‘ Ibid at 252, 253, where the court stated:so long as the position of the rejecting respondents is not being unduly jeopardized, thereshould be an opportunity for the applicant to be put back on a firm foundation.I do not fmd that the debt of the objecting creditors will be compromised in the short term orthat I would be necessarily delaying the inevitable if the application were granted.”180 Ibid at 252 where the court stated:“However, the applicant states that while the objecting respondents would have to give upsomething at the present time, it would not be totally lost as they should be able to regain inthe future what they are now losing.”120use of the stay at a very early stage of the reorganization proceeding. By focusing on the debtor’sright to posit a plan of reorganization or compromise, rather than on the protection afforded a securedcreditor during the stay period, the courts place themselves in the unenviable position of having todetermine the likelihood of the debtor putting forth a successful plan of reorganization at a stage of theproceedings when the parties themselves are still attempting to grapple with their respective positions.The debtor is in the panicked state of attempting to formulate a plan that will pacify all creditors,wile, at the same time, attempting to determine how the business deteriorated to such an insolventstate. The secured creditors, on the other hand, are attempting to determine how the stay affects themand how best to protect their secured positions vis-a-vis the secured collateral.The Canadian courts use various terms to describe the standard necessary for the creditor tosucceed in having the stay lifted or the stay application dismissed. The courts require the opposingcreditor to show that the plan is “doomed to failure”8’or that there is no reasonable “chance,”82“prospect,”83or of acceptance of a plan of arrangement or compromise. Although ithas been suggested that these terms impose different standards of proof,’85 it appears that the courtsrely on factors such as lack of adequate protection of the creditor’s interests or the conduct of theparties. Only the clearest case will allow the court to dismiss an application using one of theforegoing standards. In all other cases, the debtor should be given the benefit of the opportunity toformulate a plan provided that it adequately protects the creditors’ positions. In this manner, the courtscould tailor the remedy to fit the circumstances and deal with the matter on a creditor by creditorbasis. Should the debtor be unable to provide interim protection to its creditors, this may be an181 ChefRecdy, supra note 95.182 Cango, supra note 171.‘ Basgain Harold’s, supra note 81.‘ Fairi’iew Industries Ltd (No. 2) (1991), 109 N.S.R. (2d) 12 at 23 (N.S.S.C.).185 Alec Zimmerman, “Effective Implementation” in Co?porate Restructuring, (Toronto:Canadian Institute, 1992) at 32-38.121indication that the business is not worth saving.This approach is the one set forth in the Code, to which we will now turn our attention. Wemust note at the outset however, that the American system is not without its faults. The sheer volumeof the cases considering this issue bears witness to this fact. However, the approach satisfies therequirement of allowing the debtor some “breathing space” while at the same time attempting toprotect the interests of secured creditors. If provision is made to provide protection to creditors inCanada while the debtor is formulating a plan, the only question is how adequate the protection mustbe, not whether the debtor should have the opportunity to formulate a plan.(b) CodeSubsections (d) through (g) of section 362 govern relief from the automatic stay under theCode.’86 To obtain relief from the automatic stay, the secured creditor must take a positive step to186 Code ss. 362(d)-(g):(d) C)n request of a party in interest and after notice and a hearing, the court shall grantrelief from the stay provided under subsection (a) of this section, such as by terminating,annulling, modifying, or conditioning such stay -(1) for cause, including the lack of adequate protection of an interest in propertyof such party in interest; or(2) with respect to a stay of an act against property under subsection (a) of thissection, if -(A) the debtor does not have an equity in such property; and(B) such property is not necessary to an effective reorganization.(e) Thirty days after a request under subsection (d) of this section for relief from the stayof any act against property of the estate under subsection (a) of this section, such stay isterminated with respect to the party in interest making such request, unless the court, afternotice and a hearing, orders such stay continued in effect pending the conclusion of, or as aresult of, a final hearing and determination under subsection (d) of this section A hearingunder this subsection may be a preliminary hearing, or may be consolidated with the fmalhearing under subsection (d) of this section. The court shall order such stay continued ineffect pending the conclusion of the fmal hearing under subsection (d) of this section if thereis a reasonable likelihood that the party opposing relief from such stay will prevail at the122seek such relief. A court may not act sua sponi’e.’87 Should the secured party do nothing, the stay ofan act against property of estate continues until the property is no longer property of the estate and thestay of an act against the debtor continues until the case is closed or dismissed or the court grants ordenies the debtor’s application for a discharge, whichever is earliest.’88Should the secured creditor wish to seek relief from the stay, it must request such relief byway of motion on reasonable notice to the debtor’ and other interested parties,’9°although the courtmay allow the creditor to make the application on an ex parte basis in appropriate circumstances.’91After notice and hearing,1the court shall grant relief from the stay “for cause, including lack ofconclusion of such fmal hearing. If the hearing under this subsection is a preliminary hearing,then such fmal hearing shall be commenced not later than thirty thys after the conclusion ofsuch preliminary hearing.(f) Upon request of a party in interest, the court, with or without a hearing, shall grantsuch relief from the stay provided under subsection (a) of this section as is necessary toprevent irreparable damage to the interest of an entity in property, if such interest will suffersuch damage before there is an opportunity for notice and a hearing under subsection (d) or (e)of this section.(g) In any hearing under subsection (d) or (e) of this section concerning relief from thestay of any act under subsection (a) of this section -(1) the party requesting such relief has the burden of proof on the issue of thedebtor’s equity in property; and(2) the party opposing such relief has the burden of proof on all other issues.187 R.M Martin “Creditor Alternatives to Obtain Relief From Automatic Stays in Bankruptcy”(1981) 98 Banking L.J. 525 at 536.188 Code s. 362(c).189 U.S. Bankruptcy Rules ss. 4001(a) (1), 9014.190 U.S. Bankruptcy Rules ss. 1007(d), 4001(a)(1); Code s. 1102.191 U.S. Bankruptcy Rules s. 4001(a)(2).192 This phrase is defmed in subsection 102(1) of the Code:(1) “after notice and hearing”, or a similar phrase-(A) means after such notice as is appropriate in the particular circumstances, and123adequate protection of an interest in property of’ the secured creditor.’93 A lack of adequate protectionis merely one “cause” that may result in the court granting relief from the stay and “cause” is only onealternative on which the secured creditor may rely in seeking relief from the stay. On a hearing forrelief from the stay, the only issue to be considered is whether the court will grant the requestedrelief.194 Unlike the CCAA, the granting of relief from the stay may or may not dispose of thereorganization proceeding. It merely deals with the interest of the applicant party and no otherinterests.The courts in the United States, like those in Canada, are reluctant to grant relief from theautomatic stay in the early weeks of the proceeding.’95 This gives all parties an opportunity to assessthe situation and determine whether the creditor’s security is valid, whether adequate protection isnecessary and in what form and whether the possibility of formulating a successful reorganization planis feasible.Section 362(d) of the Code prescribes four modes of relief from the automatic stay, which arenonexclusive. The court may:’1. terminate the stay with respect to the applicant creditor or generally. Termination allowssuch opportunity for a hearing as is appropriate in the particular circumstances; but(B) authorizes an act without an actual hearing if such notice is given properly andif -(i) such hearing is not requested timely by a party in interest; or(ii) there is insufficient time for a hearing to be commenced before suchact must be done, and the court authorizes such act;Code s. 362(d)(l).194 House Report at 344.195 Jordan and Warren, supra note 115 at 786.‘ F.R Kennedy, “The Automatic Stay in Bankruptcy” (1978) 11 Mich. J.L. Ref. 177 at 253-254.124the creditor to pursue its remedies to their full extent;’972. annul the stay which terminates it ab initio. Annulment generally operates retroactively tothe date of the filing of the petition;’983. modify the stay to allow one act or one creditor to pursue a remedy, such as allowing anaction to continue to judgment but disallowing enforcement;’ or4. place a condition on the stay that, if breached or unsatisfied, may automatically terminatethe stay.20°Relief from the stay is mandatory, if the creditor shows cause for the granting of the relief, or, withrespect to property, the debtor does not have equity in the property and the property is not necessaryto an effective reorganization.20’Cause includes a lack of adequate protection. It also includes anaction that lacks any connection or will not interfere with the bankruptcy case, such as a personalinjury action against the debtor and its insurer202 or actions involving the debtor’s postpetition‘ Ibid at 253.198 In re Albany Partners, Ltd. 749 F.2d 670 (11th Cit 1984) [hereinafter Albany Partners]. Seealso Sikes v. Globd Mañne, Inc., 881 F.2d 176 (9th Cir. 1989).‘ Kennedy, supra note 196 at 254; In re Holtkamp, 669 F.2d 505 (7th Cir. 1982).200 Blazon, supra note 44, where the court required the debtor to continue transmitting fmancialinformation to it and to the secured creditor on a regular basis. Although the court did not orderautomatic termination of the stay upon a failure of the debtor to meet the condition, it confinned theright of the secured creditor to apply on short notice for a revision of the order (at 865).201 One of the more important portions of the Timbers decision is the guidance that Justice Scaliaprovides concerning section 362(d)(2). In particular, His Honour set forth the burden the the debtormust meet to show that the collateral is necessary to an effective reorganization.“What this requires is not merely a showing that if there is conceivably to be an effectivereorganization, this property will be needed for it; but that the property is essential for aneffective reorganization that is in prospect. This means ... that there must be a reasonablepossibility of a successful reorganization within a reasonable time.” [at 751, emphasis original]This not only provides an alternative manner for undersecured creditors to seek relief from the stay butit also opens the door for American counsel to perhaps use some of the reasoning adopted by theCanadian courts considering the CCAA.202 In re Holtkainp, supra note 199.125activities.203 A stay of this type of action is unnecessary, as it is unrelated to the purpose of the stay,which is to protect the debtor from its creditors.204The debtor’s malafides or misconduct is another cause that may result in relief from theautomatic stay.205 Jndicia of lack of bonafides may be that”... there is no going concern topreserve, there are no employees to protect, and there is no hope of rehabilitation, except according tothe debtor’s ‘terminal euphoria’ •“206The creditor may seek the more drastic remedies of having the case dismissed in its entirety orhaving the case converted to a liquidation case pursuant to section 1112. A lack of bonafides hasbeen held to be grounds for dismissal of a case207 so that a creditor seeking relief from the stay mayfmd the cases considering that issue useful.An application seeking relief from the automatic stay based on “cause” invites the court tomake a broad inquiry into the facts. The court will examine economic factors and may examinebehavioral and equitable factors.208 The facts of each case will determine whether relief is appropriatein the circumstances209but the courts have been responsive to many types of requests. Although thefacts may not warrant a complete dismissal or conversion of the case, facts evidencing the “causes”203 House Report at 343-344.204 ibid.205 See generally, Ordin, “The Good Faith Principle in the Bankn.iptcy Code: A Case Study”(1983) 38 Bus. Law. 1795.206 Ibid at 1073.207 Albany Partnei, supra note 198.208 Nimmer, supra note 165 at 284. A recent example of a court considering behavioral factors inreaching its decision was in In re Kleinman, 156 B.R 131 (Bankr. S.D.N.Y.), where the court grantedthe secured creditor relief from the automatic stay and, in so doing, noted the fmancial irresponsibilityof the debtors and the fact that one of the debtors “has undertaken a scorched earth campaign oflitigation, including making numerous attacks on the court’s integrity.” [at 1321.209 House Report at 344.126listed in section 1112(b) of the Code may be sufficient to obtain relief from the stay.21°Under paragraph 362(d)(2), which is the second ground for seeking relief from the automaticstay, the secured creditor has the burden of proof on the issue of the debtor’s equity in the propertyand the debtor has the burden of proof on all other issues.21’ The two elements comprising paragraph362(d)(2) are that the “debtor does not have an equity in such property” and “such property is notnecessary to an effective reorganization.” The paragraph requires both elements to be present for therelief to be granted. If both elements are not present, the court will dismiss the application but thesecured creditor may attempt to show a lack of adequate protection at that hearing, or subsequently, or210 Code, s. 1112(b):(b) Except as provided in subsection (c) of this section, on request of a party in interest orthe United States trustee, and after notice and a hearing, the court may convert a case underthis chapter to a case under chapter 7 of this title or may dismiss a case under this chapter,whichever is in the best interest of creditors and the estate, for cause, including -(1) continuing loss to or diminution of the estate and absence of a reasonablelikelihood of rehabilitation;(2) inability to effectuate a plan;(3) unreasonable delay by the debtor that is prejudicial to creditors;(4) failure to propose a plan under section 1121 of this title within any time fixedby the court;(5) denial of confirmation of every proposed plan and denial of a request made foradditional time for filing another plan or a modification of a plan;(6) revocation of an order of confirmation under section 1144 of this title, anddenial of confirmation of another plan or a modified plan under section 1129 of thistitle;(7) inability to effectuate substantial consummation of a confirmed plan;(8) material default by the debtor with respect to a confirmed plan;(9) termination of a plan by reason of the occurrence of a condition specified inthe plan; or(10) nonpayment of any fees or charges required under chapter 123 of title 28.211 Code s. 362(g).127some other “cause” entitling it to relief from the stay.In determining whether the debtor has equity in the property, the court looks at the differencebetween the property value and the total value of the liens against the property and not just the valueof the lien of the creditor seeking relief from the stay plus all senior liens.212 With respect to thesecond element, the courts have embraced the requirement established by Timbers that the debtor mustshow a reasonable prospect for a successful reorganization within a reasonable time.213 It isinsufficient for a single-asset debtor to argue that it requires the sole asset for an effectivereorganization214 or that the property is indispensable to the debtor’s survival and ultimaterehabilitation.215(c) BIASection 69.4 governs the lifting of the automatic stay. It provides:69.4 A creditor who is affected by the operation of sections 69 to 69.3 may apply to thecourt for a declaration that those sections no longer operate in respect of that creditor, and thecourt may make such declaration, subject to any qualification that the court considers proper, ifit is satisfied(a) that the creditor is likely to be materially prejudiced by the continued operationof those sections; or(b) that it is equitable on other grounds to make such a declaration.In addition, however, the secured creditor may effectively terminate the stay by successfullychallenging an extension of the period within which the insolvent person may file a proposal pursuantto section 50.4(9), or by having the period within which the insolvent person may file a proposalterminated pursuant 50.4(11).212 Stewart v. Gurley, 745 F.2d 1194 (9th Cir. 1984).213 See e.g., In re Canal Plcs.e Limited Partnersh4,, 921 F.2d 569 (5th Cir. 1991); In re SnapwoodsApartments ofDekdb County Ltd, 153 B.R. 524 (Bankr. S.D. Ohio 1993); In re Grand TraverseDevelopment Co. Limited Partnership, 150 B.R. 176 (Bankr. W.D. MIcK 1993).214 Bienenstock, supra note 164 at 135-136.215 Norton Bankr Law & Practice s. 20.27.128Section 69.4 gives the court some discretion in the remedy it may grant, although the forms ofrelief are not as extensive as those under the Code. For example, whether the court has thejurisdiction to retain the stay, on the insolvent person providing the secured creditor with adequateprotection, is questionable. Although courts have equitable jurisdiction, the wording of section 69.4does not appear to support the argument that the court may exercise that jurisdiction in thesecircumstances. On a strict reading of the section, the court may “make such a declaration,” being a“declaration that [the stay provisions] no longer operate in respect of that creditor.” That is, the courtmay either lift the stay or retain the stay.However, the court may make the declaration “subject to any qualification that the courtconsiders proper.” Should the court deny the application, it cannot impose a condition on that order.The stay would continue to unconditionally bind the secured creditor. The court could, however, grantleave to reapply under section 69.4, on short notice, should circumstances change.216 Should the courtgrant the application and make the declaration that the stay provisions no longer operate in respect ofthat creditor, the court could stay the operation of the order so long as the insolvent person makesperiodic payments, provides a replacement or additional lien, or provides some other type of adequateprotection. This would meet the objective of the proposal provisions and the stay period would notprejudice secured creditors. If the courts take an absolute approach by lifting or retaining the stay,without qualifications, either the business reorganization objective will be completely frustrated, byleaving the insolvent person without cash flow, key assets or any assets with which to reorganize, orsecured creditors will be materially prejudiced by allowing the insolvent person to continue to use orexpend the collateral, without compensation. The courts must devise some compromise position.Although the wording of section 69.4 is not as clear in that respect as section 362 of the Code, anopening exists within which to accommodate such a position.Subsection 69.4(a) provides that the court may lift the stay in respect of the applicant creditor216 BIAs. 187(11).129if that creditor is likely to be “materially prejudiced” by the continued operation of the stay. Denyingthe secured creditor its right to realize on its collateral immediately is prejudicial, to a certain extent.However, it is difficult to conceive of when the prejudice becomes “material” and when, even if theprejudice is material, the secured creditor’s interests outweigh the public policy interests ofencouraging business reorganizations. “Material prejudice” is beneficial as it attempts to focus onprotecting the secured creditor rather than on the insolvent person’s right to effect a reorganization.The term also provides the court with some flexibility, which is also beneficial, as the decisions willhopefully ebb and flow with the tides of business. However, the BIA does not give the courts anyguidance concerning this matter and it is possible that a stay of whatever magnitude and for whateverperiod may be considered materially prejudicial. Should the concept evolve in such a manner, theamendments will have accomplished nothing. On the other hand, if the courts interpret the standard ofproof of material prejudice narrowly, they will deny secured creditors of the benefit of their respectivebargains, which will have dire effects on the credit market generally.217 The material prejudicestandard will likely fall between the two extremes. However, the concept is so amorphous that eachinterpretation will be fact specific. This will undoubtedly result in much litigation and very fewanswers.218There have been no reported cases to date that confront this issue directly, although the fewcases dealing with lifting the stay or other remedies sought by creditors may provide us with a previewof how the courts will approach these matters and the scope of the automatic stay. The courts may217 Whether secured creditors should bear any cost in a business reorganization at all will bediscussed, chapter V(5), below.218 Not unlike the litigation attempting to defme the doctrine of “reasonable notice” which startedin earnest with Ronald Elwin Lister Ltd v. Dunlop Cancda Ltd, [198211 S.C.R 726 and whichcontinues today. Although there have been many cases considering this issue, the doctrine is so factspecific that few lawyers, with certainty, will opine on an absolute minimum amount of notice.130place considerable emphasis on the conduct of the parties.219 For example, the cooperation of thedebtor and its principals may tip the balance in favour of requiring the stay to remain in place.°However, if the debtor commences a proposal proceeding in bad faith as a sham or delaying tactic, thecourt may be inclined to censure the insolvent person by lifting the stay.22’ One court stated, as obiterdictum, that it would be materially prejudicial to a secured creditor if the debtor sold the collateral at“fire sale” prices to allow the debtor to attempt to stay in business by generating cash flow from thecollateral.222One of the grounds justifying termination of the period within wiuich the insolvent person mayfile a proposal is if “the creditors as a whole would be materially prejudiced were the applicationunder this subsection rejected.”223 The court, in NT. W. ,224 interpreted that section to mean that all ofthe creditors must be materially prejudiced for the applicant to succeed on this ground. It held that,although the delay caused the secured creditor prejudice, the insolvent person was permitted tocontinue to use secured funds to operate the companies, while making no payments to the securedcreditor. This decision makes that ground very difficult or impossible for a secured creditor to relyon, as any action taken by the court for its benefit would likely have a detrimental effect on the219 See e.g., 156190 Cancria Ltd v. Bciiown Drugs Ltd (1993), 19 C.B.R (3d) 129 (N.W.T.S.C.)[hereinafter 156190 Canada Ltd 1; Leslie Mcrlnlyre Maritime Assocktes Inc. v. Zutphan Bros.Construction Ltd (1993), 19 C.B.R. (3d) 94 at 100 (N.S.S.C.). See also Nimmer, supra note 165 at298-300.° Re NT W. Management Gmiq, Ltd (1993), 19 C.B.R. (3d) 162 (Ont. GeiiDiv.) [hereinafterNT W. J, vkiich was not an application for relief from the stay but was an application pursuant tosection 50.4(11) of the BIA for an order terminating the notice of intention; Re High StreetConstruction (1993), 19 C.B.R. (3d) 213 (Ont. Gen. Div.) [hereinafter High Street], where the courtwas dealing with an extension of time to file a proposal under section 50.4(9) of the BIA. See alsoNirnmer, supra note 172 at 301-303.221 See e.g., Re Malenfant (1993), 19 C.B.R (3d) 295 (Que. S.C.).156190 Canada Ltd. supra note 219.BIA s. 50.4(1 1)(d.224 NT W., supra note 220.131unsecured or junior secured creditors. The decision in this case, may have been based on theprotection accorded to the secured creditor during the stay. The court provided directions to theinterim receiver “to protect the interest” of the creditor.225 The secured creditor may have felt that thisprotection was adequate as it adjourned its application under subsection 50.4(11) sine die.One of the requirements that an insolvent person must show to obtain an extension of the timewithin which to file a proposal is that “no creditor would be materially prejudiced if the extensionbeing applied for were granted.”226 In High Street,227 the court held that the applicant was notmaterially prejudiced by the failure of the debtor to pay the arrears of interest on the outstandingindebtedness to the applicant and accruing realty taxes. This case is noteworthy, as the courtsuggested that the secured creditor was adequately protected because the secured assets “are non-depreciating and cannot be dissipated”228 and the stay did not prevent the secured creditor from“issuing its notice of sale with respect to its mortgages.”229Although the courts attempt to avoid using the CCAA cases to arrive at their decisions,° thesame thought processes are operating. In High Street, the court cited Elar?3’ and (]ltrxareManagement Inc. v. Zevenberger (Trustee ofl232 and held that the secured creditor could not say that itwould not accept the insolvent person’s proposal under any circumstances. The court in NT. W. also225 Ibid at 164.226 BIA s. 50.4(9)(c).227 High Street, supra note 220.228 Ibid at 215.229 Ibid.230 In fact, the NT. W. case, supra note 220, explained some of the features which distinguish thetwo acts.‘ Elan, supra note 97.232 (1991), 3 C.B.R. (3d) 151 (Ont. Gen. Div.).132made the following comment that is reminiscent of the CCAA cases:The question is whether they “will not be likely able to make a viable proposal.” It is difficultto make this determination so early in the proceedings. It is clear that for any proposal to beviable it will have to contain provisions for a complete discharge of the C.I.B.C. obligation.The evidence indicates the principals are negotiating with other banks to arrange new take-outfinancing. The onus is on the applicant to prove on a balance of probabilities that theinsolvent companies will likely not be able to make a viable proposal before the expirationperiod. The applicant has not met this onus.233The second ground for declaring that the stay is no longer applicable to the applicant gives thecourt considerable discretion in balancing the equities of the case. That ground is “that it is equitableon other grounds to make such a declaration.234 NTW. considered this ground and retained the stayon the basis that to grant the application would effectively defeat the proposal and accordingly, it wasinequitable, as it, would prejudice all other creditors.235These sections have received only limited consideration to date. Accordingly, it is difficult todraw any convincing conclusions. However, the cases serve to illustrate the difficulties the courtsmust face, without legislation providing clear guidance. A further concern is that the nature of thelegislation may not lend itself to the development of general principles to guide business people andtheir advisors. It is hoped that the closing paragraph of High Street does not foreshadow this concern:At the conclusion of this application counsel for T.D. noted that I must be cautious in grantingthis extension. I have made my decision based on the pan’icularfctts of this application andmy findings that High Street has satisfied the three prerequisites for an extension under s.50.4(9) of the Act.236 [Emphasis added]5. Analysis of the BIA and Pmposals for RefonnThe Tassé Report recommended that, on the filing of a notice of intention to present aproposal, the debtor would receive” ... a short stay of proceedings during which the debtor couldNTW, supra note 220 at 167-168.234 BIA s. 69.4(6).Ibid236 High Street, supra note 220 at 266.133formulate his proposal and arrange the necessary fmancing, guaranties and other details.”7 TheColter Committee Report adopted this notion and recommended a 21-day period.238 The BIA actuallyadopted a 30-day period during which time, the insolvent person must to file a cash-flow statementand apply for any extension of the 30-day period. The question is whether these periods realisticallyallow the debtor time to formulate its proposal and arrange the necessary fmancing. We must alsoremember that an entity intending to file a proposal is insolvent, by definition. Is it reasonable torequire such a person to retain a trustee to certify the cash-flow statement and a lawyer to apply for anextension of the 30-thy period? As it s the intent of the policymakers that the BIA deal with abroad range of fact patterns, it might have been more prudent to avoid strict periods of time and allowthe courts to deal with the time periods on a case by case basis, as is presently done under section 11of the CCAA and under section 362 of the Code. This would allow the court (or the parties) todetermine, for example, the time required by the debtor to secure financing for the proposal or whetherfmancing is indeed available. The time periods will vary depending on the nature and size of thebusiness to be reorganized. The foregoing illustrates that perhaps the policymakers failed to considerpractical realities and the difficulties of attempting to balance the conflicting interests of the parties.This brings us back to the original purpose of this chapter which is, to attempt to detenninethe objectives of a business reorganization proceeding. If an objective is to balance the respectiveinterests of creditors and debtors with a view to having the debtor emerge as a healthy, viablebusiness, the BIA has failed. The system, as presently structured, gives the debtor a limitedenvironment within which to reorganize in terms of time and substantive rights. While a demand forrepayment of a loan or a notice of intention to realize on security usually comes as no surprise to thedebtor, it usually results in a flurry of activity by the debtor, attempting to stave off the securedcreditor, seeking alternate debt or equity financing and keeping the business operating. The debtorTassé Report at 175.238 Colter Committee Report at 56.134spends little time on formulating a workable plan which requires not only analyzing external matterssuch as alternate fmancing and market conditions, but also internal factors such as the history of thebusiness that resulted in the fmancial difficulties and how to solve the problems. While one mightargue that the debtor had ample opportunity to consider these matters before the creditor served thedemand or notice, few debtors actually face the reality of the financial difficulties. Instead theychoose to immerse themselves in their work in the hopes that the problem will disappear withincreased productivity.The debtor also faces substantive problems created by the BIA that, combined with t