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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 MODELS  by  KEITH DENNIS YAMAUCHI B.A., The University of Calgary, 1977 LL.B., The University of Saskatchewan, 1981  A THESIS SUBMIEfED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF LAWS in THE FACULTY OF GRADUATE STUDIES (Faculty of Law)  We accept this thesis as conforming to the required standard  THE UNPIERSITY OF BRITISH COLUMBIA September 1994 © Keith Dennis Yarnauchi  In presenting this thesis in partial fulfilment of the requirements for an advanced , I agree that the library shall make it degree freely available for reference and study. I further agree that permission for extensive copying of this thesis for scholarly purposes may be granted by the head of my department or by his or her representatives. It is understood that copying or not be allowed without my written publication of this thesis for financial gain permission.  Department of  Li.’  The University of British Columbia Vancouver, Canada Date  DE-6 (2/88)  ‘  11  ABSUACE  The business reorganization systems available to fmancially-distressed businesses in Canada are evolving into a system similar to that employed in the United States under Bankruptcy Reform Act of 1978 (Code). Business reorganizations have been an integral part of American commercial culture for almost a century. In Canada, business debtors may resort to the Companies’ Ceditoi A nwgemeni’ Act (CCAA) or the Bankruptcy and Insolvency Act (BIA), when seeking to reorganize their affairs. However, Canadian debtors use those systems sparingly. A primary objective of a business reorganization system is to balance the debtor’s rehabilitation efforts with the rights of creditors. This paper examines the Code and conducts a functional comparative analysis of certain aspects of the Canadian and American systems. The purpose of this examination is to detemiine whether the systems accomplish that objective and whether the Canadian systems could accomplish that objective more effectively by examining and incorporating aspects of other systems. This paper argues that the BL& neither encourages the debtor’s rehabilitation efforts nor treats creditors equitably. The primary reason for this shortcoming was the failure of the policymakers to consider the objectives of a business reorganization system. These policy objectives formed the foundation of the Code. As a result, the Code contains concepts that attempt to balance the interests of debtors and creditors and gives the courts the necessary flexibility to mould the concepts to achieve that balance. The CCAA provides little procedural or substantive guidance concerning its policy objectives. 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 a workable business reorganization model. Further efforts at bankruptcy reform must include a thorough study of legislative and doctrinal aspects of systems other than those used domestically. This paper  111  argues that Canadian policymakers could create a fair and equitable business reorganization system by using the concepts in the Code and those developed under the CCAA and by attempting to resolve shortcomings of those systems identified by the courts and commentators.  v TABLE OF CONTENTS ABSTRACT  ii  TABLE OF CONTENTS  iv  GLOSSARY  vii  CHAPTER I  CHAPTER II  CHAPTER ifi  INTRODUCTION  1  A.  CONCEPTUAL FRAMEWORK AM) ISSUES  1  B.  LITERATURE REVIEW  6  C.  METHODOLOGY  9  D.  “BUSII.1ESS REORGANIZATION”  14  LEGISLATIVE HISTORY  16  A.  BIA  16  B.  CCAA  21  C.  CODE  22  ELIGIBILITY TO REORGANIZE  29  A.  DEFINITIONAL DIFFERENCES  29  B.  TECHNICAL REQUIREMENTS UNDER THE CCAA  36  C.  GOOD FAITH IN COMMENCING REORGANIZATION PROCEEDINGS  39  1.  The Concept of Good Faith in a Business Reorganization  40  2.  Legislative History and Evolution of the Concept of Good Faith in Reorganization Proceedings  42  Should Good Faith Be a Consideration?  51  3. D.  CONCLUSION  53  V  CHAPTER 1V  CHAPTER V  CUSTODY OF THE ESTATE OF THE DEBTOR  55  A.  DEBTOR IN POSSESSION (DIP)  56  1.  Legislative History and Conceptual Basis  56  2.  Fiduciary Duty ofthe DIP  61  3.  External Control ofthe DIP  63  4.  Appointment of a Trustee or Examiner  66  B.  THE CANADIAN APPROACH  69  C.  FULFILMENT OF OBJECTIVES AND PROPOSALS FOR REFORM  72  CERTAIN ADMINISTRATiVE POWERS A.  ADEQUATE PROTECTION DURING THE STAY OF PROCEEDINGS  77  1.  80  Terminology (a)  Secured Creditor  80  (b)  Adequate Protection  84  2.  Nature ofthe Stay of Proceedings  95  3.  Scope ofthe Stay ofProceedings  103  4.  Lifting the Stay / Dismissing the Case  114  (a)  CCAA  116  (b)  Code  121  (c)  BIA  127  5.  B.  76  Analysis of the BIA and Proposals for Reform  132  REPUDIATION OR REJECTION OF REAL PROPERTY LEASES  140  1.  140  Legislative History  vi 2.  Repudiation / Rejection  145  3.  Rejection or Repudiation of Unexpired Leases to Facilitate Reorganization  152  4. C.  CHAPTER VI  The Necessity for the Existence of a Lease  153  (b)  Ipso Facto or Bankruptcy Clauses  155  (c)  Time Limit for Election to Reject or Repudiate  159  (d)  Performance of Obligations During the Stay of Proceedings  162  (e)  The Landlords Claim or Compensation for Breach  168  (f)  Standards for Rejection or Repudiation  171  Considerations for Reform  173  FINANCING THE PROCEEDING  175  1.  Use of Cash Collateral  177  2.  Obtaining Credit  186  3.  Conclusion  200  MOVING TOWARD CONFIRMATION OF A PLAN OF REORGANIZATION  201  A.  STEPS PRECEDING CONFIRMATION  202  B.  TIME WITHIN WHICH THE PLAN MUST BE FILED  210  C.  CLASSIFICATION AN]) VOTING ON THE PLAN  223  1.  Voting on the Plan and Required Majorities  225  2.  Classification of Claims and Interests  234  D. CHAPTER VII  (a)  CRAM DOWN  254  CONCLUSION  270  Vu  GLOSSARY 77B: 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. 98-3 53, 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 Boardman Callaghan, 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. 30 1-399. Code: Bankruptcy Refonn Act of 1978, Pub. L. No. 95-598, 92 Stat. 2549 (codified as amended at 11 U.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 1978 U.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 1978 U.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).  1 EERI 7 CHAI IN1RODUCHON  A.  CONCEPTUAL HAMEM)RK AND ISSUES  Tn 1947, in the seminal article on the CCAA, Stanley E. Edwards wrote the following, when speaking 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 of Canadian conditions in an effort to devise the fairest and most feasible scheme possible for application of the C.C.A.A. 1 From the time of Edwards’ article to the early 1980s, there were few business reorganizations in Canada. There were two reasons for this. First, there was the notion that the CCAA was intended for  large companies with complex capital structures. 2 Few companies met these criteria. The second reason was that the former Canadian Act did not allow the debtor to bind secured creditors to the proposal 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 “remedy of choice” 3 of debtors seeking to reorganize their fmancial affairs. However, the structure of the CCAA requires the debtor to make numerous court applications to accomplish the objectives of the act. Thus, companies that use the CCAA must have the necessary fmancial backing to withstand the significant costs attendant on such a proceeding. The former Canadian Act continued to be of little use to debtors with significant secured debt. Bill C-22, 4 which received Royal Assent on June 23, 1992, resulted in significant amendments S.E. Edwards, “Reorganizations Under the Companies’ Creditors Arrangement Act” (1947), 25 Caii Bar Rev. 587 at 592. 1  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 in consequence thereof, 3d Sess., 34th Parl., 1991 (assented to 23 June 1992). ‘  2 to the former Canadian Act. The amendments changed the name of the former Canadian Act to the Bankruptcy and Insvlvency A ct 5 and they were proclaimed in force on November 30, 1992.6 The BIA completely changed substantive and procedural aspects of the proposal provisions of the former Canadian Act. The most significant change was to the rights and duties of secured creditors. The debtor now has the ability to stay proceedings of secured creditors and to bind a minority of secured creditors 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 a parliamentary committee established for that purpose. 7 Parliament has formed the committee and its purpose is to: provide a forum to discuss and determine priorities for insolvency reform for the next several years and to allow for the development of a consensus on policy recommendations in 8 various areas of concern. The parliamentary committee has established a number of working groups. The object of each 9 Working Group #2 is to focus on, inter alia, working group is to focus on a specific area of concern. commercial reorganization issues. The Superintendent of Bankruptcy views the provision requiring the  S.C. 1992, c. 27, s. 2. P.C. 1992-2180, ST192-194, C. Gaz. 1992.11.4079. Certain administrative provisions were proclaimed in force prior to that time [P.C. 1992-1665, SJJ92-135, C. Gaz. 1992.11.3300]. Those provisions will not be addressed in this paper. 6  S.C. 1992, c. 27, s. 92 provides: “After the expiration of three years after this section comes into force, this Act shall stand referred to such committee of the House of Commons, of the Senate or of both Houses of Parliament as may be designated or established for that purpose and the committee shall, as soon as practicable thereafter, undertake a comprehensive review of the provisions and operation of this Act and shall, within one year after the review is undertaken or within such further time as the House of Commons authorize, submit a report to Parliament thereon.” S.J. Kershman, “Working Groups of the Bankruptcy and Insolvency Committee” (1993) 13:3 Insolv. Bulletin 342 at 343. 8  lbid 9  3 review by the parliamentary committee as continuing the momentum started by the enactment of the He goes on to state: The opportunity presented by that review will only be meaningful if interested parties keep the process 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 for research 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 meet the broader objectives of a business reorganization regime. This paper will show that the committee cannot 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 their arguments and discussion and they have alluded to the fact that the CCAA is evolving in a way that provides the parties to the proceeding with rights similar to those contained expressly in the Code.’ 2 The few cases that have considered the BIA appear to be taking an approach similar to that taken under the CCAA. The Colter Committee Report specifically rejected the wholesale adoption of the reorganization provisions contained in Chapter 11 and the administrative provisions contained in chapter 3 of the  13 Parliament appeared to have taken this advice, although there may be sufficient flexibility in Code. the BIA to allow some of the Code’s more desirable concepts to be used in a Canadian business  G.F. Redling, “The First Year of the Bankruptcy and Insolvency Act: The Policy and Regulatory Perspective” (1993) 13:4 Insolv. Bulletin 381 at 391. 10  ‘  Ibid  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 United Maritime Mshennen Co-op. (1988), 69 C.B.R. (N.S.) 161 at 169 (N.B.C.A.); Re Perkins Holdings (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. 12  13  Colter Committee Report at 53-54.  4 reorganization. It is not clear wi’y the Colter Committee Report and Parliament were determined to reject all aspects of the American model. There are aspects of the American model that are less than desirable, such as the time necessary to complete most proceedings under Chapter 11 and the fact that few debtors emerge from the proceedings as viable entities.’ 4 However, this should not have discouraged Parliament from incorporating some of the Code’s more equitable provisions and the notions 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 and the practical effects flowing from it.  This paper will illustrate the utility of conducting such an examination, to show that certain concepts developed in the United States could more effectively deal with Canadian business  reorganizations. While it is acknowledged that Parliament incorporated certain mechanisms similar to those used in the Code, considerable litigation will be necessary to resolve the uncertainties created by such piecemeal incorporation. This shortcoming could have been avoided in the original drafting of the BIA. A further concern is the suggestion’ 5 that Parliament will repeal the CCAA sometime following the presentation of the parliamentary committee report.’ 6 The CCAA is a flexible reorganization tool that the courts have generally athpted to fit the circumstances of the particular case. Should Parliament repeal the CCAA, without incorporating some of the principles developed under it into the BIA, a debtor seeking relief must reestablish those principles to obtain equivalent relief. This is not an efficient way of proceeding, given that the CCAA and the American statutory and 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.  5 With respect, the BIA is not a useful reorganization tool. A reason for this shortcoming is that the legislators failed to determine the “spirit and intent” of the legislation and, in particular, they failed to consider the broader objectives of the legislation or how the legislation would actually work in 7 A primary objective of a business reorganization statute is to provide the debtor with a practice.’ structure within which to rehabilitate, while ensuring the equitable treatment of creditors. This paper will examine whether the structure of the proposal provisions of the BIA serves to accomplish that objective or whether the American model or the model established under the CCAA is more conducive to accomplishing that objective. In exploring these issues, this paper will pay special attention to the rights and duties of secured creditors. In the United States, the Code tends to restrict the rights of secured creditors in to facilitate the object of achieving equity and fairness in the distribution of the assets comprising the estate and affording the debtor a fresh start.’ 8 However, in restricting those rights, the Code attempts to 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 Tassé Report suggested that, when Parliament passed the first Canadian bankruptcy statute, secured creditors held such a small proportion of the total debt that giving them special treatment was not justified.’ 9 That report and the Colter Committee Report suggested that any bankruptcy reform should include provisions 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 on them. One of the purposes of this paper is to explore whether the amendments are conceptually effective to alleviate the inefficiencies and inadequacies perceived by the Tassé Report and the Colter 17  G.C. Thornton, Legislative Drq/ting, 2d ed. (London: Butterworth, 1979) at 106.  F.R Kennedy, “Secured Creditors Under the Bankruptcy Reform Act” (1982) 15 Ind. L. Rev. 477 at 482. 18  19  Tassé Report at 56.  20  Colter Committee Report at 56-58; Tassé Report at 96-98.  6 Committee Report.  B.  LITERATURE REVIEW Most of the articles and treatises written on business reorganizations have dealt with issues  arising out of domestic legislation, with very little attention being paid to the legislation or case law of other jurisdictions. Several excellent articles have been written that describe and synthesize the case law decided under the CCAA 21 and there are numerous American textbooks and services that describe in detail the policies and procedures involved in a Chapter 11 proceeding. 22 The reader may obtain background information from those works, as it is not the intent of this paper to describe the procedures 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 prepared for continuing legal education panels that, for the most part, describe the amendments, with possible 23 ramifications. Three articles have taken a more general approach to the policy issues arising out of a business reorganization system by looking to Canadian and American legislation and case law. ELward& 24 article is important and frequently-cited, as it sets forth the policy objectives of a business See e.g., J.D. Honsberger, Debt Restructuring (Aurora: Canada Law Book, 1994); Newbould supra 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 Conference Materials, 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. 21  See e.g. Norton Bankruptcy Law & Practice, vol. 4; MJ. Bienenstock, Bankruptcy Reorganization (New York: Practicing Law Institute, 1987). 22  One exception is RA. Klotz, “Protection of Unpaid Suppliers Under the New Bankruptcy and Insolvency Act” (1993) 21 Can. Bus. L.J. 161, where the author undertakes an examination and a comparative analysis of the right of repossession under the BIA and refers to similar rights under the Quebec Civil Code, the American Uniform Commercial Code and the Code. This issue will not be examined in this paper. See also Honsberger, supra note 21. 23  24  Edwards, supra note 1.  7 reorganization system. While recognizing the “great potential importance” of the CCAA, Edwards expressed the limitation of his work by stating that the CCAA “has received little attention in either Canadian legal literature or the decisions of the courts.” 25 He proposed a methodology for the study of Canadian reorganization law by recommending that the student consider the reorganization laws of other countries. 26 Edwards abides by that advice and illustrates his points by reference to American and English cases. In reviewing his article, one must remember that he was considering a previous version of the American reorganization regime and therefore, its present use for interpreting particular provisions may be limited. However, the valuable insight that Edwards provided into the policy of business reorganization systems is as valid today as in 1947 and therefore, this paper will refer to his work, from time to time. An article by Professor George Triantis  27  examined the effectiveness of the draft BIA in  quelling the desire of creditors in a reorganization proceeding to hold out for a greater proportion of the “going concern surplus.” Professor Triantis sees the objective of bankruptcy reorganization law as a solution to this “collective action problem” which results in the liquidation of a debtor that is worth more as a going concern than the aggregate liquidation value of its assets. He discusses the stay of proceedings and the voting and acceptance of proposals and concludes that neither mechanism addresses the collective action problem. He proposes a simpler, albeit hypothetical, model that addresses the problem and incorporates certain features of the Code, such as the cram down and the prepackaged plan. He does not conduct a comparative doctrinal analysis of these concepts but merely uses them for illustrative purposes. Professor Triantis also points to certain difficulties arising out of the wholesale adoption of the extensively regulated system of Chapter 11.  25  Ibid at 587.  26  Supra note 1 and accompanying text.  G.G. Triantis, “Mitigating the Collective Action Problem of Debt Enforcement Through Bankruptcy Law: Bill C-22 and its Shadow” (1992), 20 Can. Bus. L.J. 242. This article, although published in 1992, was written in 1991, prior to the passage of the BIA. 27  8 Professor Douglas G. Baird questioned the wisdom of Professor Triantis’ suggestion that 28 Professor Baird’s Canada move along the reorganization spectrum toward a Chapter 11 model. article does not analyze the doctrinal or normative bases of the Canadian and American business reorganization provisions. Rather, he provides a critique or, more accurately, a criticism of Chapter 11.  We must temper any suggestion of adopting certain features of another system with the concerns  raised by those living under the system. Accordingly, this paper will refer to Professor Baird’s thesis throughout the discussion that follows. This paper will expand upon the notion put forth by Triantis and Edwards that certain features of the Code be incorporated into the Canadian business reorganization regime. However, rather than looking at a business reorganization system as a rationale for the mitigation of the collective action problem, this paper will treat the distributional objective of balancing debtor and creditor rights, along with the objective of rehabilitation of the debtor, as the primary objectives of a business reorganization 29 These objectives provide the normative platform upon which to build a business system. reorganization system. One may take the position that business reorganizations are desirable and that the rights of the debtor (and hence, the reorganization itself) should take precedence over the rights of the creditors. However, one can hardly make an argument that business reorganizations are desirable in every situation. Conversely, it is equally eoneous to suggest that business reorganizations should not be a part of a commercial system, as certain businesses should have the opportunity to adapt to the changing circumstances in the marketplace. To that extent, the system may modify the strict rights of creditors. A system that favours neither the debtor nor its creditors but attempts to balance the interests of each is one that we should seek to attain. In attempting to strike such a balance, the respective positions of the parties that have the least to gain should not be sacrificed. Conversely, Baird, supra note 14. This article was prepared and published at the same time as the foregoing article by Professor Triantis. 28  Professor Triantis considers bankruptcy law as attempting to achieve efficiency rather than balancing the rights of debtor and creditor, given that the parties consider the distributional impact of bankruptcy rules long before the rules become operative. 29  9  those that may prosper from a successful reorganization should be made to incur the risks of the reorganization proceeding. ° 3  C  MKIIIODOLOGY  This work will use, in a very general way, the methodology suggested by Edwards, although it will not stress the public policy objectives upon which Edwards based his work. Since his article, the Canadian and American systems have developed sufficiently to justify a doctrinal analysis of the concepts that have evolved. This type of analysis will allow us to determine whether we have realized the “great potential importance” of the CCAA and business reorganization laws, foreshadowed by 31 Edwards. It would however, be naive to think that one could study a topic dealing with business reorganizations, insolvent business debtors and potential loss of jobs, through a purely doctrinal analysis, without some type of policy analysis. The normative values underlying a business reorganization system will significantly affect the nature of this analysis. This will be an important aspect of this discussion, as it appears that the Parliament of Canada left the development of a business reorganization system to the courts. With respect, the courts should not be required to bear this 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 without being required or permitted to establish broad, seemingly unrelated policies. Furthermore, the courts have limited sources of information from which to draw, compared to the vast resources available to 32 Without clearly articulated policies, as reflected in the legislation, it may take the policymakers. See D.G. Baird and T.H Jackson, “Corporate Reorganizations and the Treatment of Diverse Ownership 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.  RA. Heineman, ed., The World of the Policy Analyst (Chatham: Chatham House, 1990) at 141-169. 32  10 years to realize those policies or they may never be realized, should the precise issue not come before the courts. 33 The specific methodology to be undertaken will be one of comparative analysis of the proposal provisions of the BIA, the reorganization and certain administrative provisions of the Code and the CCAA. This methodology raises several issues that must be dealt with before embarking on the  examination. Given the differences in the structures of the respective regimes it is difficult to overlay one system on another. Therefore, this paper will undertake functional comparisons of similar mechanisms 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, 34 approach will be undertaken. Such an approach does not merely an “applied comparative law” describe the laws being considered or their differences, but is a functional comparison of the mechanisms and concepts used in each system. 35 As part of this examination, a brief review of the  legislative histories of the statutes under consideration will be made. This may give us some insight as 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 provisions of 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 in  enacting Chapter 11 have been realized in practice. Furthermore, this approach may point to positive and negative aspects of the Code and may assist us in formulating proposals for reform that are lucid  36 As well, because of the perception that the Canadian and accomplish the desired objectives. E.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. Ibid 36  It has been said of this type of methodology that: “To study the way other systems at comparable stages of development deal with problems that  11  reorganization regimes are evolving into a system similar to the American model, 37 examining the American 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 trade will undoubtedly continue or escalate under the Canada-U.S. Free Trade Agreement 38 and the North American Free Trade Agreement. 39 If both countries reexamine their respective business  reorganization regimes with a view to harmonizing the provisions, the expectations of creditors involved 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 English statutes and case law, ° this paper will make only passing reference to those laws. Alan Watson 4 described the importation of rules or systems of law from one country to another as a “legal 41 and developed an analogy to describe the level of acceptance of the transplant: transplant” A successful legal transplant like that of a human organ will grow in its new body, and become part of that body just as the rule or institution would have continued to develop in its parent system. Subsequent development in the host system should not be confused with 42 rejection. -  -  An interesting question is why business reorganization law continued to develop in the United States  our own system either does not handle very well or to which we have not yet worked out satisfactory solutions, is often extremely enlightening. Comparatists do not ordinarily view this sort of study as preliminary to wholesale transplantation of a foreign institution, but rather as a source of inspiration, and an indication of the problems, as well as the benefits, to be anticipated 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 of Bankniptcy (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.  12  whereas in Canada, neither the former Canadian Act nor the CCAA were used to any great extent prior to the early 1980s. Tn 1947, Edwards attributed the lack of Canadian reorganization law to Canada’s relatively immature economic 43 development. This however, does not explain why, since that  time, business reorganizations in Canada continued to lie dormant while American reorganization law was flourishing. Certainly, it did not take Canada to the early 1980s to reach the economic development of the United States in the 1940s. A comparative analysis approach is also fraught with the danger of ethnocentricity or a suggestion that one law is a superior or exemplary regime. Hopefully, a paper which suggests that none 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 analysis  involving 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 commentaries  interpreting that legislation. It is dangerous to assume that the approaches taken by scholars and the judiciary are completely objective and as such, there is some difficulty in exercising autonomy in the interpretation of the legislation. In combatting this difficulty however, the reader must remember that the object of this paper is not to provide a critique of the American system, but to use American materials as a benchmark from which to determine whether the Canadian courts and legislators would benefit from adopting a similar approach. In this manner, the commentaries on the American legislation 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 will assist in interpreting the provision being considered, but also may be useful in giving us insight into the social objectives that the legislation sought to accomplish. The aim in reviewing the American law is not to determine whether the system is inherently good or bad, but whether aspects of it help to accomplish the broader objectives of a business reorganization system. “There was little reorganization law in America when its economic development was at a stage comparable to Canada’s present condition.” [Edwards, supra note 1 at 592).  13 This approach is not meant to suggest that a uniformity of business reorganization laws is possible or advisable. To make such a suggestion, it would be necessary to examine broader nonbankruptcy matters such as regimes involving real and personal property security and  macroeconomic 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 that affects a broad range of individuals and entities in the business conmiunity must be addressed. As mentioned above, one purpose of insolvency legislation is to attempt to balance the interests of the  various parties involved in the proceeding. An attempt has been made to attain scholarly objectivity in conducting the research. However, depending on the position of the reader, the results of the research may be seen as biased in favour of one or more parties. For example, in discussing the concept of adequate protection under the Code, it has been said that: In resolving the conflict, many bankruptcy courts appear to give undue deference to the secured creditor’s rights, leading them to impose standards of adequate protection that seriously 45 impede and often arrest the debtor’ reorganization. On the other hand, some ‘witers see the concept of adequate protection as one which favours the debtor such that “the balance is usually in favour of the debtor so as to effectuate the underlying bankruptcy 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 not  truly reflect the best interests of the business community as a wiole. The committee that prepared the 47 although it solicited Tassé Report stated that it was not a committee of inquiry or investigation,  Supra note 29 and accompanying text.  Comment, “Adequate Protection and the Automatic Stay Under the Bankruptcy Code: Easing Retraints on Debtor Reorganization” (1982) U. Pa. L. Rev. 423 at 426. at 742.  D. Price, “Adequate Protection Under the Bankruptcy Act of 1978” (1982-83) 71 Ky. L.J. 727  Tassé Report at xi.  14 information 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 as an appendix to the Tassé Report, made written submissions. Only one party specifically represented 48 One must question whether the Tassé Report fairly represented the position of debtor and debtors. accordingly, 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 and  arrangements 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 paper specifically avoids use of the term “corporate reorganization,” as the Code and the BIA also apply to individuals and partherships that are carrying on business. Excluded from the term are consumer proposals or arrangements, 49 arrangements involving farmers and farm 5 corporations, plans for ° adjustment of a municipality ’ and raifroad reorganizations or schemes of arrangement. 5 52 Although one may define a business reorganization in terms of the objectives that it seeks to accomplish, it may be more appropriate to defme it by its intiinsic nature. For the purposes of this paper, “reorganization” or “business reorganization” means a judicially-supervised 53 settlement between a debtor and its creditors and among the debtor’s creditors concerning the fmancial affairs of the It is acknowledged that submissions were made by organizations such as the Canadian Bar Association and La Chambre de Commerce du District de Montréal, wiuich may have addressed the interests of debtors but overwhelmingly, the written submissions were from interest groups representing creditors. 48  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.  15 debtor. The reorganization seeks to solve the problem of how to make a debtor in failing circumstances economically sound, while at the same time preserving or modifying the legal rights of its creditors and shareholders.M  Collier on Bcinkniptcy, vol. 1, 14th ed. (New York: Matthew Bender, 1974) s. 0.01.  16 CHAPTER II LEGISIATWE HISTORY  This chapter will provide a brief legislative history of each system being considered in this paper.’ Placing the provisions within a historical context may provide an indication of the interests sought to be protected at the time of their enactment. It may also assist a contemporary law reformer in determining whether those interests continue to require protection or alternatively, whether current values require protection of different interests.  A.  BIA  The first bankruptcy legislation enacted by the Parliament of Canada 2 was the Insolvent Act of This chapter will deal with the legislative history of business reorganization legislation generally. Throughout this paper, reference will be made to the legislative history of the particular provisions under consideration.  Bankruptcy laws and specifically, business reorganization laws, are promulgated pursuant to the respective jurisdictions granted to the federal governments of the United States and Canada under their constitutions. Subsection 91(21) of Constitution Act, 1867, (U.K.), 30 & 31 Vict., c. 3 [hereinafter the Canadian Constitution], delegates to the Parliament of Canada legislative authority over bankruptcy and 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 the subject 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 Court of Missouri stated: 2  “I hold it extends to all cases where the law causes to be distributed the property of the debtor among his creditors; this is its least limit. Its greatest is a discharge of the debtor from his contracts. And all intermediate legislation, affecting substance and form, but tending to further the great end of the subject distribution and discharge are in the competency and discretion of 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 will prevail or pre-empt the provincial or state law. This is based, in Canada, on the federal paramountcy doctrine [Tennant v. Union Bank, [1804] A.C. 31 (P.C.)] and, in the United States, on the “supremacy clause” in the U.S. Constitution, that provides: “This Constitution, and the Laws of the United States which shall be made in Pursuance thereof shall be the supreme Law of the Land; and the Judges in every State shall be bound thereby, any Thing in the Constitution or Laws of any State to the Contrary notwithstanding.” [art. VI, s. 2] ...  17 1869. That act contained provisions allowing an insolvent debtor to make a composition 4 with its  These doctrines are applicable when the federal law and the provincial or state law are valid and enacted within each government’s delegated or residual authority, but they yield inconsistent or conflicting results [P.W. Hogg, Constitutional Law of Canada, 3d ed. (Toronto: Carswell, 1992) at 418]. A recent challenge to the commercial tenancy provisions in Part ifi of the BIA was undertaken in Re Janpar Inc. (1993), 20 C.B.R (3d) 8 (C.S. Qué.), where the court upheld those provisions on the basis of the federal paramountcy doctrine. The Canadian and American courts have upheld the jurisdictions of the Parliament of Canada and Congress to enact legislation providing for compositions, extensions and reorganizations under their respective bankruptcy powers. The constitutionality of a provision permitting the debtor to effect a compromise of its debts with its creditors was upheld on the basis that the bankruptcy power was nothing less than “the subject of the relations between an insolvent or non-paying or fraudulent debtor and 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 composition of 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 Re Companies’ 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 of compositions and arrangements is a natural and ordinary component of a system of bankruptcy and insolvency law.” [at 660] The Alberta Court of Queen’s Bench recently had occasion to consider the constitutionality of the 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 the constitutionality of reorganization statutes generally. In discussing the CCAA Reference case, Forsyth J. said: “The C.C.A.A. is an Act designed to continue, rather than liquidate, companies. In upholding the C.C.A.A., the Supreme Court of Canada must be taken as having extended the meaning of the term “insolvency” to include dealing with insolvent companies outside of a liquidation setting. The critical part of the decision is that federal legislation pertaining to assisting in the continuing operation of companies is constitutionally valid. In effect the Supreme Court of Canada has given the term “insolvency” a broad meaning in the constitutional sense by bringing within that term an Act designed to promote the continuation of an insolvent company.” [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. A composition is an arrangement between the debtor and its creditors where the creditors agree with the debtor and among themselves to take less than the full amount of their respective claims on a pro rata basis in full satisfaction of the debts due or accruing due to them from the debtor [Blxk’s Law Dictionaiy, 6th ed. (St. Paul: West, 1990) at 286]. It is important to note the difference between common law compositions and compositions created by statute. In the case of a statutory composition, the statute allows the majority to bind the minority to the composition. For example, section 94 of the Insolvent Act of 1869, ibid, provided:  18 5 The Insolvent Act of 18756 repealed the Insolvent Act of 1869. The Insolvent Act of creditors.  1875 contained provisions similar to those repealed. 8 These acts applied only to insolvent traders. 9 Because 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 the creditors of an Insolvent who are respectively creditors for the sums of one hundred dollars and upwards, and who represent at least three fourths in value of the liabilities of the Insolvent subject to be computed in ascertaining such proportion, shall have the same effect with regard to 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 the agreement of others. In the context of a business reorganization, an extension is an agreement between the debtor and its creditors where, in consideration of the creditors agreeing not to enforce their rights to collect the debts owing by the debtor for a period of time after the debts are due, the debtor agrees to pay the debts in full within that period [Tassé Report at 93]. Finally, a scheme of arrangement, in strict terms, includes any arrangement where the property or income of a debtor is proportionately applied to its debts {R. Bird, Osboum’s Concise Law Dictionary, 7th ed. (London: Sweet & Maxwell, 1983) at 297]. The assets of the debtor are transferred 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 and J.D. Honsberger, Bankntptcy in Canada, 3d ed. (Toronto: Canada Law Book, 1961) at 261]. Other than the distinguishing feature of the third party intermediary, it appears that a scheme of arrangement could have the substantive features of an extension or composition. Although the definition of “proposal” in the BIA includes a proposal “for a composition, for an extension of time or for a scheme of arrangement” [BIA s. 2 “proposal”] and the CCAA allows the debtor 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 concerned whether the proposal falls into one of these. headings or is a combination of them” [L.W. Houlden and C.H Morawetz, Bankruptcy and Insolvency Law of Canada, 3d ed. (Toronto: Carswell, 1994) at 2-74]. This paper has chosen to use the words “business reorganization” to denote one or all of these types of arrangements. This term is broader than the three terms used in the BIA, as it encompasses the potential of there being fundamental changes to both the debt and the equity structures of the debtor, including the elimination of some interests. The current practice of the courts appears to treat proceedings 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 shall have the strict, narrow meanings described above. .  .  Insolvent Act of 1869, supra note 3 ss. 94-108. 6  ‘‘  8  S.C. 1875, c. 16. Ibid ss. 149 and 151. Ibid ss. 49-66.  Section 1 of both acts.  19 1878, public discontent with legislation that permitted “dishonest and designing debtors” to escape 10 led to the passage of An Act to repeal the Acts Respecting Insolvency now in force their liabilities, in Canzki.’ A further reason for the repeal was the “constant irritation caused by ill-considered  legislative tinkering with so important a piece of legislation.” 2 Canada was without bankruptcy legislation until 1919, when the Bankruptcy Act’ 3 was passed. The 1919 Act enlarged the scope of proposals that an insolvent debtor could make to its creditors to include, not only compositions, but 14 In 1923, Parliament passed The Bankruptcy Act also extensions and schemes of arrangement.  Amenthnent Act, 1923.’ Section 15 of that act repealed section 13 of the 1919 Act and replaced it with a provision allowing only a bankrupt to make a proposal. This amendment resulted from allegations that debtors were avoiding bankruptcy by securing creditor consent to a proposal through 6 bribes and other fraudulent means.’ Parliament repealed the 1919 Act in 1949’ and replaced it with the 1949 Act.’ 8 It appears that Parliament intended to clarify bankruptcy legislation by the passage of the 1949 Act. When the bill was introduced to the Senate, the Honourable J. Gordon Fogo said “[t]he bill provides a more orderly  arrangement of subjects and the language in many sections of the Act has been simplified.” 9 For our  10  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.  20 purposes, the most notable change was the reinstatement of the provision allowing an insolvent person to make a proposal, without being bankrupt. The 1949 Act was criticized as inefficient, obsolete and incapable of dealing with fraudulent bankruptcies?° Thus, in 1966, Parliament made significant amendments to the 1949 Act by the Act to amend the Bankniptcy Act. ’ Among other things, the 2 amendments gave the court the right to appoint an interim receiver 22 and provided that the insolvent person would be considered bankmpt on the refusal of the creditors or the court to accept or approve the 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 committee presented the Tassé Report to the Minister of Consumer and Corporate Affairs in June of 1970 and recommended the adoption of a new bankruptcy and insolvency statute. 24 Since the presentation of the Tassé Report, Parliament made no fewer than six attempts to repeal and replace the former Canadian Act 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, the  Minister of Consumer and Corporate Affairs at that time, suggested that it may be more expedient to amend the former Canadian Act. 25 The Minister struck the Committee on Bankruptcy and Insolvency  that presented the Colter Committee Report in 1986. The Tassé Report and the Colter Committee Report recommended the retention of a system allowing for the reorganization and rehabilitation of  20  Colter Committee Report at 18.  21  S.C. 1966-67, c. 32.  22  Ibid s. 5.  23  Ibid ss.7and8  24  Tassé Report at 81.  Colter Committee Report at 18.  22 statements to induce them to accept the proposal being put forth. ’ As a result, Parliament enacted 3 amendments 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 favour of a trustee? 3 However, in recent years, the courts have allowed less than complex debtors to use the CCAA, 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 it  may serve to quell any abuses of the legislation. 34  CODE  C  The debtor’s right to make a composition with its creditors first appeared in the 1874 35 to the Bankruptcy Act of 1867.36 A debtor could effect a composition without being amendments adjudicated a bankrupt. 37 Tn 1878, Congress repealed the Bankruptcy Act of 186738 because of abuses on the part of the courts and excessive fees. 39 The United States was without bankruptcy legislation for twenty years until the passage of the 1898 U.S. Act. ° The composition provisions of the 1898 4  ‘  Ibid  32  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 intended to have application were “companies that have complex financial structures, and a large number of investor 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).  23 U.S. Act were similar to those included in the amendments to the Bankruptcy Act of 1867. A debtor could only make a composition with its unsecured creditors. ’ This limitation curtailed the use of the 4 composition provisions. However, the 1898 U.S. Act did not require the debtor to be insolvent to be eligible to make a composition. 42 Provided the composition met the necessary prerequisites, it could be confirmed by the court’ and the debtor would be discharged from its debts, following its compliance with the provisions of the composition. Congress enacted minor amendments to the composition provisions of the 1898 U.S. Act in l910 and 1922.46 However, major amendments were not made until the onset of the depression that took place in the 1930s. The depression resulted in a significant increase in the number of 47 As a result, Congress saw a need to amend the provisions of the bankruptcy regime to bankruptcies. protect the integrity of the system and allow honest but unfortunate debtors easier access to the system 41  Collier on Bankruptcy, supra note 37, vol. 6, s. 0.03.  1898 U.S. Act s. 4 provided that “[amy person who owes debts. shall be entitled to the benefits of this Act as a voluntary bankrupt”, cf First National Bank of Cincinnati v. Flershem, 290 U.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 the business, it found that the course of action proposed by the debtor was in “deliberate disregard” of the rights of the affected creditors [at 517]. The court went further however, and found that the purpose sought to be effected by the debtor was “fraudulent in law.” [at 519]. 42  .  .  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 could be made. ‘  Ch. 22, 42 Stat. 354 (1922), which added the necessity of an indemnity for any losses suffered as 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 staggering statistics: “The number of cases in bankruptcy has steadily increased from 23,000 in the fiscal year 1921 to 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 losses to 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]  24 and more expeditious relief. 48 Unfortunately, the time required to study the existing system and make recommendations necessitated the passage of “emergency” legislation in the mid-1930s. The legislation that preceded the enactment of the emergency legislation, permitted only compositions. It did not permit a comprehensive reorganization of the debt and capital structures of the debtor to facilitate its ongoing operation. 49 Among other things, the emergency legislation attempted to accomplish this. For our purposes, the addition of section 7713 was the most significant amendment effected by the emergency legislation, as it was the first comprehensive code for the reorganization of corporate debtors. Section 7Th laid the groundwork for the reorganization provisions that evolved into Chapter 11. It provided that on acceptance of a plan by special majorities of creditors and stockholders, the  48  Ibid  W.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 were accomplished through a device known as the equity receivership. An equity receivership was commenced by a creditor whose execution had been returned unsatisfied. The creditor would seek the court’s assistance in having a receiver appointed to take control of and, ostensibly, sell the debtor’s assets to satisfy the creditors. However, once a receiver was appointed, the debtor and the creditors could formulate a plan that would see the debtor’s assets sold and the rights and obligations of the parties adjusted with a view to having the former business of the debtor continue, as reorganized [for a full 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 many inadequacies that section 7Th attempted to rectify. The inadequacies were summed up by the United States Supreme Court, where Goldberg J. said: “Before passage, in 1934, of s. 7Th of the Bankruptcy Act, 48 Stat. 912, bankruptcy procedures offered no facilities for corporate rehabilitation, which, therefore, was left to equity receiverships, with their attendant paraphernalia of creditors’ and security holders’ committees, and of rival plans of reorganization. Lack ofjudicial control of the conditions attending formulation of the plans, inadequate protection of widely scattered security holders, frequent adoption of plans which favoured management at the expense of other interests and which afforded the corporation only temporary respite from fmancial collapse, so often characteristic As does the of equity receivership reorganizations, led to the enactment of s. 7Th. present Chapter X, s. 7Th perniitted the adjustment of all interests in the debtor, secured creditors, unsecured creditors, and stockholders.” [Securities and Exchange Commission v. American Trailer Rentals Co., 379 U.S. 594 at 603-604 (1965) [hereinafter American Trailer Rentals]]. ...  25 plan would be binding on the dissenting minority. 50 It also provided for the classification of claims, ’ 5 the stay of proceedings, 52 the continuation of the debtor in possession in the absence of the appointment of a trustee 53 and allowed the court to make an independent detennination concerning the 54 fairness of the plan. However, section 7Th lacked provisions for the protection of creditors and investors and supervision of the business of the debtor during the reorganization procedure. 55 Accordingly, Congress passed the Chandler Act in 1938. Section 7Th essentially became Chapter X which governed corporate 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 provided for the mandatory appointment of an independent trustee to monitor the affairs of a large debtor during 57 and a more comprehensive means of control by the courts during the the reorganization 58 One of Chapter Xs strengths was in permitting the debtor to reorganize and reorganization process. compromise 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. J.I. Weinstein, The Bankniptcy Law of 1938 (New York: National Association of Credit Men 1938) at 192. 56  Chandler Act s. 156 provided: “Where the liquidated and non-contingent indebtedness of a debtor is $250,000 or over, the judge shall, upon the approval of the petition, appoint one or more disinterested trustees, who shall be qualified, except as to residence and location of office, as prescribed in section 45 of the Act. Where such indebtedness is less than $250,000, the judge may appoint one or more trustees or may continue the debtor in possession.” 58  American Trailer Rentals, supra note 49 at 604.  26 provisions were intended for large publicly-held corporations that needed readjustment of secured 59 debt. The 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 the provisions of Chapter X applied. 60 As Chapter XI permitted a debtor to reorganize its affairs only with its unsecured creditors, 61 it suffered the same weakness as the former Canadian Act. The plan could not affect secured creditors. 62 One commentator explained the rationale for excluding secured  creditors from the provisions of Chapter XE as follows: The policy of dealing with secured debts was unsound; it was soon recognized that the interference with the free exercise by secured creditors of their remedies was bound ultimately to impair the liberal extension of credit upon collateral. Besides, its provisions were ineffective; in the majority of cases the secured indebtedness wss a single debt held by a single person and in an amount sufficient to constitute a substantial, if not the major, part of the indebtedness. Such a secured creditor held and frequently exercised a virtual veto power over the proceeding. 63 ...  Collier on Bankruptcy, supra note 37 at s. 0.09. Tn this manner, the focus of Chapter X was the same as the intended focus of the CCAA. Under Chapter X, public investors were protected by the intervention of the Securities and Exchange Commission. See e.g., Chandler Act s. 172 which provided: “After hearing and before approval of any plan, the judge may, in cases in which the scheduled indebtedness does not exceed $3,000,000 and shall, in cases in which the scheduled indebtedness exceeds $3,000,000, refer to the Securities and Exchange Commission for examination and report the plan or plans deemed by him worthy of consideration. Such report shall be advisory only.” 60  Chandler Act s. 147, provided: “A petition improperly filed under this chapter, because adequate relief can be obtained by the debtor under chapter XE, may upon the debtor’s application, be amended to comply with the requirements for a petition under chapter XE, and thereupon shall be regarded as if originally filed thereunder.”  See also Chandler Act ss. 146(2) and 141 which together, provided that a court may dismiss a petition that 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  Ibid  63  Ibid at 260.  27 The provisions of Chapter Xl were much less stringent than those of Chapter  X given the  interests to be served by Chapter X Despite the intent of Congress, it appeared that a corporation had a choice of regimes under which it could attempt to effect a reorganization. The United States Supreme Court held that the consideration controlling the choice of regime was not the character of the debtor, the nature of its capital structure or its size, but the nature of the interests and the needs to be served in the rehabilitation of the debtor.M Although generally, Chapter X was intended for adjustment of publicly-held debt, 65 the courts allowed larger, publicly-held corporations to use Chapter XL However, on application of the Securities and Exchange Commission, the court had the discretion to dismiss a Chapter XI proceeding, unless the debtor complied with the more stringent 67 Despite these procedures, fewer that 10 percent of all requirements of a Chapter X proceeding. reorganizations were commenced under Chapter X Debtors used the the less rigorous provisions of Chapter XI more frequently. 68 The House Report 69 referred extensively to the shortcomings of having two reorganization chapters 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 standards 64  General Stores Corp. v. Shlenky, 350 U.S. 462 (1956).  65  American Trailer Rentals, supra note 49 at 613.  (1955).  See e.g, In re Transvision, Inc., 217 F.2d 243 (2d Cir. 1954), cen’. denied, 348 U.S. 952  11 U.S.C. 728 (1970). See e.g, In m Lea Fabrics, Inc., 272 F.2d 769 (3d Cir. 1959), where, in describing the scope of the discretion to be exercised by the courts in such a case, Goodrich J. said: 67  But “That discretion, it is to be observed, is not one limited greatly by settled legal niles. the criterion by which the district judge’s discretion is to be exercised has to do with the best arrangement for all parties concerned under the circumstances confronting the particular corporation.” [at 771]. ...  House Report at 222. 69  Ibid  28 for confirmation. Chapter XI needs to be expanded to pemiit adjustment of secured debt and equity, and needs to have added certain public protections not now found in chapter XI. As these changes are integrated into the two chapters, the differences between them begin to disappear, 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].  29 CHAPTER ifi E[IGIBILHY TO REORGANIZE  At first blush, the eligibility of an entity to take advantage of a statute allowing it to reorganize its fmancial affairs may seem like a simple matter. However, the Code, because of its  permissive eligibility description, has been creatively used in a way that may seem unusual to Canadian insolvency practitioners. The CCAA and the BIA use more restrictive descriptions. This chapter will examine the definitional requirements of the legislative schemes with a view  to determining whether those requirements encourage or restrict certain entities from using the reorganization opportunities offered by the legislation. Should the conclusion resulting from such examination 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 the legislation. 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 a reorganization proceeding, such as the stay of proceedings,’ the courts consider whether the debtor must act in good faith in commencing the proceeding. This chapter will examine whether good faith should be considered by the courts and whether the concept supports the objectives of a reorganization proceeding.  DEFINiTIONAL DIFFERENCFS  A.  2 that resides, is domiciled or has a place of Subsection 109(a) of the Code allows a person  business or property in the United States to be a debtor under the Code. Section 109 then provides See discussion in chapter V(A), below. Code s. 101(4 1) defmes “person” as including an individual, a partnership and a corporation. The defmition excludes governmental units, under certain circumstances. 2  30 that all persons, other than stock and commodity brokers and certain donstic and foreign insurance companies 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 the essence 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 and banking institutions, comprehensively supervise and regulate those entities. 5  The CCAA pemiits a “debtor company” to propose a compromise or arrangement with its creditors. A company, under the CCAA, includes any federally or provincially incorporated company or any incorporated company having assets or doing business in Canada, wherever incorporated. 6 It excludes 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 is one that is or is deemed to be insolvent, has committed an act of bankruptcy under the BIA or is 8 Section 3 sets forth the further precondition that there be outstanding bonds issued by the bankrupt.  debtor under a trust deed or other instrument running in favour of a trustee. 9 Subsection 50(1) of the BIA allows a proposal to be made by, inter alia, a bankrupt or an insolvent person. “Insolvent person” is, in turn, defmed as a person ° who resides or canies on 1 Code ss. 109(b) and (d). House Report at 319.  House Report at 318; Senate Report at 31. 6  CCAA s. 2 “company”.  lbid. 7 8  CCAA s. 2 “debtor company”.  Use by the debtor company of an “instant trust deed” to permit its use of the CCAA has been the subject matter of a number of cases and commentaries. This issue will be examined in chapter ffl(B), below. BIA s. 2 defmes a “person” as including a corporation, partnership or unincorporated association. ‘°  31 business in Canada, ’ whose liabilities amount to one thousand dollars and who has ceased paying or 1 is unable to meet its obligations as they become due or whose assets would not be sufficient to pay all obligations that are due and accruing) 2 The most striking difference between the Canadian and American reorganization regimes is the absence of a requirement in the Code that the debtor be insolvent or bankrupt at the time the voluntary proceeding is commenced.’ 3 The Code, therefore, permits seemingly solvent debtors to take advantage of the protective aspects of the Code. Before the enactment of the Code, either the courts or the legislation required the petitioning creditor or debtor to show that the debtor was insolvent at the time of the commencement of the case. The 1898 U.S. Act did not require the debtor to be insolvent, only that it owed debts) 4 However, the United States Supreme Court held that it would be “fraudulent” for a 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 the respective country to seek the relief being offered by the legislation. The CCAA and Code further provide that an entity that merely has assets in that country may use the provisions of the statute. This broad jurisdictional base has caused difficulties in multinational insolvencies. These difficulties will not be considered in this paper but the reader is referred to various treatises and commentaries that consider 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 decades by Professor Kurt Nadehnann, commencing with “The Recognition of American Arrangements Abroad” (1941-42) U. Pa. L. Rev. 780 and “Compositions Reorganizations and Arrangements in the Conflict 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 petition with the bankruptcy court. An involuntary case is commenced under section 303 of the Code by the requisite number of creditors as provided in subsection 303(b). Tn order to grant the relief requested in the involuntary petition, the court must be satisfied either that the debtor is generally not paying its debts as they become due or that a trustee, receiver or agent was appointed to take possession of all or substantially 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 application under the CCAA for an order that a meeting of creditors be summoned. The BIA however, does not permit a creditor to commence the proposal proceedings, other than indirectly through a bankruptcy trustee, liquidator or receiver. ‘  1898 U.S. Act s. 4, provided that “any person who owes debts. benefits of this Act as a voluntary bankrupt.” 14  .  .  shall be entitled to the  32 or 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 under this section; and that the corporation is insolvent or unable to meet its debts as they mature and that it desires to effect a plan of reorganization.” 6 Insolvency was also a requirement under Chapter X and Chapter  )j17  The legislative history of the Code does not suggest the reason for removal of the insolvency requirement, in the case of a voluntaiy petition. One whter suggested that Congress may have felt that a solvent debtor that was facing fmancial distress could lose the opportunity to reorganize if it waited 18 Also, the removal of the insolvency requirement alleviates a too long to commence proceedings. preliminary objection requiring a hearing to determine the financial condition of the debtor. Unless  the debtor is clearly insolvent, a hearing to determine the debtor’s fmancial condition could be a lengthy and costly procedure, as it would require the debtor and the objecting party to retain third parties to provide valuations of the debtor’s assets and opinions concerning its solvency. Should the debtor be in a tenuous fmancial condition, the fmancial and other resources expended on such a Plist National Bank of Cincinnati v. Plendiem, 290 U.S. 504 (1934) [hereinafter Plerchem] at 517, 519. 15  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, the debtor was solvent, as the only significant liabilities were those owing to stockholders on account of dividends and amounts owing upon maturity of the stock. Accordingly, the court held that the debtor was 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 debtor remain viable and avoid eventual fmancial demise. In so doing, the court felt that “it is very, very clear that in applying the substance or intention of this Act we do not have to wait until a corporation is absolutely insolvent.” [at 417]. 16  Chandler Act ss. 106(3) and 306(3), respectively. See e.g, Tucker v. Texas American Syndicate, 170 F.2d 939 (5th Cir. 1948), where the court held that the petition was not filed in good faith as the debtor, although “cash poor” was “asset rich” and made no effort to borrow money toy maturing obligations. In other words, the debtor was not insolvent and accordingly, it could not use the provisions of Chapter X See also In ir Southwest Enteiprises, Inc., 261 F.Supp. 721 (W.D. Ark. 1966). 17  MS. Bever, “Manville Corporation and the ‘Good Faith’ Standard for Reorganization Under the Bankruptcy Code” (1983) 14 U. Toledo L. Rev. 1467 at 1495-1497. 18  33 procedure 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 determine  whether to permit it to continue. Paragraph 305(a)(1) of the Code allows the court to dismiss or suspend the reorganization proceeding if the interests of the debtor and the creditors would be better served by a dismissal or suspension. The court also has the ability to permit a party to commence or continue any action that it has against the debtor or debtor’s the property by granting relief from the automatic stay.’ 9 Finally, under subsection 1112(b) of the Code, a case may be dismissed or converted from a reorganization case to a liquidation case, whichever is in the best interests of the creditors and the estate. In the case of relief from the automatic stay and conversion or dismissal, the court may grant such relief “for cause.” Although the Code does not list the debtor’s insolvency or good faith ° as a 2 prerequisite 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 or the fmancial condition of the debtor could be examined.” ’ 2 A case that raised the concern over the use by solvent entities of the reorganization provisions of the Code and that established the right of such entities to use the protective measures contained in the 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.  The issue of whether good faith is a prerequisite to commencing and maintaining a reorganization proceeding will be discussed in chapter ffl(C), below. 20  See e.g., In re Pappas, 17 B.R. 662 at 666 (Bankr. D. Mass. 1982); In re Victoiy Construction Co., 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 case under Chapter 11 is ‘cause’, independent of the existence or lack of adequate protection. . .“ [at 5601 21  Johns-Manville Corporation is hereinafter referred to as Manville. See, In re Johns-Manville Coiporation, 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). 22  34 under Chapter 11, Manville’s net worth exceeded $1.1 billion and its total sales for the immediately preceding year were more than $2 billion. 23 Although there were many reasons for its filing, Manville filed primarily to control and quantify existing and anticipated toxic tort liability claims of victims suffering from asbestos-related diseases. Although solvent at the time of the filing, Manville submitted  that the time and expense of litigation and the quantum of the awards would, in the opinion of company officials, leave Manville with no alternative but to liquidate or otherwise dispose of its assets and dismember its business. 24 Commentators have criticized and defended the Manville filing. 25 However, it must remembered that the court upheld the filing. The Bankruptcy Court specifically held  that insolvency was not a precondition to filing a voluntary petition under Chapter 11 •26 Moreover, the court upheld the policy “that a fmancially beleaguered debtor with real debt and real creditors should not be required to wait until the economic situation is beyond repair in order to file a reorganization petition. “27 We must contrast the Code’s eligibility requirements with the Canadian eligibility requirements. Given the restrictive descriptions in the Canadian reorganization statutes, it is unlikely  L.A. Flyer, “Will Financially Sound Corporate Debtors Succeed in Using Chapter 11 of the Bankruptcy Act as a Shield Against Massive Tort Liability?” (1983) 56 Temple L.Q. 539 at 541-542 (f. 11). 23  24  JJ,jd (f. 13).  See e.g., Flyer, ibid at 566-567, where the author said “. . . courts should conclude that a financially healthy corporation which has filed for reorganization for the purpose of escaping tort liability has not filed in good faith. . . . To allow a stable corporate debtor to cloak itself in the protective provisions of chapter 11 would render the chapter a sham.”; M Kunlder, “The Manville Corporation Bankruptcy: An Abuse of Judicial Process?” (1983/84) 11 Pepperdine L. Rev. 151, where the 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 the attempt by Manville to account and provide for the victims whose health problems had yet to manifest themselves, the filing was indeed within the contemplation of the Code and accords with the spirit and intent of Chapter 11. 25  26  In re Johns-Manville Coiporation, 36 B.R. 727 at 732 (Bankr. S.D.N.Y. 1984).  27  Ibid at 736.  35 that a solvent debtor could seek the protection of reorganization. Both statutes require the debtor to be insolvent or bankrupt and it would appear the debtor must be insolvent at the time it commences the proceeding. However, a debtor may be able to devise its eligibility to commence proceedings under the CCAA or the BIA. For example, a debtor company under the CCAA is one that, inter alia, “has committed an act of bankruptcy within the meaning of the Bankruptcy and Insolvency Act”. 28 One act of bankruptcy under paragraph 42(l)(h) of the BIA is the debtor giving notice to any of its creditors that it is about to suspend payment of its debts. Under the BIA, a debtor could fall within the definition of “insolvent person” by merely ceasing to pay its current obligations in the ordinary course of business as they generally become due. 29 The BIA says nothing concerning the inability of the debtor to make such payments, only that the payments have ceased. Whether devising its eligibility to propose a compromise or arrangement under the CCAA or to file a proposal or a notice of intention to file a proposal under the BIA breaches any good faith requirement ° does not derogate from the fact 3 that, 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 is remote, given the size of awards made by Canadian courts or the fact that Canadian industry is simply not 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 the policymakers, 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, such  28  CCAA s. 2 “debtor company”(b).  29  BIA s. 2 “insolvent person”(b).  °  See discussion infra notes 7 1-89 and accompanying text.  E.g., the case involving Silcorp Ltd. involved a substantial downsizing wiiere the court pennitted the debtor to repudiate a substantial number of leases of unprofitable premises. The issue concerning repudiation of real property leases is discussed in chapter V(B), below. 31  36 disclaiming other onerous types of contracts. 32 Is an insolvency requirement necessary or desirable in a business reorganization regime? The probability or even possibility 33 of financial demise is within the contemplation of the objectives of a  business reorganization system. Thus, if an entity is facing financial distress, it should be able to take advantage of a reorganization regime, whether or not it is insolvent. However, removal of a requirement of insolvency could present an opportunity for abuse of the system. If removed, the courts should be given the power to scrutinize all of the circumstances of the case to detennine whether the proceeding meets objectives of the legislation. It is arguable that despite the solvency of Manville, its filing fell within the intent and spirit of a business reorganization system. Had it not filed, the claims of existing victims could have taken precedence over those victims whose damages had yet to manifest themselves, in the sense that the claims of existing victims may have resulted in Manville’s liquidation and dismemberment. By allowing the filing to stand, all of the victims, both  existing and future, would be treated equally. However, a debtor that is merely attempting to gain some strategic advantage over its creditors or is seeking the protection of a reorganization statute for some purpose that does not further the objectives of the legislation should not be able to take advantage of its provisions. In such a case, the legislation should be sufficiently flexible to allow for the dismissal of the case. The Code provides that flexibility. The Canadian statutes have yet to be tested in this regard.  TEQINICAL REQUIREMFNIS IJNDER ThE CCAA  B.  The CCAA is unique among the reorganization statutes being considered, as it sets forth a  For example, in the United States, Chapter 11 has been used by debtors to extricate themselves from obligations under collective bargaining agreements. See e.g., In te Continental Airlines Coip., 38 B.R 67 (Bankr. S.D. Tex. 1984). 32  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.  37 precondition to its application. When Parliament first enacted the CCAA, any company incorporated by or under any federal or provincial act or any company having assets or doing business in Canada could use it. 35 The 1953 amendment 36 attempted to limit the use of the CCAA to widely-held companies with complex fmancial structures. When the amendment was introduced in the House of Commons for second reading on January 23, 1953, the Honourable Stuart S. Garson, provided the House 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 Arrangement Act 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 whose business it will be to look after their interests properly, a provision which is ahnost invariably absent in the case of the mercantile creditors. The mercantile companies will be able to use the provision of part ifi of the new revised Bankruptcy Act, which, unlike the Bankruptcy Act in force in 1933, has a provision whereby companies may apply for an extension to work out their affairs without incurring the stigma of bankruptcy. 37  Companies made little use of the CCAA during the first four decades of its existence. One may surmise that the trust deed requirement had the intended effect of limiting its use to certain types of  companies. The 1980s saw a significant increase in the use of the CCAA, although the trust deed requirement did not limit its use to entities with complex fmancial structures or many investor creditors.  Debtors met the precondition by issuing bonds or debentures under trust deeds created  immediately 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 United Maritime Fishennen  Re 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 telegraph companies, 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 CCAA [now s. 3]. House of Commons Debca’es (23 January 1953) at 1269.  38 38 the New Brunswick Court of Queen’s Bench specifically held that: Co-op, the words “bona fide” do not appear in section 3 of the Act and that the Court, upon hearing such an application, had no obligation and indeed no rights to raise the issue and determine the validity of the trust deeds. 39 With respect, one must question the court’s rationale in this case. The New Brunswick Court of  Queen’s Bench, as a court of equity, ° has the jurisdiction to question the bonafides of any matter 4 before it, whether or not the statute specifically allows for that examination. Despite this criticism, the courts have permitted debtors to seek relief under the CCAA following the issuance of an instant trust  ’ 4 deed. Thus, section 3 merely constitutes a procedural hurdle. Although other reasons exist that may dissuade a debtor from seeking the protection afforded by the CCAA, section 3 does not impose a serious impediment. The effect of this impediment is lessened by the doctrine of reasonable demand  and section 244 of the BIA that requires a secured creditor to give the debtor notice of the creditor’s (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 United Maritime Rshennen]. 38  Thid at 54 (N.B.Q.B.). °  Judicature Act, RS.N.B. 1973, c. J-2, s. 26.  See e.g. Elan Corporation v. Cominskey (Trustee of) (1991), 1 C.B.R. (3d) 101, per Doherty J.A. (dissenting in part); Hongkong Bank of Cancth v. Chef Rec4’ 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 of Appeal affirmed an order of the British Columbia Supreme Court allowing an application of the debtor for a stay of proceedings under the CCAA notwithstanding the creation of an instant trust deed. The Court of Appeal specifically recognized that the debtor created the trust deed “so as to qualify” under the CCAA [at 313]. Cf Re Nonnc Hauling Ltd (1991), 6 C.B.R. (3d) 16 (Sask. Q.B.), where the court refused to follow the courts of the other jurisdictions in sanctioning the use of instant trust deeds. In so doing, Wimmer J. stated: 41  “It is the duty of the court to give effect to legislation, not to emasculate it. The plain language of s. 3 offers no other conclusion than that it was enacted to exclude certain companies 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 access to a legal remedy not otherwise available. I cannot think that the legislation was intended to be interpreted in a way that permits this. In my opinion, s. 3 contemplated the existence of securities characterized by genuineness in the sense that they were issued to raise capital or secure existing indebtedness and not, as here, to achieve an oblique purpose. To hold otherwise would fail to give effect to the spirit and intent of the legislation.” [at 19]  39 intention to enforce its security. These time periods provide a debtor with ample opportunity to create a trust deed and issue bonds or debentures thereunder. Any reform should remove the requirement of the trust deed. The requirement was originally intended to protect investor creditors by having a trustee monitor the debtor’s affairs. A more comprehensive reorganization regime that requires extensive reporting by a debtor in possession or the appointment of a trustee or interim receiver with broad investigative powers could provide this protection. Another alternative may be to create a twotiered reorganization system; one that deals with more complex entities, the other to deal with the less complex 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 and procedural matters. This flexibility and the costs attendant on such a proceeding results in the CCAA being used by the larger, more complex entities, in any event.  C  GOOD FAiTH N COMMENCING REORGANIZATION PROCEEDINGS  None of the statutory schemes expressly requires the debtor to be acting in good faith, when commencing a reorganization proceeding. However, the good faith issue arises in a number of situations under the Code and at least one Canadian commentator has suggested that good faith should 42 considered by the courts under the CCAA and the BIA.  This section will examine the concept of good faith in a business reorganization proceeding. It will then, briefly examine the history of the concept under the American enactments and analyze whether a debtor should be acting in good faith in commencing a reorganization proceeding.  J.D. Honsberger, “The Companies’ Creditors Arrangement Act: How to Use It and Not Use It and a Critical Comparison with Part ifi of the Bankruptcy Act, Chapter 11 of the U.S. Bankruptcy Code and Administration Proceedings in England” in Canadian Insolvency Association 1991 National Semincc (Toronto: Canadian Insolvency Association, 1991) Tab 2 at 23. 42  40 1.  The Concept of Good Faith in a Business Reoiganizafion Poceeding  Black’s Law Dictionary 43 defmes “good faith” as follows: Good faith is an intangible and abstract quality with no technical meaning or statutory defmition, and it encompasses, among other things, an honest belief, the absence of malice and the absence of design to defraud or seek unconscionable advantage, and an individual’s personal good faith is concept of his own mind and inner spirit and, therefore, may not conclusively be determined by his protestations alone. Honesty of intention and freedom from knowledge of circumstances which ought to put the holder upon inquiry. An honest intention to abstain from taldng an unconscientious advantage of 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 this term is ordinarily used to describe that state of mind denoting honesty of purpose, freedom from intention to defraud, and, generally speaking, means being faithful to one’s duty or obligation. A Canadian law dictionary4 5 adds a further element to the definition of good faith that is relevant to the issue at hand. It states that good faith implies an “absence of ulterior motive.” This element is crucial to any determination of good faith of the debtor in commencing reorganization proceedings and requires an examination of the objectives or purposes of a business reorganization regime against the actual, subjective motives of the debtor. In other words, for the debtor to have an ulterior motive, the proper objectives must be manifest. As good faith is a “state of mind,” a debtor must 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 the absence of good faith, a debtor may examine the statute and conclude that it falls within its jurisdictional 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 a reorganization proceeding of an individual. However, the defmition refers to a provision of the Code that expressly requires good faith as part of the confirmation process and accordingly, it is inapplicable to 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 It must not be based on some objective criteria that would suggest whether there is a reasonable  possibility of reorganization The circumstances may point to factors that would allow the court to glean the subjective intention of the debtor despite its “protestations,” but these factors must not derogate from the primary thrust of the examination, which is to determine the debtor’s motives. 48 A primary purpose of a business reorganization statute is to allow the debtor to reorganize its financial affairs to facilitate its rehabilitation, while treating creditors in an evenhanded, fair and equitable manner. If there is no realistic hope of reorganization and the debtor commences the proceeding merely to delay, defeat or defraud creditors, then there is an absence of good faith. 49 However, one must question whether such an analysis truly examines the state of mind of the debtor or whether it is an objective examination of the circumstances of the case to arrive at a conclusion as to the prospects of reorganization or the future viability of the debtor. The timing of such an D.L. GaIThey, “Bankruptcy Petitions Filed in Bad Faith: What Actions Can Creditor’s Counsel Take?” (1979-80) 12 U.C.C.L.J. 205 at 210. Black’s, supra note 43.  But see discussion concerning the good faith standard under Chapter X infra notes 54-59 and accompanying text. 48  Eg., much has been witten on the single-asset cases in the United States, where a debtor transfers 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 in effecting the transfer is to shield the debtor’s active and profitable operations and to delay any foreclosure proceedings through the use of Chapter 11, in the hopes that the property will appreciate in value. It is submitted that a petition filed for this purpose is one that lacks good faith. See e.g., In re Phoenix Piccdilly, Ltd, 849 F.2d 1393 (11th Cir. 1988) [hereinafter Phoenix Piccdilly]; In re Little Creek Development Coip., 779 F.2d 1068 (5th Cir. 1986) [hereinafter Little Creek], in which the court characterized 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 of bad faith. [at 1008]; cf In re Becrh Club, 22 B.R. 597 (Bankr. N.D. Cal. 1982), where the court found no bad faith in the filing of the petition on the grounds that there was a legitimate business purpose in the debtor effecting a transfer of the assets to the “new debtor” and the creditors were adequately protected notwithstanding the transfer. ‘  42 examination is crucial. If the court conducts the examination very early in the proceedings under the CCAA or Code, there may not be sufficient evidence before the court concerning the future prospects  of the debtor, such as the possibility of securing additional debt fmancing or equity capital. Under the BIA, the policakers have made provision for the filing of a projected cash-flow statement within 10  days after the filing of a notice of intention to make a proposal. ° This is presumably intended to give 5 the creditors some idea of the debtor’s bonajides in filing the notice of intention. However, one must remember that the debtor prepares the projected cash-flow statement and, although a trustee reviews the statement for its reasonableness, the trustee’s report is based on assumptions and information provided by management of the debtor and contains language sufficient to exonerate the trustee from any liability other than errors resulting from gross negligence or fraud. 51 It may be difficult to argue that the courts should sanction the commencement of reorganization proceedings when there is an absence of good faith by the debtor. However, a plain reading of the statutes does not mandate this type of examination.  We now turn to the issue of whether the policymakers deliberately excluded an express mandate to make a determination of good faith from the Code and whether the courts have the  statutory or inherent authority to examine this issue at the outset of a reorganization proceeding.  Legislative Ilistoiy and Evolution of the Concept of Good Faith in Reoiganizafion Pmceedings  2.  The 1898 U.S. Act required good faith as a condition of the court approving a composition 52 However, it did not make good faith a prerequisite to the following acceptance by the creditors.  50  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.” .  .  .  .  43  commencement’ of a composition proceeding. Tn 1933, Congress enacted section 7Th wiuich made good 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 as properly filed under this section if satisfied that such petition or answer complies with this section and has been flied in goodfaith, or dismissing. 53 The Chandler Act repealed section 7Th and created Chapter X and Chapter XE to govern business 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 be deemed not to be filed in good faith if the petitioning creditors have acquired their claims for the purpose of filing the (1) petition; or adequate relief would be obtainable by a debtor’s petition under chapter Xl of (2) the Act; or (3) it is unreasonable to expect that a plan can be effected; or it appears that in a prior proceeding pending in any court, the interests of (4) creditors and stockholders would be best subserved thereby.” -  For our purposes, subsections 146(3) and (4) are of interest. Subsection 146(4) allowed the court to dismiss the petition in a two-party dispute between the debtor and one of its creditors. As bankruptcy only deals with problems involving the collective interests of all or substantially all of the debtor’s  55 for creditors, subsection 146(4) would protect the debtor from a petition filed by one of its creditors 57 It also protected the creditors an improper purpose, 56 such as collection proceedings of the creditor. Ch. 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 that the petition complies with the requirements of this chapter and has been flied 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 or trustee 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.).  44 and stockholders from a debtor that was merely attempting to obtain some strategic advantage by seeking protection through bankruptcy legislation when state court proceedings were pending. 58 Subsection 146(3) of the Chandler Act provided that a petition was deemed not to be filed in good faith if it was “unreasonable to expect that a plan can be effected.” This appeared to address the situation of a petition being filed when there was little objective hope that a plan could be effected. As mentioned previously, 59 a court, in attempting to determine whether the petitioner commenced the proceeding 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 the  petitioner. 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 of  mind of the petitioner, but the state of mind of a reasonable petitioner. Although this type of inquiry derogates from the “pure” concept of good faith that deals with subjective intention, Congress may have been attempting to address the unreasonable expectations and optimism of entrepreneurs in  financial 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 Chapter  ° Victoiy went further, however, and held that, as the good faith filing requirement was implied 6 X1. into Chapter XI, despite an absence of an express requirement, so too should it be implied into the ’ Professor Flaccus has recently argued that this conclusion is ong on the basis that the cases 6 Code. In re Willicimsport Wire Rope Co., 10 F.Supp. 481 (D. Pa. 1935); In re Phelps Manor Redly Co., 73 F.2d 1010 (3d Cir. 1934). 58  See Chapter ffl(C)(1), above. See e.g., Victoiy, supra note 21 at 557, where the court observed “[a]s we have seen, Chapter XI, 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 Evolving Bankruptcy Policy” (1991) 85 Nw. U.L. Rev. 919 at 922-923 (ii. 10); RM Cohn, “Good Faith and the Single-Asset Debtor” (1988) 62 Am. Bankr. L.J. 131 at 132. 60  61  Victoiy, ibid at 557.  45 upon which Victoiy relied to support the conclusion, were based on faulty reasoning. 62 She concludes that all of the cases cited by Victoiy were considering statutory provisions that made good faith an express filing requirement, such as Chapter X, an express requirement for confirmation of the plan, or other factors listed in section 146. Accordingly, she concludes that a good faith filing requirement should not have been implied as part of Chapter XI in the cases preceding Victoiy. It follows therefore, that if the decision in Victoty was incorrectly grounded, its conclusion is likely not strong  authority. That is, it may be improper to imply a good faith filing requirement into Chapter Xl or the Code. The legislative history also refutes any argument that there is a good faith filing requirement under the Code. The Report of the Commission on the Bankruptcy Laws of the United States 63 recommended the elimination of the good faith filing requirement. TM The footnote explaining this recommendation stated: allows any party in interest to move the court for an order of The proposed Act dismissal or conversion to liquidation if it is unreasonable to expect that a plan can be effectuated, rather than requiring the court to determine whether good faith exists at an often premature stage and without adequate evidence. 65 ...  In adopting this recommendation, Congress intended to delete a finding of good faith as a precondition to the filing of a petition. It also enacted paragraph 11 12(a)(1) which allows a court to convert a Chapter 11 case to a liquidation or dismiss the Chapter 11 case for cause, including, “continuing loss to or diminution of the estate and absence of a reasonable likelihood of rehabilitation” [emphasis added]. The “state of mind” element has been deleted. That is, the paragraph speaks of the absence  J.A. Flaccus, “Have Eight Circuits Shorted? Good Faith and Chapter 11 Banlcruptcy Petitions” (1993) 67 Ani Bankr. L.J. 401 at 412-413. 62  House Doc. No. 93-137, Part I, 93d Cong., 1st Sess., reprinted in A.N. Resnick and E.M Wypyski, eds., Bankntptcy Refonn Act of 1978: A Legislative Histoiy, vol. 2, doe. 21 (Buffalo: William S. Hem, 1979). 63  64  Ibid at 183.  65  Ibid at 222-223.  46 of a reasonable “likelihood” of rehabilitation rather than a reasonable “expectation.” It is submitted  that 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 the petitioner. In other words, it appears that the Congressional intent was not to have the courts determine the good or bad faith of the petitioner in filing the case. The courts are to make an objective determination of the likelihood of a successful reorganization, quite apart from the motives of the petitioner. Accordingly, good faith of the petitioner is not necessary in the filing of a petition under Chapter 11. The important issue for the courts to consider is not whether the petitioner was acting in good faith, but whether the objectives of the legislation may be achieved through a reorganization. Even if the petitioner had ulterior motives in filing the Chapter 11 case, a reorganization may be the most appropriate means of treating creditors equitably. Although the list of “causes” that would result in conversion or dismissal is not exhaustive 67 the court should not and the court possesses equitable powers to carry out the provisions of the Code, be permitted to base its reasoning on a ground that was specifically removed by Congress in enacting the legislation Such an approach subverts the legislative grant and allows the court to go beyond its jurisdiction, which is to decide whether a reorganization proceeding may be beneficial for all concerned, whatever the state of mind of the debtor. Good faith, as a requirement for filing a petition under Chapter 11, has also been implied  under paragraph 362(dXl), which allows the court to grant relief from the automatic stay of House Report at 406, where it was said that the court “vill be able to consider other factors as they arise, and to use its equitable powers to reach an appropriate result in individual cases.” See also In 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 on the basis that the debtor lacked good faith in changing its structure to make it eligible for Chapter 11 relief.. A lack of good faith in filing the petition on the part of the debtor has been held to be an equitable ground which would justify dismissal of the case [Phoenix Piccdilly, supra note 49].  Code s. 105(a). See In re Hartford Run Apartments of Buford, Ltd, 102 BR. 130 at 132 (Bankr. S.D. Oh. 1989). 67  68  Flaccus, supra note 62 at 416.  47 proceedings, “for cause, including the lack of adequate protection of an interest in property  “69  The courts have granted creditors relief from the automatic stay of proceedings when it appears that  the debtor lacks good faith in filing the petition. Paragraph 362(dXl) does not allow for the dismissal of the case but it provides an effective means of enforcement of the concept of good faith, ° especially 7 in 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 the legislative schemes being considered. As mentioned previously, the New Brunswick Court of Queen’s Bench refused to read an element of good faith into the provisions of the CCAA based on a plain  reading of the act. 71 The court found, however, that the debtor was not acting in bad faith in creating the instant trust deeds. Although the New Brunswick Court of Queen’s Bench rejected the argument that the debtor  must be acting in good faith in commencing proceedings under the CCAA. Canadian courts have since implied a concept that appears to approach a notion of good faith. The approach taken by the courts in this regard is similar to the approach taken by some courts in the United States when considering whether a Chapter 11 case should be converted to a liquidation or dismissed on the basis that there is  See e.g, Victoiy, supra note 21 at 560; cf In re Beach Club, supra note 49, where the court found 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: 69  “While s. 362(d)(1) does not specifically incorporate s. 1112(b), it is reasonable to conclude that a creditor should be granted relief from the stay if the case is one which the court should dismiss 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 an element 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. E. Di Donato, “Good Faith Reorganization Petitions: The Back Door Lets the Stranger In” (1983) 16 Conn. L. Rev. 1 at 7. 70  71  United Maritime shennen, supra notes 38 and 39 at 54 (N.B.Q.B.).  48  an absence of a reasonable likelthood of rehabilitation under paragraph 11 12(b)(1) of the CodeY Under the CCAA, a challenge to the debtor’s ability to successfully rehabilitate itself is generally taken as a challenge to the stay of proceedings. If a creditor that holds security on all or substantially all of the property of the debtor succeeds in its challenge, the proceeding will be effectively dismissed, as the debtor will no longer have assets with which to attempt to reorganize. Tht Treaswy Fincincid Inc. v. Congo Petroleums  74 Inc  illustrates the approach. In that case, a secured  creditor of the debtor brought an application for the appointment of a receiver and manager pursuant  to its debenture. Secured creditors holding approximately 60 percent of the amount owing to all secured creditors and an unsecured creditor whose claim constituted “well over half of the unsecured claims” of the debtor supported the application. 75 The debtor brought a cross-application for relief under the CCAA. The court allowed the application of the secured creditor and dismissed the application of the debtor on several bases, including the fact that “any plan Cango could put forward would dmost certainly be turned down by both the secured and the unsecured creditors.” 76 The court did not discuss  the motives of the debtor in seeking relief under the provisions of the CCAA in terms of its good or  Paragraph 11 12(b)(l) of the Code requires an additional element to be proved when a court dismisses or converts a case under that provision, viz., the “continuing loss to or diminution of the estate.” Despite this additional requirement, some courts have considered the likelthood of a successful reorganization as a separate element and have dismissed or converted the case on that basis alone. 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 re Pappas, supra note 21 where the court applied both arms of the test. The diminution of the estate would result from the fact that the debtor had no equity in its assets and the debts would continue to increase as a result of accruing interest and taxes. 72  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 majority in number, representing three-fourths in value of the creditors, or class of creditors, voting at the meeting directed by the court. [CCAA s. 6]. 76  Ibid at 240 [emphasis added].  49 bad faith. However, one might infer from the reasons for the decision that the court may have been influenced by certain factors that pointed to the lack of bonafides of the debtor or its principals. The court observed that: (a) the debtor had “deliberately qualified itself’ to seek relief under the CCAA by issuing an “instant debenture” so as to bring itself within the requirements of section 3 of the CCAA; 77 the family that controlled the debtor had “enhanced its o position vis-a-vis [the (b) unsecured creditors] by taking security to the extent of $5 million.., from the company to that value”; 78 the objective of any plan would not be to continue the business of the debtor but to (c) sell it off in whole or in part and that a merchant banker retained by the debtor to assist the debtor with its fmancial difficulties “was concerned with the agenda” of the family that controlled 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 during the past 9 months, and that something will permit the company to be salvaged.” 80 We must contrast the approach taken in Congo with the approach taken by the same court in Re Perkins Holdings. ’ In that case, the court recognized that proceedings under the CCAA should be 8 discontinued if the situation is “totally hopeless,” since the plan would have no hope of succeeding given the creditors’ strong opposition to it. However, the court allowed the debtor’s application under the CCAA on the basis, inter alia, that the debtor “recognized its fmancial problems and retained outside help in an attempt to resolve theni” 83 Again, the court did not allude to the motives of the debtor in seeking relief under the CCAA. However, the basis on which the court allowed the  Ibid 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.  50 application certainly points to the “state of mind” of the debtor.  Reported cases considering the BIA have not addressed the issue of good faith in commencing proposal proceedings. However, one commentator suggested that good faith may be an issue to be considered under subsection 50.4(11) in a motion by a trustee, interim receiver or a creditor for the termination of the period during which the debtor may file a proposal. 8 This does not directly address the issue of whether the debtor must be acting in good faith in commencing proposal proceedings, as the issue is not considered at the outset of the case. It is considered as part of an application that is heard 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 for Canadian practitioners seeking to challenge the commencement of reorganization proceedings by a debtor on that ground. Unlike the Code, where it is at least arguable that good faith should not be an element to be considered as a filing requirement, given its specific exclusion, in Canada, the courts have the right to consider the concept under their equitable jurisdiction. 85 Under the BIA, the courts listed in section 183 “are invested with such jurisdiction at law and in equity as will enable them to exercise original, auxiliary and ancillary jurisdiction in bankruptcy and in other proceedings authorized by this Act” [emphasis added]. The CCAA provides certain courts with jurisdiction to hear applications and make orders thereunder. 86 The various courts listed in the CCAA, by their enabling provincial statutes, are invested with legal and equitable jurisdiction within their respective tenitorial jurisdictions. 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” in Coiporate 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”.  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. 87  51 may apply the doctrine of good faith, apart the holding in United Maritime Fishennen. 88 This is illustrated by the following quotation from a leading text on equity:  These three maxims may be viewed as together illustrating that great distinctive and governing principle of equity, that nothing can call forth a court of equity into activity but conscience, 89 good faith, and personal diligence. Having established that the courts in Canada may have the jurisdiction to consider the “state of  mind” of the debtor in commencing reorganization proceedings, we now turn our attention to whether the courts should consider good faith in determining whether to allow a debtor to commence or continue reorganization proceedings.  Should Good Faith Be a Consideiufion?  3.  The commentators who suggest that there is or should be a good faith standard for commencing reorganization proceedings under the Code cite the legislative history and general principles of equity in support of that position. ° Conversely, those who argue that there is not or 9 should not be such a standard cite the legislative history and the plain meaning of the statute in  88  Supra note 38.  E.HT. Snell, The Princ4,les of Equity (London: Steven and Haynes, 1868) at 33. The three maxims referred to by the author are: 89  (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. See e.g, J. Moss, “Consecutive Chapter 11 Filings: Use or Abuse?” (1991/92) 19 Fordham Urban 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 Case Study” (1983) Bus. Law. 1795; D.M Zavagno, “Tort Claims Against Business Debtor Filings For Reorganization and a Fresh Start” (1983) 52 U. Cin. L. Rev. 791. 9°  52  support of that position. ’ 9 It is difficult to argue that good faith should not be present when a debtor commences a reorganization proceeding. Said another way, should a business reorganization statute allow a debtor with improper or fraudulent motives the benefit of its protections? One’s visceral reaction to such a proposition is to reject it outright. After all, it seems logical and proper that to take the benefit of a reorganization statute, the debtor should have an honesty of intent to use the legislation to attempt to reorganizeY In addition, the good faith standard prevents the debtor from abusing the bankruptcy process for illegitimate or reprehensible purposes and maintains the jurisdictional integrity of the bankruptcy courts. 93 While these arguments are compelling, the difficulty in requiring good faith as a precondition to allowing a reorganization proceeding to be commenced or continued is its abstract and intangible quality, as described in the definition set forth earlier. 94 To be of assistance in the commercial environment, standards governing conduct must have predictability of result. Without such predictability, transaction costs will increase and forum shopping may result. One commentator expressed this concern over lack of predictability by noting that “the major problem with the good faith standard [is that] it is so vague that there will always be conflicting case law.” 95 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 Bankruptcy Code: Treating the Symptom, Not the Cause” (1985) 52 U. Chi. L. Rev. 795; Di Donato, supra note 70. 91  cohn, supra note 60 at 134. Little Creek, supra note 49 at 1072. ‘  said:  Supra note 44 and accompanying text.  Flaccus, supra note 62 at 434-43 5; see also, Phoenix Piccr]illy, supra note 49, where the court there is no particular test for determining whether a debtor has filed a petition in bad faith. Instead, the courts may consider any factors which evidence an intent to abuse the judicial process and the purposes of the reorganization provisions or, in particular, factors which evidence that the petition was filed to delay or frustrate the legitimate efforts of secured  53 While there may be reasons for attempting to determine the motives of the debtor in conmiencing 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 stay lifted under the Code for cause, including a lack of adequate protection. Under the BIA, the party may 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 or vexatious may be dismissed. 97 if the normative basis of a business reorganization proceeding is evident, the motives of the debtor should be irrelevant. That is, the court would merely be asked to consider whether the proceeding meets the objectives of the legislation. One writer suggested that dismissing a case based on bad faith may adversely affect creditors and the public interest by thwarting a reorganization and equitable distribution of the assets of the debtor based on the “mental sin of the debtor’s proprietor or corporate 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 benefit creditors through an equitable distribution, whether there is a benefit to society as a whole by salvaging the business and having it continue as an ongoing entity and whether, through a 9 reorganization, the debtor may be rehabilitated?  D.  CONCLUSION  The character and motives of the debtor should not be considered by the courts in deciding creditors 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 a successful reorganization cannot transfer a bad faith filing into one undertaken in good faitK”  54 whether to allow a reorganization proceeding to be commenced or to continue. The focus of the examination should be whether the proceeding will accomplish the objectives of the legislative scheme. Whether the debtor is insolvent, has issued bonds or debentures under a trust deed or is acting 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 compromising the interests of the parties to the proceeding. The court could, for example, lift the automatic stay of proceedings or dismiss the proceeding on the grounds that it is ffivolous or vexatious, If there are legitimate reasons for maintaining the proceedings, irrespective of the character, conduct or motives of the debtor, the proceeding should be maintained.  55 CHAFFER IV CUSTODY OF ThE FSTAFE OF ThE DEBTOR Reorganization 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 evaluate the cause of its financial difficulties. 2 Section 47.1 of the BIA gives the court discretion to appoint an interim receiver, in addition to the trustee appointed under the proposal or named in the notice of intention to make a proposal. The court will appoint an interim receiver if it is considered necessary for the protection of the debtor’s estate or the interests of one or more creditors or the creditors  3 Under the CCAA,, although there is no express provision allowing for the appointment of a generally. trustee or interim receiver, the orders promulgated at the outset of a proceeding under the CCAA “typically include provision for the appointment of a ‘monitor’.” 4  We must contrast this virtual automatic appointment of an independent entity having powers ranging from overseeing the debtor’s operations and financial affairs to ousting its management, with the approach taken under the Code that maintains the debtor in possession 5 of the business and its affairs. The ouster of the debtor’s management by the appointment of a trustee under the Code 6 has  BJA 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’ Creditors Arrangement 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 has qualified under section 322 of this title is serving as trustee in the case”. In this chapter, the acronym DIP will be used to denote the debtor in possession. 6  Code s. 1104(a).  56 been described as an “extraordinary remedy” 7 that will be allowed only on the basis of clear and convincing evidence. 8 In other words, the debtor’s right to remain in possession and control its financial and business affairs is a strong presumption. 9  This chapter will examine the concept of the DIP, its rights and duties and the checks and balances imposed by the Code and the courts which ensure that the DIP is fulfilling its duties. It will then examine the circumstances under and standards by which the courts determine whether the appointment of a trustee or an examiner is appropriate. 10 The 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 the fulfilment of the objectives of a business reorganization system. In so doing, this chapter will examine the advantages and disadvantages of appointing a trustee or examiner.  A.  DEBTOR IN POSSFSSION (DIP)  1.  legislative Ilistoty and Conceptual Basis The legislative history of the Code and the structure of Chapter 11 make it clear that the  In re Ionosphere Clubs, Inc., 113 B.R. 164 at 167 (Bankr. S.D.N.Y. 1990) [hereinafter Ionosphere]; 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’d 871 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.]. 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. 8  Committee of Dalkon Shield Claimants v. A.H Robins Co., 828 F.2d 239 (4th Cir. 1987) where the court affirmed the fmding that the debtor was in civil contempt, but held that such fmding was not to be equated with fraud or mismanagement sufficient to justify the appointment of a trustee [at 240]. Code s. 1104(b). The appointment of an examiner is a less drastic remedy. An examiner has investigative and reporting duties under paragraphs 1 106(a)(3) and (4) but it does not have the same managerial and supervisory rights and duties as a trustee, such as the right to carry on the business of the debtor pursuant to section 1108 [D.W. Given, “When and Why Courts Appoint Trustees in Bankruptcy” (1988) 34:6 Prac. Law. 29 at 35]. 10  57 debtor’s prepetition management is to remain in possession and control of the debtor’s fmancial and business affairs following commencement of the proceedings.  Section 1107 provides that the DIP  shall have all the rights and powers and shall perform all the duties of a trustee, other than certain obvious exceptions, such as the duty to investigate itself and report thereon. Section 1108 of the Code allows a trustee, unless the court orders otherwise, to operate the debtor’s business. Thus, the DIP is entitled, inter dia, to carry on the debtor’s business. ’ 1 The concept of the DIP first appeared in section 77B.’ 2 Chapter X retained the concept,’ 3 but only with respect to entities that owed less than a prescribed amount. In all other cases, Chapter X required the appointment of an independent trustee. 14 Chapter X included the requirement for the appointment of an independent trustee, in large cases, at the instance of the Securities and Exchange 15 to protect public investors and the public interest. The trustee’s role was not merely to Commission, investigate or supervise, but to take a very active role in the reorganization process. Besides investigative and supervisory powers, the trustee would supervise the negotiations leading to a reorganization 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 “does not presume that a trustee will be appointed to operate the business of the debtor. Rather, the power granted to trustee under this section is one of the powers that a debtor in possession acquires by virtue of 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, the judge shall, upon the approval of the petition, appoint one or more disinterested trustees, who shall be qualified, except as to residence and location of office, as prescribed in section 45 of the Act. Where such indebtedness is less than $250,000, the judge may appoint one or more such trustees or may continue the debtor in possession.”  14  Ibid  J.I. Weinstein, The Bankriçtcy Law of 1938 Chandler Act (New York: National Association of Credit Men, 1938) at 212. 15  16  -  RJ. McAfee, “Business Rehabilitation Chapter 11” (1979) 48 U. Cin. L. Rev. 392 at 393. -  58 Chapter XI provided, in substance, that the debtor was to remain in possession and authorized the debtor to operate the business, unless a trustee was appointed.’ 7 This was very similar to the  Code’s provisions. This issue of the appointment of a trustee was the subject of a “substantial 8 prior to the Code’s passage. The resulting legislation is a composite of the Senate and House debate” versions. Chapter X required the appointment of a trustee in cases involving large, widely-held companies. The Senate Report felt that it was necessary to differentiate between a case involving a public company and one involving a private company and sought to retain a requirement for appointment of a trustee in the case of public companies, whatever their size.’ 9 The Senate Report expressed the necessity of this protective mechanism as follows: In a large public company, whose interests are diverse and complex, the most vulnerable today are public investors who own subordinated debt or equity securities. The bill, like chapter )ç is 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 scattered public investors. 20 In 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 his property 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 conditions which the court may, from time to time, prescribe. 343. The receiver or trustee or the debtor in possession, when authorized by the court and subject to its control, shall have the power to operate the debtor’s business and manage its property during such limited or indefmite period as the court may, from time to time, fix, and shall 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 and B.G. Arnold, “Displacing the Debtor in Possession: The Requisites for and Advantages of the Appointment of a Trustee in Chapter 11 Proceedings” (1984) 67 Marquette L. Rev. 457 at 460-469. very few issues dealt Illustrative of the extent of the debate, the writers of the latter article noted with by Congress in connection with the drafting of the Code produced a greater divergence of views than the standards for the appointment of trustees.” [at 461]. ‘  “.  ‘  Senate Report at 9-11.  20  Ibid at 10.  .  .  59  whereas, 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 report specifically referred to the fact that the securities laws and the vigorous enforcement by the Securities and Exchange Conmiission provide sufficient public protection. ’ The House Report felt that “[t]he 2 public and the creditors will not necessarily be harmed if the debtor is continued in possession in a 22 The court, in considering whether a trustee would be appointed, would reorganization case.” consider all factors and determine, in each case, whether there is a need for a trustee. 23 The major divergence between the recommendations of the House Report and the resulting  Code provisions was in the method of selecting the trustee. The House Report recommended that the 4 make the appointment of the trustee, following consultation with the parties in United States truste& interest and su1ject to approval of the court, which, in most cases, would be perfunctory. 25 The Code  rejected this notion and provided that the court appoint the trustee “on request of a party in interest or 26 the United States trustee.” The DIP is the prepetition management of the debtor and practically, there is no change in or 21  House Report at 233.  22  Ibid  23  Ibid  The United States trustee is a government official appointed the Attorney General, see 28 U.S.C. 581 (1988). In creating the office of the United States trustee, the House Report explained the duties of the office as follows: 24  “Some of the servisory functions removed from the judge will be transferred to a new system of United States trustees who will act as bankruptcy watchdogs, overseeing the qualifications and appointments of private trustees in bankruptcy cases, servising their performance, monitoring their fees, and serving as trustees in cases where a private trustee cannot be found to serve.” [House Report at 4] The United States trustee is not mlike the &qeiintendent of Bankruptcy in Canadi See BIA ss. 5 and 6. 25  House Report at 234.  26  Code s. 1104(a).  60 replacement of the personnel of preexisting management. 27 However, conceptually, because the DIP has powers and assumes duties that, before the filing of the petition, the debtor did not have, 28 the DIP does not appear to be one and the same as the debtor. This has resulted in some courts describing the DIP 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 valid contract. However, if one proceeds on the basis that the DIP is a different entity from the debtor and that 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, the United States Supreme Court in National Labor Relations Board v. Bildisco and Bildisco, 32 held that  the debtor and the DIP were the same entity but that the Code conferred on the DIP certain powers  27  In re DeLuca Distributing Co., 38 BR. 588 (Bankr. N.D. Oh 1984).  The DIP, postpetition, has the power, for example, to recover preferences or fraudulent transfers pursuant to sections 547 and 548 of the Code, respectively or it may reject or assume and assign executory contracts or unexpired leases pursuant to section 365 of the Code. This latter power is discussed at chapter V(B), below. Prior to the filing of the petition, the debtor did not have these powers. Conversely, the DIP has additional duties such as the filing of lists, schedules and statements required by subsection 521(1). 28  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 under chapter X a trustee under the latter chapter, or a trustee in a straight bankruptcy proceeding is not the same entity as the pre-bankruptcy company.” [at 704, emphasis original]. 29  See e.g., Kevin Steel, ibid This type of analysis is also useful for determining the priority of claims. 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 allowed unsecured claims. If the DIP incurred the expense, the claim would be given an administrative expense priority. On the other hand, if the expense was incurred by the debtor, it would merely be an unsecured claim. See Baldwin, ibid. See also Re Wil-Low Cqfeterios, Inc., 35 F. Supp. 965 at 968 (S.D.N.Y. 1940). °  See e.g. Cle- Ware Industries, Inc. v. Sokolsky, 493 F.2d 863 (6th Cir. 1974) where, in rejecting the notion of appointing separate counsel for the debtor and for the DIP, the court said “[t]he debtor and the debtor-in-possession is one and the same person, although ‘wearing two hats’.” [at 870-871]. 31  32  465 U.S. 513 (1984).  61 and duties that the prepetition debtor did not have. 33 This type of analysis is in keeping with the notion that legislation, if it is clear and unambiguous, may effect an object that, at first blush, appears to be contrary to our notions of fair play. The Code is clear in providing the DIP the right, for example, to reject a valid and enforceable executory contract or unexpired lease in circumstances where the debtor could not do so. The United States Supreme Court merely interpreted the plain and unambiguous language of the Code without seeing the necessity of attempting to draw a conceptual distinction between the DIP and the debtor. One witei characterizes this distinction between the debtor and the DIP as nothing more than a distinction in roles. That is, the DIP exercises its duties and powers for the benefit of “diverse constituencies,” 35 including creditors and shareholders, whereas the debtor’s duties are limited to benefitting the equity holders. 36  Hduciaiy Duty of the DIP  2.  Although the structure of the Code makes the duties of the DIP and the trustee coextensive, 37 with certain exceptions, the following examination will focus on the DIPs fiduciary duty, as the trustee, usually, will not exercise its duties in a biased manner. 38  Ibid at 528 T.G. Kelch, “The Phantom Fiduciary: A Debtor in Possession in Chapter 11” (1992) 38 Wayne L. Rev. 1323 at 1334.  Ibid at 1323. MJ. Bienenstock, “Conflicts Between Management and the Debtor in Possession’s Fiduciary Duties” (1992) 61 U. Cm. L. Rev. 543 at 553. 36  Codes. 1107. Subsection 324 of the Code penriits the removal of a trustee “for cause.” The legislative history makes it very clear that removal may be made in a summary fashion if the trustee is fI.inctioning “improperly, poorly or even illegally” [House Repon, HR. No. 99-764, 99th Cong., 2d Sess. (1986) at 27, repHnted in 1986 U.S.C.C.A.N. (554 Stat.) 52271. 38  62 The DIP has the duty to act as a fiduciary of the estate and the estate’s creditors. 39 The United  States Supreme Court outlined this duty as follows: [T]he willingness of courts to leave debtors in possession is premised upon an assurance that the officers and managing employees can be depended upon to carry out the fiduciary duties of ° 4 a trustee. This duty does not extend to the debtor itself or the debtor’s principals unless the principals are also  ’ In acting in its fiduciary capacity, the DIP must maintain a level of impartiality and treat 4 creditors. all parties fairly and equitably. 42 In addition, it must exercise the care and skill that a reasonable person would exercise in similar circumstances 43 and must avoid profiting at the expense of creditors and the debtor’s shareholders. With the fiduciary duty imposed on the DIP comes liability for its breach. Negligence in the performance of its fiduciary duty may result in liability of the estate 45 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 long as 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 as fiduciaries of the estate.” [at 8851 For an extensive discussion of the fiduciary duties of the DIP, see Kelch, supra note 34. Commodity Futures Trcriing Commission v. Weintrc&b, 471 U.S. 343 at 355 (1985) [citations omitted], on remand 776 F.2d 1049 (7th Cir. 1986). 4°  In ie L & S Industries, Inc., 122 B.R. 987 at 993-994 (Bankr. N.D. 111. 1991), qtj’d 989 F.2d 929 (7th Cir. 1993). ‘  Kelcl supra note 34 at 1344. See also In re Cochise College Park, Inc., 703 F.2d 1339 (9th Cir. 1983) at 1357 [hereinafter Cochise College Patic]. 42  Cochise College Park, ibid  Microwave, supra note 7, where the court held that “any attempt by the individual board members [of the DIP] to structure deals that would benefit them privately to the detriment of other creditors would contravene the fiduciary relationship.” [at 672]. 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). “i  63 personal liability will certainly result from intentional violation of the fiduciary duty. 47 As there are only finite resources available for distribution among the debtor’s creditors, the DIP must make  decisions concerning the allocation of those  s.’ Accordingly, what one party sees as a breach of  the 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 uphold decisions based on reasonable business judgment. ° The DIP must exercise caution in making such 5 decisions and be able to justify the basis of its decision, from a practical and documentary point of view. The DIP may be put in the unenviable position of having to make decisions detrimental to both the debtor and the prospects of reorganization in the interests of “impartiality,” if to do otherwise may be seen as a breach of its fiduciary duty.  External Contrnl  3.  of  the DIP  Besides the appointment of a trustee 52 and the imposition of disclosure ’ or examiner 5  Mosser 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 have intentionally breached court orders requiring the payment of surplus funds to the debtor. The court granted personal judgment against the trustee. See also In re Weber, 99 B.R. 1001 (Bankr. D. Utah 1989), where the court “pierced the corporate veil” and held the sole shareholder and director of the DIP 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.  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 on all legislative and regulatory matters with respect to, inter alia, asbestos compensation legislation on the basis that there was a “reasonable basis for its business decision.” 5°  Code s. 1104(a). See discussion infra notes 6 1-75 and accompanying text. 52  Code s. 1104(b). See discussion infra notes 76-79 and accompanying text.  64 53 the Code provides mechanisms for overseeing the powers exercised by the DIP. The requirements, legislative history suggests that Congress, while recognizing that creditor control in bankruptcy cases could be beneficial and is “theoretically sound,M also recognized that most creditors are simpiy not interested in pursuing the debtor or participating in the bankruptcy process. 55 This seems logical whether one is examining a Canadian proceeding or an American one. To continue its pursuit of a debtor once the debtor commences bankruptcy proceedings, a creditor will incur expenses that may result in a judgment against a person from whom the creditor will not recover anything. Should the creditor choose to participate in the proceeding directly as either an inspector (in a Canadian bankruptcy proceeding) or as a member of a creditors’ committee (in an American reorganization proceeding), there may be significant time commitments involved in attending meetings and instructing outside advisors. Not surprisingly, Congress observed that “[c]reditor control in bankruptcy cases is a 56 Congress diminished certain functions of the creditors’ committee in an attempt to make the myth.” creditors’ committee procedure less onerous on the participants. 57 The creditors’ committee may consult with the DIP, investigate the debtor’s affairs, participate in the formulation of the plan and request the appointment of a trustee or examiner. 58 In reality however, creditors are still reluctant to participate directly in monitoring the debtor’s affairs. Creditors’ committees were appointed in only a minority of cases. They usually failed to obtain assistance from an attorney, accountant, or other person familiar with the reorganization Reference has afready been made to the filing of lists, schedules and statements under subsections 1106 and 52 1(1) of the Code [See discussion supra note 281. Other examples of disclosure during the reorganization proceeding is the duty to disclose the identity and affiliations of individuals 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. Ibid 56  Ibid House Report at 104. Codes. 1103.  65 process. They seldom conducted investigations of the cause of business failure or provided serious opposition to any course the debtor chose to follow. In those cases where they did oppose the debtor, they were unsuccessful. 59 Thus, 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 in thearsenal ofacreditor is thecdhocpowertoraiseandbeheardonanyissue inacaseunder Chapter 1 1.60 Under subsection 1109(b), a party may raise issues that affect it directly, though it is not involved in the case in any general supervisory capacity. The court may also limit the powers of the 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 cany out the provisions of this title. No provision of this title providing for the raising of an issue by a party in interest shall be construed to preclude the court from, sua sponte, taking any action or making any determination necessary or appropriate to enforce or implement court orders or niles, or to prevent an abuse of process. Under subsection 1107(a), the court may circumscribe the powers of the DIP. This right points to the broad power of the court to control the operation of the business and the transactions entered into by the debtor, as well as the entire procedure contemplated by Chapter 11. The court may exercise the powers on a transactional basis, such as through hearings for relief from the automatic stay 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 less than full advantage of these controls because of creditor apathy, which may be the result of the perception that the system is working adequately or, conversely, that the system is a complete failure and participating in it is a waste of time and resources. This paper will not examine that issue but  L.M LoPucki, “The Debtor in Full Control Systems Failure Under Chapter 11 of the Bankruptcy Code?” (2d Install) (1983) 57 Am. Bankr. L.J. 247 at 272. Professor LoPucki’s study is one of the few quantitative analyses conducted in the field of business reorganizations. -  Code s. 1109(b). This right must be contrasted with the section 34 of the BIA which permits only the trustee to apply for directions and does not permit any other party to apply. Creditors are given very little recourse to the courts and only in limited circumstances, see e.g. the right under section 69.4 of the BIA to apply to the court for a declaration that the stay of proceedings no longer operates in respect of that creditor. 60  66 merely observes that creditor participation in Chapter 11 cases is minimal. Provided that creditors are adequately protected and their positions are not eroding during the pendency of the case, one wonders whether the mandatory appointment of an independent third party is necessary or advisable.  AppoinUnent of a Tiustee or Examiner  4.  The appointment of a trustee is an extraordinary remedy that the courts use sparingly. ’ One 6 court stated that, absent fraud, a trustee should not displace the debtor. 62 The practical reason for this reluctance is that the DIP is usually more experienced and more familiar with the debto?s business and operations than the trustee. As well, the decision has financial aspects, as a trustee will uadoubtedly consume the debtor’s scarce financial resources in its attempt to familiarize itself with the debtor’s  63 While courts recognize that, in most reorganization cases, business and the operation of the business. some mismanagement or imprudent decision-making has taken place, they are sceptical that a trustee is in any better position to manage a business, properly and pnidently, with which it has little or no  TM Thus, as complexity of the debtor’s business or industry increases, the applicant’s onus familiarity. becomes heavier and there is an increased likelthood of the application failing. 65 Generally, the courts  require 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).  In re Anchorage Boat Sdes, Inc., 4 B.R 635 at 644 (Bankr. E.D.N.Y. 1980), where the court felt it appropriate to conduct a cost-benefit analysis in order to detem,ine whether the appointment of a trustee was appropriate in the circumstances; Microwave, supra note 7 at 676. 63  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] every it being the business decision of a reorganization debtor will reflect exemplary business acumen. exceptional reorganization case that does not come into this court at least in part because of some imperfect managerial decisionmaking.” [at 610]. 64  .  .  D.W. Given, “When and Why Courts Appoint Trustees in Bankruptcy” (1988) 34:6 Prac. Law. 31-32. 29 at 65  Supra note 8 and accompanying text.  67 although 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 request of a party in interest or the United States trustee, and after notice and a hearing, the court shall order the appointment of a trustee (1) for cause, including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor by current management, either before or alter the commencement of the case, or similar cause, but not including the number of holders of 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, and other interests of the estate, without regard to the number of holders of securities of the 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) and 67 a “cause” under paragraph (1) that would not the “best interests” standard in paragraph 1104(a)(2), justify the appointment of a trustee under that paragraph would likely be an element considered in an  analysis under paragraph (2). The causes listed in paragraph (1) are not exclusive but are merely illustrative of causes that may justify the appointment of a trustee, as Congress listed the factors as “included” 68 in the description of “cause.” Also, the applicant need not prove all of the factors listed in paragraph (1) to have a trustee appointed but the listed factors are alternatives. For example, incompetent management is not necessarily dishonest. 69 Improper conduct by prepetition management involving fraud ° or 7 breach of fiduciary duty ’ will justify the appointment of a trustee. Cases involving prepetition 7 negligence, incompetence or errors of judgment of management are less clear. The courts examine  67  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).  See e.g. In , New Haven Rcdio, Inc., 23 BR. 762 at 767 (S.D.N.Y. 1982); In ir Bonded Mailings, Inc., 20 BR. 781 at 786 (Bankr. E.D.N.Y. 1982). 7°  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 a breach of fiduciary duty; In n McCorhill Publishing Inc., 73 B.R 1013 at 1017 (Bankr. S.D.N.Y.). 71  68 these cases on a case by case basis to decide whether the conduct or omission is sufficient to justify the appointment of a trustee. 72 These types of cases require the applicant to show cause by clear and convincing evidence. 73 Paragraph 1 104(a)(2) provides the second basis for the appointment of a trustee. In  considering the “best interests” standard, the court balances the respective interests at stake and, in particular, it examines the advantages and disadvantages of appointing a trustee. The court will consider 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’s rehabilitation; (c) the confidence or lack thereof of the business community and of the creditors in present management; and -  -  (d) the benefits derived by the appointment of a trustee, balanced against the cost of the appointment. 74 The court must consider the additional costs imposed on the estate by the trustee’s appointment and the availability of a trustee that is capable and willing to act. However, at the heart of the inquiry is whether 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 be justified in appointing a trustee. 75 The court or the parties may consider the appointment of an examiner under subsection 1104(b) if there are concerns regarding the DIP or the conduct of prepetition management that are not  Sharon 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).  69 serious enough to justify the appointment of a trustee. 76 The examiner’s primary role is to investigate and report to the court and not to manage the debtor’s business and affairs. 77 The 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 court expert An Examiner performs the investigative duties of the trustee, and may perform other investigative duties as the Court directs, but he stands on a different legal footing than a 78 trustee. ...  The examiner’s reduced role results in a corresponding reduction in the onus on the party seeking the appointment. All that appears necessary to justify the appointment of an examiner is an allegation and evidence of mismanagement.  B.  ThE CANADIAN APPROACH The Colter Committee Report recommended that in all cases where a secured creditor has not  appointed a receiver, the debtor should appoint a trustee to act as interim receiver. 80 The role of the 76  Code s. 1104(b) provides: If the court does not order the appointment of a trustee under this section, then at any time before 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 conduct such an investigation of the debtor as is appropriate, including an investigation of any allegations of fraud, dishonesty, incompetence, misconduct, mismanagement, or irregularity in the management of the affairs of the debtor of or by current or former management of the debtor, if (1) such appointment is in the interests of creditors, any equity security holders, and other 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 for the 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.  70 trustee or interim receiver, as contemplated by the report, was similar to the role assigned to the proposal trustee under the BIA, as the trustee or interim receiver would have been required to review the books and records of the debtor and maintain control and account for the disposition of the debtor’s property during the interim period. ’ However, the Colter Committee Report went further and 8 provided the court the discretion to grant additional powers to the trustee or interim receiver, including the right to take possession and sell all or part of the debtor’s property or manage the debtor’s business. The BIA gives the proposal trustee relatively noninvasive duties, such as to report on the  reasonableness of the debtor’s projected cash-flow statement, 83 notify the creditors of the filing of the notice of intention to make a proposal, monitor and report on the debtor’s business and affairs 85 and advise on and participate in the preparation of the proposal. The court may give an interim receiver appointed pursuant to section 47.1 more invasive powers. Subsection 47.1(2) gives the court very broad discretion in determining the powers that may be given to the interim receiver, including the powers to take control over the debtor’s business or property and to “take such other action as the court considers advisable.” Although case law under the BIA has yet to establish the contours of the role of an interim receiver, the legislative grant appears to  87 contemplate a broad and potentially invasive role. 81  Ibid  82  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 a petition for a receiving order (a liquidation proceeding). It has been held that the interim receiver, in those circumstances, is to take only conservatory measures to protect the debtor’s estate and is not to divest 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 carrying  71 The recent case of Re NT. W. Management Group Ltd 88 illustrates the separation of the roles of the proposal trustee and an interim receiver. In that case, the court appointed an interim receiver on the basis that the debtor, after filing the notice of intention to make a proposal, opened a new bank account and deposited funds into that account that were subject to a security interest. Rather than appointing a separate entity as the interim receiver, the court appointed the proposal trustee, to reduce 89 The court further held that the proposal trustee need not relinquish its duties as proposal costs. trustee but thereafter, it must fuffil the duties of proposal trustee and also, comply with the court ordered duties of an interim receiver. The BIA does not provide a list of persons who may apply for the appointment of an interim receiver. It has been suggested that the proposal trustee or any creditor or creditors may make the 90 In such an application, the applicant has the onus of showing that the appointment of an application. interim receiver is necessary for the protection of the estate or the interests of one or more creditors or the creditors generally. ’ The courts have held that they must act cautiously in considering whether to 9 appoint an interim receiver. The reason for this cautious approach is their desire to avoid precipitous action that could not only prejudice the hopes of the debtor for its recovery, but also the interests of 92 The applicant must adduce evidence of an actual danger of dissipation of assets; mere creditors.  on of his business except as may be necessary for the conservatory purposes or to comply with the order of the court.” [BIA s. 46(2)1. 88  (1993), 19 C.B.R (3d) 162 (Ont. Gen. Div.).  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 interim receiver is “to reduce or control costs as much as possible.” 89  L.W. Houlden and C.R Morawetz, The Annotated Bankniptcy and Insolvency A Ct 1993 (Scarborough: Carswell, 1992) at 92. 9°  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.).  72 suspected or feared dissipation will not be sufficient. 93 A monitor appointed in an order under the CCAA must assess and review the debtor’s business and affairs on an ongoing basis. 94 The court has the discretion to grant powers in excess of these duties. In Canadian Imperial Bank of Commerce v. Quintette Coal Ltd , the court refused to expand the 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 of the CCAA would be best accomplished through the limited role of the monitor, who would be subject to the court’s supervision.  FULFILMENT OF OBJECIIVFS A1NI) PROPOSALS FOR REFORM  C  Although the primary objective of a business reorganization proceeding is the confirmation of a plan of reorganization, there will be a period between the commencement of the proceeding and confirmation of the plan, during which many interim decisions and interlocutory proceedings will take place. 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 former management, will inject elements of objectivity and impartiality into the proceedingY 7 This has the advantage of easing the minds of the creditors, should there be a suspicion of wrongdoing or negligence on the part of the former management of the debtor. The independent party will take an objective 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 Canada Ltd 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, to continue 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.  73 henceforth, unencumbered by previous loyalties and relationships that may have clouded the judgment of former management. Following its review, the independent party may decide to liquidate or dispose 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 a reorganization is a feasible alternative. The independent party will also undertake examinations and investigations that former management may be unwilling or unable to undertake, such as the review of insider transactions. Conversely, the appointment of an independent third person will result in additional, often significant, costs that the creditors will bearY 8 In addition, because the trustee or interim receiver may lack 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 these 9 This delay may result in loss to the debtor in terms of time, customers and suppliers. A mattersY more practical concern is that the independent person may not have the time or incentive to maintain the business in a way that will result in a confimed plan of reorganization. This proposition has two aspects. First, the independent person may not have the necessary human resources to dedicate to the debtor’s business. In times of severe macroeconomic difficulty, the independent person may be working at full capacity, with no personnel to dedicate to the debtor’s affairs. Although this may result in a loss to the debtor’s business, the more serious consequence is that the independent third  person 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 party can deal with and conclude the matter expeditiously, the appointing creditors may be more inclined to provide the trustee or monitor with replacement work. Although this is a valid consideration for the free-market mentality of the insolvency practitioners, it hardly encourages support of the debtor’s  98  House Report at 233.  Ibid. 99  74 reorganization efforts. In a broader sense, the virtual automatic appointment of a trustee or monitor may provide a disincentive for management to seek the protection of a reorganization statute, even if a reorganization is the most effective means of solving the debtor’s problems. ° Management may feel that a total or 10 partial loss of control may spell the demise of the business because of the lack of knowledge of trustees and monitors and the costs resulting from their appointment. This type of approach defeats  the purpose of a business reorganization regime, as it results in debtors waiting until the last possible moment 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 the business community wants a business reorganization regime. If that inquiry leads to an affirmative response, we must determine the best method of accomplishing that objective, If we accept Professor LoPucki’s observation that creditors take little active interest in the affairs of their debtors,’° 1 we must  question 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 a monitor to supervise the debtor’s business may not encourage a debtor to seek the protection of a business 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 “zero 102 game, where there is a limited amount for distribution among the parties, with some parties sum” gaining and others losing, the effective deployment of assets is of primary concern to the parties. The  appointment of an independent third person will erode the resources available for the creditors and equity holders and accordingly, the decision to appoint an independent person to protect those interests should be left to the parties that will be paying for the benefit of that person’s advice. Should the  100  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.  75 parties 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 all cases, the presumption should be that the debtor remains in possession and control of the business and operations, but that the creditors be permitted to apply summarily to the court for the appointment of a trustee or monitor. The parties or the court, if the parties are unable to agree, will be determine the rights and duties of the trustee or monitor. In this manner, the stakeholders are making the decision concerning the disposition of “their” money. In analyzing the creditors who are supporting the application, the court must be cognizant of the actual creditors that will bear the costs of the trustee or monitor. An undersecured creditor with security on all or substantially all of the debtor’s assets will bear those costs, as any further expenditures will further erode its security, if the secured creditor is frilly secured, the unsecured assets will bear the costs. In such a situation, the court must pay special attention to the interests of preferred and unsecured creditors. if the policymakers put this type of system into place, sufficient checks and balances must exist for the courts and creditors to monitor and control the debtor’s affairs. The debtor may see this as a small price to pay for the opportunity to attempt a reorganization. The legislation could implement provisions for adequate disclosure requirements, the possibility of having the reorganization proceeding converted to a liquidation, requirement for court approval and easy access to the courts by the DIP and other parties in interest for advice and direction. These proposals do not derogate from the objective of a business reorganization system but enhance it. If the checks and balances and the debtor remaining in possession are satisfactory to the parties, there is no reason why the debtor should not remain in possession. The system should serve the constituents whose interests it seeks to protect. Providing flexibility to allow the parties to structure the proceeding in a way that serves their respective needs, while always providing the courts the opportunity to supervise the proceedings, attains this objective.  76 CHAPTER V CEREAN ADIIMSThAT1VE PORS The title of Chapter 11 is “Reorganization” which may lead the reader to conclude that the focus of this paper would be on that chapter. However, chapters 1, 3 and  51  are general provisions  applicable to all proceedings under the Code. The “administrative powers” in subchapter IV of chapter 3 of the Code are the essence of a business reorganization proceeding, as those powers will determine whether 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, simple sections. However, there is a very rich history underlying each section and they have each engendered a significant body of case law. This chapter will examine whether the administrative powers assist the American courts in defming and attaining the objectives of a business reorganization system. The CCAA, through its loosely-worded provisions or through case law, has developed administrative powers similar to those outlined in subchapter IV of chapter 3 of the Code. This chapter will examine the development of those powers under the CCAA to determine whether they have enhanced or hindered the debtor in its reorganization efforts. The BIA also has incorporated mechanisms similar to most of the administrative powers contained in the Code. However, the differences have a significant impact on whether the insolvent person will be able to put forth an acceptable proposal. This chapter will contrast the administrative powers contained in the Code with the mechanisms contained in the BIA to determine which system will better attain the objectives of the legislation. This chapter will examine the concept of adequate protection and the automatic stay of proceedings that the Code imposes at the outset of a case. It will also review the discretionary stay of proceedings under the CCAA and the automatic stay of proceedings under the BIA and will consider  They are, respectively, entitled “General Provisions”, “Case Administration” and “Creditors, Debtor and Estate”. 1  77 whether importation of the concept of adequate protection during the stay would assist a Canadian  debtor in its attempts to reorganize its fmancial affairs. We will then examine of the issue of repudiation of real property leases. The Code and the BJA specifically give the debtor the right to repudiate, reject or disclaim real property leases. In  certain circumstances, the courts allow debtors a similar right under the CCAA. Again, this chapter will 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 to fmance the proceeding and its operations during the proceeding. The Code has a comprehensive and complex scheme for fmancing during the proceeding. Neither of the Canadian legislative schemes appears to have addressed this specific issue, although out of necessity, creditors who allege material prejudice 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 the debtor’s perspective, a determination adverse to its interests on any of these issues may destroy the possibility of its effecting a reorganization of its fmancial affairs. A creditor may find itself fmancially unable to cope with the consequences of the exercise of an administrative power and may face the possibility of its own insolvency.  ADEQUATE PROTECHON DURING THE STAY OF PROCEEDINGS  A.  This section will examine certain changes to the rights and duties of secured creditors that 2 Tn particular, this section will examine the stay of proceedings resulted from the passage of the BIA.  The relationship between a debtor and its secured creditors and the validity and enforceability of security are generally governed by law promulgated by the provinces pursuant to subsection 92(13) of the Canadian constitution. That subsection delegates authority to the provincial legislatures to enact legislation governing “property and civil rights in the provinces.” However, when bankruptcy intervenes, the federal bankruptcy and insolvency laws govern the relationships between the debtor and its 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: 2  “It would be impossible to advance a step in the construction of a scheme for the  78  administration of insolvent estates without interfering with and modifying some of the ordinary rights of property, and other civil rights, or without providing some mode of special procedure for vesting, realization, and distribution of the estate, and the settlement of the liabilities of the insolvent. It is therefore to be presumed, indeed it is a necessary implication, that the Imperial Statute, in assigning to the Dominion Parliament the subjects of bankruptcy and insolvency, intended to confer on it legislative power to interfere with property, civil rights, and procedure within the Provinces, so far as a general law relating to those subjects might affect them” [at 416]. .  .  The courts in the United States have come to a similar conclusion. Chief Justice Fuller of the United State Supreme Court expressly recognized this right of Congress in Hanover National Bank of the City ofNew York v. Moyses, 186 U.S. 181 (1902): “The subject of ‘bankruptcies’ includes the power to discharge the debtor from his contracts and legal liabilities, as well as to distribute his property. The grant to Congress involves the power 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 secured creditors pursuant to their jurisdiction over bankruptcy and insolvency, the courts jealously guard the property rights of secured creditors. In the United States, constitutional challenges to federal bankruptcy laws take place primarily under the “due process” and the “unlawful taking” clauses of the Fifth Amendment. The relevant provisions of the Fifth Amendment provide that “[nb person shall be deprived of life, liberty or property, without due process of law, nor shall private property be taken for public use, without just compensation.” The concept of “due process of law,” as that term is used in the Fifth Amendment, requires that a particular law not be unreasonable, arbitrary or capricious and that the law and its means of enforcement 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 Amendment applies. Substantive due process is the doctrine that a person shall not be deprived of life, liberty or property arbitrarily, and legislation that results in such deprivation must have a rational basis [Jeffries v. Turkey Run Consolidated School District, 492 F.2d 1 (7th Cir. 1974)]. Procedural due process, on the other hand, requires procedural fairness prior to depriving a person of life, liberty or property. At a 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 a meaningful time and in a meaningful manner [Fuentes v. Shevin, Attorney-General of Florida, 407 U.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 the decision 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 considering certain amendments to the 1898 U.S. Act that added provisions designed to save family-owned farms from foreclosure. The court held the amendments to be unconstitutional as a violation of the principles contained in the Fifth Amendment and stated that “The bankruptcy power, like the other great substantive powers of Congress, is subject to the Fifth Amendment.”[Rc4’ord, supra at 589]. The court noted that despite -  79 imposed on secured creditors at the outset of a reorganization proceeding and the protection afforded  to secured creditors as a result of the imposition of the stay of proceedings. The fmal part of this section will consider the issue of whether stay provisions further the objectives of a business reorganization proceeding. The Colter Committee Report advised the policymakers that “[amy proposed change to our bankruptcy legislation should be assessed in terms of how well it contributes to meeting the basic  the 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 just compensation.”[Rcdford, supra at 602]. Rcdford uses the wording of the unconstitutional “taking” provision of the Fifth Amendment and not the deprivation of life, liberty or property without due process of law. However, subsequent decisions cite Rcdford as authority for the due process proposition [Wright v. Vinton Branch of the Mountain Trust Bank of Roanoke, 300 U.S. 440 at 457 (1937)], as well as for the unconstitutional taking proposition. Although there is some dispute among commentators and courts as to the nature of the Rc4dford decision, it is clear that both concepts have been applied and followed in subsequent decisions [For a discussion of the debate, see In re Gfford, supra]. Thus, it can be said generally, that the bankruptcy power is limited by the Fifth Amendment. In Canada, there is a common law limitation on the legislative power to take property without compensation. The lack of constitutional protection places the interests of secured creditors in jeopardy should the Parliament of Canada choose to exercise its broad legislative powers to deprive secured creditors of their interests in the bankrupt’s property [J.M Ferron, “The Constitutional Impairment 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 a clear intention to the contrary, legislation which takes private property or impairs a vested interest in private property for public use or the use of third parties must provide compensation for that which is taken. The courts have gone so far as to require not just reasonable compensation for the property taken but full compensation [Belfast Coip. v. O.D. Cai Ltd, [1960] A.C. 490 (HL.)]. The general principle 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 of Appeal held: “For Revenue Canada to succeed, the plain and unambiguous meaning of the section must be that it deprives a properly secured creditor. . of all or part of its security without compensation, for the purpose of paying another debt entirely unrelated to the security. It is surely equivalent to the transfer of proprietary rights without compensation.” [at 58] .  Practically, the rights of secured creditors in Canada are similar to those of their American counterparts, notwithstanding the lack of constitutional protection of property rights. This functional similarity however, may be shattered by Parliament at any time by the utilization of “plain and unambiguous” [International Wanvnty, supra] language.  80 goals or objectives of the law.” 3 Laws facilitating business reorganizations must attempt to strike a delicate balance between “the desire to achieve equity and fairness in the distribution of the bankrupt’s 4 and assets, on the one hand, and the contractual rights of secured creditors, on the other hand. funds” The Code and the CCAA tend to restrict the rights of secured creditors in a business reorganization proceeding to facilitate the object of achieving equity and fairness in the distribution of the assets  comprising the estate and affording the debtor a fresh start. 5 The former Canadian Act placed few restrictions on the rights of secured creditors. The Tassé Report recognized the significant increase in secured credit in Canada and the inadequacy of the former Canadian Act to adjust, efficiently and fairly, the relationship between debtors and creditors. 6 It recommended changes to the legislation that would monitor and place certain restrictions on the rights of secured creditors. This chapter will consider whether the BIA is conceptually effective to resolve the inefficiencies and inadequacies  perceived by the Tassé Report.  1.  Temnnology  (a)  Secured Creditor The Code does not defme “secured creditor.” Rather, it describes the claimant according to  the nature of its allowed claim. Thus, whereas the 1898 U.S. Act referred to a creditor holding a security interest in the assets of the debtor as a “secured creditor,” the Code now describes it as a 7 That is, it classifies “creditor secured by a lien on property in which the estate has an interest.”  Colter Committee Report at 20. 4  Bankof Mann 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).  81 claims, not creditors, as secured or unsecured. 8 The Code made this change to obviate the vagueness of the 1898 U.S. Act, where it was necessary to determine whether a creditor with a security interest in collateral of a value less than the amount secured was to be treated as a secured creditor or as a creditor that was partly secured and partly unsecured. 9 Subsection 506(a) resolves this apparent problem 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. This is a very important concept, as certain provisions of the Code define the interest or limit the claims of such creditors on basis of the amount of the secured claim and not by the full amount owed to the ’ 1 creditor. As mentioned above, the creditor’s claim is secured to the extent that the creditor has a “lien on property in which the estate has an interest.” The Code provides a very broad defmition of “lien,” 2 which 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 way  of security agreement and not with nonconsensual liens created by statute or judicial process. Liens See Barash v. Public Finance Coiporation, 658 F.2d 504 (7th Cir. 1981); In re Glenn, 796 F.2d 1144 (9th Cir. 1986). 8  Bkr-L Ed, Code Commentary and Analysis s. 21:25 1. Under the Code, such a creditor is commonly known as an “undersecured creditor”. The distinction between oversecured creditors and undersecured creditors is important for determining the extent of their entitlement to “adequate protection”. 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 to a class of creditors secured by liens on property in which the estate has an interest, only if the plan to provides, inter dia, that the claimants retain their liens on the collateral and that they receive deferred cash payments, each totalling the allowed amount of the secured claims and not the full amount of such creditors’ claims [Code s. 1 129(b)(2)(A), emphasis added]. ‘  Code s. 10 1(37) “lien” means charge against or interest in property to secure payment of a debt or performance of an obligation; 12  13  House Report at 312.  14  Code ss. 101(36), 101(51) and 101(52), respectively.  82 created by way of security agreement include real property mortgages and liens on personal property or fixtures created pursuant to appropriate state law. Generally, nonbankruptcy state law detemiines the validity of the lien.’ 5 However, even though valid 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 of whether a particular type of claim or interest makes the claimant a secured creditor. The vagueness of an in personain defmition of the temi has not yet caused any difficulty in practice. However, the BIA  oscillates 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 classes as provided in the proposal, and may also be made to secured creditors in respect of any class 15  Butnerv. US., 440 U.S. 48 (1979).  16  BIAs. 2:  “secured creditor” means a person holding a mortgage, hypothec, pledge, charge, lien or privilege on or against the property of the debtor or any part thereof as security for a debt due or accruing due to him from the debtor, or a person whose claim is based on, or secured by, a negotiable instrument held as collateral security and on which the debtor is only indirectly or secondarily liable; CCAA s.2: “secured creditor” means a holder of a mortgage, hypothec, pledge, charge, lien or privilege on or against, or any assignment, cession or transfer of, all or any property of a debtor company as security for indebtedness of the debtor company, or a holder of any bond of a debtor company secured by a mortgage, hypothec, pledge, charge, lien or privilege on or against, or any assignment, cession or transfer of, or a trust in respect of, all or any property of the debtor company, 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 be deemed to be a secured creditor for all purposes of this Act except for the purpose of voting at a creditor’s meeting in respect of any of those bonds; “unsecured creditor” means any creditor of a company who is not a secured creditor, whether resident or domiciled within or outside Canada, and a trustee for the holders of any unsecured bonds issue under a trust deed or other instrument running in favour of the trustee shall be deemed to be an unsecured creditor for all purposes of this Act except for the purpose of voting at a creditors’ meeting in respect of any of those bonds.  83 or 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 does not defme “secured claim,” we must assume that it is a claim by a person whose security has been proved and appropriately validated by the trustee. This subsection, furthenriore, does not recognize the possibly bifurcated nature of a secured creditor’s claim and specifically does not place the unsecured portion of the creditor’s claim within the body of general creditors. These problems are, to a certain extent, 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, the secured creditor may file with the trustee a proof of claim in the prescribed form, and may vote as an unsecured creditor on all questions relating to the proposal in respect of an amount equal 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 the section prescribing the voting procedure specifies that “all unsecured claims constitute one class” and that the proposal will be accepted only if “all classes of unsecured creditors” vote for its acceptance.’ 7 The BIA provides that the secured creditors may vote as unsecured creditors (the inperonam description) for the shortfall amount but does not state that their shortfall claim would rank as an unsecured claim (the in rem description). Although one may argue that this is merely semantic discussion that has no practical consequence, in a proper case, it may prove to be problematic. For example, must unsecured creditors, simpliciter, or unsecured creditors and secured creditors voting as unsecured creditors accept the proposal? This problem is magnified by the CCAA which neither sets forth the detailed procedure of the BIA nor provides specifically for the bifurcation of an undersecured credito?s claim. In fact, the  decision in Re Northland Properties Ltd’ 8 questioned the notion of bifurcation under the CCAA, by holding that the same debt cannot give rise to separate classes. Despite the foregoing discussion, “secured creditor,” in this section, refers to a creditor having 17  Emphasis, in both cases, added.  18  (1988), 73 C.B.R. (N.S.) 166 (B.C.S.C.).  84 a valid security interest in an asset or assets of the debtor. This defmition applies to references under the American or Canadian legislation.  Adequate Protection  (b)  The Code does not defme adequate protection although it refers to the concept in the sections describing an application for relief from an automatic stay, 19 use, sale or lease of property of the estate when such property is subject to a lien in favour of a secured party ° and the obtaining of credit. 2 21 We  may garner an understanding of the concept from its objective, which is to ensure that the creditor receives “essentially what he bargained for” 22 unless of course, receipt of that benefit frustrates or seriously interferes with the purposes of the Code’s reorganization provisions. In the latter event, the creditors will receive the benefit of the bargain by alternate means. 23 Section 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 interest of an entity in property, such adequate protection may be provided by -  (1) requiring the trustee to make a cash payment or periodic cash payments to such entity, to the extent that the stay under section 362 of this title, use, sale, or lease under section 363 of this title, or any grant of a lien under section 364 of this title results 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 that such stay, use, sale, lease or grant results in a decrease in the value of such entity’s interest in such property; or granting such other relief, other than entitling such entity to compensation (3) allowable under section 503(b)( 1) of this title as an administrative expense, as will result in the realization by such entity of the indubitable equivalent of such entity’s interest in such property. 19  Code s. 362(d).  20  Code s. 363(e).  21  Code s. 364(d).  22  House Report at 339.  Ibid. 23  85 These means are neither exclusive nor exhaustive. 24 However, they are all intended to protect the  creditor’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, both  of which may be more or less than the interest in the property. This appears to be reasonable. For example, in the absence of the stay, the secured creditor could recover only the amount of the debt or the value of the collateral, whichever is less. 26 It follows then, that if the interest of the secured creditor has no value, there is nothing to protect. 27 The Fifth Amendment that protects a creditor from being deprived of its property without due process of law or just compensation 28 is the source of the concept of adequate protection. Adequate protection seeks to address both of the issues raised by the Fifth Amendment. While acknowledging the constitutional basis of the concept, the legislative history indicates that public policy played a significant role in the development of the concept and the drafting of section 361 ? The constitutional basis protects the rights of the creditors. Public policy, on the other hand, focuses primarily on debtor rehabilitation or reorganization by the preservation of businesses and employment, the continuation of  24  House Report at 339.  In re Alyucan Interstate Corp., 12 B.R 803 (Bankr. Utah 1981); In re Pine Lake Village Apartment Co., 19 B.R 819 (Bankr. S.D.N.Y. 1982). 25  As to whether a component of the secured creditor’s bargain is compensation for lost opportunity cost has been the subject-matter of much debate. This topic will be examined infra notes 49-77 and the accompanying text. 26  See e.g. In re 620 Church Street Building Corp., 299 U.S. 24 (1936), which held that, if a parcel of land on which there are a number of mortgages has an appraised value of less than the amount of the first mortgage, the subordinate mortgagees have no interest in that property which requires adequate protection. 27  Continental Illinois National Bank & Trust Co. v. Chicago, Rock Island & Pcrjfic Railway Co., 294 U.S. 648 (1935); Radford, supra note 2. 28  29  House Report at 339.  86 ° and the protection of investment. It also protects macroeconomic interests by preserving 3 credit essential and viable industries. The concept of adequate protection requires the courts in the United States to attempt to balance those interests. ’ 3 Negotiation and agreement on a method and procedure for providing adequate protection are the most economical ways of dealing with it. 32 One writer suggested that the requirement of adequate protection should foster cooperation between the debtor and its creditors. 33 Once the creditor requests adequate protection of its interest, the onus is on the debtor or the trustee to propose a method of adequately protecting the creditor. The debtor will propose a method of adequate protection that will be acceptable to the creditor while minimizing the effect on its efforts to reorganize. 34 If the secured creditor objects to the method of protection, the court detennines the adequacy 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. 35  J.L. Smaha, “Automatic Stay Under the 1978 Bankruptcy Code: An Equitable Roadblock to Secured Creditor Relief’ (1980) 17 San Diego L. Rev. 1113 at 1123. 30  31  See e.g., Radford supra note 2.  U.S. Bankruptcy Rules s. 4001(d) prescribes a procedure for the approval by the court of a settlement agreement between the debtor and its creditors concerning adequate protection. Although the U.S. Bankruptcy Rules do not mandate a priori approval, it has been held to be the preferred approach [In re Blehm Land & Cattle Co., 859 F.2d 137 at 140 (10th Cir. 1988)1. Otherwise, the creditor is at risk that the court will refuse to sanction the agreement postfcrto, as being inequitable or contrary to the intent and purpose of the Code. U.S. Bankruptcy Rules s. 400 1(d) seeks to preserve the due process rights of third party creditors who are entitled to notice of an application for approval of such an agreement. 32  A.N. Karlen, Adequate Protection Under the Bankruptcy Code, Its Role in Business Reorganizations” (1982) 2 Pace L. Rev. 1 at 33 where he states: “Adequate protection may encourage a spirit of cooperation and negotiation between the debtor and its secured creditor, since it is to both parts advantage to confirm a plan to revitalize the debtor’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.  87 Subsection 36 1(1), allowing periodic cash payments, and subsection 36 1(2), allowing additional or replacement liens, compensate the creditor for the “decrease in the vdue of such entity c interest in such property” [emphasis added], not an interest in specific collateral. Consequently, if  there 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 at a relatively fixed rate. Similarly, an additional or replacement lien protects the creditor’s value in the original property, should it decline during the pendency of the case. The additional or replacement lien gives the secured creditor alternate or additional property upon which to realize the decreased value of the 37 collateral. Most of the case law attempting to defme the concept of adequate protection deals with the extent of the protection necessary to result in the creditor realizing the “indubitable equivalent” of its interest in the collateral. Congress borrowed the concept of “indubitable equivalent” from the frequently-quoted statement of Judge Learned Hand in In re Murel Holding Coiporation 38 where, in discussing 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 the section, but the constitutional limitations to which it must conform. It is plain that “adequate protection” must be completely compensatory; and that payment ten years hence is not generally the equivalent of payment now. Interest is indeed the common measure of the difference, but a creditor who fears the safety of his principal will scarcely be content with that; he wishes to get his money or at least the property. We see no reason to suppose that the statute was intended to deprive him of that in the interest of junior holders, unless by a  House Report at 339. See e.g, In e Bermec Coiporation, 445 F.2d 369 (2d Cir. 1971), which originated the periodic cash payment method [Bkr-L Ed, Code Commentary and Analysis s. 15:5]. In that case, the debtor was in the business of leasing trucks and tractor-trailers. A number of secured creditors provided fmancing on security of the vehicles and opposed the reorganization petition. The court 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 status quo” [at 3691. 36  Ibid 75 F.2d 941 (2d Cir. 1935) [hereinafter Mwel].  88 substitute of the niost indubitable equivalence. 39 The legislative history indicates that the concept of indubitable equivalence was a general category intended 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 fmancing such as government mortgage guaranties, ’ a combination of equity in the property, current payments 4  and insurance coverage 42 or curing defaults under a security agreement or lease and undertaking to meet payments as they fall due or providing the creditor with a security deposit. 43 More novel however, is the use by the courts of an “equity” or “value” cushion as adequate protection. As a secured creditor must be adequately protected for the value of its interest in the collateral and not for the amount of the debt, when the amount of the debt is greater than the value of  its interest in the collateral, the secured creditor is “undersecured.” The amount of the debt that exceeds 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 the collateral, the secured creditor is “oversecured.” Accordingly, the full value of its interest in the collateral should be adequately protected and the courts hold, in some cases, that the “equity cushion” provides sufficient adequate protection.”’ Ibid at 942. Ibid 40 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). 41  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 creditor approximately $1,340,000 for which it held security valued at $5,731,000. The secured creditor’s concern was that by allowing the debtor to use the accounts receivable and inventory, which were valued in aggregate at $3,700,000, its Fifth Amendment rights were being violated. The court held  89 Several writers are critical of the evolution of the equity cushion concept 45 where the “collateral cusHon” is eroding through depreciation, accruing interest and costs, such as when the court holds the equity cushion in real estate to be adequate protection, without more. 47 These writers do 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 as periodic payments or replacement liens. One form of adequate protection that they suggest is  that in view of the value of the assets of the debtor and the amount owed to the secured creditor, the secured creditor’s interests were adequately protected [at 864-865]. There were four factors that must be noted with respect to this case: 1. the amount owed to the secured creditor s approximately 23% of the value of the collateral; 2. there would be no detrimental effect on the security of the secured creditor as long as the accounts receivable and inventory were maintained at a level sufficiently in excess of the secured interest of the secured creditor; 3. the court ordered the debtor to provide fmancial reporting to it and to the secured creditor on a regular basis; and 4. the court allowed revision of its orders to be made on short notice in light of any changes in 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 maintenance of the equity cushion. J. McCafferty, “‘Value Cushion’ Reexamined: A Critical Review of Value Cushion as Adequate Protection in Chapter 11 Real Estate Cases” (1984) 89 Comm. L.J. 31; E.D. Flaschen, “Adequate Protection for Oversecured Creditors” (1987) 61 Am. Bankr. L.J. 341; J.L. Fellows, “In re Alyucan Interstate Corporation: Determining Adequate Protection in Actions for Relief From the Automatic Stay” (1982) Utah L. Rev. 393.  Flaschen, ibid at 348 defines “collateral cushion” as the amount by which the value of the collateral 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 court held that an equity cushion of approximately 2O% was sufficient adequate protection. These types of cases prompted McCafferty to state: ‘  “[the equity cushion as adequate protection] has now been applied to frustrate completely the rights 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 Blazon financing arrangement look like the best loan Citicorp ever made!” [at 32].  90 providing the oversecured creditor with compensation for iost opportunity cost. 48 Although such compensation usually concerns undersecured creditors, 49 secured creditors that are provided adequate protection by the equity cushion alone, with no current interest being paid, will also seek that  compensation. Opportunity cost is defmed as the loss incuiTed by a secured creditor by not being permitted to foreclose its lien, sell the collateral and reinvest the proceeds. ° Subsection 506(b) of the Code 5 provides: To the extent that an allowed secured claim is secured by property the value of which, after any 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 reasonable fees, 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 costs to the extent of the value of the collateral exceeding the amount of its secured claim, it still loses the time value of those amounts and thereby suffers a loss. An award of periodic payments to cover its opportunity cost 51 would fully compensate the secured creditor in such circumstances. However, while it may be arguable that compensation for opportunity cost, 52 should be awarded to an oversecured creditor, there is no statutory authority for awarding it to an undersecured creditor. 53 Compensation for opportunity cost has more importance to undersecured creditors. Unlike an  oversecured creditor which may recover postpetition interest, fees and costs from the value of the 48  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’d 484 U.S. 365, 98 L Ed 740 [hereinafter Timbers, cited to L Ed]. °  51  Flaschen, supra note 45 at 354.  A secured creditor would be well-advised to include a provision in its security agreement for lost opportunity cost to at least allow the argument to be made that such cost was contemplated by the agreement. 52  Timbers, supra note 50.  91  collateral that exceeds its claim, the Code has no provision entitling an undersecured creditor to such amounts. Before the decision in Timbers, there was some uncertainty as to an undersecured creditor’s  entitlement to compensation for its opportunity cost. 54 To understand the uncertainty, we must refer to Judge Learned Hand’s notion that adequate protection should be “completely compensatory” and that “payment ten years hence is not generaliy the equivalent of payment now.” 55 Many Bankruptcy and District Courts in the early 1980s held that the right of a secured creditor to repossess, sell and reinvest the proceeds is a valuable right worthy of protection and, following Judge Hand’s opinion in Murel, awarded compensation for the present value of 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 adequate protection but whether 58 the value of the collateral or the present value of the interest of the undersecured creditor in the collateral is an interest that must be protected. It was then necessary to determine the nature of that interest. While the court acknowledged that neither the legislative history nor the Code expressly mentioned protection of the secured creditor’s right to foreclose, sell and reinvest the proceeds of sale of the collateral, it held that, “[u]nquestionably, however, these are valuable rights of secured creditors, and nothing in the reports suggests that they are not among those  Immediately following the decision in Timbers’, numerous law review articles praised the Supreme Court’s decision as being strictly in accordance with statutory interpretation and provided undersecured 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 that were contrary to the approach in the Timbers’ case as being ill-conceived. If the Timbers’ decision was so 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 Founthy Co. Inc., 9 B.R493 (D.C.W.D. Va. 1981); Metmpolitan Life Insurance Co. v. Monme Park, 17 B.R 934 (D.C.D. Del. 1982). 734 F.2d 426 (9th Cir. 1984) [hereinafter American Mariner]. 58  Ibid at 430.  92 equitable and legal interests entitled to protection.” 59 The court therefore concluded that opportunity cost was an interest that required protection for the secured creditor to realize the benefit of its 60 The court acknowledged that it was being “guided by equitable principles.” bargain. 61 It held that  the award was consistent with Judge Hand’s wording that Congress adopted in enacting section 361(3),62  which “at least encourages if not requires a present value analysis.” 63 The court  acknowledged several times that it was standing on less than firm ground. However, from a pure public policy perspective, the decision is defensible.M The policy underlying the decision is obvious from the following: To the extent that the debtor in bankruptcy can prevent the secured creditor from enforcing its rights against collateral while the debtor benefits from the creditor’s money, the debtor and his unsecured creditors receive a windfall at the expense of the secured creditor. 65 Meanwhile, Bankruptcy Courts in a number of other circuits concluded that neither Murel nor  Ibid 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.  American Mariner, supra note 57 at 435. The Fourth Circuit Court of Appeals followed the American 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.2d 1339 (8th Cir. 1985), also accepted that in an appropriate case, interest payments for the delay in foreclosing, liquithting and reinvesting the proceeds may be awarded but refused to “hold as a matter of 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 a case by case basis whether such interest is worthy of such protection. This approach would have resulted 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 Undersecured Creditors in Bankruptcy” (1987) 100 Harv. L. Rev. 1106 at 1120. 65  93 the Code intended to protect the foreclosure, liquidation and reinvestment interest and therefore refused to require compensation for loss of that “right.” This position ultimately prevailed. In a carefully reasoned decision, Mr. Justice Scalia, who wrote for a unanimous court in Timbers, denied the undersecured creditor compensation for its opportunity cost. The decision is an exercise in statutory interpretation and is therefore of limited value for our purposes. 67 The court did not accept any of the equitable arguments put forth by the creditor. It is submitted that it could not accept those arguments as the Code, when read as a whole, presented the court with no ambiguity. 68 Given the care that Justice Scalia used in drafting his decision and his logical approach, it is difficult to challenge the soundness of the decision and the law review articles bear witness to that  fact. However, the articles do not give credit to the soundness of the public policy concerns that American Mariner and subsequent decisions adopting that approach were attempting to address. In  discussing an opinion that supported the public policy of American Mariner and was “notable for its misconceptions,” one author wrote that the judge”... was apparently unaware or chose to ignore the fact 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 consequences  See 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 conclusions reached by these courts accord with the decision of the United States Supreme Court in Timbers, a discussion of the reasoning in these cases will not be undertaken..  For example, the court held that section 506(b) allows postpetition interest to oversecured creditors only and not to undersecured creditors. As to oversecured creditors, they are only entitled to postpetition interest to the extent of the value of the collateral. Undersecured creditors as to the unsecured portions of their claims, must share the benefits and losses of a business reorganization with other unsecured creditors. They should not be given the benefit of interest on their secured claims before unsecured creditors receive any principal payments. Furthermore, section 502(b) of the Code prohibits the payment of unmatured interest. 67  Timbers, siqIv note 50. T.T. Shepard ifi “The Plight of Secured Creditors After In re Timbers of Inwood Forest Associates, Ltd.” (1989) Comm. L.J. 26 at 39.  94  on corporate reorganizations and would result in more liquidations said “accordingly, granting undersecured creditors lost opportunity costs would be poor public policy.” 70 While decision in Timberc is sound, based on the wording of the Code, awarding compensation for opportunity cost is not necessarily poor public policy, for the reasons set forth by the court in American Mariner. 71 Bankruptcy law is not designed exclusively for debtors or unsecured creditors. It seeks to balance the interests of all parties in interest. Is it poor public policy to allow a secured creditor the benefit of its bargain, which is finite (ie. a secured creditor can only recover, at most; its principal, interest and costs) while allowing the parties that have the most to gain from a reorganization and the least to lose from its failure, to use part of the assets upon which the secured creditor based its bargain? Several authors eqressed the concern that Timbers would result in secured creditors requiring increased marglns or alternatively, higher borrowing costs which could result in fewer out of court settlements and increased bankruptcies7 One wonders if this is sound public policy. As the courts are moving away from fully compensatory adequate protection, several writers have suggested that creditors will be moving more quickly to seek relief from the automatic stay of proceedings and requiring the debtor to show that it has a reasonable possibility of successfully 73 The result will be dismissal of the case or conversion to reorganizing within a reasonable time. liquidation 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 the Inwood 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) 41 Ala. L. Rev. 503 at 522; J.U. Schorer “The Right of the Undersecured Creditor to Postpetition Interest in Bankruptcy on the Value of its Collateral: Implications of Recent Cases” (1988) 21 U.C.C.L.J. 61 at 70. Timbe,, supra note 50 at 751. P.R Scanlon “Adequate Protection and Secured Creditors’ Strategies After Timbers” (1989-90) Coll. L. Rev. 59 at 76. Miss.  95 jurisprudence is moving toward the CCAA approach of questioning the feasibility of reorganization at the outset of the proceeding and forcing the court to look at the debtor’s chances of success rather than the creditor’s right to protection Unfortunately, there have been few reported cases that test this 75 As one writer noted, “[flew undersecured creditors waste time filing early motions for hypothesis.  stay relief, and few bankruptcy courts are willing to write extensive opinions on a matter that has been clearly decided against the creditor’s position” 76 To avoid the risk of leaving the reader with the idea that the concept of adequate protection is illusory, it may be useful to summarize the concept. The court must grant adequate protection to a creditor on the creditor’s request or when the Code requires it. Adequate protection protects the creditor from a decrease in the value of its collateral and it may assure the creditor that it will ultimately receive the value of its collateral at the dismissal or conclusion of the case. It also requires the debtor to maintain the property and not to expose the property to noncompensable loss through a lack of insurance. Finally, it is arguable that adequate protection would protect the “collateral cushion” or lending margin of an oversecured creditor. However, it does not protect an undersecured creditor for its opportunity cost and, to that extent, it is not completely compensatory, as it deprives the undersecured creditor of the right to foreclose, sell and reinvest the proceeds, which is the “essence of secured lending.”  Natme of the Stay of Pioceedings  2.  The BIA and the Code impose an automatic stay of proceedings upon the commencement of  The reported cases to date merely confirm Timbei. See e.g., In r Reddington/Swaiww Limited 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 11 Reorganization: Compensation for the Delay in Enforcing Foreclosure Rights” (1984) 60 N. Dakota L. Rev. 515 at 517.  96 business reorganization proceedings. 78 The BIA imposes the stay upon the filing of the notice of intention to file a proposal or the proposal itself. Under the Code, the filing of a petition under Chapter 11 results in the commencement of the stay. Unlike the BIA and the Code, a stay of  proceedings under the CCAA is not automatic. It is a discretionary remedy 79 granted by the court on 80 In keeping with the philosophy that a business reorganization will be beneficial to all application. creditors, the CCAA allows “any person interested in the matter’ to make the application, although usually it will be the debtor who seeks the stay. In considering whether to grant a stay of proceedings under the CCAA, the current trend is for the courts to examine the bonafides exhibited by the debtor and the feasibility of a successful reorganization, from the perspective of the creditors and from an ’ The analysis conducted by the courts in these cases is not unlike the analysis 8 economic perspective. conducted by United States courts when considering whether to grant a secured creditor relief from the automatic stay imposed by the Code. The former Canadian Act contained no provision for automatically staying the rights of secured creditors upon the filing of a proposal. This severely restricted the use of the proposal provisions contained in the fonner Canadian Act. Until the revitalization of use of the CCAA in the early 1980s, this limitation resulted in there being no effective method under which to structure a business reorganization in Canada. The imposition of the automatic stay under the BIA is perhaps the 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 appeal denied (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).  97 The specific policies addressed by the stay of proceedings are common to the statutes being analyzed. However, the broader purposes of the legislation are reflected in the American version of the automatic stay, which seeks to attain the public policy objective of balancing the interests of debtors and creditors. 85 This broader perspective requires the American courts to determine whether the stay is beneficial to all those concerned. The Canadian courts, in considering the stay provisions of the CCAA, focus on the rights of the debtor only and the public policies involved in a reorganization proceeding, which usually results in the balance tipping in favour of the debtor. Furthermore, neither the CCAA nor the BIA contain  the significant provisions of the Code that seek to protect creditors during the business reorganization proceeding. In the CCAA cases, this has led to an imposition of the stay with no provision for interim protection other than in some cases, the appointment of a monitor, or a complete dismissal of the 87 case. Smaha, siq’ra note 30 at 1116. MA. Frey, W.L. McConnico and P.R Frey, An Introduction to Bankruptcy Law (St. Paul: West, 1990) at 16. 85  It is acknowledged that this generalized proposition does not take into account a number of other factors that the judiciary considers in an application by a secured creditor for relief from the stay. One such factor may be the relative shortness of time to complete a CCAA proceeding as compared to a Chapter 11 proceeding. However, in the case involving Quintette Coal Limited, the court granted the debtor a period of six months within which to effect a plan of arrangement. While the stay period may not appear inordinate, it must be remembered that the companies seeking relief from the stay were owed in excess of $36,000,000. It is submitted that a six month stay with no protection of the claims of the creditors could hardly be considered equitable from the creditors’ point of view. 86  The Quebec Superior Court hinted at the possibility of “carving out” a secured creditor which considered 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: 87  “L’intervenante n’a démontré a la Cour que ladite machinerie était plus en danger maintenant qti’auparavant et, tout comme lea garanties de l’intervenante, la Banque Lloyds, celles de la Banque 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 the machinery was now in greater danger than it had been before. Its securities, like that of the  98 The Colter Committee Report 88 suggested a means of staying proceedings by secured creditors that recognized their need to be adequately protected while the debtor considered whether a reorganization was feasible. The recommendations allowed the secured creditor to collect accounts receivable, sell rapidly depreciating or perishable property, cany on the business of the debtor, solicit but not accept offers to purchase the collateral and take possession of but not remove property. In addition, the recommendations gave the courts a wide discretion to determine whether to lift the stay against 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, it gave secured creditors none of the rights, other than to apply to the court to seek relief from the stay on 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 under the 1898 U.S. Act and the rules promulgated thereunder were inadequate from the perspectives of the debtor, who required the protection of the stay, and the creditor against whom the stay applied and who needed relief from the stay when the collateral was deteriorating in 9 value. The following ’ frequently-cited excerpt from the House Report reflects the rationale and objectives of the automatic stay provisions of the Code: The automatic stay is one of the fundamental debtor protections provided by the bankruptcy laws. It gives the debtor a breathing spell from his creditors. It stops all collection efforts, all harassment, and all foreclosure actions. It permits the debtor to attempt a repayment or reorganization plan, or simply to be relieved of the fmancial pressures that drove him into principal 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 have been willing to allow the creditor to have the stay lifted against it alone and allow it to realize on the machinery. Colter Committee Report at 56.  Ibid at 57. 9°  BIA s. 69.4.  9°  House Report at 174.  99 bankruptcy. The automatic stay also provides creditor protection. Without it, certain creditors could pursue their own remedies against the debtor’s property. Those who acted first would obtain payment of the claims in preference to and to the detriment of other creditors. Bankruptcy is designed to provide an orderly liquidation procedure under which all creditors are treated equally. A race of diligence by creditors for the debtor’s assets prevents that. 92 The foregoing policy statement reflects the culmination of the evolution of the concept of the stay of 93 proceedings since the passage of section 77B. Canadian courts, in describing the purpose of the stay provisions in the CCAA, use similar language. The courts describe the purpose as being to maintain the status quo for a period while the debtor attempts to gain the approval of its creditors for a proposed arrangement that will enable the debtor to remain in operation for the future benefit and well-being of the debtor and its creditors. 94 The courts see the stay as a mechanism for “holding the creditors at bay” 95 until the compromise or arrangement is approved by the court and the creditors or it is obvious that the attempt is “doomed to failure.” For policy reasons that tend to favour the debtor, the courts are inclined to allow the debtor the opportunity to attempt a reorganization, even in circumstances where secured creditors have made it clear that they will not sanction a plan under any circumstances. The basis on which the courts hold that the stay should remain in place is that it is possible that the debtor could formulate some type of plan that would see the secured creditor paid out in full. The creditor would clearly accept this type  House 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. Chef Recidy Foods Ltd (1991), 4 C.B.R (3d) 311 at 315 (B.C.C.A.) [hereinafter Chef Ready]. Ibid.  100 of plan. 97 That is, the courts seem to grant the stay based on the “interest of the public in the continuation of the enterprise,” 98 such as by the number of people that the business employs or the  nature 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 initial application under the CCAA must seek an order for a meeting of creditors, shareholders or both.’°° It  does not give any direction concerning the proceedings or substance of the meeting but we may assume that the purpose of the meeting is to consider the plan of compromise or arrangement. Section  11 allows the court to grant a stay of proceedings “whenever an application has been made under” the CCAA. The only application that the debtor can make is the initial application seeldng an order for a  meeting. In this manner, the court must consider some of the merits of the case when agreeing to grant the stay. ’ Given the limited information provided to the court at that stage by the applicant, the 10 fact that most initial applications are ex porte and faced with the general objectives of the CCAA, the courts seem to rely on the general policy and objectives of the CCAA in granting the stay. The courts have been reluctant to “carve out” certain creditors and allow them to realize on their security.’ 02 This  See e.g., Timber Lodge Ltd v. Timber Lodge Ltd (Creditors of) (1992), 15 C.B.R. (3d) 244 at 252 (P.E.I.S.C.) [hereinafter Timber Lodge]; Icor Oil & Gas Ltd v. Cancdiaii Imperial Bank of Commerce (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. S.E. Edwards, “Reorganizations Under the Companies’ Creditors Arrangement Act” (1947) 25 Can. Bar Rev. 587 at 593. 98  Ibid However, one case denied an application for a stay on the basis that the public did not have 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 case appears to be an anomaly however, and is not indicative of the general trend. 100  CCAAss.4and5.  It is therefore more appropriate to discuss the exercise of the court’s discretion in the context of a creditor seeking relief from the stay. See discussion, chapter V(AX4)(b), below. 101  Quintette Coal Ltd v. Nzpon Steel Coip. (1991), 2 C.B.R. (3d) 291 at 297 (B.C.S.C.) [hereinafter Quintette]. 102  101 has resulted in applications to lift the stay entirely and to have the CCAA proceedings vacated. This approach clearly favours the debtor, as the only alternative to reorganization is liquidation, which is contrary to the intent of the legislation. This situation has prompted one writer to note, “[tjhis creates a heavy onus on the creditor seeking to vary stay orders or oppose the reorganization and technical arguments are rarely likely to succeed in the face of ‘economic reality’ the ends will invariably justify -  the nans.”° 3 In the United States, on the other hand, the stay is automatic, which obviates the necessity of justifying the stay. The courts first face the issue of the necessity of the automatic stay on an application by a disgruntled creditor to have the stay lifted. The Code gives the court some direction  concerning 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”° 4 to a creditor. As the court need not deprive the debtor of the opportunity to reorganize and as the secured creditor will be entitled to have its interest “adequately protected,” the court balances the interests of the 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 the courts authority to grant adequate protection and accordingly, they have simply denied secured creditors the ability to realize on their security, without providing any interim protection or 06 compensation for loss during the stay period.’ In summary, although the specific objectives of the stay of proceedings are common to all of  MA. Fitch, “The Reorganization of Quintette Coal Limited: An Unsecured Creditor’s Perspective” in Insolvency Institute of Cancda Second Annual Meeting and Conference Materials, October 20-22, 1991, Horseshoe Valley Inn, Orillia, Ontario 99 at 107. 103  104  Code s. 362(d)-(g).  ‘°  See discussion, chapter V(A)(1)(b), below.  e.g., Re Phil4is Manufirturing Ltd (1992), 12 C.B.R (3d) 133 at 138 (B.C.S.C.), where denied payment to a secured creditor of interest during the period of the stay as it would be the court “unfair” to “prefer” the bank as to interest when no other creditor will receive it. 106  102 the statutory schemes, the statutory schemes have detennined, to a great extent, the way in which the stay will operate. The courts, in considering the CCAA, with its “all or nothing” approach to the stay look favourably at allowing the debtor the opportunity to reorganize. Unless the plan is “doomed to failure,” the courts allow the debtor time within which to formulate the plan. The creditor has the onus of showing why the court should not grant the order.’° 7 The courts in the United States, on the other hand, look at whether the creditor’s interests are protected..’° 8 Other than with respect to the issue as to whether the debtor has any equity in the property, the debtor has the burden of proof on all other 109 issues. Although the structure of the BIA allows the courts to consider relief from the stay on a creditor by creditor basis, the wording of section 69.4110 appears to place the burden of proof on the creditor seeking relief. That section provides: A creditor who is affected by the operation of sections 69 and 69.3 may apply to the court for a declaration that those sections no longer operate in respect of that creditor, and the court may make such declaration, subject to any qualifications that the court considers proper, if it is satisfied (a) that the creditor is likely to be materially prejudiced by the continued operation of 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 section places a burdensome onus on the creditors. The courts, in considering cases under the CCAA, choose not to exercise their equitable jurisdiction to allow such interim relief or protection and, in fact, refuse to allow it.” It is open to the courts, in considering cases under the BIA, to exercise their specific  107  Baigain Harold’s, supra note 81 at 30.  108  Code s. 362(d).  ‘  Code s. 362(g).  ‘o BIA s. 69.4. 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 agreements notwithstanding continued use of the secured property by the debtor. 111  103 equitable jurisdiction” 2 and grant interim protection to secured creditors.  3.  Scope of the Stay of Pmceedings Section 362(a) of the Code defmes the scope of the automatic stay.’ 13 The legislative history  intended the scope of the stay to be broad and to encompass not only judicial proceedings, but also arbitration, license revocation and administrative proceedings against the debtor, as well as civil  BIA ss. 183(1) and (2); Re Gold (1927), 8 C.B.R. 39 (Ont. S.C.); Re Heron (1933), 15 C.B.R. 39 (Ont. S.C.). 112  113  Code, s. 362 (a): Except as provided in subsection (b) of this section, a petition filed under section 301, (a) 302, or 303 of this title, or an application filed under section 5(a)(3) of the Securities Investor Protection 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 of process, of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title, or to recover a claim against the debtor that arose before the commencement of the case under this title; (2) the enforcement, against the debtor or against property of the estate, of a judgment 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 the estate 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 to the extent that such lien secures a claim that arose before the commencement of the case under this title;  (6) any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title; (7) the setoff of any debt owing to the debtor that arose before the commencement of the case under this title against any claim against the debtor; and the commencement or continuation of a proceeding before the United States (8) Tax Court concerning the debtor.  104 actions and all proceedings even if they are not before governmental tribunals.’ 14 The stay also enjoins a secured creditor holding a security interest under article 9 of the Uniform Commercial Code from repossessing its collateral by self-help or judicial 115 process. To appreciate the extent of the stay, one only need review the definition of the term “entities,” 6 to which the automatic stay is applicable. An entity includes, inter dia a governmental unit and a person, which in turn, is defined” 7 as including an 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 clearly applicable to secured creditors. We should also note that a “claim against the debtor” includes a claim  against the debtor’s property” 8 and 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 the CCAA 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 ct whenever 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 or without notice as it may see fit, (a) make an order staying, until such time as the court may prescribe or until any further order, all proceedings taken or that might be taken in respect of the company under 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 the company on such terms as the court sees fit; and  make an order that no suit, action or other proceeding shall be proceeded with (c) or commenced against the company except with the leave of the court and subject to such 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.  RL. Jordan and W.D. Warren, Bankruptcy (Mineola: Founthtion Press, 1985) at 754; Code s. 362(aX3). 115  116  Code s. 101(15).  117  Code s. 101(41).  118  Code s. 102(2).  105 the extent of the stay will be limited accordingly. Two early CCAA cases serve to illustrate this proposition. In Re Arthur Flint Company 9 Limited,” the court considered a provision in an order that stayed all actions by unsecured creditors and a further order that stayed proceedings for the recovery of debts. The court held that proceedings under the former Canadian Act were not proceedings for the recovery of debts. In allowing a petition under the former Canadian Act to stand, the court noted that the stay order did not correspond to the wording of the CCAA that allowed the staying of proceedings under the former Canadian Act Gray v. Wentworth Canning Company Limited’ ° further illustrates the strict interpretation of a 2  provision in a stay order. In that case, the court held that a provision in an order restraining proceedings that may “be taken” against the debtor prohibited only future actions, suits or proceedings against the debtor and that preexisting proceedings may continue. ’ Because of Arthur Flint and 12 Weniworth Canning, orders under the CCAA incorporate the language of section 11, enjoining the  commencement or continuation of all present and future suits, actions and proceedings against the debtor, including proceedings under the BIA and the Winding-up A ct.’ 22 The courts have upheld these broad provisions.’ 23 119  (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.  FR. Foran and T.M Warner, ‘Reorganizing the hisolvent Oil and Gas Corporation: The Courts and Fairness” (1990) 28 Alta. L. Rev. 132 at 143. See e.g., the stay order in the Quintette Coal Limited case which read as follows: 122  AND THIS COURT ORDERS that all proceedings taken or that might be taken in respect of the 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 proceeding against the Petitioner be restrained; AND IF11S COURT ORDERS that no suit, action or other proceeding shall be proceeded with or 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.).  106 The term “proceeding” determines the breadth of the stay. While it may be difficult to argue  that 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 in Wentwon’h Canning, gave the term a very narrow meaning. Using ejusdem generis, Kelly J. held that  the word “suit” governs the word “proceeding” and accordingly, the stay enjoins only proceedings instituted in a court) 24 Such a narrow interpretation would not prevent extra-judicial proceedings such as self-help remedies (where they are available under provincial law) or realizing on assigned or  pledged property. An early case that saw the revitalization of the CCAA rejected this narrow approach. In  25 Wachowich J. gave section 11 a wide interpretation to accommodate the purposes of the Meridian,’ CCAA. Specifically, His Lordship refused to restrict the term “proceedings” to those involving a court or a court official. The courts have embraced this broad approach to abrogate the rights of secured creditors, for example, to foreclose on a real property mortgage,’ 26 realize on security granted pursuant to section 427 (formerly section 178) of the Bank A ct’ 27 and notify third party lessees pursuant to an assignment of rents given to the secured creditor.’ 28 The overriding principle, it seems, is that if realization on the security, regardless of its nature, prejudices the opportunity of the debtor to attempt a reorganization of its fmancial or business affairs, the court will enjoin the secured creditor from realizing on its security. The stay provisions of the BIA are broad and appear to encompass most realization proceedings 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]; Chef Recdy, supra note 95.  128  Timber Lodge, siqra note 97.  107 Subject to subsections (2) and (3) and sections 69.4 and 69.5 on the filing of a notice of intention under section 50.4 by an insolvent person, (a) no creditor has any remedy against the insolvent person or the insolvent person’s property, or shall commence or continue any action, execution or other proceedings, for the recovery of a claim provable in bankruptcy, no provision of a security agreement between the insolvent person and a (b) secured 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 security agreement, or (iii) the filing by the insolvent person of a notice of intention under section 50.4, the insolvent person ceases to have such rights to use or deal with assets secured under the 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 subsection 224(1.2) of the Income Tav Act in respect of the insolvent person where the insolvent person is a tax debtor under that subsection, and Her Majesty in right of a province may not exercise her rights under provincial legislation substantially similar to that subsection in respect of the insolvent person where the insolvent person is a tax debtor under provincial legislation until the filing of a proposal under subsection 62(1) in respect of the insolvent person or the bankruptcy of the insolvent person. Paragraph (a) of the stay provisions imposes a stay against creditors that, by defmition, includes secured creditors. 129 The terminology appears, at first blush, to be straightforward and selfexplanatory. However, on closer examination, the stay provisions of the BIA leave one with the feeling that the policymakers were unaware of the concerns raised in the cases under the CCAA. The terms “action” and “execution” should not be the subject-matter of debate. However, we again, must face the term “other proceedings.” Although one would think that the courts will look to the decisions under the CCAA as a statute in pai materia to determine the scope of “other proceedings,” Parliament could 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 claim under this Act;  108 In the event that the courts give “other proceedings” a broad interpretation, as under the CCAA, then the opening words of paragraph (a) may be superfluous, as the word “remedy,” likely includes both judicial and self-help remedies. Should the courts give “other proceedings” a narrow interpretation, 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 appear to have settled. The stay of actions, executions or other proceedings in paragraph (a) concerns “the recovery of a claim provable in bankruptcy.” A secured creditor may realize its security and prove the balance due after deducting the realized amount or, surrender the security to the trustee, and prove for the entire claini ° Assuming, as often happens, that the secured creditor chooses to realize its security 13 and prove for the balance, the stay provision arguably only stays the secured creditor with respect to the 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 or the insolvent person’s property.” This would, logically, apply to a mortgagee under a real property mortgage or a secured party holding a security interest in the debtor’s equipment. However, does it prevent a secured creditor from realizing on property that the debtor absolutely assigned to it or property in which the secured creditor has an interst that is tantamount to ownership? For example, a properly framed assignment of book debts conveys all of the right, title and interest in the book debts ’ In such a 3 to the assignee such that the book debts “were never more the property of the assignor.” case, it is arguable that the secured creditor is not seeking a remedy against either the insolvent person or the insolvent person’s property by requesting payment from the third party debtor. Similarly, 132 gives the bank the same rights and powers as if the security under section 427 of the Bank Act  130  BIA s. 127.  ‘‘  Royd Bank of Caiicda v. R. (1985), 52 C.B.R (N.S.) 198 (F.C.C.).  132  Siqra note 127.  109 bank had acquired a warehouse receipt or bill of lading in the secured property and consequently, all the right and title to those documents and the goods, wares and merchandise secured thereby.’ 33 It is therefore arguable that the bank is realizing on what it already owns and it is seeking no remedy against the insolvent person or the insolvent person’s property. While one may raise arguments to counter the foregoing positions, they illustrate problems that the courts may face under the stay provisions. The policymakers could alleviate these arguments by clarifying 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’s point of view, this provision may be more troubling than the actual stay of proceedings, as the BIA provides no protection to the secured creditor for the debtor’s use of “liquid” collateral such as inventory or accounts receivable (assuming that the stay prevents the secured creditor from realizing on those assets). A debtor could continue collecting accounts receivable or consuming inventory without having to protect or compensate the secured creditor. While the secured creditor may apply for relief from the stay, in such circumstances, such an application will force the courts to choose between the interests of the secured creditor and those of the debtor or more broadly, the public policy interests of allowing the debtor an opportunity to reorganize its affairs. The courts are placed in the difficult position of determining the objectives of the legislation, with the wording of the BIA providing little or no guidance. 134 This provision is of even greater concern when one considers that the BIA deems such provision in a security agreement to be of no “force or effect.” This may provide legislative sanction to the debtor diverting funds from the creditor that previously held security on such funds, with no compensation being paid to such creditor. It is suggested that, in such a case, the 35 in judiciary exercising its equitable jurisdiction, could inject the concept of adequate protection’  133  Ibid s. 435.  134  See discussion, chapter V(5), below.  135  See discussion, chapter V(A)(1)(b), below.  110 favour 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 broad powers to stay proceedings against the debtor. However, the inherent power of the court further augments these powers. Under the Code, the courts use subsection 105(a) to issue injunctions against parties or proceedings not otherwise stayed by subsection 362(a) or that subsection 362(b) specifically excepts 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 cany out the provisions of this title. No provision of this title providing for the raising of an issue by a party in interest shall be construed to preclude the court from, sua sponte, talcing any action or making any determination necessary or appropriate to enforce or implement court orders 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 Otero Mills, Inc. that was subject to protection under subsection 362(a) of the Code. The debtor asserted that the guarantor was going to contribute personal assets to it to effect the reorganization plan. The court, pursuant to subsection 105(a), prohibited the creditor from enforcing its judgment against the guarantor. Enforcement against the guarantor would affect the debtor’s estate and adversely influence and pressure the debtor through the guarantor.’ 37 The importance of this case lies in the formulation by the Bankruptcy Court of the test to determine wiiether the court would grant an injunction to enjoin a 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; and 38 3. no harm or minimal harm to the other party or parties.’ To this, the District Court added a fourth factor, which appeared to be the overriding and most influential factor. The court held that “in the bankruptcy setting, the public interest lies in promoting  136  25 B.R. 1018 (D.N.M 1982) [hereinafter Otero Mills].  137  Ibid at 1019-1020.  138  Ibid at 1021, quoting the Bankruptcy Court.  111 reorganizationtl The court reinforced this factor by stating: successful 39 At the beginning of the reorganization process, a court must work with less evidence than might be desirable and should resolve issues in favour of reorganization. Although reorganization by any bankrupt may be speculative early in the proceedings, [the creditor] is protected in that if a reorganization plan is not approved, it may apply to the bankruptcy court to lift the injunction. ‘4° .  Subsequent case law and legal scholars’ ’ have criticized the approach in Otero Mills as it”... 4 would distort congressional purpose to hold that a third party solvent co-defendant should be shielded against his creditors by a device intended for the protection of the insolvent debtor and creditors 142 Despite the criticism, other courts have followed it in different contexts. thereof.” 143 Therefore, the stay provisions may apply to the secured creditor even though the creditor seeks a remedy for which the stay provisions appear inapplicable. The Canadian courts have recently begun explicitly recognizing their inherent jurisdiction in cases under the CCAA.’’ The courts, however, do not require the increased burden of showing irreparable harm to the debtor’s estate or a strong likelthood of a successful plan of reorganization. In  139  Ibid at 1021.  “°  Ibid.  See e.g., Lynch v. Johns Manville Sdes Coip., 710 F.2d 1194 (6th Cir. 1983) [hereinafter Lynch]; D.R Kuney, “The Bank Guaranty Agreement: The Emerging Threat of the Bankruptcy Stay” (1985-86) Bus. Law. 77. 141  142  -  Lynch, ibid at 1197.  E.g., In re A.H Robins Co., Inc., 828 F.2d 1023 at 1026 (4th Cit 1987) [hereinafter A.H Robins], where the court enjoined the plaintiffs from pursuing products liability insurers of the manufacturer of the Dalkon Shield on the grounds that such an action would require the insurer to involve the debtor and such involvement would cause irreparable harm to the bankruptcy estate by placing a burden on the officers, directors and employees of the debtor “which would exhaust their energies 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 by the debtor. But see In re The Russell Coiporation, 156 B.R. 347 (Barikr. N.D. Ga. 1993), where the court held that the automatic stay “was not designed to benefit third parties, except to the extent that third parties benefit generally from the preservation of assets of the debtor.” (at 349). 143  ‘ See e.g. Re Westar Mining Ltd (1992), 14 C.B.R. (3d) 88 (B.C.S.C.), where the court granted a “super-priority” to suppliers who were prepared to keep the debtor operating.  112  Ccanpeau v. Olympia & York Ltd,’ 45 the court exercised its inherent jurisdiction to restrain the plaintiff from continuing an action against a co-defendant of the debtor. Implicit in the decision is a recognition 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 the reasoning in similar cases in the United States) the court stated,”... the restraining power extends as well to conduct which could seriously impair the debtor’s ability to focus and concentrate its efforts on the business purpose of negotiating the compromise or arrangement.” 47 The court then makes the  very curious statement that “[tlhe balance of convenience must weigh significantly in favour of granting the stay, as a party’s right to have access to the courts must not be lightly interfered with.” 48 The curiosity of this statement lies not in the proposition itself but the court’s failure to justify interference 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’s inherent power to grant stays “can be used to supplement s. 11 of the CCAA when it is just and reasonable to do so.”° In this manner, His Lordship stayed proceedings, not only against the debtor companies but also against the individual interests of limited partners, as the business of the debtor companies s significantly intertwined with that of the limited partnerships. ’ 15 Although the British Columbia Supreme Court, in the case involving Quintette Coal Limited enjoined creditors from demanding payment from the guarantors of the obligations of the debtor, it  145  (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.  113 appears from the reported cases that that provision went unchallenged by the creditors. However, other courts refuse to stay actions against guarantors, directors and officers.’ 52 In Philzp’s,’ 53 the debtor obtained the stay by an ex parte application. The stay prevented creditors from taking proceedings against directors, officers, employees, agents or consultants of the debtor. The court refused to exercise its inherent jurisdiction to maintain the stay. It distinguished the American cases upholding such 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’ to carry out the provisions of the Code.” 54 However, the court granted liberty to reapply in the event that the lack of the stay significantly interfered with the preparation of the reorganization plan.’ 55  The stay provisions under the BIA are limited to proceedings against the insolvent person or the insolvent person’s property. As mentioned above, however,’ 56 the BIA gives the the courts equitable jurisdiction. In addition, the court has inherent jurisdiction with respect to all matters under the BIA.’ This gives the court a broad discretion to stay various actions that are in some y related to the insolvent person, the insolvent person’s property or, more generally, the broad purposes of the  See e.g. Guardian Tiust Co. v. Gaglardi (1990), 64 D.L.R (4th) 351 (B.C.S.C.); Re Keddy Motor 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.) 152  Philip’s, supra note 81. 154  Ibid. at 9. Ibid  156  said:  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 court  “1 realize that the bankruptcy law is statutory mainly and a Court should not go beyond the provisions of the statute applicable. But, if the subject-matter is within the statute, the Court may draw on its inherent powers to give effect to the provisions of the statute.”  114  legislation. However, the stay of proceedings is in the nature of an injunction’ 58 and governed by the 59 In particular, the three factors cited in Otero Mills reflect the general principles in same principles.’ a bankruptcy case 160 and the public policy of promoting business reorganizations should not significantly influence the courts, unless all other factors are equal.’ 61 The oveniding consideration should not be the policy of encouraglng business reorganizations but the very special and extraordinary nature of the exercise of inherent jurisdiction. As stated by the Supreme Court of Canada, “[i]nherent jurisdiction cannot, of course, be exercised so as to conflict with a statute or Rule. Moreover, because it is a special and extraordinary power, it should be exercised only sparingly and in a clear ii162  lifting the Stay! Dismissing the Case  4.  A challenge to the granting or continuation of the stay is “one of the major battlegrounds” 63 of  158  A.-G. Man. v. Metropolitan Stores (MTS) Ltd, [19871 1 S.C.R. 110 at 127 [hereinafter MTS].  Ibid at 127-29, where Beetz J. set forth tests employed by the court in considering whether an injunction should be granted, being: 159  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 is granted, suffer irreparable harm, that is harm not susceptible or difficult to be compensated in damages; and 3. a determination of which of the two parties will suffer the greater harm from the granting or refusal of the interlocutory injunction, pending a decision on the merits. 160  Supra note 138 and accompanying text.  MTS, supra note 158 at 129-30. While the Supreme Court of Canada felt that the public interest should be a factor to be considered under its third test, it did so in the context of a challenge to the constitutionality of a statute promulgated by the Manitoba legislature. Although a business reorganization affects certain sectors of the public and the economy, it is suggested, with respect, that the 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 to fall within the purview of what the court referred to as “the interests of private litigants’ which in most cases, will be the types of interests sought to be protected under the inherent or equitable jurisdiction of the court under the BIA. 161  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.  115 business reorganization proceedings. One American writer stated that “stay relief is the main event in many chapter 11 cases.lM The difference in structure of the Code and the CCAA results in the parties seeking to challenge the stay taking different approaches. The courts in Canada focus on aspects of the case or stages in the proceeding that differ from their American counterparts. A strict comparative analysis of the approaches taken is difficult to conduct, although the approaches intersect periodically. This section 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 cannot overstate the importance of the concept of adequate protection in an American proceeding. The theory underlying American stay litigation is that, so long as the secured creditor is provided with adequate  protection or has an opportunity to repossess the collateral, there is no need for that creditor to question the right of the debtor to attempt to reorganize. The reorganization process is not harming the creditor. 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 dealing with cases under the CCAA. Accordingly, secured creditors have no alternative but to challenge the entire proceeding based on the lack of bonajIdes of the debtor or the feasibility of a successful reorganization.  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 reorganization alternative. In other words, the courts must choose between the secured creditor, whose interests are compromised, or the debtor, which is seeking to reorganize its affairs. Without the concept of adequate protection, there is no mechanism for the courts to use to strike a compromise; one party wins, the other loses. A second matter that we must note is that, throughout the discussion that follo, passing  164  132.  MJ. Bienenstock, Bankmptcy Reorganization (New York: Practising Law Institute, 1987) at  116 reference will be made to the conduct of the parties. Although, generally, the courts do not expressly state that their decisions are heavily influenced by the conduct of the parties, such conduct appears to have some influence. One ‘.witer noted: while economic or financial factors are significant in automatic-stay litigation, these factors are not the only consideration that courts apply. Instead, litigation by creditors to lift the stay is often reached in light of the creditor’s and debtor’s behavior before and during the bankruptcy case. The result is a general balancing of equitable factors, especially in business cases, that is significantly more complex than the pure economic evaluation often suggested in the literature.’ 65 With the limited number of cases under the CCAA, the fact that few cases specifically refer to the conduct of the parties and, most importantly, the fact that this aspect of the decision-maldng process 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)  CCAA A challenge to the stay generally takes place at the initial hearing, if the debtor applies on  notice to other parties, or soon after the creditors receive or become aware of the stay order, if the debtor’s application was ex pan’e. As the court is reluctant to carve out certain creditors, it is forced to consider 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 defeat the compromise or arrangement advises the court that no compromise or arrangement will be 67 the court must face the issue of whether the compromise or arrangement is doomed to acceptable,’ RT. Nimmer, “Real Estate Creditors and the Automatic Stay: A Study in Behavioral Economics” (1983) Ariz. St. L.J. 281 at 281. 165  ‘ The issue concerning the dismissal of a proceeding based on the inability of the debtor to secure 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 puts the entire proceeding into question, there will necessarily be some overlap in the discussions.  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 directed by the court [CCAA s. 6]. There is no provision in the CCAA which allows the court to “cram down” 167  117 failure. In such a case, the court will dismiss the application for the stay of proceedings or lift the  stay, if the court granted the stay order on the ex parte application of the debtor. The Ontario Court of Appeal faced this issue Elan.’ 68 The majority of the court held that the appellant bank should be placed in its own class and, as that class would reject a plan of arrangement, the plan could not 69 As a result, the court lifted the stay of proceedings and dismissed the proceeding. In succeed.’ Diemc’ster Tool Inc. v. Skvotsoff (Trustee  oj),17o  the court reached a similar conclusion despite  testimony that the plan of compromise and arrangement would result in payment in full to the secured ’ 7 creditor.’ the plan on a class of creditors that has rejected the plan as contemplated by section 1129 (b) of the Code. A rejection of the plan by a class of creditors merely results in a failure of the plan with respect 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.  Ibid at 115. In reviewing the decision of the majority, one wonders whether the erosion of the collateral was the major factor being considered by the court, ie. the lack of adequate protection. One of 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 bank from acting on its security and allowing the debtor to spend up to $321,000 from accounts receivable collected by it [at 109]. 169  170  (1991), 3 C.B.R (3d) 133 (Ont. Gen. Div.) [hereinafter Diemaster].  The debtor required the stay period to seek new debt or equity fmancing. The court appeared concerned with the fact that the debtor had been in fmancial difficulty and had been seeking debt or equity fmancing for almost two years prior to the application under the CCAA. Although not expressed, it appears that the court had little confidence in the debtor finding sufficient debt or equity fmancing to pay the secured creditor in fill. This conclusion is implicit in the following statement: 171  “The bank would hardly vote for a result that would go against its own interests. Since it opposes 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 under section 11, said: “In the present case, 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 in the past 9 months, and that that something will permit the company to be salvaged.”  118 The Ontario Court of Justice refmed the test more recently in Ba,gain Ha,vld’s.’ 72 While accepting the general proposition that the court will refuse an application for a stay if it is clear that no  plan will be acceptable to the required percentages of creditors, the court held that the advice of certain secured creditors that they would not approve any plan put forth by the debtor does not put an end 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.’ The court ultimately held that there was no reasonable prospect that the debtor could devise a plan that would satisfy those voting constituencies under section 6 and therefore, refused to impose the stay.’ 74 We must distinguish the foregoing cases from the cases that allow the debtor an opportunity to  reorganize in the face of advice that a single-class secured creditor or a sufficient majority of a class will reject any plan put forth by the debtor. All of the cases, save one, emanate from jurisdictions outside Ontario. The British Columbia Court of Appeal in Phi4ps 175 and the Alberta Court of Queen’s  172  Baigain Ha,old’s, supnr note 81.  ‘  Ibid at 30.  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 fmancial difficulties and that its auditors advised that the cause may never be known 2. 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 assist in refmancing had made no offer to so assist; 4. the debtor failed or abandoned an attempt to raise equity to fmance expansion on the basis of its fmancial and accounting problems; and 5. the debtor’s admissions of mismanagement, with no proposed solution. 174  Cf Re Perkins (1991), 6 C.B.R. (3d) 299 (Ont. Gen. Div.) [hereinafter Perkins], where the court distinguished Cango, supra note 171, on the basis of the conduct of the debtor and the support of the unsecured creditors, the latter of which was absent in Cango. In Perkins, the debtor itself “had recognized its fmancial problems and had retained outside help in an attempt to resolve it [sic]” [at 306]. 175  Phil4,’s, siq,n7 note 81.  119 Bench in 1cor 176 imposed a stay of proceedings to allow the debtor an opportunity to negotiate and fonriulate a plan of reorganization and compromise. Each court further held that advice concerning the unequivocal rejection of any plan at any stage of the proceedings was not a sufficient basis upon which to dismiss the case, as the plan could result in full payment of the objecting creditor’s claims or some other satisfactory arrangement.’ 77 Similar considerations appeared to have influenced the Prince Edward Island Supreme Court in Timber Lodge. 178 The value in this case goes beyond the affirmation of those approaches, as the court  suggested that there was evidence tendered which not only showed the objecting creditors to be “adequately protected” 79 but also intimates that the creditors may be able to recover compensation for opportunity cost.’ ° 8 The foregoing illustrates the difficulties faced by the courts in analyzing the use or continued 176  Icor supra note 97.  The Alberta case is interesting, as the court briefly discusses the fmancial position of one of the creditors. Although the terminology used by the court does not make clear whether it was using an appraised value of the collateral or the face value of the security, it is clear that the court felt that the creditor was “adequately secured”[at 164]. The debt was $2.2 million, the accounts receivable $1.4 million and the creditor held “debenture security of 1.5 million dollars.” The creditor was complaining that the accounts receivable were being used for continuing operations to which the court replied “It is likely however, that the use of some of accounts receivable for ongoing operations will ultimately impinge upon unsecured creditors, rather than the [complaining creditor].” This indicates that the debenture security together with some of the accounts receivable would pay out the complaining creditor. The balance of the accounts receivable would be distributed among the unsecured creditors. W7  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, there should 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 or that 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 up something at the present time, it would not be totally lost as they should be able to regain in the future what they are now losing.”  120 use of the stay at a very early stage of the reorganization proceeding. By focusing on the debtor’s right to posit a plan of reorganization or compromise, rather than on the protection afforded a secured creditor during the stay period, the courts place themselves in the unenviable position of having to determine the likelihood of the debtor putting forth a successful plan of reorganization at a stage of the proceedings 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 insolvent state. The secured creditors, on the other hand, are attempting to determine how the stay affects them and 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 to succeed in having the stay lifted or the stay application dismissed. The courts require the opposing creditor to show that the plan is “doomed to failure” ’ or that there is no reasonable “chance,” 8 82 83 or “prospect,”  of acceptance of a plan of arrangement or compromise. Although it  has been suggested that these terms impose different standards of proof,’ 85 it appears that the courts rely on factors such as lack of adequate protection of the creditor’s interests or the conduct of the parties. Only the clearest case will allow the court to dismiss an application using one of the foregoing standards. In all other cases, the debtor should be given the benefit of the opportunity to formulate a plan provided that it adequately protects the creditors’ positions. In this manner, the courts could tailor the remedy to fit the circumstances and deal with the matter on a creditor by creditor basis. Should the debtor be unable to provide interim protection to its creditors, this may be an 181  Chef Recdy, 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.).  Alec Zimmerman, “Effective Implementation” in Co?porate Restructuring, (Toronto: Canadian Institute, 1992) at 32-38. 185  121 indication 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. We must note at the outset however, that the American system is not without its faults. The sheer volume of the cases considering this issue bears witness to this fact. However, the approach satisfies the requirement of allowing the debtor some “breathing space” while at the same time attempting to protect the interests of secured creditors. If provision is made to provide protection to creditors in Canada while the debtor is formulating a plan, the only question is how adequate the protection must be, not whether the debtor should have the opportunity to formulate a plan.  (b)  Code Subsections (d) through (g) of section 362 govern relief from the automatic stay under the  86 To obtain relief from the automatic stay, the secured creditor must take a positive step to Code.’  186  Code ss. 362(d)-(g): C)n request of a party in interest and after notice and a hearing, the court shall grant (d) relief 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 property of such party in interest; or (2) with respect to a stay of an act against property under subsection (a) of this section, 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 stay of any act against property of the estate under subsection (a) of this section, such stay is terminated with respect to the party in interest making such request, unless the court, after notice and a hearing, orders such stay continued in effect pending the conclusion of, or as a result of, a final hearing and determination under subsection (d) of this section A hearing under this subsection may be a preliminary hearing, or may be consolidated with the fmal hearing under subsection (d) of this section. The court shall order such stay continued in effect pending the conclusion of the fmal hearing under subsection (d) of this section if there is a reasonable likelihood that the party opposing relief from such stay will prevail at the  122 seek such relief. A court may not act sua sponi’e.’ 87 Should the secured party do nothing, the stay of an act against property of estate continues until the property is no longer property of the estate and the stay of an act against the debtor continues until the case is closed or dismissed or the court grants or denies the debtor’s application for a discharge, whichever is earliest.’ 88 Should the secured creditor wish to seek relief from the stay, it must request such relief by way of motion on reasonable notice to the debtor’ and other interested parties,’ ° although the court 9 may allow the creditor to make the application on an ex parte basis in appropriate circumstances.’ 91 After notice and hearing, 1 the court shall grant relief from the stay “for cause, including lack of conclusion 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 of such preliminary hearing. (f) Upon request of a party in interest, the court, with or without a hearing, shall grant such relief from the stay provided under subsection (a) of this section as is necessary to prevent irreparable damage to the interest of an entity in property, if such interest will suffer such damage before there is an opportunity for notice and a hearing under subsection (d) or (e) of this section. In any hearing under subsection (d) or (e) of this section concerning relief from the (g) stay of any act under subsection (a) of this section -  (1) the party requesting such relief has the burden of proof on the issue of the debtor’s equity in property; and (2)  the party opposing such relief has the burden of proof on all other issues.  R.M Martin “Creditor Alternatives to Obtain Relief From Automatic Stays in Bankruptcy” (1981) 98 Banking L.J. 525 at 536. 187  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, and  123  adequate protection of an interest in property of’ the secured creditor.’ 93 A lack of adequate protection is merely one “cause” that may result in the court granting relief from the stay and “cause” is only one alternative on which the secured creditor may rely in seeking relief from the stay. On a hearing for relief from the stay, the only issue to be considered is whether the court will grant the requested 194 Unlike the CCAA, the granting of relief from the stay may or may not dispose of the relief. reorganization proceeding. It merely deals with the interest of the applicant party and no other interests. The courts in the United States, like those in Canada, are reluctant to grant relief from the automatic stay in the early weeks of the proceeding.’ 95 This gives all parties an opportunity to assess the situation and determine whether the creditor’s security is valid, whether adequate protection is necessary and in what form and whether the possibility of formulating a successful reorganization plan is feasible. Section 362(d) of the Code prescribes four modes of relief from the automatic stay, which are nonexclusive. The court may:’ 1. terminate the stay with respect to the applicant creditor or generally. Termination allows  such opportunity for a hearing as is appropriate in the particular circumstances; but (B) if  authorizes an act without an actual hearing if such notice is given properly and  -  (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 such act must be done, and the court authorizes such act; Code s. 362(d)(l).  254.  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-  124 the creditor to pursue its remedies to their full extent;’ 97 2. annul the stay which terminates it ab initio. Annulment generally operates retroactively to the date of the filing of the petition;’ 98 3. modify the stay to allow one act or one creditor to pursue a remedy, such as allowing an action to continue to judgment but disallowing enforcement;’ or 4. place a condition on the stay that, if breached or unsatisfied, may automatically terminate the stay. ° 20 Relief from the stay is mandatory, if the creditor shows cause for the granting of the relief, or, with respect to property, the debtor does not have equity in the property and the property is not necessary to an effective reorganization. ’ Cause includes a lack of adequate protection. It also includes an 20 action that lacks any connection or will not interfere with the bankruptcy case, such as a personal injury action against the debtor and its insurer 202 or actions involving the debtor’s postpetition  ‘  Ibid at 253.  In re Albany Partners, Ltd. 749 F.2d 670 (11th Cit 1984) [hereinafter Albany Partners]. See also Sikes v. Globd Mañne, Inc., 881 F.2d 176 (9th Cir. 1989). 198  ‘  Kennedy, supra note 196 at 254; In re Holtkamp, 669 F.2d 505 (7th Cir. 1982).  Blazon, supra note 44, where the court required the debtor to continue transmitting fmancial information to it and to the secured creditor on a regular basis. Although the court did not order automatic termination of the stay upon a failure of the debtor to meet the condition, it confinned the right of the secured creditor to apply on short notice for a revision of the order (at 865). 200  One of the more important portions of the Timbers decision is the guidance that Justice Scalia provides concerning section 362(d)(2). In particular, His Honour set forth the burden the the debtor must meet to show that the collateral is necessary to an effective reorganization. 201  “What this requires is not merely a showing that if there is conceivably to be an effective reorganization, this property will be needed for it; but that the property is essential for an effective reorganization that is in prospect. This means that there must be a reasonable possibility 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 but it also opens the door for American counsel to perhaps use some of the reasoning adopted by the Canadian courts considering the CCAA. 202  In re Holtkainp, supra note 199.  125 203 A stay of this type of action is unnecessary, as it is unrelated to the purpose of the stay, activities. which is to protect the debtor from its creditors. 204 The debtor’s malafides or misconduct is another cause that may result in relief from the automatic stay. 205 J