Preferential Payments: Commercial Imperative Or Creditor Pressure? 

publication 

December 2013

Restructuring Bulletin

In the recent decision of the Alberta Court of Appeal in Orion Industries Ltd. (Trustee of) v Neil's General Contracting Ltd.1 ("Orion Industries") the Court interpreted and applied section 95(2) of the Bankruptcy and Insolvency Act ("BIA") which deals with preferential payments. That provision provides that evidence of pressure by a creditor is inadmissible to support a preferential payment. The decision in Orion Industries suggests that a preferential payment made by a debtor that appears to have been made under pressure from the recipient creditor may withstand challenge by a trustee in bankruptcy if the payment is supported by evidence it was made in furtherance of a reasonable business imperative.

The Challenged Payment

The payment in question in Orion Industries was made to a creditor that, at the debtor's request, had dismantled a piece of equipment owned by the debtor and transported the disassembled equipment to a storage site owned by the creditor. More than half the debt owed to the creditor had been incurred in the dismantling and transporting of the equipment. The creditor was unwilling to release the equipment until it was paid for its services. The debtor paid the amount owed to the creditor and obtained release of the equipment. Less than three months after the payment was made, the debtor became bankrupt.

The debtor's chief financial officer gave evidence that the debtor had made the payment in order to secure access to the equipment so that it could sell it to generate revenue. The trial judge found that the amount of income the debtor hoped to generate by liquidating the asset was considerably greater than the cost of paying the creditor. However, the chief financial officer also stated that the payment was made in the belief that the recipient creditor was in a position to cause a major customer of the debtor to cease doing business with it and effectively put the debtor out of business.

‘View to Prefer' Intention Test

At trial it was acknowledged that the payment granted a preference. The payment was therefore capable of being successfully impugned by the trustee as a voidable preference under section 95 of the BIA. Pursuant to section 95, a payment by a debtor to an arm's length creditor that grants the creditor a preference may be held to be void against the trustee if the payment is found to have been made with a view to prefer the creditor. If the payment has the effect of giving that creditor a preference, then the debtor is presumed to have made the payment with a view to prefer unless the creditor rebuts the presumption through evidence that the debtor made the payment for some other purpose. Section 95(2) provides that evidence the debtor made the preferential payment while under pressure from the recipient creditor is not admissible as evidence that the payment was not made with a view to prefer.

In assessing the debtor's motivation in making the payment, the trial judge found that the debtor's dominant intent was to permit it to liquidate the equipment to recover funds for use in the business. The trial judge accepted that the debtor's decision was a reasonable response to a financial imperative and held that the evidence rebutted the presumption that the payment was made with a view to prefer.

Commercial Imperative or Creditor Pressure?

The trustee appealed on the basis that the trial judge had erred in finding that the presumption of a view to prefer had been rebutted. The Court of Appeal disagreed and held that the trial judge had arrived at a reasonable characterization of the evidence.

The Court noted that it is settled law in Canada that a payment made in the "ordinary course of business", for example to purchase goods or services required for on-going operations or to honour contractual obligations, will not be found to have been made with a view to prefer. The Court referenced the decision of the New Brunswick Court of Appeal in St. Anne-Nackawic Pulp Co. (Trustee of) v Logistec Stevedoring (Atlantic) Inc. ("St Anne-Nackawic")2 as authority for the proposition that even a preferential payment made by an insolvent debtor at a time when its financial collapse is inevitable may nonetheless be found to be legitimate if the payment was made with a view to generating income or liquidating assets to satisfy the insolvent debtor's creditors.

Following the decision in St Anne-Nackawic, the Court held that an instructive analysis in determining a debtor's intention is to ask what the trustee would have done had it been in the debtor's shoes. In this case, assuming the trustee had no better information than the debtor's chief financial officer at the time of the payment, the Court found that the trustee might itself have opted to pay the creditor in order to generate income by freeing up the stored asset for a possible sale. It is noteworthy that the Court held that the absence of an actual or pending sale did not render the purpose of the payment unreasonable, "as the payment may have paved the way for the generation of income and certainly removed an obstacle to generating income". The Court noted that if the payment had not been made, the prospects of selling the equipment for additional liquidity would have been diminished.

The decision in Orion Industries suggests that distinguishing inadmissible evidence of creditor pressure from admissible evidence of a commercial imperative is an exercise in characterization, and as noted by the Court in this case, "characterizing such evidence is something upon which reasonable people can disagree." Further, Orion Industries suggests that evidence of creditor pressure, while potentially inadmissible to rebut the presumption of a view to prefer, does not undermine other evidence that supports a finding that the payment would have been made anyway on the basis of a reasonable commercial imperative.

It will be interesting to see how this issue will be treated in future cases and whether the Alberta Court's distinction between evidence of pressure and evidence of a reasonable commercial imperative will be followed by Courts in other jurisdictions.

1 2013 ABCA 330.
 
2 2005 NBCA 55.

a cautionary note

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2013