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February 16, 2022

Tempering Kitco: SCC Clarifies Right to Pre-and Post-Filing Set-Off under the CCAA

By Adrienne Ho and Rachel Nicholson1

In its recent decision, Montréal (City) v. Deloitte Restructuring Inc. (“SM Group”),2 the Supreme Court of Canada (“SCC”) clarified the circumstances in which creditors can set-off claims against a debtor company that arose pre-filing with those claims that arose after an initial order has been granted under the Companies Creditors’ Arrangement Act (“CCAA”).3

Generally speaking, there are three types of set-off: legal, equitable, and contractual/statutory.4 Insolvency legislation, including under the CCAA, explicitly preserve a party’s set-off rights.5 As the jurisprudence in this area has developed, two issues that have arisen include: (a) the supervising judge’s right to stay a party’s set-off rights in CCAA proceedings; and (b) the ability to set-off debt arising post-filing against claims that arose pre-filing.

The SCC’s recent decision in SM Group has provided guidance on both matters. In doing so, the SCC has not only provided a framework for when courts can exercise their discretion to permit set-off rights but also has effectively overruled prior appellate jurisprudence from Quebec.

Background

SM Group, an engineering consulting firm, had conducted various construction work for the City of Montreal (the “City”). The Charbonneau Commission, which had been set up to investigate corruption in the construction industry, discovered a link between SM Group and certain parties implicated in the collusion. In August 2018, SM Group filed under the CCAA, but it continued to perform work for the City after its filing.

In November 2018, the City asserted that it did not have to pay SM Group for work done post-filing, as such amounts could be set-off against the City’s claims against SM Group that arose pre-filing. The City’s first pre-filing claim stemmed from a settlement agreement signed in 2017 between SM Group and Minister of Justice (who was acting on behalf of the City) pursuant to a government initiative known as the Voluntary Reimbursement Program (the “VRP Claim”). The second pre-filing claim relates to the City’s proceedings against SM Group for alleged collusion in a tender for a water meter contact (the “Water Contract Claim”). 

The City asserted it could set-off both the VRP Claim and the Water Contract Claim against the amounts owed to SM Group for work done post-filing. The City’s rationale was that: (a) the VRP Claim remained outstanding; (b) certain assets of the SM Group were intended to be sold to a third party shortly; and (c) neither the VRP nor the Water Contract Claims could be compromised in an insolvency process without the City’s consent as they arose from fraud and a misappropriation of public funds. The Court-appointed Monitor, Deloitte Restructuring Inc. (the “Monitor”), sought a declaratory judgment that the City could not assert its set-off rights.

Judicial History

The Quebec Superior Court granted the relief sought by the Monitor. It held, amongst other things, that based on the Quebec Court of Appeal’s ruling in Quebec (Agence du revenu) v. Kitco Metals Inc. (“Kitco”),6 the set-off being sought here was not possible. The ruling was upheld by the majority of the Quebec Court of Appeal.

SCC Ruling

The majority of the SCC, in a 6-1 decision, dismissed the appeal. Chief Justice Wagner and Justice Côté, writing for the majority, started the analysis by analyzing whether the VRP Claim could be considered a claim related to a fraudulent debt under section 19(2)(d) of the CCAA, and thereby unable to be compromised without the City’s consent.  The majority determined that the VRP Claim was not a claim properly falling within the scope of section 19(2)(d).7 With respect to the set-off issue, it held that this highly disruptive right ought to be stayed pursuant to the terms of the CCAA and Initial Order. Accordingly, the majority dismissed the appeal. The following provides an overview of the majority’s decision.

a) Interpretation of Section 21 of the CCAA

As noted above, insolvency legislation preserves a party’s right to set-off. Section 21 of the CCAA states that “[t]he law of set-off or compensation applies to all claims made against a debtor company and to all actions instituted by it for the recovery of debts due to the company in the same manner and to the same extent as if the company were plaintiff or defendant, as the case may be.”8

The SCC clarified the scope of section 21, holding that it provides a creditor with the right to set-off debt that arises before an initial order only against a claim that arose before the order was made (which the majority refers to as “pre-pre compensation”). This is only for the limited purpose of quantifying a creditor’s claim at the date of the initial order. The SCC’s rationale was that section 21 of the CCAA was found under the “Claims” section of the CCAA. In coming to this conclusion, the SCC’s ruling is consistent in this respect with how the Quebec Court of Appeal interpreted section 21 in Kitco.9

The SCC, however, departs from Kitco by clarifying that though section 21 does not authorize parties to set-off pre- and post-filing debts, this section does not act as a bar either.  Rather, it confirmed that the CCAA court has the discretion to either stay or authorize creditors to exercise their right to set-off, including with respect to pre- and post-filing debt.

b) The Court’s Discretion to Stay Parties’ Set-Off Rights

 The SCC’s confirmation that an initial order can stay a party’s set-off rights is consistent with prior case law. As the majority of the SCC recognized, it is already common practice to include a general prohibition against set-off in model CCAA initial orders.

The common law jurisprudence has also recognized the discretion afforded to CCAA’s judges in this area. In Air Canada, Justice Farley of the Ontario Superior Court of Justice granted Air Canada’s request to implement a temporal stay against any right to equitable set-off. Air Canada sought such relief, which was not opposed, on the basis that the CCAA proceeding needed to be stabilized.10 Case law following Air Canada confirmed that a supervising CCAA judge has the discretion to stay or defer a party’s right to exercise set-off against pre and post-filing debt during CCAA proceedings, including as recently as last year in the proceedings involving Just Energy Group Inc. and its related parties.11

c) The Court’s Discretion to Lift the Stay to Permit Set-Off

The SCC in SM Group also clarified that the CCAA court retains the discretion to lift the stay to permit set off of pre- and post-filing debt in rare instances, though the court must do so cautiously. The majority observed that permitting set-off right could be highly disruptive to a debtor’s operations as without the payment of post-filing accounts receivable, a debtor’s working capital could be affected along with its ability to obtain interim financing and resale value.

In Air Canada, Justice Farley had recognized that legal set-off was available for debts that arose before and after the date of the CCAA initial order.12 However, over a decade later in Kitco, the Quebec Court of Appeal seemed to suggest that set-off of pre and post-filing debt was not possible.13

The SCC did not necessarily view Kitco to be in conflict with common law cases like Air Canada. Rather, the SCC distinguished the common law cases on the basis that the courts in such decisions did not need to consider the remedial objectives of the CCAA, nor did they set out the framework in which the rights of set-off would apply.

Regardless of whether Kitco was truly in conflict with Air Canada, the SCC’s ruling in SM Group does provide welcomed clarity to the law. The majority not only held that the absolute prohibition to the set-off of pre and post-filing debt that was suggested in Kitco must be “tempered”, but also discussed the factors that a CCAA court should consider in exercising its discretion to lift the stay of proceedings. The SCC noted that the court must do so cautiously, and should take into account (i) the appropriateness of granting such relief, (ii) due diligence on the claimant’s part, and (iii) good faith on the applicant’s part.

With respect to the first factor as to the appropriateness of such an order, the majority of the SCC explained that the court should consider the remedial objectives of the CCAA. These objectives include maximizing creditor recovery, preserving the going-concern value of the company, and protecting the public interest. The majority noted that the CCAA court can also consider whether the proceedings were a liquidating CCAA and the impact of permitting set-off.

In applying the first factor to whether the City seeking set-off of the VRP Claim was appropriate, the majority held that the City’s claim should not be elevated just because it was a public body.  Though the majority conceded that protecting the public interest might favour permitting a party who is a victim of fraud to exercise set-off rights, the majority noted that the City could not prove that SM Group engaged in fraud. The fact that SM Group participated in the Voluntary Reimbursement Program was not sufficient proof of fraud.

The second factor concerns the due diligence of the party seeking to assert the right of set-off. The majority found that the City waited anywhere from 47 to 58 days, after learning of the CCAA filing, before claiming a right to set-off. The majority held that the City gained an advantage from this delay, as it continued to receive the benefit of work performed by SM Group. The majority observed that had the City asserted its set-off rights earlier, it is likely that SM Group would have refused to perform further work.

Finally, given its ruling on the first two factors, the majority held it was unnecessary to consider the element of good faith.

As for the City’s Water Contract Claim, the majority held that the City could not assert the right of set-off for similar reasons. The majority also noted that permitting the City to withhold amounts pending the outcome of the litigation concerning the Water Contract Claim would be inappropriate. It observed that this would place SM Group’s third party purchaser at the “mercy of the outcome of lengthy and complex judicial proceedings”.14

Takeaways

The ruling in SM Group provides helpful guidance in the law concerning set-off. It clarifies any confusion that might have resulted from Kitco and it lays out factors that a CCAA court may consider before exercising its discretion to lift the stay in permitting creditors to exercise the right to set-off claims. It also provides a helpful tip that parties who wish to exercise their right to set-off cannot sit on their rights to do so.

What remains to be seen, however, is how such discretion will be applied in cases. For example, the SCC found that the City’s decision to wait over 47 days to raise set-off rights to be too long given that the City was continuing to receive services from the SM Group. The SCC, however, did not specify what an appropriate time would be and whether going forward, creditors would be expected to raise their concerns at the comeback hearing.

Another area that will be of interest to practitioners would be the application of set-off rights in liquidating CCAAs. The majority in SM Group noted that a court can take into account whether the proceeding is a liquidating CCAA, but it did not comment on whether such a factor would necessarily favour lifting the stay to permit set-off, or how this may contradict the break in mutuality found in bankruptcy proceedings, in which pre- and post-filing set off is not necessarily permitted.

Justice Brown, in dissent, observed that in a liquidating CCAA, it would be unfair to creditors with certain, liquid and exigible claims to prevent them from exercising the right to set-off pre and post-filing claims. Justice Brown observed that once the sale occurs, those creditors’ rights are stayed permanently since the debtor is an “empty shell” following the sale, nor are there any of the remedial considerations of set-off affecting the restructuring process as there is no restructuring.

The majority in SM Group noted that situations where the stay would be lifted would be rare. It remains to be seen if a CCAA court will more readily lift a stay to permit pre- and post-filing set off in a liquidating CCAA, in light of some of the factors raised by Justice Brown in dissent.

Finally, it will be interesting to see if this decision opens the door to more active appellate intervention in insolvency matters. Here, the majority cites the prejudice to third parties from the delays in this case as part of the reason for not remanding the case back the lower court. Instead, the majority substituted its own analysis of whether set-off would be permitted and dismissed the appeal. The majority held that even if the case were remanded, the outcome would have been the same. 

Justice Brown, in dissent, would have allowed the appeal solely for the purpose of remanding the case back to the supervising judge at the lower court. He noted the SCC itself has recognized that in cases involving the exercise of discretion, the SCC’s role is limited to a deferential one, and that the SCC should not step into the supervising court’s shoes.15 It has been recognized that there is a sense of urgency to CCAA proceedings.16 Time will tell if following this ruling, appellate courts will more readily intervene in matters to avoid further delay if they view that a lower court would likely reach the same result.

 

Published in National Insolvency Review (LexisNexis), and republished with permission.



1 Adrienne Ho and Rachel Nicholson are lawyers at Thornton Grout Finnigan LLP, a law firm in Toronto specializing in restructuring and commercial litigation.

2 2021 SCC 53. 

3 R.S.C., 1985, c. C-36

4 See Robert Thornton, “Air Canada and Stelco: Legal Developments and Practical Lessons”, in J. P. Sarra, ed., Annual Review of Insolvency Law 2006 (2007). Robert Thornton is a founding partner of Thornton Grout Finnigan LLP.

5 See Bankruptcy and Insolvency Act (“BIA”), R.S.C., 1985, C. B-3, s. 97(3); the Winding-up and Restructuring Act (“WURA”) R.S.C., 1985, C. W-11, s. 73(1), and CCAA, s. 21. The provisions in the CCAA, the BIA, and the WURA are similar though not identical.

6 2017 QCCA 268.

7 This article focuses on the SCC’s analysis regarding a creditor’s right to assert set-off for pre- and post-filing claims in insolvency proceedings rather than the section 19(2)(d) discussion, which is fairly fact specific.

8 CCAA, s. 21.

9 See Kitco, 2017 QCCA 268 at paras 81-82.

10 Air Canada (Re), 2003 CanLII 64234 (ON SC) [“Air Canada”]. See also supra, Robert Thornton, “Air Canada and Stelco: Legal Developments and Practical Lessons”.

11 See e.g., North American Tungsten Corp., 2015 BCSC 1382 at paras 28-32, leave to appeal ref’d, 2015 BCCA 390 at paras 11-17 & 23 and Re Just Energy Group Inc., 2021 ONSC 1793 at para 102. Thornton Grout Finnigan LLP acts as counsel to the Court-appointed Monitor in the CCAA proceedings of Just Energy Group Inc. et. al.  

12 See Air Canada, supra, 2003 CanLII 64234 at paras 23-24. See also supra, Robert Thornton, “Air Canada and Stelco: Legal Developments and Practical Lessons”.

13 See Kitco, supra, 2017 QCCA 268 at paras 81-83.

14 2021 SCC 53 at para 99.

15 See Canadian Broadcasting Corp. v. Manitoba, 2021 SCC 33 at para 88.

16Stelco Inc., Re, 2005 CanLII 5394 at para 4.

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