Contributed by Danielle Maksimow (Norton Rose Fulbright Canada)
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Montréal (City) v. Deloitte Restructuring Inc. (City v Deloitte)
Canadian Update: The Supreme Court of Canada Clarifies the Court’s Discretion to stay Pre-Post Set-off Claims under the Companies’ Creditors Arrangement Act
Introduction
In December 2021, the Supreme Court of Canada (the “SCC”) confirmed the majority decision of the Quebec Court of Appeal (the “QCA”) in Montréal (City) v. Deloitte Restructuring Inc. (City v Deloitte). In its decision, the SCC rejected the previous QCA judgement in Quebec (Agence du revenue) v. Kitco Metals Inc. where it was held that pre-post set-off was prohibited under the Companies’ Creditors Arrangement Act (the “CCAA”). The SCC in City v Deloitte decided that while pre-post set-off is permitted under the CCAA, it is subject to the court’s discretion. City v Deloitte clarifies that pre-post set-off is possible under the CCAA and also guides courts as to the circumstances under which they may permit such set-off.
Background
SM Group is a consulting engineering firm with a number of public contracts with the City of Montreal (the “City”). Resulting from a commission investigating collusion and fraud in the course of tendering, awarding, or managing public contracts in Montreal, SM participated in a voluntary program to help recover funds paid where there may have been fraud or fraudulent tactics. City and SM entered into a settlement agreement, where no admission of guilt was registered, whereby SM agreed to pay City for certain amounts alleged to have been improperly paid. While some payments were made under the settlement agreement, SM ran into financial difficulty and filed for protection under the CCAA. A stay of proceedings was granted putting a hold on legal actions against the company. Deloitte Restructuring Inc. was appointed as monitor.
In Canada, the CCAA enables financially distressed companies with liabilities of more than $5 million to restructure and avoid bankruptcy, foreclosure or asset seizure. Its regime is flexible with considerable judicial discretion allowing for more creative solutions for complex corporations.
Following the order, SM continued to do work under other contracts with City. City refused to pay for the work performed post-filing on the basis of its right to set-off between what it owed SM post-filing and the amounts due pre-filing from the settlement agreement. City argued that monies owed by SM resulted from fraud and therefore should be exempt from the pre-post prohibition under the CCAA.
In response to City’s refusal to pay, Deloitte applied to the Quebec Superior Court for an order to compel City to pay for the post-filing services. The court granted Deloitte’s application and City appealed this decision. The QCA agreed with the Quebec Superior Court decision. City then appealed to the SCC.
The Ruling
The SCC dismissed City’s appeal. The majority determined that under sections 11 and 11.02 of the CCAA, courts have discretion to stay pre-post set-off claims, thus rejecting the absolute prohibition to stay those claims per the decision in Kitco. Moreover, the SCC stated that this discretion also includes the possibility of not staying proceedings, or lifting the stay of proceedings, thereby allowing creditors to exercise pre-post set-off rights.
Similarly, the SCC considered the scope of section 21 of the CCAA, which explicitly states that the law of set-off is applicable in insolvency proceedings under the CCAA. The SCC explained that this provision only applies to situations of pre-pre set-off. Pre-pre set-off occurs when debts are set-off with payments owed, in each case arising before an initial order under the CCAA is granted. The SCC explained that while section 21 does not authorize pre-post set-off, it does not prohibit it either. A supervising judge has discretion to stay or allow the exercise of pre-post set-off rights that is invoked by a creditor.
However, the SCC cautioned CCAA courts that this discretion should only be exercised in exceptional circumstances given its potential to be highly disruptive to the restructuring process. If a creditor was allowed to exercise pre-post set-off rights and refused to pay for goods or services provided by the debtor while restructuring, the whole CCAA process could be jeopardized by creating a higher risk of bankruptcy as a debtor would be deprived of the funds needed to continue to operate. Thus, pre-post set-off may render the protection granted by the CCAA process ineffective.
The SCC added that a judge’s discretion under the CCAA is not unlimited and must be exercised with the CCAA’s rehabilitation goals in mind. There are three baseline considerations that judges must keep in mind when exercising their discretion to allow pre-post set-off:
- the appropriateness of the order being sought, which is assessed in light of the CCAA’s remedial objectives;
- due diligence by the parties to diligently exercise their rights and participate in the CCAA proceedings, which ensures creditors are not strategically positioning themselves to gain an advantage or undermine the proceedings; and
- the applicant’s good faith.
The SCC applied these factors to the facts and decided that the QCA mistakenly relied on the absolute prohibition of pre-post set-off as set out in Kitco. Nonetheless, the SCC agreed that the Court should not lift the stay order. The SCC determined City’s pre-post set-off right should not be exercised given that City failed to:
- justify that the pre-post set-off was in the public interest;
- diligently pursue the exception as it waited roughly 50 days to notify the debtor of its intention to assert its set-off rights; and
- prove the elements that constitute fraud relating to the alleged allegations that led to the settlement agreement. The fact that SM voluntarily participated in the program was insufficient to prove fraud.
The SCC concluded that the facts at hand did not amount to the exceptional circumstances in which pre-post set-off should be allowed. The order to lift the stay order was deemed inappropriate.
Practical Considerations
This decision reiterates the broad discretion given to supervising courts under the CCAA in determining set-off rights by rejecting the Kitco decision, providing certainty as to whether pre-post set-off is available and in what circumstances under the CCAA, and clarifies the availability of pre-post set-off throughout Canada.
This more discretionary approach to set-off allows courts to uphold CCAA’s legislative purpose of ensuring no creditor has an advantage over another while the restructuring process is ongoing. However, a CCAA court will, in exceptional circumstances, allow a creditor to exercise pre-post set-off rights. Even so, a court’s discretion to allow pre-post set-off must meet a high threshold in consideration of the CCAA’s remedial objectives, due diligence, and the applicant’s good faith.
In similar cases, courts must balance the need to protect restructuring debtors and treat all creditors equally. However, this decision provides greater stability to restructuring businesses under the CCAA since creditor’s pre-post set-off rights will only be enforced in accordance with the strict guidelines set out in City v Deloitte.
