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Shifting priorities in insolvency

There are rarely any winners in the insolvency or bankruptcy of a business, but some lose more than others. Normally, secured lenders fair better than unsecured creditors because they can be paid from the sale of the assets of the business, but there can be important exceptions.

Super priorities

If the company enters into insolvency proceedings under the CCAA, the court may grant a "super-priority" for debtor-in-possession (DIP) financing to help the company continue to operate so it can liquidate its assets or restructure its operations to get back on its feet. If the restructuring ultimately fails, the DIP financing will be paid out in priority to the secured creditors. The court grants this priority because nobody would lend to a distressed business without it.

The court may also grant an administration charge with super priority for the fees of the professionals who assist the company through the insolvency proceedings. The court grants this priority because insolvency professionals need to get paid and the company may not otherwise have the funds to pay them.

Deemed Trusts

Up to $2,000 of unpaid employee wages and employers' unpaid contributions to the Canada Pension Plan and Employment Insurance also receive super priority. Unremitted GST (and HST where applicable) also receive super priority status. Such arrears are subject to a deemed trust that must be paid out of the debtor's assets in priority to the claims of secured creditors.

Additionally, the entire amount of any deficiency in a defined-benefit pension plan may be considered a deemed trust that ranks ahead of secured lenders. This was the issue in Grant Forest Products, 2013 ONSC 5933, where the court ruled that if the company files for insolvency before the defined-benefit plan is wound up, the priority of secured creditors over the pension plan is preserved. But if the wind-up of a defined-benefit pension plan precedes the insolvency, then the deemed trust ranks ahead of secured creditors.

The court in Grant Forest Products reiterated the well-established principle that reversing priorities between deemed trust holders and secured creditors is a legitimate purpose for initiating bankruptcy proceedings.

Where the financial health of a debtor company is in any way questionable, and deemed trusts are present or possible, lenders need to be especially attentive.

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