Under section 70 of the Bankruptcy and Insolvency Act (BIA), when a debtor assigns into bankruptcy, or is adjudge a bankrupt by a court, and subject to the rights of secured creditors and other provisions of the BIA, all of the debtor's non-exempt assets pass to and become vested in a Licensed Insolvency Trustee. The trustee will realize on the assets and, together with any other proceeds generated in the course of the bankruptcy, distribute the proceeds to creditors. However, not all creditors are treated equally.
Priority rankings under the Bankruptcy and Insolvency Act
Pursuant to section 136 of the Act, proceeds from the sale of assets are distributed to repay creditors in the following order:
- Secured creditors
- Reasonable funeral and testamentary expenses in respect of a deceased bankrupt
- Administration costs related to the estate such as the expenses and fees of the trustee
- A levy on dividends paid to secured, preferred and unsecured creditors
- Various types of unsecured but "preferred creditor" claims, including, certain employee claims, certain types of child and spousal support claims, some types of municipal taxes, claims by landlords, and certain claims for pre-bankruptcy execution fees and costs
- Unsecured creditors with no unique priority.
Secured creditors enjoy a superior status in the funds disbursement hierarchy, but only to the extent that there is recovery from assets that were charged by the security. For example, a secured creditor with a mortgage over land will have priority for the loan against the proceeds of sale of the land; but if those proceeds are insufficient to pay the whole of the mortgagee's claim after satisfaction of any priority claims, the mortgagee will be an unsecured creditor for any shortfall.
Section 136 of the BIA prescribes the order of priority among preferred creditors. Each class of preferred creditor will be paid to the amount of their entitlement before preferred creditors in the next class receive payment. If a class has multiple claimants, for example, if the bankrupt had more than one landlord and there are insufficient funds to satisfy all the landlords' claims, the creditors in the class will be paid on a pro-rata basis.
Once all preferred creditors have been paid in accordance with their preferred entitlement, the balance of the funds in the estate will be available for distribution to the unsecured creditors on a pro-rata basis.
Creditors are wise to consult with an experienced insolvency lawyer on the options available to them for recovering their claim in the event of the bankruptcy of the debtor.