Pre-filing claims can be set off against post-filing claims in CCAA proceedings, Supreme Court rules

City of Montreal cannot apply payments from Quebec reimbursement scheme to cover what it owed a contractor

Pre-filing claims can be set off against post-filing claims in CCAA proceedings, Supreme Court rules
Marc Duchesne is an insolvency and restructuring partner in Borden Ladner Gervais LLP in Montreal.

Can pre-filing claims be set off against post-filing claims in proceedings under the Companies’ Creditors Arrangement Act? The Supreme Court of Canada answered ‘yes’ on Friday, in a decision that clarified pre- and post-filing compensation and the common law principle of “set-off” between debts.

In a 6-1 decision in Montréal (City) v. Deloitte Restructuring Inc., the Supreme Court found against the City of Montreal, which had claimed a right to effect compensation/set-up between what it owed a contractor for work performed after the CCAA filing and claims it had against that contractor resulting from an alleged pre-filling fraud.

The claim arose from an agreement entered into before an initial order was made under Quebec’s Voluntary Reimbursement Program, which was established under Quebec’s “Act to ensure mainly the recovery of amounts improperly paid as a result of fraud or fraudulent tactics in connection with public contracts,” or Bill 26.

Friday’s decision also marks the first time the Supreme Court has decided a case falling under Bill 26: legislation resulting from the recommendations of Quebec’s Charbonneau Commission, a public inquiry into corruption in the management of public construction contracts that completed its work in 2015.

Background

SM Group, an engineering consulting firm, was a contractor to the City of Montreal, working on major infrastructure projects including the Samuel De Champlain Bridge and the Turcot Interchange in Montreal. SM Group had also participated in the two-year voluntary reimbursement program intended to help recover money paid “in the course of the tendering, awarding or management of a public contract in relation to which there may have been fraud or fraudulent tactics.”

These reimbursements are made without admissions of guilt in relation to obtaining public funds fraudulently, and the company coming forward will not be charged criminally or lose its licence; in other words, it can pay the money back with no consequences.

In August 2018 Quebec’s Superior Court made an order that SM Group was subject to proceedings under the Companies’ Creditors Arrangement Act (CCAA), which also stayed any claims and proceedings against them and contemplated the filing of a plan of arrangement, or “initial order.”

The Superior Court appointed Deloitte Restructuring (Deloitte) to monitor the company’s restructuring, and following the initial court order SM Group continued working on projects for the City of Montreal. The City refused to pay for that work, though, claiming it could use “pre-post compensation” to reduce or cancel the amount owed for the work performed by SM Group.

“Pre-post compensation” refers to compensation between debts arising before and after an initial order; so, it concerns whether payments made or owed by a contractor under the voluntary reimbursement program (VRP) scheme can be used to offset what the City owes to the contractor for other work the contractor has performed.

This meant the City of Montreal could apply payments received through the VRP to cover the amount it owed SM Group for the work done on the bridge and interchange. Although pre-post compensation is not normally allowed by the courts, the City claimed it should be allowed in this case because, it said, the money SM Group owed through the VRP resulted from fraud, specifically through an alleged consortium collusion in relation to a call for tenders for a water meter contract.

Deloitte, the court-appointed monitor, then applied to the Superior Court to stop the City from using pre-post compensation. The court granted Deloitte’s application, and on appeal the Court of Appeal agreed the City could not use pre-post compensation.

Before the Supreme Court, the City argued that the majority of the Court of Appeal failed to properly consider the public interest in the recovery of fraudulently embezzled public funds. Deloitte argued that the City ignores the fact it is an unsecured creditor and the courts below properly considered its interest along with the interests of other creditors and stakeholders.

Claim of fraudulence

The case hinged on whether the City had proven that SM Group had engaged in fraud. The majority of the court found that that the City had not met the burden of proof required to show that the VRP claim was based on fraud.

“To discharge its burden of proving that its claim relates to a debt ‘resulting from obtaining property or services by false pretences or fraudulent misrepresentation,’ a creditor must establish, on a balance of probabilities, the following four elements: (i) the debtor made a representation to the creditor; (ii) the representation was false; (iii) the debtor knew that the representation was false; (iv) the false representation was made to obtain property or a service,” wrote Chief Justice Richard Wagner and Justice Suzanne Côté in their reasons for the majority, with Justices Michael Moldaver, Andromache Karakatsanis, Malcolm Rowe and Sheilah Martin concurring.

“The City’s burden was certainly not negligible: it had to prove that SM Group had knowingly made a false representation that led to the VRP claim. However, the City considered it sufficient for that purpose to mention that the claim existed, and did not try to prove or even allege any of these elements, presuming or assuming that the VRP claim resulted from fraudulent representations.”

The majority also found a court should generally not allow pre-post compensation, unless there are exceptional circumstances, and there were none in this case.

“It is not to be granted lightly, this right of set-off, but there may be cases where it needs to be for fairness and to respect the rights or the balance of the rights of the parties,” says Marc Duchesne, a partner in Borden Ladner Gervais LLP in Montreal and lead counsel for the intervener Union des municipalités du Québec. In this case, he says, the Supreme Court said “the rule should be that it's normal to have an initial order to suspend the right to set off,” but it also should be open to a creditor to ask to “lift this right of suspension, … where set-off should be compensated.”

The decision “confirms all the good principles under the CCAA,” Duchesne adds: “that the supervising judge is the right person to establish whether or not that set-up should be allowed.”

Liquidating CCAA

In addition, Duchesne says, “there used to be a difference between Western Canada and Eastern Canada in whether ‘liquidating CCAA’ should be allowed.” Liquidating CCAA, as opposed to a “restructuring CCAA,” starts with an initial order granting a stay of proceedings but does not result in a plan of arrangement being proposed to the creditors, he explains. “The stay is there to protect the company from its creditors while it usually runs a sale process to find a buyer for the assets of the company while it is operating, generating a better value for the creditors.”

Once the assets are sold to a third party under court supervision, the company is an empty shell with no operations; its assets have been liquidated and proceeds paid in accordance with priorities of rank provided under the law.

Friday’s decision confirms that liquidating CCAAs “are a trend and they are legal; they are there and for a good reason. It allows us to get the best price for the assets and allows for the continuation of the business without the corporate entity, and so people keep jobs, suppliers keep customers, and life goes on for the best of society even though there were losses.”

In dissenting reasons Justice Russell Brown would have returned the matter to Quebec’s Superior Court, solely for it to decide whether the City could effect compensation, since the supervising judge – mistakenly, Justice Brown believed -- did not see that she was permitted to exercise her discretion in the case.

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