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Early Bird (2)

Posted on June 1, 2021 | Posted in Collections

In our December 2014 newsletter, we discussed a British Columbia Supreme Court decision in Re Walker dealing with costs awarded before bankruptcy and the means by which an execution creditor can be transformed into a preferred creditor in the bankruptcy. That decision was reviewed in Re Kim, a 2020 Ontario Superior Court of Justice decision.

To give you an appreciation of these decisions, we will shamelessly reproduce parts of the December 2014 newsletter.

A bird perched on a fence.

Possibility

A creditor commences an action against a debtor and obtains a judgment after a trial. The debtor then appeals and loses. The creditor does its due diligence and tracks down land that the debtor owns. The creditor files a writ of seizure and sale and commences proceedings whereby the land is to be sold to pay the judgment debt. By this time, the judgment debt, including interest, is $200,000 and the costs that the creditor has incurred have ballooned to $110,000. Not to worry, the equity in the land is $320,000 and payday is coming.

However, not so fast. Just before the sale takes place, the debtor assigns himself into bankruptcy. Aside from cursing, what is the creditor to do? According to a seemingly little-known provision of the Bankruptcy and Insolvency Act (“BIA“), depending upon the facts the creditor may recoup much of the costs spent in chasing the debtor.

BIA

The BIA has 3 rungs of creditors: secured creditors (who usually care little about the bankruptcy and are paid from assets they have taken as security), preferred creditors (e.g. the trustee in bankruptcy, a landlord for some months of rent, etc.), and ordinary creditors (i.e. everybody else). Section 70(1) of the BIA provides that all ordinary creditors are treated the same, regardless of judgments, seizures, garnishments, and executions. In essence, under this section, a creditor who has done nothing to validate and collect its debt is in the same position as any judgment creditor.

However, there is one saving grace; section 70(2) provides that a creditor, “who has first attached by way of garnishment or filed with the executing officer an attachment, execution or other process against the property of the bankrupt” is paid “one bill of costs”. Section 136(1) of the BIA grants priority to the fees and costs referenced in section 70(2) over normal distributions to ordinary creditors. In effect, if a creditor has incurred legal fees and disbursements in the judgment and execution process and is the first creditor to file a writ of seizure and sale affecting the bankrupt’s property, then, to the extent of the property’s equity, those legal fees are bumped from ordinary creditor status to preferred creditor status. In our example, the creditor would be an ordinary creditor in the bankruptcy for its $200,000 debt, but would be a preferred creditor for the $110,000 it incurred in costs.

Costs

The facts in the Re Kim decision were a stripped down version of the facts we set out in the introduction. The creditor submitted a $6,733 bill of costs to the trustee in bankruptcy comprised of an award of costs of $6,000 for a judgment against the bankrupt before the bankruptcy plus $733 for execution costs to file three writs of seizure and sale under the Rules of Civil Procedure.

The trustee in bankruptcy, who seemingly had not read Re Walker, sought the guidance of the Office of the Superintendent of Bankruptcy. That institution said that the $6,000 portion did not need to be taxed because the judge had ordered it paid and that the remaining $733 needed to be taxed. Since it was easier to comply with this request rather than fight it, the creditor submitted its bill of costs for $733, approved by the trustee and the inspector of the estate, to the bankruptcy court for taxation of that amount.

Not only did the Master refuse to tax that account, she indicated that the entire $6,733 in claimed costs constituted an unsecured claim and was not to be given any priority. The creditor appealed this decision to a single judge of the Ontario Superior Court of Justice.

The judge quoted from the decision of Re Walker as follows:

“For the reasons that follow, I have concluded that s. 70(2) of the BIA grants a preference in favour of a litigant over the whole of the costs he or she is awarded in proceedings against a bankrupt prior to an assignment having been made, including appeals and execution proceedings connected with an original judgment. I have further determined that provided they have been awarded prior to an assignment in bankruptcy being made, these costs need not be taxed to fall within the scope of that provision.”

The judge implicitly agreed with that decision because he held the following:

  • The Master erred in deciding that the bill of costs was an unsecured claim in the bankruptcy.
  • The creditor’s claim for $6,733 was a proper claim within section 70(2) of the BIA.
  • A bill of costs delivered to the trustee administering a bankrupt estate should be reviewed by the trustee at first instance without requiring taxation and the trustee should make the determination of whether the bill of costs is properly a preferred claim under sections 70(2) and 136(1) of the BIA.
  • These bills of costs do not require taxation by the bankruptcy court.

Although it was never stated in the reasons for decision, we assume that the creditor’s writs of seizure and sale were the first writs to bind the property of the bankrupt.

Moral

The creditor in Re Kim had all of its costs paid in priority to all of the ordinary creditors, but only because it was the first execution creditor of the bankrupt. An ordinary creditor or a 2nd place execution creditor would have received nothing for its costs, other than as part of the ordinary, pro rata, distribution process. Accordingly, like so many other aspects of life, it pays handsomely to be first.

We have continually cited the Re Walker decision to trustees in bankruptcy when claiming our costs in proceedings held before a bankruptcy. Most either knew about the case or, when referred to it, agreed that these costs had priority. Now that we have an Ontario Superior Court decision agreeing with the British Columbia Supreme Court decision, any uncertainty should be laid to rest and trustees in bankruptcy should understand that (i) the first execution or garnishment creditors have priority to ordinary creditors for pre-bankruptcy costs and (ii) it is not necessary to have the bankruptcy court tax these costs.

 

Image courtesy of CJ.

Jonathan Speigel

 

Written by Jonathan Speigel, the founding partner of Speigel Nichols Fox LLP, leads the litigation and construction practices.

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