Legal Blog

Reciprocal

We often see situations in which one party breaches a settlement agreement, but then tries to hold the other party to it.  One such occasion was outlined in Re Dilollo, a 2013 Ontario Court of Appeal decision.

 

First Deal

 The creditor obtained a judgment against the debtor in 2006 for a mere $22 mil. Later that year, the creditor commenced an application to petition the debtor into bankruptcy. The debtor opposed the application. The debtor and the creditor then started to talk settlement. In mid-2007, they entered into an agreement by which the debtor agreed to pay the creditor $1.2 mil of the $22 mil judgment, the creditor would consent to a dismissal of the bankruptcy application, and the two parties would exchange releases.

In late-2007, the debtor paid the creditor $1.136 mil (most, but not all, of the settlement amount). However, the creditor accepted the debtor’s lesser payment instead of the full $1.2 mil settlement amount and, as the motions judge found, the debtor could have forced the creditor to give a release. Regardless, the bankruptcy application was not dismissed and releases were not exchanged.

It seems that neither the creditor nor the debtor took any further active steps after that. However, in early 2008, more applicants were added to, and pursued, the outstanding bankruptcy application and, in January 2010, a judge granted the application and the debtor was adjudged bankrupt. The debtor appealed and the Court of Appeal dismissed that appeal in September 2010. The first meeting of creditors took place in May 2011, at which time the original trustee was replaced.

One can see that this process proceeded at a glacial pace.

 

Surprise

The new trustee, presumably the choice of the added creditors, initiated a motion on August 24, 2012. It sought a declaration that the $1.136 mil the debtor had paid the creditor pursuant to their settlement was a preference under s. 95 of the Bankruptcy and Insolvency Act (BIA), to be returned by the creditor to the trustee for distribution in accordance with the BIA.

 

The creditor acknowledged that the debtor’s payment to it would be a preference under s. 95 of the BIA. It was paid between “a day that is three months before the date of the initial bankruptcy event and ending on the date of the bankruptcy.”

 

However, the creditor argued that the trustee’s motion was statute barred by the Limitations Act, 2002 (the “Act”) and that, if it were not, the creditor was entitled to file a proof of claim in the debtor’s estate for the full amount of its $22 mil judgment. It seems that the other creditors’ claims were paltry in comparison. Accordingly, if the creditor had to return the $1.136 mil, the size of its judgment, compared to the other creditors’ claims, would mean that most of the monies it had to return to the trustee would ultimately be repaid to it.

The trustee argued that, if its motion were successful, the creditor ought to be limited to a proof of claim for only $1.2 mil because, in the settlement, it had agreed to accept that amount.

 

Limitation

The Act has been held to apply to bankruptcy situations. The trustee knew about the settlement in January 2010; the bankruptcy judge’s reasons for decision referred to it. Accordingly, the creditor argued that, by February 2012, the time to attack the preference had expired and the trustee’s August 2012 motion was commenced too late.

 

The trustee argued that the limitation period was extended by the time it took for the debtor’s appeal to be heard, about 9 months. That extension would result in the limitation period expiring in September 2012, a few weeks after the trustee had brought its preference motion.

 

The Act states that it does not affect the extension or suspension of a limitation period by or under another statute. The trustee argued that the BIA stayed the limitation period because the BIA stays proceedings until an appeal is heard. This means that, until the appeal is completed, no person, including the trustee, could take any step regarding the debtor’s estate, including the launching of a preference motion.

 

The judge disagreed with the trustee’s argument. The BIA does not extend or suspend a limitation period on an appeal; rather, it just limits the actions that can be taken during an appeal and a stay is “not the functional equivalent of a limitation period.” Limitation periods set deadlines for the commencement of legal proceedings; a stay is not a limitation period. If a person feels that he may be prejudiced by a stay, he can always apply to the court to lift the stay. In any case, the trustee had ample time, even after the appeal was completed, to bring the motion. The trustee simply waited too long.

 

Quantum

Given his ruling, the judge did not have to answer the question regarding the value of the creditor’s proof of claim had the creditor been forced to repay to the trustee the payments it had collected under the settlement. He did so regardless.

 

The judge would have allowed the creditor to file a proof of claim for the full $22 mil. He held that the trustee cannot move to set aside the settlement and then claim that the creditor ought to be bound by the same settlement. It would be a harsh result if the creditor were required to repay the consideration it received under the settlement and then be bound by the terms of the settlement.

 

Alternative

We analyse the proof of claim issue differently from, but arrive at the same result as, the motions judge. When two people enter into an agreement, both parties are subject to the benefits and the obligations of the agreement. Once a party breaches a condition of the agreement (i.e. a term that is so important that the entire agreement would founder without it), then the other party has a right to terminate the agreement and not be bound by the obligations contained in it.

 

Had the trustee, who was the debtor’s alter ego, successfully set aside the payment, then the debtor would have given no consideration whatever to the creditor’s agreement to reduce its claim from $22 mil. If payment of the $1.2 mil (or $1.136 mil) was not a condition of the settlement, what was?

 

Appeal

The trustee (meaning the other creditors because the trustee was following their instructions) appealed. The Court of Appeal noted that the trustee relied on two sections of the BIA for its argument: s. 69, which stays all proceedings pending the termination of the bankruptcy proceedings, and s. 195, which stays the bankruptcy until an appeal of the order is heard. The Court held that neither of these sections is a provision that stays or extends limitation periods and therefore were of no assistance to the trustee in its bid to avoid the 2-year limitation provision of the Act.

 

Since the Court dismissed the appeal on the limitations issue, it did not deal with the appeal on the proof of claim issue.

 

The law is now settled. If a creditor or a trustee wishes to commence an action in or outside of the bankruptcy proceedings, during the requisite bankruptcy stay of proceedings, the claimant must commence the action before the expiry of the two-year limitation period and must obtain leave of the court to do so.