PROTECTING UNPAID SUPPLIERS
TABLE OF CONTENTS
PROTECTING UNPAID SUPPLIERS
The notion of providing some type of protection to unpaid suppliers of goods when a purchaser goes bankrupt is not new to Canadian law. Unpaid suppliers were first granted protection, in the form of a right to repossess their goods, with the enactment of section 81.1 of the Bankruptcy and Insolvency Act (BIA) in 1992.(1) This right was intended to prevent suppliers from being taken advantage of by insolvent debtors who ordered excessive amounts of inventory shortly before bankruptcy in order to increase the assets available to satisfy secured creditors – a practice known as “juicing the trades.”
The unpaid suppliers’ right of repossession, also called the “30-day goods rule” because the right applies to goods delivered within 30 days prior to a purchaser’s bankruptcy, has been the subject of considerable debate. This debate focuses on both the right’s effectiveness and whether it should exist in the first place.
At the same time as unpaid suppliers of goods were granted a right of repossession, farmers, fishers and aquaculturists were also granted bankruptcy rights – a charge on the inventory of the purchaser – in relation to products for which they had not received full payment. Enacted as section 81.2 of the BIA, this right differs substantially from the repossession right granted to unpaid suppliers under section 81.1.
This paper provides an overview of sections 81.1 and 81.2 of the Bankruptcy and Insolvency Act.
Section 81.1 of the BIA gives unpaid suppliers a right to repossess goods sold and delivered to a purchaser who becomes bankrupt or who has been placed in receivership.
In order for the right to be operative and the goods eligible for repossession, the criteria set out in subsection 81.1(1) must be followed.
The right to repossess the goods expires if not exercised within 10 days after the trustee, receiver or purchaser has confirmed it.
Where the goods have been partly paid for, a supplier has the right to repossess a portion of them, proportional to the amount owing, or to repossess all the goods after repaying the amount of any partial payment previously received.
The supplier’s right to repossession ranks ahead of any other claim in respect of those goods, other than a claim by a bona fide purchaser for value without notice of the repossession request.
Section 81.2 of the BIA establishes a special right for farmers, fishers and aquaculturists who deliver their farm and fisheries products to a purchaser for use in the purchaser’s business. Where the purchaser subsequently becomes bankrupt or is placed in receivership and such products are delivered within 15 days prior to the purchaser’s bankruptcy or receivership, the farmer, fisher or aquaculturist can file a claim for any unpaid amount in respect of those products within 30 days after the bankruptcy or receivership. This claim is secured by a charge on all the inventory held by the purchaser; it takes priority over all other rights or charges against that inventory, except an unpaid supplier’s right of repossession.
If the trustee or receiver subsequently disposes of the goods in question, the charge extends to the proceeds of sale less realization costs.
When section 81.1 was introduced, it was greeted with a certain degree of scepticism. Some 10 years later, reviews are still mixed. While suppliers support the concept of protecting trade creditors, many complain that the current regime is ineffective and inefficient. In other words, critics claim that section 81.1 does not afford the protection it was intended to provide.
The time frames within which unpaid suppliers must act to preserve their repossession right are particularly problematic. The main problem is that the event that triggers repossession – the date of the purchaser’s bankruptcy – is not germane to establishing the beginning or the end of the 30-day time period.
The following example illustrates the problem:
Under this scenario, the unpaid supplier loses his or her repossession right. Because section 81.1 provides that the supplier must deliver a written demand to repossess his or her goods within 30 days after delivery of the goods to the purchaser and the purchaser must be bankrupt at the time the demand is made, when a purchaser goes bankrupt near the end of the 30‑day delivery period, it is often difficult, if not impossible, for a supplier to receive notice of the bankruptcy and thus deliver a repossession demand before the 30-day period expires.
Another problem area is the requirement that the goods be in the same state as they were on delivery. If the goods are transformed through a production process, the right will be lost.
Professor Ronald Cuming of the University of Saskatchewan describes the protection offered by section 81.1 as arbitrary. He states:
Furthermore, there are evident gaps in the protection afforded by section 81.1. Those who provide services rather than goods have no protection. Moreover, there is no real protection in reorganization proceedings under either the BIA or the Companies’ Creditors Arrangement Act (CCAA).
Interestingly, there has not been a great deal of criticism of section 81.2. It is generally accepted that the section is less complicated than its section 81.1 counterpart.
Nevertheless, Professor Ronald Cuming has identified “three serious deficiencies”(3) in the section. These are:
In anticipation of a statutory five-year review of the BIA, Industry Canada held consultations on the Act. Protection for unpaid suppliers proved to be one of the most contentious issues emerging from these consultations.(5)
Suppliers pointed to difficulties in applying section 81.1. Their concerns related to both the application of the section and its narrow judicial interpretation, notably in relation to the requirement that goods be in the same state as they were when first sold. In this regard, suppliers called for the BIA to be more explicit in order to give greater guidance to the courts.(6)
Suppliers supported amending the timing provisions in order to allow more time after a purchaser’s bankruptcy to repossess goods delivered 30 days prior to the bankruptcy.(7) This proposal would make the date of the bankruptcy the event that demarcates the 30-day delivery period and the period within which the repossession demand must be made.
Suppliers also proposed that they be offered a first right option to purchase the goods back from a bankrupt purchaser. Such a proposal, they noted, could improve recovery for all creditors, and give suppliers an opportunity to recover full value of the goods by reselling them to another person.(8)
The impact of reorganization proceedings on unpaid suppliers’ rights raised concerns, as well.(9) For example, the stay of proceedings, which takes effect upon the filing of a notice of intention to reorganize under the BIA, does not give unpaid suppliers the right to repossess unpaid goods delivered to a debtor business. In this situation, debtors have been known to liquidate assets during the stay period and pay other creditors from the proceeds of sale.
Remedies proposed to address problems with section 81.1 include:
Other critics of the current regime, notably insolvency lawyers and trustees, were opposed to enhancing suppliers’ rights, arguing that the ability to obtain security through contract is sufficient.(14)
Insolvency professionals further contended that the right was infrequently used, in part because its effectiveness had been diminished through court interpretations.(15)
In his analysis of unpaid suppliers’ rights, Professor Cuming concludes that the right of recovery should not be dependent “upon the types of goods involved or what happens to the goods once they are delivered.”(16) He prefers the conceptual approach embodied in section 81.2(17) that creates a first charge on the purchaser’s assets and employs less onerous timing constraints. Professor Cuming recommends that the BIA be amended to provide a limited special charge for claims for amounts owing to unpaid suppliers of goods and services. This charge would have priority over security interests, certain liens, and other charges but not over unpaid wage claims, purchase money security interests or certain other liens.(18) Details of the administration and operation of Professor Cuming’s proposed charge are set out in a background paper prepared for Industry Canada, Priority for Unpaid Suppliers of Goods and Services in Bankruptcy, Insolvency, Winding-up and Receivership Proceedings.
Protecting unpaid suppliers of goods in bankruptcy proceedings has been a contentious area of bankruptcy law since the repossession right was enacted in 1992. After a decade of operation, it is no less controversial. Singling out a particular group of creditors for enhanced protection involves trade-offs and policy choices that often pit various types of creditors against one other. In the case of unpaid suppliers’ rights, the two main antagonists are typically suppliers, who want to reduce the adverse affects of a bankruptcy on their ability to recover monies owing for goods supplied, and credit-granting organizations that see the value of their claims diminished by repossession rights.
Views about the present regime are as varied as they are strong. Suppliers argue that section 81.1 is necessary and should be improved. Recommendations have also been made to broaden the application of the protection to services, change the operation of the timing criteria and enhance protection in reorganization proceedings.
Professor Ronald Cuming asserts that there may be objections to removing some of section 81.1’s inadequacies because of problems with the definitions used and the impact an extension of suppliers’ rights may have on the interests of third parties. In this regard, he states:
Despite such problems, Professor Cuming goes on to recommend a number of changes to section 81.1. Others, arguing that the current regime is ineffective and burdensome, believe that unpaid suppliers should have no special protection under the BIA. Regardless of the position taken, few, if any, appear to be content with the status quo.
(1) R.S. 1985, c. B-3, as amended.
(2) Ronald C. C. Cuming, Priority for Unpaid Suppliers of Goods and Services in Bankruptcy, Insolvency, Winding-up and Receivership Proceedings, Background Paper prepared for Industry Canada (June 1998), p. 4.
(3) Ibid., p. 6.
(5) Industry Canada, Report on the Operation and Administration of the Bankruptcy and Insolvency Act and the Companies’ Creditors Arrangement Act (September 2002).
(6) Ibid., p. 33.
(7) Ibid., p. 34.
(14) Report on the Operation and Administration of the Bankruptcy and Insolvency Act and the Companies’ Creditors Arrangement Act (September 2002), p. 34.
(16) Cuming (1998), p. 32.
(18) Ibid., p. 35.
(19) Cuming (1998), p. 4.