A Licensed Insolvency Trustee’s obligation to examine a proof of claim and using the civil standard of proof and the creditor’s onus of proof to value unliquidated claims

One of the functions of a Licensed Insolvency Trustee in bankruptcy or proposal proceedings is to assess and allow or disallow the claims of creditors. 

In some cases it takes no effort to make that assessment.  If the creditor has a judgment then for the most part the trustee can rely on the judgment in allowing the claim.  If the creditor is relying on a promissory note or a contract with a clause providing for liquidated damages, the trustee will have some documents to review but ultimately there should not be too much difficulty in assessing the claim. 

But what about unliquidated claims?  How does a trustee deal with a claim where the damages are uncertain or there is competing evidence showing vastly different valuations of the claim?  The trustee may be tempted to throw up its hands, deny the claim, let the creditor appeal, and let the courts figure it out. 

As tempting as this solution may be, the recent British Columbia Supreme Court decision in Sellathamby (Re)[1] makes it clear that this is not an option at all.

What happened in Sellathamby (Re)?

Sellathamby (Re) was an application by a creditor, David Lofthaug (“Lofthaug”), for an order annulling the trustee’s disallowance of Lofthaug’s proof of claim and other related relief.

Lofthaug’s claim arose from an Alberta judgment.  In 2008 the Alberta Court of Queen’s Bench issued a consent judgment that Sellathamby was liable for certain debts owed to Lofthaug but quantum was not determined.  In 2014 the court ordered that a trial should be held to determine damages but no trial was scheduled.

In December 2015 Sellathamby filed a Notice of Intention to Make a Proposal. 

Lofthaug filed a proof of claim with Sellathamby’s trustee.  The proof of claim included an expert report valuing Lofthaug’s losses at between $1,144,000 and $1,249,000.  Sellathamby filed his own expert report responding to Lofthaug’s expert which concluded that the losses were substantially less. 

Sellathamby’s trustee disallowed the claim.  The reason for disallowing the claim set out in the disallowance was “[y]ou have not provided the documentation quantifying the amount of your claim as per the Consent Judgment dated September 8, 2008.”

On the application brought by Lofthaug, the trustee filed an affidavit explaining why the claim was disallowed.  The trustee noted that the claim related to a court action in Alberta which had been underway since 2008.  The trustee also noted that even though significant time had passed since 2008, the Alberta court had not made a determination as to the quantum that was owed to Lofthaug.  The trustee decided that he was not in any better a position than the Court to make a determination as to the value of the claim.  In circumstances where the trustee is unable to place a value on a claim, the trustee said that it is his practice to disallow the claim. 

Among other arguments, Lofthaug argued that the trustee was required to value his claim but failed to do so.

In analyzing this issue the court first considered section 135 of the Bankruptcy and Insolvency Act which deals with the admission and disallowance of proofs of claim.  Section 135(1) to (2) states:

Admission and Disallowance of Proofs of Claim and Proofs of Security

Trustee shall examine proof

135 (1) The trustee shall examine every proof of claim or proof of security and the grounds therefor and may require further evidence in support of the claim or security.

Determination of provable claims

(1.1) The trustee shall determine whether any contingent claim or unliquidated claim is a provable claim, and, if a provable claim, the trustee shall value it, and the claim is thereafter, subject to this section, deemed a proved claim to the amount of its valuation.

Disallowance by trustee

(2) The trustee may disallow, in whole or in part,

(a) any claim;

(b) any right to a priority under the applicable order of priority set out in this Act; or

(c) any security.

The court held that, under s. 135(1), the trustee has a responsibility to value a claim.  The trustee cannot defer to the court in Alberta.  There was no evidence that the Alberta court declined to make a determination on quantum.  The fact that the court made no determination does not mean that the trustee is unable to place a value on the claim.

Section 135(1.1) of the BIA requires the trustee to do two things:

  1. the trustee shall determine whether any contingent claim or unliquidated claim is a provable claim; and
  2. if it is a provable claim, the trustee shall value it.

The section is not permissive.  The trustee is required to determine if the claim is a provable claim, and, if a provable claim, the trustee is required to value it.

Read together, the sections require a trustee to determine whether a contingent or unliquidated claim is provable and, if provable, to value it.  It is only after the trustee takes these steps (including valuing the claim) that the trustee is permitted to disallow the claim.

Lofthaug was the holder of a consent judgment for liability in connection with a commercial contract.  The parties agreed that the holder of such a judgment has a claim provable in bankruptcy. 

The trustee did not value Lofthaug’s claim as it was required to do.  Instead the trustee wrongly concluded that the claim was not supported by any documentation.  The trustee also deferred to the Alberta court regarding the valuation of Lofthaug’s claim.  This was not correct.  It was clear that the trustee had a complete record, including expert reports, from Lofthaug and Sellathamby.

Since the trustee did not value the claim under section 135(1.1), the trustee was not permitted to disallow it pursuant to section 135(2).

How can a trustee value an unliquidated claim?

Sellathamby makes it clear that a trustee is required to examine a claim.  The trustee cannot disallow it “as a matter of practice”. 

This is relatively simple for liquidated claims.  A trustee can look behind a judgment in some circumstances[2] but a judgment of a court of competent jurisdiction should almost invariably satisfy a trustee regarding the legitimacy of a debt if, in awarding the judgment, the court has considered the merits of the claim[3].  Claims based on promissory notes or contracts with liquidated damages clauses will require more investigation but ultimately should not cause a trustee too much difficulty.

What about unliquidated claims?  What should a trustee have done to comply with its obligation? 

The trustee is required to value the claim based on the evidence provided to the trustee by the creditor.  The trustee had expert reports from Lofthaug and Sellathamby.  The trustee should have reviewed all the evidence presented to it, including the expert reports, in order to value the claim. 

The two expert reports presented very different amounts for valuing the claim.  The trustee is required to review the two reports and to decide which of the reports is more persuasive.  How does the trustee arrive at a valuation based on different reports? 

The court in Re HDYC Holdings Ltd.[4]offers some guidance on how a trustee should approach an unliquidated claim.  At paragraph 70 the court says that “certainty” is not the test for deciding the validity of a claim or calculating its value.  The court goes on to say that if the method for calculating the claim is reasonable and the evidence is relevant and probative, that is sufficient to quantify the claim. 

The trustee does not have to be “certain” that one report is correct and the other is wrong.  The trustee only has to conclude that one of the reports is more reasonable and probative than the other.

How can a trustee value a claim where equally persuasive evidence suggests different valuations?

How does the trustee decide how to value a claim when faced with two diametrically opposite, but equally persuasive, reports?

While Re HDYC Holdings Ltd. offers some guidance it still does not help the trustee resolve a situation where there are different calculations of the value both of which are reasonable and supported by relevant and probative evidence.  What can a trustee do in such circumstances? 

There are two legal principles – the standard of proof and the onus of proof – that can assist a trustee in resolving this issue.

What is the “standard of proof”?

“Standard of proof” is the standard that has to be met in order to prove a fact.  In criminal proceedings the standard is proof beyond a reasonable doubt[5].  In some cases, such as proving that a bankrupt has committed an offence under the BIA, this standard is applied.  However for the most part in bankruptcy proceedings the civil standard is applied[6].

The civil standard of proof is proof on a balance of probabilities.  Balance of probabilities means “more probable than not” or that the chance of a fact being true is more than 50%[7].  This means in a civil proceeding, the party trying to prove something has to prove that, on balance, it is more likely than not to be true.

What is the onus of proof?

The next question is who has to prove a fact.  This is called the onus of proof or burden of proof.  The party with the onus of proof or burden of proof is responsible for proving that a fact is true. 

Section 124(1) of the BIA provides that “[e]very creditor shall prove his claim, and a creditor who does not prove his claim is not entitled to share in any distribution that may be made.”  The creditor bears the onus of establishing its claim[8].  This means it is the creditor’s responsibility to prove that it has a claim.  No one is responsible for disproving that a creditor has a claim.

Taken together how do these two principles help in a situation where a trustee cannot decide between competing evidence led by, for example, a creditor and the bankrupt? 

If the trustee can decide that, on a balance of probabilities, the creditor’s evidence is more compelling than not, then the creditor has discharged its onus of proof and the claim should be allowed.  On the other hand if the trustee can decide that, on a balance of probabilities, the creditor’s evidence is less compelling than not, then the creditor has not discharged its onus of proof and the claim should disallowed. 

What about a situation where there is equally compelling evidence for two different valuations or where there is equally compelling evidence in favour of and against a proof of claim? 

This is where the creditor’s onus of proof comes into play.

The creditor has the onus of proof.  This means the creditor is responsible for proving its claim.  The standard of proof that the creditor must meet is a balance of probabilities.  In other words the creditor must show that it is more likely than not that it has a valid claim. 

If the evidence in support of and against the creditor’s claim is equal then the creditor has not shown, on a balance of probabilities, that it has a claim.  This means the creditor has not discharged its onus and, as a matter of law, must lose.  The trustee is justified in disallowing the claim because the creditor has not proven it. 

It may at first appear that by disallowing the claim in these circumstances the trustee is throwing up its hands and doing exactly what the court in Sellathamby (Re) said that it could not do.  However this is not the case.  In Sellathamby (Re) the trustee had evidence in support of two different valuations.  Instead of analyzing this evidence the trustee disallowed the claim both because it felt that the Alberta courts would do a better job and because this was the trustee’s “practice”.

If a trustee reviews the evidence both in favour of and against a proof of claim, decides that the evidence is equally compelling, and then applies the standard of proof and onus of proof to disallow the claim, the trustee has met its obligation pursuant to section 135(1) to “examine” the proof of claim. 

Properly examining a proof of claim is necessary to allow a court to deal with an appeal from a disallowance.

There is another way in which following this process will help with the administration of bankruptcy estates. 

Section 135(4) of the BIA provides that the trustee’s disallowance of a claim is final and conclusive unless the creditor appeals from the disallowance.  An appeal from a disallowance is a true appeal, not a hearing de novo[9].  This means that, on an appeal of a disallowance, the court will not consider the matter anew, with the parties leading fresh evidence.  Instead the court will review the documents that were filed with the trustee and will consider whether the trustee arrived at the correct decision.

In order for the court on an appeal from a disallowance to be able to consider the trustee’s decision and to treat the appeal as a true appeal, the trustee must have properly examined the proof of claim and all the evidence that was available to the trustee and must render a decision that an appeal court can consider.

The decision in Sellathamby (Re), the trustee’s obligation to examine a proof of claim under section 135(1) of the BIA, and the nature of an appeal from a trustee’s disallowance make it clear that a trustee cannot merely disallow a claim because arriving at a decision is difficult or because it is the trustee’s “practice”.  The trustee has to properly consider the evidence and prepare a reasoned decision in order for the claims process, including appeals, to function properly. 

[1] 2020 BCSC 1567 (CanLII)

[2] Re Van Laun; Ex parte Chatterton, [1907] 2 K.B. 23, 76 L.J.K.B. 644, 97 L.T. 69 (C.A.)

[3] Re Canadian Asican Centre Development Inc. (2003), 39 C.B.R. (4th) 35, 2003 CarswellBC 270

[4] Re HDYC Holdings Ltd. (1995), 35 C.B.R. (3d) 294 (B.C. S.C.)

[5] R. v. Lifchus, 1997 CanLII 319 (SCC), [1997] 3 S.C.R. 320

[6] see for example Hefler (Bankruptcy), Re, 1997 CanLII 1953 (NS SC), Sran (Re), 2010 BCSC 937 (CanLII), Asian Concepts Franchising Corporation (Re), 2018 BCSC 1022 (CanLII), Roberts v. E. Sands & Associates Inc., 2014 BCCA 122 (CanLII) and Toro Aluminum v. Sampogna, 2008 ONCA 125 (CanLII)

[7] Continental Insurance Co. v. Dalton Cartage Co., 1982 CanLII 13 (SCC), [1982] 1 SCR 164

[8] Mamczasz Electrical Ltd. v. South Beach Homes Ltd., 2010 SKQB 182 (CanLII)

[9] Re Galaxy Sports Inc. (2004), 2004 CarswellBC 1112, 1 C.B.R. (5th) 20; Charlestown Residential School (Re) (2010), 70 C.B.R. (5th) 13 (Ont. S.C.)

How can a trustee in bankruptcy protect a bankrupt’s interest in real estate using a bankruptcy caution without being registered as the owner?

You’ve been appointed as trustee in bankruptcy of a bankrupt who owns real estate.  But you don’t know if there is equity in the property or what the condition of the property is.  Is the equity worth the risk of being registered as the owner?  Is there another way to protect the interest and to stop the bankrupt from transferring or mortgaging the property?

A trustee of an insolvent person who owns real estate has an obligation to protect the property so that it is available for the creditors of the estate.  This includes making sure that the property is not transferred or encumbered. 

The simplest way to make sure the property is not encumbered is for the trustee to transfer the property into its name.  Subsections 74(1) and (2) of the Bankruptcy and Insolvency Act allows the trustee to register a bankruptcy order or assignment on title to any real property that the bankrupt has an interest in and, upon registration of the order or assignment, entitles the trustee to be registered as owner of the real property.

However there are risks associated with the trustee being registered on title. 

As the registered owner the trustee will be liable for the upkeep of the property and any injuries that occur on the property.  The registered owner can also be responsible for cleaning up any environmental issues that arise on the property or for hazardous materials stored on the property.  The trustee can even become responsible for something as simple as utilities delivered to the property. 

If there is equity in the property that will cover these expenses and the property can be insured then it makes sense for the trustee to be registered as the owner.  Being registered as the owner will also allow the trustee to transfer title to the property once it is sold. 

But what if there is little or no equity or the concerns about the property outweigh whatever equity there is?  What if the property can’t be insured or it isn’t clear at first whether the property can be insured?  Is there anything the trustee can do to protect title to the property without taking on personal liability?

The solution is to register a caution against title to the property. 

Section 74(3) of the BIA permits a trustee to register a caution against title to the property instead of registering the order or the assignment and being registered as the owner.  The section says that the effect of the caution is that any registration (such as a mortgage or transfer) made after the caution is subject to the caution.

Anything registered by the bankrupt after the caution will not affect the trustee’s interest in the property.  The trustee will be able to sell the property without worrying about the bankrupt transferring it or encumbering it.

Section 128 of the Ontario Land Titles Act deals with cautions that can be registered if there is a dispute about ownership of land.  These are not the cautions we are talking about.  These cautions only stay in place for 60 days and give the parties time to go to court to get a Certificate of Pending Litigation. 

The right to register the caution comes straight from section 74(3) of the BIA.  The caution registered pursuant to the BIA does not expire after 60 days.  It remains on title until the trustee discharges it (either because the property is sold or the trustee disclaims its interest in the property).

How is the caution registered in Ontario?

The Electronic Registration Procedures Guide put out by the Ministry of Government and Consumer Services permits a trustee to register two types of cautions, a Caution – Land (Bankruptcy and Insolvency Act) and a Caution – Charge (Bankruptcy and Insolvency Act).  The “Land” caution is used if the bankrupt has an interest in land.  The “Charge” caution is used if the bankrupt has an interest in a mortgage.  In each case, any subsequent registration is subject to the caution.

The guide contains an entire section dealing with bankruptcy and in particular has a section dealing with the cautions that a trustee can register.  It sets out the form to be used, the statements that have to be made by the trustee, and the statements to be made by the lawyer registering the caution.

What is the benefit of the caution?

The caution prevents the bankrupt from transferring or mortgaging the property since any subsequent transfer or charge is subject to the caution.  At the same time the trustee is not registered as the owner which means the trustee does not take on any of the liabilities associated with being an owner.

Even after the caution is registered the trustee can be registered as the owner of the property.  The trustee can market the property and enter into a transaction.  When it comes time to close the transaction and transfer title the trustee can be registered as the owner and can then transfer title to the new purchaser.

Wojtek Jaskiewicz is a commercial litigator and insolvency lawyer with WeirFoulds LLP.  If you have any questions about the bankruptcy caution, dealing with the real estate of a bankrupt, or insolvency in general, contact Wojtek Jaskiewicz at wjaskiewicz@weirfoulds.com or visit our website at www.WeirFoulds.com.

What happens if you default on a business loan?

Defaulting on a business loan is a reality for many Canadian businesses, especially during COVID-19. But what happens when you default? And are there any ways to avoid the worst consequences of a default?

What to expect when your bank demands payment

The first thing the bank will do will be to demand payment and to send a notice of intention to enforce a security. 

Why do banks demand payment when you default?

Most loan and security agreements will say that the full amount of the loan is due if there is a default. However most loans will also say that, at any time, the bank can demand payment in full. The bank does not have to wait for a default. It can demand even if there is no default.

By demanding payment the bank ensures that the full amount of the loan is due. Even if it turns out that there was no default, the bank can rely on the demand to require payment in full.

Why the notice of intention to enforce a security and what is the notice anyway?

The Bankruptcy and Insolvency Act (the “BIA“) governs a bank’s ability to enforce on security. The bank can always demand payment and sue but if it wants to seize assets and sell them to recover the loan it has to comply with the BIA.

The BIA says that a secured creditor (such as a bank) who intends to enforce a security on all or substantially all of:

  1. the inventory,
  2. the accounts receivable, or
  3. the other property

of an insolvent person that was acquired for or used in a business shall send to the insolvent person a notice of that intention. Where such a notice is required to be sent, the secured creditor shall not enforce the security until ten days after the notice is sent.

The notice that the bank has to send is called a notice of intention to enforce a security.

The notice is a prescribed form and looks something like this:

What this means is that, before a bank enforces on its security, it has to send a notice of intention to enforce a security and wait for ten days. Once the ten days passes the bank can take steps to start enforcing on its security.

Two ways banks enforce when you default on a loan

The bank’s next steps will depend on the bank, the borrower, and the relationship between them. At this stage the bank has two choices: negotiate a forbearance agreement or continue enforcing on its security.

What is a forbearance agreement?

A forbearance agreement is an agreement with the bank where the bank agrees not to enforce on its security. There are many reasons why a bank might enter into a forbearance agreement but the main reason is that this may be the fastest way for the bank to be repaid.

Your bank is not interested in selling your assets. It wants to get paid. If the bank thinks that by giving some extra time it will be paid, the bank will wait. Typically a forbearance agreement will buy the debtor anywhere from three to, on occasion, six months of time to find a new lender. For more details on what a forbearance agreement is, including what you typically have to give up to get a forbearance agreement, click here.

What can you expect if the bank continues to enforce?

If the relationship has broken down completely, and a forbearance agreement is not in the cards, the bank will take steps to enforce on its security once the ten day notice period ends. The most typical way in which a bank enforces is to appoint a receiver.

What to expect when your bank enforces by appointing a receiver

A receiver is a licensed insolvency trustee who is appointed by the bank to take over the business and to sell it in order to recover the debt owed to the bank.

How is a receiver appointed?

There are two ways for a bank to appoint a receiver. Most security agreements allow a bank to privately appoint a receiver. The security agreement gives the receiver the power to take over the business, sell the assets, and pay the bank.

However a privately appointed receiver is constrained in a number of ways. The receiver cannot force anyone to do anything. Instead the receiver will rely on cooperation from the debtor. The receiver also has no protections if it makes a mistake or if anyone (other creditors, the owners of the debtor, other interested parties) complain about what the receiver has done.

For these reasons a receiver is typically appointed by court order.

Appointing a receiver by court order

To appoint a receiver by court order, the bank will bring an application against the debtor for an order appointing the receiver. The bank is required to give ten days notice of the application to allow the debtor to respond. The debtor may object to the application being heard so quickly however these matters are generally considered to be urgent. The debtor can ask for more time but even if it is granted, the debtor rarely gets more than an extra few weeks.

The unfortunate reality for business owners is that a receiver is usually appointed. If there is a default in paying the loan, there is little that can be done to prevent the bank from getting an order appointing a receiver.

How does the receiver enforce when you default on a loan?

Once the receiver is appointed, the receiver will take over the business, market it, sell it, and distribute the proceeds to the bank and any other secured creditors.  The receiver can either sell the business as a going concern or sell the assets separately. The amount of time all of this will take will depend on the assets but it typically takes 3-6 months.

Each step (selling the assets, distributing the proceeds, etc.) is approved by the court. This gives the receiver the protection it wants. If anyone wants to complain that the price is too low or too much is being paid to a creditor those issues have to be raised in the receivership proceeding. Once the receivership is finished it is too late to make any complaints.

For example guarantors may want to argue that the assets were sold for too little (called an improvident sale). The guarantors will often raise these issues when they are sued on their guarantees. If the sale of the assets was approved by the court in the receivership it will be too late to raise these issues in the guarantee claim.

How can you avoid losing your business when you default on a loan?

The first way to avoid a receiver being appointed is to keep a good relationship with your bank so that the bank wants to enter into a forbearance agreement with you.

How do you keep on good terms with your bank?

Ideally pay your loans and otherwise comply with all of your obligations. But you don’t control this. If the business is suffering there may not be enough money to pay the loans. And even if there is enough money, the business may be breaching other covenants. If this is going to happen, communicate as soon as possible with your bank. The last thing you want to do is to surprise your bank. If you think there will be a problem, tell your bank. If you think you’re going to miss a payment, tell your bank. If you’re communicating with your bank then your bank is calm and is likely to give you more room to work out whatever problems you have.

What if it’s too late to negotiate?

If the bank does not want to negotiate a forbearance agreement or any other agreement to give you room to work through the problems, the only option is a formal restructuring.

There are two types of proceedings that a company can start in order to delay or stop its security creditors – a proposal under the BIA or an application under the Companies’ Creditors Arrangement Act (the ”CCAA“).

A proposal under the BIA will only stop a secured creditor if the creditor has not served its notice of intention to enforce a security or, if the notice has been served, the ten day notice period has not elapsed. For this reason, if the bank serves a notice of intention to enforce a security it is important to act quickly and to get proper advice.

An application under the CCAA can be brought even after the ten day notice period has elapsed but a company is only eligible to apply for protection under the CCAA if it has a minimum of $5 million in debt and the application is very expensive.

When should you get a lawyer involved to save your business when you default on a loan?

Getting the right advice quickly is key to ensuring that your business survives. You may have as little as ten days to decide what steps have to be taken. An experienced insolvency lawyer will be able to give you the right advice to make that decision.

Knowing how a forbearance agreement will affect your business is also important when you are negotiating with a bank. The bank has professional lawyers to protect its interests. This is not the time to “do it yourself” and learn on the job. An experienced insolvency lawyer will understand the short and long term consequences of all of the terms in a forbearance agreement.

At WeirFoulds LLP we act for both lenders and borrowers.  We understand your business needs and we know what lenders want.  We can help you communicate with your bank, negotiate a forbearance agreement, or consider your insolvency options. If your company is facing financial difficulty contact Wojtek Jaskiewicz at wjaskiewicz@weirfoulds.com or visit our website at www.WeirFoulds.com

Credit Application Best Practices to Get You Paid

We all want customers and we go to great lengths to keep them happy.  One of those lengths is letting customers pay for products in 30, 60 or even 90 days.  It is important to remember that when you do this you are lending your money to your customer. 

Here’s how to safely extend credit to your customers

Here are six steps you should follow to make sure that lending your money to your customer is a sound business decision. 

Get the customer to complete a credit application

  • Identify the customer’s legal name, business address, website, telephone number and any other contact information so that you know who you are lending to and so that you can find the customer in case you need to sue.  You may be delivering products to a different location or company and you may get paid by a different company.  Make sure you know exactly who you are advancing credit to.
  • Identify your customer’s bank and branch.  If the customer doesn’t pay and you get a judgment you need this information to be able to enforce.  You will also want the customer to tell you what their bank balance is, what their credit limit is, how much they owe and whether they pay regularly and to allow you to contact their bank to verify this information.
  • Collect references from your customer.  This will be a list of other supplier who supply on credit, how much credit they advance, what the payment terms are and how quickly the customer pays.  Make sure you have contact information and consent to contact the suppliers.
  • Get copies of recent financial statements.  If the customer is reluctant to provide financial information (or references or banking information) this is a red flag.
  • Check your customer’s business history. That is, find out how long your customer has been in business and how long they have been with their bank and the suppliers (references).
  • Get consent to perform a credit check.  You cannot perform a credit check without written consent.

Assess creditworthiness

  • From the credit application, you should have financial statements, references and details about the customer’s existing credit. The first step will be to analyze the financial statements and speak to the customers existing lenders – both banks and suppliers. Are they happy with the customer? And more importantly, is the information the customer gave you consistent with what the other creditors are saying?
  • If the customer looks good at this point, consider further searches.  A credit report can give you an idea of the customer’s borrowing habits to date. A PPSA (security) search can tell you what other debts the customer has and whether the customer owns the assets. An execution search can tell you if there are any judgments against your customer.
  • Other considerations:
    • How long has the customer been in business? If not long, was the customer operating using a different name/company? Why did the customer close the old company? The customer may have formed a new company to avoid creditors. 
    • Google the customer and the principal of the customer. For example, you may get positive or negative reviews which you can use as part of your credit decision. 

Set smart credit limits and payment terms

  • Decide how much credit you should advance to the customer and for how long – then stick to this!
  • Deciding how much credit and what the term should be will depend on a number of factors:
    • What risk you are prepared to take on?  The longer you wait to be paid, the higher the risk that something will go wrong and the customer won’t pay
    • How long you are prepared to wait to be paid?  Extending the time to get paid will affect your cash flow and force you to operate using your own line of credit – which you have to pay for!
    • What is the industry standard?  You still have to be competitive but there is no point in being so competitive that you run yourself out of business.  Its better not to have a customer than to have a customer who doesn’t pay. 
  • If the customer looks promising but you have some concern, keep the payment term short – say 15 days – and keep the amount low.  Then, as your confidence in the customer builds, increase the term and the amount.

Consider other forms of security

  • Guarantee
    • Getting a guarantee from the owner of the business gives you another pocket if you have to sue. More importantly, if you have a personal guarantee you ensure that the principal stays involved in the business even if it is struggling. It is more difficult to walk away from a struggling business if you are personally on the hook for its debt.
  • Security interest
    • Ideally, if you are lending you get a security interest in all of the customer’s assets. If the customer doesn’t pay you can seize all the assets and sell them to recover your debt. However, this may be impossible. The customer may have an operating line of credit with a bank which will be secured against all the assets. Even if you get security you will be behind the bank. In this case you can still get security in the specific product you are delivering and that security will rank ahead of any other lenders, including the bank. This is called a “purchase money security interest”.

Use a clearly worded credit agreement

  • The credit agreement will set out terms such as:
    • The legal name of the customer;
    • The amount of credit being advanced;
    • The amount of time the customer has to pay; and
    • The maximum amount of time to report quality or quantity issues.
  • Make sure the credit agreement clearly says that you have the right to cancel credit at any time and for any reason whatsoever. If the customer’s financial situation changes you don’t want to be forced to continue supplying on credit. 
  • If you are getting a guaranty or a security interest make sure these are in writing and signed. The security agreement has to be signed by the customer. The guarantee has to be signed by the person giving the guarantee. 

Get regular updates

  • Your initial decision to give credit will be based on all of the information above — but circumstances can change. Your client should regularly update all of this information so that you can reassess whether you should advance credit. You want to make sure you catch the customer’s problems before they become your problems

Advancing credit to customers is a regular part of business.  With these tips you can make sure you make the right credit decision.  If you provide credit and want to make sure you are protected contact Wojtek Jaskiewicz at wjaskiewicz@weirfoulds.com or visit www.WeirFoulds.com

Does your corporation’s bankruptcy affect your personal credit?

The short answer is no; your corporation’s bankruptcy does not affect your personal credit. 

Your corporation is a separate legal entity.  It has its own debts, its own contracts, and its own credit.  Your corporation’s bankruptcy does not affect your personal credit and the fact that a corporation that you were a shareholder, director, or officer of made an assignment will not show on your personal credit report.

But the longer answer is more nuanced. 

There are corporate debts that can become your responsibility and, if those debts are not paid, then your personal credit can be affected.  Two common examples of this are personal guarantees and directors’ liabilities for unremitted source deductions and H.S.T. 

The Income Tax Act requires a corporation that has employees to withhold the income tax that the employee owes and to remit it to the government.  Similarly the Excise Tax Act usually requires a corporation that sells goods or services to collect Excise Tax (H.S.T.) and to remit it to the government.  If a corporation that you are a director of withholds income taxes or collects H.S.T. and fails to remit these amounts then you may be personally liable for the payments.  

Similarly if you personally guarantee your corporation’s obligations, such as the payments under a lease or the corporation’s loans, and the corporation fails to pay these amounts, then you will be personally responsible for the payments. 

In both of these cases if the corporation makes an assignment in bankruptcy then there will not be enough money to pay the debts which means you will become personally responsible.  If you are unable to pay the debt then this will have an effect on your credit.

In these specific circumstances the bankruptcy of your corporation can have an effect on your personal credit but the general rule is that your corporation’s bankruptcy will not affect your credit. 

If you have any questions about your corporation’s bankruptcy, restructuring, or any other financial issues contact Wojtek Jaskiewicz at wjaskiewicz@weirfoulds.com or visit www.WeirFoulds.com.

Can a receiver partially disclaim a lease?

One of the tools available to a receiver is the power to affirm or disclaim contracts.  Paragraph 3 of the commercial list users committee model receivership order sets out the powers generally given to a receiver appointed pursuant to section 243(1) of the Bankruptcy and Insolvency Act and section 101 of the Courts of Justice Act.  Subparagraph 3(c) includes the power to cease to perform any contracts of the Debtor. 

The power given to a receiver pursuant to subparagraph 3(c) of the model order includes the power to affirm or disclaim an equipment lease or a master lease for various pieces of equipment.  The receiver can affirm the lease, continue making lease payments and continue using the equipment or the receiver can disclaim the lease, return the equipment and stop making the lease payments.

But what happens if the receiver needs some, but not all, of the equipment leased pursuant to a master lease?  Can a receiver disclaim part of the lease?  And if the receiver does this, how are the lease payments calculated?

This issue was recently considered by the Honourable Justice Duncan in Yukon (Government of) v. Yukon Zinc Corporation, 2020 YKSC 16 (“Yukon”). 

In Yukon, a receiver was appointed over a flooded and deteriorating mine which was no longer operational.  The receiver’s mandate was to stabilize the mine but not to operate it as a going concern.

Yukon Zinc Corporation (the “debtor”), which operated the mine, leased 572 pieces of equipment (the “Leased Equipment”) from Welichem Research General Partnership (“Welichem”) pursuant to a sale and leaseback transaction.  The debtor entered into a master lease with Welichem for the 572 pieces of Leased Equipment.  The Leased Equipment included tools, vehicles and infrastructure at the mine.  The master lease required monthly lease payments in the amount of $110,000.

The receiver took possession of the mine and identified 79 of the 572 pieces of Leased Equipment that were essential for the continuing and necessary care and maintenance and environmental remediation of the mine (the “Essential Items”).  The Essential Items included various vehicles, trailers for staff accommodations, a water treatment plant, various tanks, generators, graders, excavators, and other items of machinery.  The receiver incurred over $200,000 to repair the Essential Items to a workable operating standard.

The receiver spent several months negotiating with Welichem to lease just the Essential Items.  When the negotiations failed the receiver issued a notice of partial disclaimer which provided that the receiver intended to disclaim the master lease but was preserving its right to use the Essential Items for a monthly payment of $13,500. 

Welichem brought an application to the court to set aside the partial disclaimer and for an order that the receiver affirmed the master lease and was required to make the full lease payments in the amount of $110,000 per month.

Welichem raised four arguments against the receiver’s power to partially disclaim the master lease:

  1. at law the receiver has a binary choice – affirm the entire master lease or disclaim the entire master lease;
  2. the partial disclaimer was an attempt to unilaterally alter the material terms of the master lease;
  3. the BIA does not include the ability to disregard property and civil rights which in this case was Welichem’s ownership of the Leased Equipment;
  4. the court’s inherent jurisdiction does not allow it to alter the master lease.

The receiver acknowledged that generally a contract is declaimed in its entirely however there is no legal authority prohibiting a partial disclaimer.  The receiver argued that:

  1. the receivership order had several provisions authorizing the partial disclaimer;
  2. the powers granted to the receiver pursuant to s. 243 of the BIA and section 26 of the Yukon Judicature Act were broad enough to include the partial disclaimer; and
  3. the court has discretion provided by s. 243 of the BIA and its judicial interpretation to allow the partial disclaimer;

The receiver also relied on the statement in Bennett on Receiverships that “in the proper case, the receiver may move before the court for an order to breach or vary an onerous contract including a lease of premises or equipment”.

Justice Duncan concluded that the receiver did have the authority to partially disclaim the master lease. 

The receiver could retain the Essential Items and make monthly lease payments in the amount of $13,500.

Generally when deciding whether to disclaim a lease the receiver has to consider whether there can be a higher realization for creditors by performing the contract while keeping in mind that if a contract is not disclaimed, the party seeking to uphold it would receive a significant preference not available to other creditors. 

When considering whether the receiver has the power to partially disclaim a lease, Justice Duncan considered the order appointing the receiver and the legislation under which the receiver was appointed.

First Justice Duncan considered the order appointing the receiver. 

Subparagraph 3(c) of the order appointing the receiver gave the receiver the power to cease to perform any contracts of the debtor.  While this suggests that the receiver has a binary choice (as argued by Welichem) the subparagraph has to be read together with other paragraphs in the order which give the receiver the general authority to take steps reasonably incidental to its powers and statutory obligations, the power to undertake environmental and worker’s health and safety assessments, and the power obtain any regulatory approvals or permits it considers appropriate or necessary.  The receiver is also given the power to cease to carry on all or part of the business of the debtor.

In this case the debtor’s business was the operation of a mine.  The receiver was not carrying on this business.  The receiver was carrying on the care and maintenance and remediation in order to preserve the assets and allow the mine to become operation at a future time.

The Leased Equipment was needed by the debtor to carry on the business of operating the mine.  The Essential Items are the specific items identified by the receiver in order for it to carry on the work it is required to do – i.e. care and maintenance and environmental remediation.  In order to carry out its mandate under the appointment order, the receiver had to have the power to partially disclaim the master lease in order to keep only the Essential Items which were required for the care and maintenance and environmental remediation of the mine.

Next Justice Duncan considered whether the BIA permitted the receiver to use the Essential Items and the Court’s authority to permit this. 

The Court’s authority to grant the receiver powers is found primarily in subsection 243(1) of the BIA which says that the Court may appoint a receiver to take possession of a debtor’s property, exercise any control over the property, and, most importantly, take any other action that the court considers advisable.  This broad language permits the court to do not only what justice dictates but also what practicality demands. 

In interpreting subsection 243(1) it is important to bear in mind the purpose of receiverships generally.  The receiver’s primary task is to ensure that the highest value is received for the assets so as to maximize the return to the creditors.  Certainty of equitable distribution of the debtors’ assets among creditors is also important.  Further, the assets of an insolvent business must be managed responsibly, in compliance with regulatory requirements, in order to preserve the assets, preserve the reputation of the insolvent and to maximize value for creditors.

Justice Duncan remarked that solutions to BIA issues require judges to consider the realities of commerce and business efficacy. 

Welichem argued that the receiver’s actions were an incursion on its property and civil rights and that it was prejudiced by the receiver’s attempt to retain the benefits of the master lease without the obligations. 

Justice Duncan did not accept this argument.  The receiver paid and continues to pay Welichem monthly for using the Essential Items.  It invested $200,000 in repairs to bring the equipment to operational standards.  The receiver is required to act to benefit all creditors, not just Welichem, in preserving the debtor’s assets by carrying on the necessary care and maintenance and environmental remediation of the mine. 

In this case, the pragmatic problem-solving approach is to allow the receiver to use the Essential Items in order to ensure the care and maintenance and environmental remediation of the mine can continue. 

For these reasons Justice Duncan found that there is authority under paragraph 243(1)(c) of the BIA for the Court to allow the receiver to use the Essential Items for the purpose of carrying out the necessary care and maintenance and environmental remediation.

The receiver calculated the $13,500 per month cost for the Essential Items on the basis of their percentage of the 572 items leased pursuant to the master lease as well as the percentage of their value based on an appraisal.  Justice Duncan accepted this as a reasonable amount for the Essential Items.

Going forward the Court will still have to give receivers guidance on when a lease can be partially disclaimed and what the new lease payments should be.

Justice Duncan thoroughly analyzes the order appointing a receiver, the relevant sections of the BIA, and the caselaw regarding disclaiming leases.  The power to partially disclaim a lease will give receivers much needed flexibility when dealing with the practicalities of administering an estate. 

However further judicial guidance is needed for receivers and lenders to know when a partial disclaimer is available and should be used.  It may be that this has to be a fact specific analysis.  This will definitely depend on the nature of the leased assets, the debtors business, the receiver’s mandate and the location of the assets.  The court may also consider the identity of the lessor and the lessor’s ability to re-lease or sell the remaining assets. 

While Justice Duncan spends significant time on whether the receiver is able to partially disclaim the lease and whether the receiver requires the Essential Items to perform certain duties, very little time is spent on the potential prejudice to Welichem. 

For example, the receiver arrived at its price based on the number of items it retained compared to the total and based on an appraisal.  However is the price fair?  The master lease was for 572 items while the receiver was only retaining 79.  Did Welichem offer the debtor a discount because 572 items were leased which the receiver was taking advantage of while only leasing a fraction of the items?  The monthly lease payment to be paid by the receiver did take into account the appraised value of the Essential Items compared to the total value of the Leased Equipment however there was no consideration of how quickly the Essential Items would deteriorate compared to all the Leased Items or whether the price should be higher because the items are more difficult to lease. 

Yukon is a very receiver-friendly decision, both in terms of giving the receiver the power to partially disclaim a lease and in terms of giving the receiver broad discretion to arrive at what is a fair payment for items that are not disclaimed.  The right to partially disclaim is likely to remain.  It is a useful tool for a receiver, if used properly.  However it is likely that subsequent decisions will place greater controls on when leases can be partially disclaimed and how the new lease payments are calculated.

WeirFoulds LLP acts for lenders and court appointed receivers to negotiate, and if necessary litigate, disclaimers of leases or any other enforcement matters.  If you’re a receiver considering partially disclaiming a lease or a lender facing the prospect of having a lease partially disclaimed contact Wojtek Jaskiewicz at wjaskiewicz@weirfoulds.com or visit our website at www.WeirFoulds.com

Specific Performance in Real Estate Litigation Made Eas(ier)

Your client just closed on the purchase of a small but successful business.  The vendor owns the property but it’s ok; your client has an option to purchase and in a few years of building the business they can close on the property too. 

A few years pass and the business grows.  The option date arrives, your client tries to exercise it, and … nothing.  Your client tenders but the vendor refuses to sell.  Now what?  Your client has a claim for specific performance but that is not a great position to be in.

The test for specific performance

When deciding whether to order specific performance the court has to consider[1]:

  1. the nature of the property;
  2. the adequacy of damages as a remedy; and
  3. the behaviour of the parties, having regard to the equitable nature of the remedy.

A consideration of the nature of the property requires an assessment of its uniqueness[2].  A property is unique if it has a quality that cannot be readily duplicated elsewhere[3]

The question of the adequacy of damages is related to the nature of the property but also takes into account factors such as the difficulty in enforcing a damages award[4]

Finally, the court will consider how the parties acted.  Courts have refused to award specific performance for a wide variety of conduct including misrepresentations made in court on a motion[5], fraud[6], or delivering improper requisitions[7]

Even if the claim is ultimately successful, the litigation can go on for years and will be costly.  There are many issues a defendant can throw up to avoid selling the property. 

Is there a way to avoid these delays and costs? 

There is a tool commonly used in the secured lending world that may assist purchasers in obtaining orders for specific performance.

Briefly, what is secured lending?

A secured loan is a loan that is secured by the assets of a business.  If the borrower defaults, the lender can seize the assets and sell them to satisfy the debt.  While a lender can seize and sell the assets itself most lenders don’t do this for two reasons. 

First, most lenders are not in the business of seizing and selling assets.  They do not have the expertise to sell assets. 

Second, while the security is over the assets, the assets are often worth significantly more if sold as a going concern (i.e. all together as a functioning business) than individually.  This is a legal example of the whole being greater than the sum of the parts.

How does a lender deal with these problems? 

The assets are usually seized and sold by a receiver appointed by court order under the Courts of Justice Act[8] and/or the Bankruptcy and Insolvency Act[9].

When deciding whether to appoint a receiver the court considers many factors, including:

  1. whether irreparable harm might occur if no order were made;
  2. the nature of the property;
  3. the waste of the debtor’s assets;
  4. the balance of convenience to the parties;
  5. the fact that the creditor has the right to appoint a receiver in its loan agreement;
  6. the principle that the appointment of a receiver is extraordinary relief that should be granted cautiously and sparingly;
  7. the conduct of the parties;
  8. the cost to the parties; and
  9. the likelihood of maximizing returns.[10]

These are not the same factors that are considered by a court when deciding whether to grant specific performance but many factors are similar – the nature of the property, the conduct of the parties, maximizing returns.

Using acknowledgments and consents in forbearance agreements

When a debtor defaults but before a receiver is appointed it is common practice for the parties to enter into a forbearance agreement.  The forbearance agreement will set out certain terms such as an acknowledgement of the debt and the default, an acknowledgement that the lender has taken the necessary steps (such as giving notice) to appoint a receiver and an acknowledgment that the debtor is asking for additional time to remedy the default or pay out the loan.  In exchange for these acknowledgments the lender will agree not to enforce its right (i.e. to forbear) and instead to give the debtor additional time.

While the acknowledgments are useful, they are often not the most important part of a forbearance agreement.  These acknowledgments are useful if the debtor defaults on the forbearance agreement but they still put the lender back in the same position of trying to appoint a receiver which means satisfying the court of the factors set out above. 

To avoid this problem, most, if not all, forbearance agreements contain a consent to judgment and a consent to the appointment of a receiver.  The consents are held in escrow and can only be relied upon if the debtor fails to pay or otherwise defaults on the forbearance agreement or underlying loan. 

The effect is that, if the debtor does default, the lender relies on the consents to get judgment and an order appointing a receiver.  The common practice is to prepare an application record that sets out the default and explains why a receiver should be appointed (i.e. to deal with the factors set out above) but ultimately to rely on the consents.

How does this apply to a real estate transaction and specific performance? 

Like the appointment of a receiver, specific performance is a discretionary remedy. The court can, but does not have to grant it. 

There are three things you can do to make it easier for the court to grant the order your client needs:

  1. Get the vendor to acknowledge in the agreement of purchase and sale that the property is unique and damages are not an adequate remedy if the vendor breaches the agreement.  Ideally list the specific ways in which the property is unique and the specific ways in which damages are inadequate.
  2. Ask the vendor to consent to an order for specific performance in the agreement of purchase and sale.  Once your client has an order requiring specific performance of the agreement of purchase and sale, the vendor is required to close the transaction.
  3. In an ideal world, get a consent to a vesting order which can be taken out upon payment of the purchase price.  The vesting order can be registered on title and will transfer title without the vendor being involved at all.

The acknowledgments in point 1. above is the key protection.  Even if the vendor consents to a vesting order or an order for specific performance the court may decide to make its own assessment.  If this happens you are back to litigating the three issues for specific performance but it will be much harder for the vendor to argue that the property is not unique and damages are adequate when faced with the acknowledgments.

Ultimately specific performance is discretionary.  There is no guarantee that the court will rely on the consents or accept the acknowledgments.  However with these in hand your client is in a much better position if a vendor breaches an agreement of purchase and sale.

At WeirFoulds LLP, we combine the expertise of our many practice groups to litigate strategically, save time and costs and give our clients the best chance of winning. 

[1] Landmark of Thornhill Ltd. v. Jacobson, 1995 CanLII 1004 (ON CA)

[2] Saeed v. Gunarajah, 2018 ONSC 4590

[3] Ibid.

[4] Sivasubramaniam v. Mohammad, 2018 ONSC 3073

[5] Silverberg v. 1054384 Ontario Limited, 2008 CanLII 59325 (ON SC) (“Silverberg”)

[6] Masson v. Shaw (1922), [1923] S.C.R. 187 (S.C.C.); Henderson v. Thompson (1909), 41 S.C.R. 445 (S.C.C.)

[7] Majak Properties Ltd. v. Bloomberg (1976), 13 O.R. (2d) 447 ONHC)

[8] R.S.O. 1990, c. C.43, section 101

[9] R.S.C., 1985, c. B-3, section 243

[10] Houlden, Lloyd W. et al, The 2019 Annotated Bankruptcy and Insolvency Act (Toronto: Carswell, 2019), L3, citing Textron Financial Canada Ltd. v. Chetwynd Motels Ltd. (2010), 2010 CarswellBC 855, 67 C.B.R. (5th) 97 (B.C. S.C.) [In Chambers])

Beware of Debtor-in-Possession Financing: The Risks to Existing Lenders and Vendor-Take-Back Mortgagees

​Priority is a major consideration for any lender when evaluating risks associated with financing. This becomes all the more important when an insolvent debtor seeks to restructure and access debtor-in-possession (“DIP”) financing (also referred to as “interim financing”). DIP financing is financing obtained by an insolvent debtor when restructuring their business. It is unique because it provides DIP lenders with a “super-priority” over the claims of other creditors in the event the business is eventually forced to liquidate.

DIP financing is an attractive option for insolvent companies, as it allows them to retain possession of their assets during restructuring. DIP financing may be used to provide operating funding, money towards capital expenditures or maintenance of the debtor’s assets – all with the goal of allowing a debtor more time and flexibility to restructure.

A debtor can apply to the courts for DIP financing under section 11.2 of the Companies’ Creditors Arrangement Act (“CCAA”) or under section 50.6 of the Bankruptcy and Insolvency Act (“BIA”). The provisions and factors considered are generally the same for both the CCAA and BIA and apply to situations where a business is attempting to reorganize under a proposal with creditors. However, DIP financing is at the discretion of the courts and is usually restricted to the amount necessary to meet the debtor’s urgent needs.

Under the legislation, certain factors are considered by the courts when deciding whether to grant an order, including:

  • the period of time the company is expected to be subject to the CCAA or BIA proceedings;
  • how the debtor’s business and financial affairs are going to be managed during the proceedings;
  • whether the debtor’s management has the confidence of major creditors;
  • whether the loan would enhance the prospects of a viable compromise or arrangement;
  • the nature and value of the debtor’s property; and
  • whether a creditor would be materially prejudiced as a result.

Though the interests of existing creditors are considered in an application for DIP financing, an existing creditor still risks having its interest in the debtor’s property subordinated by a court order approving DIP financing. Existing creditors, whether secured or unsecured, have no veto power to prevent DIP financing.

For example, a creditor who once thought they had first priority by way of a vendor-take-back mortgage (“VTB”) may discover that, despite its objections during an application for DIP financing, its priority is now subject to the “super priority” of a DIP lender. If the mortgagor in the VTB scenario is eventually forced to liquidate, the DIP lender will be first in line during the liquidation process to collect on its outstanding debts, ahead of the VTB lender. This leaves the VTB lender with less assets to satisfy its own loan.    

With this reality in mind, how can an existing creditor protect its interests when a debtor becomes insolvent? Beyond increased scrutiny in lending practices, a lender needs to move quickly to enforce its security interests in the event a debtor defaults. Lenders should remain vigilant, gather information and be aware of signs that a debtor is struggling to meets its existing liabilities. Taking action before the debtor and other creditors may reduce exposure to the lender.

Alternatively, a current creditor may decide to extend its own DIP financing to a debtor, utilizing its existing knowledge of the debtor’s business to lower its own transactional costs and move quicker than an outside third party lender. This would provide an existing lender with their own “super priority”. 

Regardless of a lender’s decision, it is important to recognize and understand the consequences of DIP financing when a debtor becomes insolvent and seeks protection under the CCAA or BIA.

At WeirFoulds LLP our real estate and bankruptcy and insolvency groups work together to protect your investment.  Please contact Wojtek Jaskiewicz to discuss further.

What to do when the bank comes knocking

The advantages and risks of entering into a forbearance agreement with your lender

COVID-19 is creating financing difficulties for all businesses.  It is now harder to pay lenders and suppliers.  What can you do about these financial difficulties?  Is bankruptcy the only option or is there something less disruptive than a formal restructuring that can help?  

A forbearance agreement with lenders can give your business the time it needs to recover from the crisis, move forward and avoid insolvency.  But is a forbearance agreement always the right plan for your business?  And what effect will the terms in a forbearance agreement have on your ability to continue operating?

What is a forbearance agreement?

A forbearance agreement is an agreement by a lender not to enforce the strict terms of a loan agreement.  

Usually, forbearance agreements arise because a borrower has defaulted either by failing to make loan payments or because of some other non-monetary breach.  The lender is in a position to enforce by suing for judgment, commencing power of sale proceedings or moving to appoint a receiver.  

Instead of taking these steps, the lender agrees to give the borrower additional time to find alternate financing to pay off the loan or to cure the default in some other way.

Recently, in light of the COVID-19 shutdowns and the related economic impacts forbearance agreements are coming up in a different context.  Some lenders, anticipating that borrowers will not be able to make loan payments, are reducing the payments to allow borrowers to ride the crisis out in the hope that business will return to a level that will allow full payments at some point in the future.

What are the common terms in a forbearance agreement?

For the borrower, the most important terms will deal with when payments have to be made and in what amount.

If the loan is in default then the entire amount will be due and owing.  The lender will want the loan paid off but the borrower will need additional time to find other financing. In these circumstances, the forbearance agreement will usually provide that, for a set period of time, the borrower can continue making the regular monthly payments even though there is a default and the entire amount is due.  The forbearance agreement will specify when the entire amount is due and in the meantime, the borrower will try to find an alternate lender or an alternate source of funds to pay off the loan.

Forbearance agreements during COVID-19

In the current COVID-19 environment the goal of the forbearance agreement is a bit different.  The goal is not to end the relationship between lender and borrower.  Instead, the goal is to allow the borrower to work through a short but particularly difficult period with the hope that at the end of the emergency the borrower’s business will return to something close to normal and the borrower will return to making regular loan payments. 

In this case, rather than continue with the regular loan payments, the forbearance will reduce or eliminate the loan payments for the duration of the forbearance period.  The payments may be reduced to interest only, the interest rate may be reduced, or the payments will be changed in some other way but the result will be to reduce the amount that the borrower has to pay at a time when the borrower is unable to pay. 

Now that the borrower has what it wants, the question remains:

What will the lender ask for in a forbearance agreement?  

The lender will ask for terms to cover its expenses of entering into the forbearance agreement, reduce its exposure to risk and make enforcing easier if it becomes necessary.  

The lender will incur legal fees to negotiate the forbearance and its own internal fees for the additional administration of the forbearance terms.  As part of the agreement, the borrower is usually required to pay a forbearance fee and the lender’s legal fees.  The legal fees will be the actual amount that the lender pays to its lawyer to negotiate the forbearance agreement.  The forbearance fee is not directly linked to any specific expense the lender can show.  It may look like a windfall to the lender however bear in mind that the lender has to spend additional time negotiating the forbearance agreement and administering it.  The forbearance fee covers these additional expenses.  

A lender, especially a secured lender, will want to make sure that the borrower protects its priority.  Certain debts, such as unremitted H.S.T. or source deductions or unpaid property taxes will rank ahead of a secured creditor.  The lender will want to make sure that these payments are made.  The lender will want to see proof that property taxes, source deductions and H.S.T. have been fully paid on the date that the forbearance is entered into and that these payments are made regularly during the forbearance period.

The lender will also want to avoid lending any more money.  This means revolving loans, such as lines of credit, are usually capped during the forbearance period.  Even if there is room to borrow more the borrower will agree that the limit will be reduced to the current outstanding amount.  This may also mean that any payments deposited into the borrower’s account will be used to pay down the loan and cannot be withdrawn again. 

Similar to ensuring that the lender does not lend more, the lender will want to make sure that ongoing revenues are not being rerouted to other lenders.  Lenders will regularly ask the borrower to get similar forbearance relief from its other lenders.  This avoids the risk to one lender that its forbearance terms are being used to pay down another lender but it is also useful for a borrower to use to negotiate forbearance terms with other lenders who may otherwise be reluctant.  

Finally, the lender will want more detailed information about the borrower’s ongoing business.  Usually, a borrower will have to provide annual financial statements to its lender so that the lender has a general sense of the borrower’s business.  With a forbearance agreement in place, whether because of a breach or because of a COVID-19-type crisis the lender will want more current information about the borrower’s business.  At the very least a borrower can expect to have to provide monthly statements but biweekly or even weekly reporting is not unheard of.  This gives the lender a much more current sense of the state of the business and whether quick action to enforce is needed. 

Now that the lender has reduced its exposure, we come to another question:

What can the lender ask for to make enforcement of the forbearance agreement easier?  

The first term that a lender will ask for to assist in enforcement is an acknowledgment of the outstanding amount and that the loan documents (the loan agreement and any related guarantees or security documents) are valid and enforceable.  The lender will want the borrower to confirm exactly how much is owing to avoid any dispute about the amount down the road.  The lender will also want the borrower and any guarantor to confirm that the borrower or guarantor will not dispute the loan agreement and, often more importantly, the security agreement and guarantees that go with the loan agreement.

In addition to acknowledgments of the amount owing, the borrower will often ask for additional security for loans.  This may take the form of guarantees from the principals of the business or related companies, mortgages against the homes of principals or security against the assets of related companies.

The most useful term for a lender to assist in enforcing is a consent to judgment and a consent to the appointment of a receiver.  Under normal circumstances, a lender has to go to court and prove its case to get a judgment or an order appointing a receiver.  With a consent in hand, this process is much quicker.  It still requires going to court but the lender no longer has to prove its case since it can rely on the consents.

Are there any risks to a borrower in entering into a forbearance agreement?

At first blush, a forbearance agreement seems like an obvious choice for a borrower.  Lower payments and more time – what’s not to love?  But there are risks in entering into a forbearance agreement, ranging from higher overall costs to additional time spent on reporting to losing the right to dispute enforcement.  

In the current COVID-19 environment forbearance agreements are being used to reduce monthly payments.  Payments may be reduced to interest-only or waived altogether during the crisis.  However, the payments are not forgiven.  

The skipped monthly payments are either capitalized, increasing the amount that has to be paid back, or future monthly payments are increased to make up the difference.  This means higher payments in the long run and potentially higher monthly payments in the near future.  While reducing payments now may be useful, it is important to consider whether the business can bear increased payments at a future date. 

The additional reporting requirements that come with a forbearance agreement will take time and often cost additional money.  Either the borrower’s management will have to prepare the reports, taking them away from running the business, or the borrower will have to pay accountants or other external professionals to prepare the reports.  The additional reporting will tax the business at a time when it is already strained because of its financial situation.  

There are also risks associated with capping the borrower’s facilities and using any deposits into the borrower’s accounts to pay down the facilities.  If this happens, where will the borrower get funding to run its operations during the forbearance period?  It is important to negotiate a forbearance agreement that allows the borrower to keep operating.  If the borrower does not have the required funds to operate then it will fail to the detriment of both its owners and the lender.

Granting additional guarantees means exposing the owners of the business personally or other related businesses.  One of the greatest advantages of a corporation is separating the corporation’s liabilities from the assets of the owners or other related corporations.  Guarantees take away this protection.  

Acknowledging the amount that is owing and the validity of the loan documents and to an even greater degree consenting to judgment or the appointment of a receiver takes away the borrower’s ability to dispute any enforcement.  

For example, in the current COVID-19 environment courts may be reluctant to appoint a receiver to allow a lender to seize assets, especially if there is no direct risk to the lender of assets being dissipated and the borrower can show that it has a chance of finding alternate financing if given enough time.  By consenting to the appointment of a receiver the borrower loses any such rights. 

A guarantor may also lose potential defences by signing a forbearance agreement.  A guarantor may be able to avoid liability by arguing that the terms of a loan changed after the guarantee was signed.  By signing the forbearance agreement, which includes an acknowledgement that the guarantee is valid and an acknowledgement of the amount that is owing, the guarantor loses the right to argue that any changes to the terms of the loan from when the guarantee was originally signed invalidate the guarantee.

How do you mitigate these forbearance agreement risks?

You should not blindly sign a forbearance agreement.  Don’t be lulled by lower payments and more time.  It is important to understand your business and to know how the new forbearance terms fit with your operations.  It is also important to know what is possible.  You won’t get more time without giving something to your lender.  Understanding what the lender wants and why is key to understanding what the options are.

At WeirFoulds LLP we act for both lenders and borrowers.  We listen to understand your business needs and we know what lenders want.  We can help negotiate a forbearance agreement that will work for both you and your lender.  If your company is facing financial difficulty and you are considering entering into a forbearance agreement, contact Wojtek Jaskiewicz at wjaskiewicz@weirfoulds.com or visit our website at www.weirfoulds.com