When a company enters formal Canadian insolvency proceedings, whether it is a restructuring or liquidation scenario, the Canadian legislation and courts have held that the “interest stops rule” applies in respect of unsecured claims, meaning interest ceases to accrue on such claims after the filing date. A recent decision from the Alberta Court of Appeal has confirmed that the interest stops rule does not apply to secured claims to the extent there is sufficient value in the creditor’s collateral. The decision has confirmed that secured creditors are entitled to payment of their post-filing interest as part of their secured claim, while unsecured creditors’ post-filing interest entitlements are to be disregarded, thereby affording equivalent treatment to the class of unsecured creditors whether or not their claims are interest-bearing.
In Canada, bankruptcy is a legal process governed by the Bankruptcy and Insolvency Act (the “BIA”) whereby an appointed trustee in bankruptcy liquidates the company’s assets, determines the claims of creditors and distributes according to a statutory priority scheme. The BIA specifically provides that for unsecured claims, interest stops accruing at the time of the bankruptcy. Interest is only payable on the provable unsecured claims after bankruptcy in instances where there is a surplus after payment of all claims. In a bankruptcy, secured creditors are unaffected and are entitled to payment of their debt, plus interest, to the extent of the value realized from their collateral, ahead of other creditors and in accordance with the statutory priority scheme.
While the interest stop rule on unsecured claims is not codified in restructuring proceedings under the Companies Creditors Arrangement Act or in receivership proceedings, the Courts have extended the rule to apply in such proceedings (see National Bank of Canada v Twin Butte Energy Ltd., and Nortel Networks Corporation ). The interest stops rule has been described as a necessary corollary of the pari passu principle, the purpose of which is to provide for fairness to unsecured creditors and an orderly administration of an insolvent debtor’s estate. The result is that the assets of the insolvent debtor are to be distributed amongst creditors of the same class rateably and equally as those assets and claims are found at the date of insolvency.
In the recent receivership proceeding of Easy Legal Finance Inc. v. Law Society of Alberta the Law Society of Alberta obtained an order appointing a custodian over Higgerty Law, a law firm where trust funds were suspected of being misappropriated from one of the firm’s trust accounts. The Law Society and custodian then applied to appoint a receiver over any financial entitlements associated with the contingency files for which Higgerty Law was retained as counsel. At the same time, they sought an order stopping accrual of interest in relation to Easy Legal Finance Inc’s secured claims, arguing that the court-ordered stay of proceedings and remedies imposed in the receivership prevented interest from accumulating and was necessary to prevent a dissipation of the assets in favour of the secured creditor, which would erode some or all unsecured creditors’ recoveries. Easy Legal Finance Inc. was the largest secured creditor of Higgerty Law.
The lower court judge favoured the disallowance of secured creditors’ post-filing interest, considering that to be a balance of the burdens of the proceedings and equities for all creditors by avoiding a shift of further recoveries in favour of the secured creditor’s accruing interest.
This lower court decision represented a novel approach to the accrual of post-filing secured interest and, if adopted widely, would have material implications for secured lenders who may find themselves and their recoveries tied up for an extended period in an insolvency proceeding they do not control, and during which their contractual interest entitlements would not accrue. This approach would significantly incentivize secured creditors to move for expedited recoveries for their own claims that are no longer accruing interest, regardless of the impact on value maximization, the overall restructuring process, or on other stakeholders.
Following the Law Society of Alberta’s success at the lower court, Easy Legal Finance Inc. appealed the decision of the lower court terminating the ongoing accrual of secured interest. In the appeal proceeding, the respondents argued that the impact of regulatory function and the nature of the collateral necessitated an expansion of the interest stops rule in this case to include the appellant’s accruing secured interest claims. They argued that there may be public policy reasons to protect particularly vulnerable unsecured creditors, specifically in this case the clients of the law firm who may suffer due to trust shortages. The Law Society tried to further distinguish the current case from other cases taking the position that the circumstances were different because these particular receivership and liquidation proceedings were not only because of the law firm’s insolvency, but were also to deal with the transfer and winding up of live files.
Despite the facts of this case being arguably unique, giving rise to a public policy argument, the Court of Appeal did not find sufficient basis to encroach on a secured creditor’s contractual right to interest. It is clear from this decision that the purpose underlying the interest stop rule is to ensure equal treatment of similarly situated unsecured creditors within the same class, and does not therefor apply to secured creditors. The decision reaffirms that a secured creditor’s contractual interest entitlements remain protected in insolvency proceedings, at least to the extent of that secured creditor’s collateral value, despite any public policy arguments that the circumstances favor equivalent treatment of all creditors’ interest claims.
Accordingly, despite proceedings taken in relation to a debtor’s insolvency, secured creditors continue to accrue interest to the extent of the value of the creditor’s collateral and as contractually or otherwise legally entitled until the date of payment, so long as the rate of interest charged is in compliance with Canadian laws regarding penalties and criminal rates.
