Know your priorities!

A fundamental purpose of the Bankruptcy and Insolvency Act (“BIA”) is to ensure a bankrupt’s assets are distributed to creditors pari passu.  Such is the latin maxim for sharing proportionally and without preference. That’s not always the case.  The priority pursuant to which a creditor receives payment of a dividend is governed by the section 136 scheme of distribution (“Scheme”) as set out in the BIA. Depending on where a creditor ranks under the Scheme it may receive the full amount of its dividend in priority to the other creditors. If, for example, a creditor has a priority claim of $100 it will receive that amount in full before the other creditors receive their pro rata share of the net proceeds.

A readily available yet often unclaimed priority is for the fees and costs of the first execution creditor pursuant to sections 136(1)(g) and 70(2) of the BIA “to the extent of the realization from the property exigible thereunder”. Section 70(2) provides that despite the precedence of a Bankruptcy Order over all judicial or other attachments including garnishments and executions, a lawyer’s Bill of Costs shall be payable to the creditor who has first attached by way of a garnishment or execution or other process against the property of the bankrupt.  By way of example, a creditor issues a Notice of Garnishment which results in the seizure of $100. Upon bankruptcy the $100 vests with the Trustee (unless funds have already been paid by the Sheriff to the creditors pursuant to the Creditors Relief Act or the bankruptcy interferes with the rights of secured creditors: section 70(1)).  The cost priority makes sense in that it would operate to ensure the creditor could claim a priority for its fees in connection with the garnishment which in turn benefited the Trustee, and in turn the general body of creditors, to the extent of the $100. 

The statutory language suggests that an actual realization may need to occur before the priority attaches and that the mere filing of an execution is insufficient. However, there is long standing authority that the intention of the BIA is to provide for the cost priority and too close or literal reading of the text ought not to be permitted to bring about a result not intended [Re Drysdale Estate [1938] 19 C.B.R. 324 (“Re Drysdale”)]. Upon reflection, it stands to reason that but for the filing of the first execution a bankrupt could have encumbered its property or transferred it to the prejudice of the estate. Consequently the first filed execution has the effect of securing the property for the benefit of the Trustee and estate creditors resulting in an eventual realization and often a fairly large one at that. This interpretation is consistent with the spirit and intent of the legislation.

Following the decision in Re Drysdale, Justice Wong of the BC Supreme Court sitting in bankruptcy provides an insightful analysis of the principles underpinning the priority in Re Walker 67 C.B.R. (5th) 71.    The intention of section 70(2) is to provide for the first execution creditor’s costs which extend to the “costs of recovering judgment” and the costs involved in “prosecuting the claim into judgment and execution”. The Court held that execution proceedings which come after judgment including appeals and execution proceedings are caught within section 70(2) and that the initial “judgment” cannot be the dividing line. It is of no consequence that the creditor’s costs may not have been taxed. That does not deprive a first execution creditor of the priority.  This in turns provides a first execution creditor with a remarkable opportunity to recover its costs in priority to the other estate creditors provided it files a Proof of Claim claiming the priority! Having acted for trustees it is surprising to note how infrequent s. 136(1)(g) claims are received.

Counsel should also be mindful the priority can be claimed to obtain payment on an outstanding account rendered to the first execution creditor client. Seeing as the priority belongs to the client it will be necessary to obtain an Authorization & Direction to have the preferred claim paid directly to counsel.  If counsel has been paid then the priority would of course be paid directly to the client.  

As a further benefit, the 5% Superintendent’s levy on all dividends payable (to assist in defraying the expenses of its supervision) is exempt on dividends paid to the first execution creditor under the s.136(1)(g) priority.

It is good practice for counsel acting for execution creditors to immediately conduct execution searches in the jurisdictions whereat writs were filed upon receiving notice of a bankruptcy. It will then become apparent whether the client can claim the priority if it filed the first execution and so long as the bankrupt has exigible property that became bound therefrom.

Sean N. Zeitz practices commercial litigation with an emphasis on bankruptcy and insolvency matters. He is certified by The Law Society of Upper Canada as a Specialist in Civil Litigation and Bankruptcy and Insolvency Law.

This article originally appeared in an issue of the The Lawyers Weekly published by LexisNexis Canada Inc.