By Benoît-Mario Papillon, Ph.D., Department of Finance and Economics School of Management, UQTR

The Bankruptcy and Insolvency Act (BIA) and the Companies’ Creditors Arrangement Act (CCAA) are two general laws designed to resolve business insolvencies. In terms of general “solutions” for business insolvency, receivership can be added to these two laws.

In a mixed economy like Canada’s, the private sector is in charge of a significant portion of goods and services production. Business insolvency occurs due to the credit that companies use to finance their investments and activities. In other words, credit and business insolvency are two sides of the same coin.

To produce the goods and services we need, it’s useful to be able to draw on a wide range of resources (know-how, working time, various types of equipment, raw materials and semi-processed products, etc.) from various places. Every separate human need arises in a given place, at a given time and for specific reasons. We sometimes say that companies are vehicles that bring resources closer to needs, by changing their location, moving them across time – in the case of retail inventories, for example – and transforming and combining them in a multitude of ways, to make, say, a car engine from a bunch of different ores. Savings, which are essential for financing these “trips,” can be seen as the fuel that keeps these vehicles running. Credit provides access to savings. Are credit and its probable outcome – business insolvency – avoidable, and if so, to what extent?

An Imaginary World, Risk Aversion and Transaction Costs

Let’s imagine an economy where companies have no recourse to credit, reducing the probability of insolvency to zero. In this scenario, the company is financed entirely by equity or customer advances. These two sources of financing are already in common use, but their scope is limited.

For equity to fully meet a company’s financing needs, two conditions must be met. The first condition is related to the distribution of available savings among the population: the distribution must give entrepreneurs and business owners access to the savings they need to carry out their projects. Although a perfect match between savings distribution and financing needs is unlikely, let’s imagine it happens.

The second condition is related to non-aversion to risk. Entrepreneurs and owners with enough savings for their business needs, but no more, must be willing to put all their eggs into one basket. Like the general public, however, many of these people are risk-averse to varying degrees.

We can also imagine that, in addition to the amount of savings that the entrepreneurs and owners are willing to invest in the business, it is financed by advances from its customers. This is already common practice in some sectors. If you ask a shipyard to build you a freighter, advances will be required as the construction of the freighter proceeds. Compared to the total financing of the shipyard, these advances are modest, even if you had to pay the full cost of the freighter before construction began. The shipyard’s main tangible asset is the dry dock and all its equipment, the cost of which will be amortized over more than a decade of operation. Full financing through customer advances would mean signing contracts with all future customers during that period and getting them to pay the full cost of the freighters they want to buy in advance. Organizational economic theory would say that this scenario is unrealistic because of prohibitive transaction costs.

In business financing, credit is an essential means of accessing savings. The frequency of business insolvencies has changed over time. To understand this trajectory and the value of insolvency proceedings, we need to consider other factors.

An Alternative for Business Insolvency and Proceedings: Credit Management

The inevitability of creditor losses stemming from a company’s insolvency is not beyond the understanding of ordinary people. The interactions between creditors and a debtor prior to insolvency influence the volume of these losses. The value of insolvency proceedings is partly the outcome of these interactions.

Over the last few decades, setting aside some sizeable annual fluctuations, the number of business insolvencies has remained relatively stable. The level of economic activity and the number of businesses have both increased significantly over this long period, however, and the most striking fact, in terms of business insolvency, is the reduction in its relative scale as measured by the business insolvency rate (number of cases per thousand businesses), which has fallen almost continuously year after year. From an annual rate of over six companies per thousand at the end of the 1990s, this rate is now just over one company per thousand. This has reduced the relative scope or scale of business insolvency proceedings in the Canadian economy by over 80%. A trend of this length cannot be explained by cyclical factors. It requires us to go back to the origins of business insolvency: the relationships surrounding companies’ use of credit.

Organization of banking services

For a long time, the banks’ main credit concern was the integrity of their employees. In the hierarchy of a branch, there were front-line staff, providing service at the tills, and managers, who were responsible for making loan decisions. These managers had to be moved frequently to ensure their integrity. This has changed a lot. First, new information and communication technologies (NICTs), combined with assessment tools derived from research on predicting bankruptcy rates (Altman (1968), ...), have given banks better ways of assessing credit applications and monitoring the loans they grant.

Second, these technologies and analysis tools have allowed financial institutions to set up teams of specialists who can operate remotely, taking more clear-sighted action with companies that report difficulties. This organizational transformation that improved assessment and monitoring in business lending unfolded over the last few decades, and employees of these institutions who took part in it and who are now at the end of their careers say it played a decisive role in the long-term decline in business insolvency rates. From this perspective, closer management of business loans serves as a kind of alternative for business insolvency and the related proceedings.

Financial institutions have to bear part of the cost of business insolvency, and the impetus for this transformation was the desire to reduce that cost while maintaining a credit offer based on interest rate levels and the projected profitability of the companies they finance.

Insolvency costs and supplier credit

A considerable proportion of business insolvency costs is also borne by ordinary creditors, especially companies that produce semi-processed or consumer goods or perform services and supply these goods or services to other companies on credit. In addition to reducing B2B transaction costs, supplier credit is the main source of external financing for SMEs.

SMEs do not have the resources of a large financial institution to use NICTs to develop supplier credit assessment and monitoring tools, but business information organizations, such as Dunn & Bradstreet and Altares, are investing in these tools to improve their service offering to SMEs. It’s too early to predict what effect this will have on the business insolvency rate, but we can assume that more careful management of supplier credit will push the rate downwards.

Zombie Companies, Competition, Jobs and the Value of Business Insolvency Proceedings 

The imaginary world evoked above, particularly the aspect where a substantial portion of company financing comes through advances from current and potential customers, is not as far-fetched as you might think. In large groups of related companies, such as Japanese keiretsus, intercompany or intragroup financing, either directly or through a bank affiliated with the group, is similar to advances from group members who are the main customers of other members that are financed in this way.

One factor that helps explain Japan’s very low business insolvency rate is the use of intragroup financing to avoid insolvency. The beneficiary company is referred to as a “zombie” in the current literature on struggling companies. A widely cited article on zombie companies (Caballero, Hoshi & Kashyap, 2008), based on a study on the financing of struggling Japanese companies, concludes that this practice slows productivity growth and job creation by keeping zombies sheltered from the effects of competition. Similarly, insolvency proceedings can slow down the effects of competition on ailing companies or help to achieve these effects more cost effectively.

We can think of the value of business insolvency proceedings and their governing law as the difference between the benefits they help generate and their cost. The effects of competition mentioned above are benefits that are discernible at the global level, but in practice, business insolvency proceedings are applied on a case-by-case basis. Could the beneficial effect generated by special treatment in a particular case be misleading?

This is one of the questions raised by the recent decision of the Ontario courts to order the re-opening of an auction duly conducted by the LIT, in the context of a receivership, on the pretext that a higher price will be obtained (Cameron Stephens Mortgage Capital Ltd. v. Conacher Kingston Holdings Inc. 2025 ONCA 732). Moreover, this decision creates judicial uncertainty around LIT work, which is likely to reduce the value of both that work and business insolvency law.

This kind of cost-benefit analysis can only partially answer the questions raised by the design and application of laws for struggling businesses. It does remind us, however, that the law is not applied in a vacuum but, rather, in a context that offers alternatives. Ideally, the law would be used to its full advantage, fostering a desirable level of competition in the economy. It should also support economic activity and innovation by avoiding excessive or overly tight management of bank or supplier credit before insolvency begins.