Authors:
William E.J. Skelly, Partner, MLT Aikins LLP
Dana M. Nowak, Partner, MLT Aikins LLP

Case Link: EncoreFX Inc. (Re), 2023 BCSC 39

Introduction

The insolvency of EncoreFX Inc. (EncoreFX) in March of 2020 raised novel issues regarding transitioning a bankruptcy proceeding to a proceeding under the Companies’ Creditors Arrangement Act, SC 1985, c C-36 (CCAA). In particular, unique considerations arose within EncoreFX’s restructuring regarding the legal framework applicable to a company’s concurrent bankruptcy and CCAA proceedings. Consequently, the Office of the Superintendent of Bankruptcy (OSB) became involved in EncoreFX’s restructuring for the purpose of advising the Supreme Court of British Columbia (Court) regarding policies relevant to such a transition.

Further, the nature of EncoreFX’s business provided a unique opportunity to consider the scope of Part XII of the Bankruptcy and Insolvency Act, RSC 1985, c B-3 (BIA), which applies to “securities firms” and was an issue raised by certain stakeholders of EncoreFX.

This article will address both (i) the novel issues regarding transitioning a bankruptcy to a CCAA restructuring and (ii) the impact that BIA Part XII could have had on EncoreFX had it applied to the company.

Transition from Bankruptcy to CCAA Proceedings

EncoreFX was in the business of providing foreign exchange or “FX” risk management services and cross-border payment solutions. On March 30, 2020, EncoreFX made an assignment in bankruptcy (Bankruptcy) in response to market volatility largely attributable to the Covid-19 pandemic. Ernst & Young Inc. was appointed as trustee of EncoreFX (Trustee).

The Bankruptcy evolved into an exceedingly complicated matter, due to both the realization of EncoreFX’s assets and the determination of provable claims against the estate of EncoreFX. On March 30 2021, the Trustee obtained a court order transitioning the Bankruptcy into a CCAA proceeding (Transition), the primary purpose of which was to simplify complexities within the Bankruptcy. The Trustee became the monitor in EncoreFX’s CCAA proceedings (Monitor).

In approving the Transition, the Court made the following observations:

1. EncoreFX was not statutorily prohibited from seeking CCAA protection despite its Bankruptcy.
2. Allowing EncoreFX the benefit of a more flexible process under the CCAA benefitted all of EncoreFX’s stakeholders.
3. The Transition was to be accomplished by way of an initial order under the CCAA rather than a conversion order, the latter of which is commonly used when a company transitions from a Notice of Intention to Make a Proposal to Creditors under the BIA to a CCAA proceeding.
4. The Bankruptcy would remain extant but stayed pending the conclusion of EncoreFX’s CCAA proceedings.

The CCAA proceedings were pre-packaged and moved quickly. In April 2021, the Monitor filed a plan of arrangement (Plan) and, in May of 2021, the Plan was approved by both the requisite creditors and the Court. In November of 2022, the Monitor obtained an order concluding the CCAA proceedings and discharging the Monitor.

A question remaining for the Court was how to address EncoreFX’s extant Bankruptcy. EncoreFX was still a bankrupt under the BIA, although EncoreFX’s assets and debts were addressed within the CCAA proceedings. Specifically, the Court needed to address whether to annul the Bankruptcy and, if so, whether to do so ab initio.

The Bankruptcy annulment issue was of particular interest to the OSB, who liaised with the Trustee to raise the following policy issues for the Court’s consideration:

1. The BIA contains a functional gap regarding the treatment of bankruptcy proceedings upon the granting of a CCAA initial order. Analogously, section 61(1) of the BIA expressly authorizes a court to annul a bankruptcy upon its approval of a proposal made pursuant to the provisions of the BIA. No such mechanism exists under the BIA to terminate bankruptcy proceedings when a bankrupt obtains a CCAA initial order.
2. The contemporary thrust of legislative reform is to harmonize aspects of insolvency law common to statutory schemes to the extent possible so as to discourage “statute shopping” and avoid “skewed incentives against reorganizing under the CCAA”: Century Services Inc. v Canada, 2010 SCC 60 at paras 24 and 47.
3. A bankrupt’s transition into a CCAA proceeding should be consistent with a transition into a BIA Division I Proposal pursuant to BIA ss.61(1): the bankruptcy should be annulled ab initio, subject to appropriate saving provisions.

The Court determined that the Bankruptcy should be annulled (Annulment), but declined to do so ab initio for the following reasons:

1. As regards harmonious statutory interpretation, it is difficult to conceive that Parliament intended a different result in respect of a bankruptcy as between a later successful BIA proposal and a later successful CCAA plan of arrangement. However, Parliament has not seen fit to expressly provide for an automatic annulment of the bankruptcy in the latter scenario.
2. BIA s.181(1) only allows an annulment if the court first determines that the “assignment ought not to have been filed”.
3. An annulment of a bankruptcy is a discretionary remedy and is to be used sparingly, in special circumstances. In exercising its discretion, a court must take into consideration and balance all the interests of all stakeholders, including the creditors, the bankrupt and third parties.
4. EncoreFX made an urgent decision to assign itself into bankruptcy before foreign exchange trading commenced on March 30, 2020. All options other than an immediate filing of an assignment into bankruptcy would have required time, which EncoreFX and its stakeholders did not have.
5. The filing of the assignment was an advisable course of action given the information known to EncoreFX and the Trustee at the time. Potentially knowable critical information that was not available to EncoreFX at the date of Bankruptcy, but which subsequently became known, included that: (i) certain security interests in EncoreFX were deficient; (ii) various property claims would be disallowed; and (iii) EncoreFX’s bank would permit electronic funds transfers to occur notwithstanding the BIA stay of proceedings.
6. Had EncoreFX had sufficient time to understand the full factual landscape and explore the above issues, it would have chosen the path of the CCAA restructuring as better serving the interests of EncoreFX’s stakeholders.
7. EncoreFX’s creditors had no residual interest in the Bankruptcy that might be served by refusing the Annulment.
8. Granting the Annulment caused no violence to the public interest or to preserving the integrity of the bankruptcy process.
9. Interpreting s. 181 to allow an annulment in EncoreFX’s unique circumstances is consistent with the overall statutory objectives of Canada’s insolvency regime. Those objectives include promoting as much flexibility as is appropriate toward allowing debtors to fashion creative solutions to what can be complex financial issues, all for the benefit of stakeholders.
10. The timing of the Annulment (ie. ab initio or at the date of the order) was not relevant to the validity of any specific actions undertaken by the Trustee or orders granted by the Court. Section 181(2) of the BIA operates so as to preserve the actions undertaken by the Trustee from March 2020 to March 2021 and the Court approved various transactions in the BIA proceedings within that timeframe. Thereafter, the Trustee’s actions in the CCAA proceedings were authorized by court order. As such, it was not necessary to address the issue as to whether an assignment in bankruptcy should be annulled under s. 181(1) on an ab initio basis.

The OSB played a meaningful role in advancing broad policy considerations to the Court regarding the Annulment.

An important takeaway from EncoreFX is recognizing when to notify the OSB regarding novel insolvency issues within a formal insolvency proceeding. The OSB may want to advance policy arguments to a court for the purpose of preserving the integrity and consistency of Canada’s formal insolvency regimes.

Consideration of BIA Part XII

BIA Part XII applies to securities firms who carry on the business of “buying and selling securities from, to or for a customer, … , and includes any person required to be registered to enter into securities transactions with the public…”. A security means “any document, instrument or written or electronic record that is commonly known as a security” and includes, inter alia, eligible financial contracts.

BIA Part XII simplifies securities firm bankruptcies by eliminating competing customer trust claims. Functionally, a trustee of a securities firm is only entitled to deal with the cash and securities which vest in the trustee under BIA Part XII, s. 261: Farm Mutual Financial Services Inc. (Re), 2009 CanLII 56737 (ONSC) at para 47. Funds held in the name of a customer do not form part of the bankrupt estate and must be returned to the customer. Property which otherwise vests in the trustee is pooled into either a “customer pool fund” or a “general fund”. A customer pool fund is distributed to customers in proportion to their net equity: BIA ss. 253 and 262(1).

Although EncoreFX may have met the BIA Part XII definition of a securities firm, none of EncoreFX’s transactions were eligible financial contracts. Rather, the transactions were over-the-counter and privately traded, which falls outside of the ambit of BIA Part XII and applicable securities legislation.

Had BIA Part XII applied to EncoreFX, customers with funds held by the Trustee would have benefitted from a customer pool fund which would have entitled them to be paid ratably from that fund in priority to other creditors of EncoreFX, except for secured creditors per BIA s. 254(5). Such an entitlement would have incorrectly and negatively impacted the rights of other creditors of EncoreFX, such as creditors with valid and enforceable property claims.

When considering whether BIA Part XII applies to a bankruptcy, it is critical to consider whether a bankrupt meets the definition of a securities firm. If so, then a trustee must then also determine whether the customers of a bankrupt: (i) are entitled to recover their investment in full pursuant to a customer name account, (ii) may recover ratably with other customers by way of a customer pool fund, or (iii) are simply unsecured creditors entitled to be paid ratably from a general fund.

Final Curtain Call

EncoreFX is precedential because it addresses best practices when converting a bankruptcy to a CCAA proceeding, a process for which scant jurisprudential guidance exists. EncoreFX’s impact on both commercial and consumer bankruptcies (the latter as it pertains to a consumer making a proposal out of bankruptcy) remains to be seen. While it is possible that EncoreFX is a stand-alone decision based on EncoreFX’s unique circumstances, a more likely outcome is that it will guide the courts, the OSB, and insolvency practitioners regarding best practices when transitioning from a bankruptcy to an alternative formal insolvency regime in order to streamline and facilitate the administration of a complex bankruptcy.