The anti-deprivation rule and its application in Alberta vs Ontario in light of Mayfield Investments Ltd.

The anti-deprivation rule

The Court of King’s Bench of Alberta recently released its decision in ATB Financial v. Mayfield Investments Ltd.,^[1] (“Mayfield”) and examined whether a forced share sale provision in a shareholder’s agreement violated the anti-deprivation rule. This decision highlights the importance of the anti-deprivation rule in maintaining equitable treatment of creditors during insolvency proceedings.

The anti-deprivation rule has existed under Canadian law for many years. The rule renders void any provision in an agreement where, upon an insolvency event or a bankruptcy filing, value is removed from the reach of creditors of an insolvent estate where such value would otherwise be available to those creditors.^[2] The fundamental rationale, purpose and policy behind the rule is to prevent parties from using contractual provisions to frustrate the ability of creditors of an insolvent estate to recover debts in the context of an insolvency, and to preserve the fair and equal treatment of creditors in an insolvency proceeding.

This article was written in light of the Alberta court’s application of the anti-deprivation rule in Mayfield and discusses how the anti-deprivation rule is currently being applied in Ontario. A table at the end of this article summarizes certain differences in approach to the application of the anti-deprivation rule in Ontario compared to the Alberta court’s decision in Mayfield.

The current leading case

The current leading case regarding the anti-deprivation rule is the Supreme Court of Canada’s decision in Chandos Construction Ltd. v. Deloitte^[3] (“Chandos”). In Chandos, the Supreme Court of Canada examined a provision in a construction contract that provided for a 10% fee upon a subcontractor’s bankruptcy.

The provision was found to be void as offending the anti-deprivation rule because it removed value from the bankrupt’s estate to the detriment of its general body of creditors. The Supreme Court of Canada outlined the test for a lower court to determine whether a contractual provision offends the anti-deprivation rule. The majority of the Supreme Court of Canada emphasized that the test is to consider the effect of the contractual clause on the general body of creditors of an insolvent party, and not the intention of the creditor and debtor who entered into the contract.

The two-part test is set out below:

1. Is the clause triggered by an event of insolvency or bankruptcy?
2. If so, does it remove value from the insolvent’s estate?

The ability of courts to override terms of private contracts as a matter of public policy in order to maintain value for all creditors in an insolvency proceeding has been applied in both the Ontario and Alberta courts. It is important to be aware of the nuances of this test. Specifically, the rule will not render void all transactions that remove property from an estate, it is not offended by the granting of security, and it is not offended by clauses triggered by events other than the debtor’s insolvency or bankruptcy.^[4]

How the anti-deprivation rule has been applied in Ontario

Prior to Chandos, the principles behind the anti-deprivation rule were analyzed by and developed in Ontario courts with its own nuances.

Pre-Chandos

In Canadian Imperial Bank of Commerce v. Bramalea Inc.^[5] (“Bramalea”), the Ontario court ruled that any agreement removing value from an insolvent person’s creditors and placing it in others’ hands (outside a valid secured transaction) is void as it violates public policy of fair distribution among unsecured creditors. In Bramalea, the court expanded on the doctrine by reasoning that the principle of fraud upon bankruptcy applies not only to the deprivation of an asset, but also to cases where an asset is acquired for less than its full value.^[6] This does not require proof of fraud per se but rather, fraud as an effect.

In Aircell Communications Inc. v. Bell Mobility Cellular Inc.^[7] (“Aircell”) the Ontario Court of Appeal extended the principle from Bramalea, declaring the clause unenforceable as it violated public policy requiring fair distribution among a bankrupt’s creditors. Bell Mobility demanded payment of a $64,000 equipment debt from Aircell before paying $189,000 in commissions, unaware that Aircell had filed for bankruptcy. The Ontario Court of Appeal ruled in favour of the insolvency trustee, stating that the clause allowing Bell Mobility to withhold commissions was void as it committed a fraud on the bankruptcy^[8] by unfairly withholding funds from Aircell’s creditors.

In Hutchingame Growth Capital Corporation v. Independent Electricity System Operator^[9] (“Hutchingame”), the Ontario court examined the public policy concerns of the anti-deprivation rule. Greenview Power entered into a contract to build a biomass renewable energy facility for the Ontario Power Authority, later succeeded by the Defendant (Respondent).^[10] After failing to meet deadlines, Hutchingame took control in 2012.^[11]

The contract was amended in 2013, but Greenview Power went bankrupt in 2014, terminating the contract.^[12] Hutchingame could have revived the contract as a secured creditor but instead tried to assign its rights to another entity. The insolvency trustee obtained a court order approving the purchase of the bankrupt’s assets.^[13]

The trial court in Hutchingame found that the contract clearly terminated on bankruptcy, the attempt to assign the contract failed, and dismissed Hutchingame’s claims for damages. On appeal, the Ontario Court of Appeal upheld this decision, stating that the termination clause did not violate the “anti-deprivation rule” as it did not cause creditor inequality therefore “does not offend the public policy expressed in [Bramalea and Aircell].”^[14]

In Hutchingame, the Ontario courts focus on the effect of the contractual provision in question rather than simply deciding whether the provision meets the two-part test to trigger the application of the anti-deprivation rule. As the contractual provision did not cause any inequality, the anti-deprivation rule was not offended.

Post-Chandos Ontario case law

After Chandos, Ontario courts continued to follow the standards set by the Supreme Court of Canada’s application of the anti-deprivation rule. This case law, while sparse, makes it clear that there are similarities in approach between Ontario and Alberta courts.

In Validus Power Corp. et al. and Macquarie Equipment Finance Limited (“Validus”),^[15] the Ontario court analyzed the provision under the effects-based test but distinguished itself from the facts in Chandos. Specifically, the anti-deprivation rule was not engaged because the entitlements under the Stipulated Loss Value provision arose from the Validus’ default on rent payments, not from their insolvency. The court emphasized that the amounts claimed by the creditor would have been the same regardless of the insolvency status of the Validus. Additionally, the agreements were made by sophisticated parties and did not intend to circumvent the statutory regime for bankruptcy.^[16]

The Ontario court also focused its analysis on the effect of the provision and the intention of the parties, finding that it was not the intent of the parties, nor the effect of the agreements, to circumvent the statutory regime that provides that all claims provable in a bankruptcy shall be paid rateably.^[17] Therefore, the provision was found to be valid.

In Urbancorp Toronto Management Inc. (Re),^[18] there was a dispute over the proceeds from the transfer of a non-arm’s length lease. The court examined whether the anti-deprivation rule applies in circumstances where an impugned provision is not expressly triggered by an event of insolvency, but the effect of the clause is to “strip value” from the insolvent debtor’s estate.

The court undertook a “form over substance” analysis in the application of Chandos by finding that the anti-deprivation rule does not apply to provisions that do not expressly reference an event of insolvency. The court made it clear that the focus of the concern is (a) whether the provision in question is “triggered” by an event of bankruptcy or insolvency and (b) whether the effect of the contractual provision is to deprive the estate of assets upon bankruptcy.

The Court of King’s Bench of Alberta’s decision in Mayfield

The Court of King’s Bench of Alberta considered the anti-deprivation rule in Mayfield^[19] where the Alberta court examined a forced share sale provision in a shareholder’s agreement and whether it offended the anti-deprivation rule. The provision entitled two shareholders to purchase the shares of the other shareholder if that shareholder entered receivership. When one shareholder was placed into receivership, the other two shareholders sought to exercise their rights under the share sale provision in the shareholder’s agreement. Ernst & Young Inc. as the receiver for Mayfield Investments Ltd. argued that the provision was void pursuant to the anti-deprivation rule, while the shareholders argued that it failed to meet the test in Chandos, namely that the triggering event was not the receivership, but rather a notice that was sent by the appointing creditor and, therefore, the receiver’s argument failed to meet the first part of the Chandos test.

The Alberta court found that the triggering event could only be the receivership after examining the factual matrix. Specifically, the Alberta court reviewed the relevant dates of various correspondence to determine what triggered the use of the share sale provision. The Alberta court found that, based on the dates, the first part of the Chandos test was met. With respect to the second part of the test, it was clear to the Alberta court that if the shareholders were permitted to purchase the shares, then assets of the estate would be sold for less than its full value. This would have the effect of reducing the debtor’s assets available for realization for the benefit of its general body of creditors.

Both Ontario and Mayfield follow the principles laid down in Chandos, with slight nuances

Mayfield highlights that the Chandos effects-based test has been applied similarly in both Alberta and Ontario, albeit with varying degrees of analysis, as set out below.

Similarities:

	Ontario	Mayfield
The test	Effects-based test	Effects-based test
Triggering event	An event of insolvency or bankruptcy	An event of insolvency or bankruptcy

Differences:

	Ontario	Mayfield
Analysis of triggering event	General analysis of the triggering event in the case	Detailed analysis of the specific triggering event
Procedural compliance	Reduced focus on determining the procedural steps taken by the parties	A consideration of the timing of procedural steps to determine whether the first part of the test is met
Public policy considerations	Emphasis placed on public policy considerations in addition to the application of the effects based test	Focused primarily on whether the facts met the two-part effects based test

The Alberta court in Mayfield and the Ontario courts share a similar approach and methodology when applying the anti-deprivation rule. The case law in both provinces value the insight provided by the Supreme Court of Canada in Chandos and utilize the two-part effects-based test as the key to the rule’s application. The case law in both provinces further provides that an event of insolvency or bankruptcy as a trigger to the use of the rule and both jurisdictions will analyze whether the provision, if enforceable, would remove value from the insolvent’s estate.

The case law does differ in analysis in certain areas. In Mayfield, a detailed fact-finding analysis was undertaken by the Alberta court to determine what event was being relied upon to trigger the anti-deprivation rule. The court in Mayfield held that if the insolvency did not trigger the provision, then it may not be found that the provision offended the anti-deprivation rule^[20]. The analysis in Mayfield denoted a more straightforward application of the effects-based test based on the factual matrix of the case.

On the other hand, the Ontario case law appears to apply additional surrounding factors in addition to the application of the facts to the effects-based test, including the intention of the parties to the contract, the effect that the impugned clause will have on creditors, and public policy concerns. For example, the court in Hutchingame^[21] went beyond simply determining whether the test was met and looked more closely at the effect of the provision. In so doing, the Ontario court found that, while it may be argued that a termination of the agreement upon bankruptcy would prevent a secured creditor from exercising its rights over a secured asset, the reality of the situation is that no inequity between the creditors was created as a result of the provision. The Ontario Court of Appeal concluded that the provision should stand under the facts of that case.

Conclusion

The Alberta court’s decision in Mayfield is a clear indication that the principles outlined in Chandos continue to be applied in both Alberta and Ontario. Parties who enter into contracts should be aware of the language that they use in their contracts and more importantly, the effect of the provisions in circumstances where an insolvency event may apply in the future. If a contractual provision is triggered by an event of insolvency, such provision cannot have the effect of depriving creditors of the value of the debtor’s assets from the insolvent estate. Varying degrees of analysis have arisen from Ontario and Alberta case law, and Canadian case law is expected to continue to evolve as the general body of law across provinces continues to develop.