As readers of the Journal know all too well, legislators in all countries deal with bankruptcy the way they deal with a trip to the dentist. It is something you have to do, but it is certainly not going to be enjoyable. So it is unusual, and perhaps even frightening, to see bankruptcy legislation changed more than once a decade. Twenty-five years seems to be a bit of a norm for major changes in bankruptcy legislation, but Canada once went 43 years without significant changes. This, however, is by no means a world record, since several countries have exceeded 50 years, and there are reports of some instances of insolvency reforms being almost 100 years apart.

During its last series of amendments, Canada tried to remedy the problem by providing a requirement for a review with amending legislation at the end of five years. That was in 1997. It is 2005, and the proposed new amendments have just been introduced in Parliament. This is good news in a way: It seems that five years takes longer these days than it used to.

Canada proposes to embark on several new directions in its bankruptcy legislation. Many constructive things may come from all of this, but there are a number of situations in which the Canadian government proposes to make things worse. It is a case of the "good," the "bad" and the "ugly."

First the "ugly:" Any thought that Canada would get provisions like §1113 of the Bankruptcy Code, allowing for the rejection of union contracts when no agreement can be reached and the existing contract imperils the reorganization, has been firmly squelched. Reorganizing companies will not be able to reject or alter collective agreements no matter what harm will result to other stakeholders of the business. There was a thought that the existing CCAA might permit this sort of thing, but the government has now indicated that it won't happen—ever.

Continuing in the "ugly" vein, the amendments propose a super-priority for arrears of wages, giving them priority over secured creditors holding security on current assets (viz, banks). Arrears of pension contributions would have priority over secured creditors on all assets of the debtor (viz, everyone). Wage arrears as a practical matter have not been a problem in Canadian practice, but no matter; the situation is going to be fixed whether it is a problem or not.

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Arrears of pension contributions would have priority over secured creditors on all assets of the debtor.... Wage arrears as a practical matter have not been a problem in Canadian practice, but...the situation is going to be fixed whether it is a problem or not.

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As if that isn't bad enough, a new bureaucratic organization will be created called the Wage Earner Protection Program (WEPP), although this organization will be based in a different department from the one that operates the bankruptcy system. (There is awfully deep thinking involved in some of this stuff.) The WEPP will "promptly" pay employee arrears and then will become subrogated to the employees' super-priority clams over secured creditors. This, of course, creates a government-sponsored agency with super-priority liens on the assets that the beleaguered reorganizing debtor needs most to survive. Will the government agency take a long-term reasonable view of the situation to assist the business in its attempts to reorganize and carry on? You can believe in that or the Easter Bunny—take your pick.

The economic fallout from the creation of major super-priority claims over security held by existing lenders has not yet been assessed, nor has any empirical research measured the extent of the harm to the credit system that these changes will present. Though very few businesses actually go bankrupt, every operating loan to every active business will now be reduced by the amount necessary to margin for the super-priority claims on the collateral involved. This could lead to significant contractions of credit for small and medium-sized businesses, which, after all, employ most of the workforce. This social engineering will benefit the only relative handful of employees who suffer wage arrears on the bankruptcy of their employer. It is worse than using a sledgehammer to swat a fly.

The original idea for protecting unpaid wages in a bankruptcy involved a fund that would be created through a very small weekly levy on workers' wages, along the lines of Social Security or employment insurance. A fund of this kind would have readily created enough resources to handle many years of unpaid employee wage claims and bankruptcies without creating the chaos on secured creditors that is going to result from the WEPP. That idea, unfortunately, was a tad too reasonable for the social engineers designing Canada's bankruptcy system.

Now to the merely "bad." It is claimed in the amendments that Canada has adopted the UNCITRAL Model Law on Cross-border Insolvency, which provides an international set of procedures for recognition of foreign insolvency proceedings and foreign insolvency representatives. To date, nine countries have adopted the Model Law, including, most recently, the United States as a new chapter 15 to the Bankruptcy Code.

It was called a "Model Law" because the international consensus was that all countries would adopt the same basic form of the Model Law. This would create a network of comparable domestic statutes around the world that would function, in effect, as a kind of international bankruptcy treaty. Canada, of course, was prominently involved in the development of the Model Law and signed on (as did some 60 other countries in the UNCITRAL Working Group that prepared the Model Law) to the idea that it would be adopted in substantially the same form all around the world. That was fine in theory, and the Canadian government supported the theory at the time.

But Ottawa, for inexplicable reasons, has devised its own form of Model Law, which doesn't resemble any other adaptation anywhere in the world.

And now to the "good"; this won't take nearly as much space. Provisions have been made to incorporate into legislation practices that have become standard in Canadian reorganizations. Such things as DIP financing, which was ostensibly anathema to Canadian creditors not so long ago, are given legislative recognition.

You will look in vain for creditors' committees, which Canadian legislators apparently continue to regard as expensive, time-consuming creations of the devil. There is an interesting provision under which the court can award reimbursement for professional costs reasonably necessary to permit an interested party to "participate effectively" in a case, although this may be more likely to assist larger creditors in protecting their own interests rather than assisting committees to look after the interests of creditors generally. The court has been given the power to remove directors who are impairing the prospects of a successful reorganization and to replace them with those who won't. Curiously, the court can also replace a director who is "acting inappropriately as a director," which sounds sort of imprecise.

At long last, claims of equity-holders (e.g., damages for misrepresentation, etc.) will be relegated to equity-level status in reorganizations rather than, as at present, being ordinary creditors like all other creditors.

Procedures for asset sales have been introduced, but they are overly complex. On asset sales out of the ordinary course of business, the court is directed to give a specific consideration to six factors, only one of which relates to the potential benefit to the creditors of the estate. Specific measures have been put in place to attempt to discourage the use of the insolvency process to convey assets from an insolvent company to its solvent principals.

Avoidance provisions have been streamlined. Under current law, the most important factor in an avoidance situation is the intention of the debtor. If the intention of the debtor was to prefer a particular creditor over other creditors, the creditor has received a preference that can be attacked and recovered by the trustee for the benefit of the estate. Under the proposed system, the test will be whether transfers by the debtor have taken place at an appropriate value. If not, the trustee can recover from the transferee the difference between the value received in the transaction and the actual value of the subject matter of the transaction. Avoidable preferences will now be called "transfers at undervalue," or TUVs. This is a major improvement over Canada's current intention-based test, which is complex in practice and does not effectively deter avoidance transactions.

Some improvement, but not much, has been made in reclamation remedies. The only reason that this is a positive development from the point of view of unpaid suppliers was that a proposal had been made to abolish reclamation rights entirely.

New provisions have been added to permit a court to grant a lien in favor of professionals for the payment of their reasonable fees in reorganizations. However, Canada will still lack an administrative expense priority, and unpaid claims for post-petition goods and services in a failed reorganization will continue to rank equally with unpaid claims for pre-petition goods and services—i.e., right at the bottom of the food chain. In Canadian reorganizations, suppliers are well advised to still observe the precept "in cash we trust."

Because Canada's current government does not have a majority in the House of Commons, it is hard to predict what amendments will eventually make their way into law. There are a number of observers who would prefer that none of the amendments be enacted. This is rather a harsh view of the process, and most observers consider that most of the amendments will be enacted, although there may be some changes to some of the more controversial provisions during the process. The International Scene will keep readers apprised of developments.