A secured creditor who has a client that has fallen into financial difficulty and has defaulted on its loan obligations is faced with the unenviable task of determining how best to recover the amounts it is owed from the collateral that has been pledged by the debtor. Depending on the nature of the security and the amount outstanding, the secured creditor may appoint a receiver to realize on the collateral for its benefit. In certain situations, the secured creditor may wish to assess its exposure relative to other potential claims against the debtor's assets. The most common situations where it may be advantageous to a secured creditor to consider bringing a bankruptcy application against the debtor would be to reverse the priority of claims against the debtor's property; to ensure unfettered access to the debtor's premises to maximize the realization on the collateral; or to utilize the provisions of the Bankruptcy and Insolvency Act to pursue preferential payments or other improper transactions made by the debtor. Regarding competing priorities, the federal and provincial governments have enacted legislation that gives them a statutory priority over the interests of secured creditors for certain amounts owed to the government such as goods and services tax, provincial sales tax and workers compensation premiums. A bankruptcy would reverse these priorities in favour of the secured creditor. Accordingly, a secured creditor would look at these claims as compared to the costs of a bankruptcy to determine if they would recover more by having the debtor put into bankruptcy. Another reason for considering a bankruptcy in conjunction with a receivership concerns the landlord. If there are significant rent arrears, a receiver will have no greater rights than a tenant with respect to the premises. As a result, should a receiver be unable to negotiate an occupation agreement with the landlord and the lease is terminated, the collateral would have to be removed from the premises at significant cost. In addition, the ultimate recovery for the secured creditor would likely be significantly lower. By obtaining a bankruptcy order prior to the termination of the lease, the secured creditor, through the trustee in bankruptcy, will be able to maximize the recovery from the collateral without interference from the landlord. This scenario can be extremely important when the success or failure of a realization is dependent on converting work in process inventory into finished goods. Prior to pursuing a bankruptcy application for the above reasons, it would be prudent for the secured creditor to have their security documentation reviewed by legal counsel to ensure that the security would be valid and enforceable as against a trustee. Otherwise, they may find themselves as only being unsecured creditors because of a defect in the security. The third situation where it may be advantageous to a secured creditor to have a bankruptcy would be to utilize the provisions of the BIA to pursue preferential payments or transactions at undervalue. The secured creditor would not have any priority under its security to recoveries that may be made from legal actions to reverse these types of transactions, but if they have a significant shortfall after realizing on the collateral and the preferential payments or transactions at undervalue are significant, a bankruptcy may still be advantageous to the secured creditor. Since the secured creditor would in all likelihood be funding the legal action to recover the asset, the secured creditor could enhance its entitlement to any recoveries by having the trustee assign the legal action to the secured creditor through a proceeding governed by Section 38 of the BIA. The above is not a complete treatment of the subject. There may be other factors for a secured creditor to consider when it is faced with having to enforce its security. » Wayne K. Palmer is a senior manager in BDO's Brandon office. He is responsible for both the consumer and commercial practices in Brandon and surrounding areas, including Boissevain , Minnedosa , Neepawa and Dauphin . Wayne has more than 25 years experience in the financial recovery services field.
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