Liens and insolvency: beware of the nuances

July 2017 | PROFESSIONAL INSIGHT | BANKRUPTCY & RESTRUCTURING

Financier Worldwide Magazine

July 2017 Issue

In Nelson Drywall Interiors Alberta Inc v. Dowland Contracting Ltd and KNC Holdings Ltd v. FTI Consulting Canada Inc et al, the superior courts of Yukon and Saskatchewan respectively provided guidance to court officers and creditors as to the treatment of lien claims in insolvency proceedings under the Bankruptcy and Insolvency Act (BIA).

Secured or unsecured, that is the question

In Nelson Drywall, the Yukon Superior Court reaffirmed the importance of being aware of the nature of a lien claim and taking steps to protect and enforce the claim prior to insolvency proceedings; especially where such a lien claim is against a contractor and not the owner of the property.

Nelson Drywall Interiors Alberta Inc. was a subcontractor of Dowland Contracting Ltd., which was the prime contractor in relation to the construction of two hospitals in Watson Lake and Dawson City, Yukon, owned by Yukon Hospital Corporation (YHC).

In May 2012, Nelson filed builders’ liens in the approximate amount of $1m against the hospitals for unpaid invoices relating to work and supplies it furnished to Dowland for the construction of the hospitals.

In July 2012, Nelson filed a statement of claim against Dowland and YHC seeking repayment of the Nelson liens.

In November 2012, YHC obtained an order authorising it to pay into court the amount of the Nelson lien claims in exchange for having the Nelson liens vacated from the applicable certificates of title. Subsequently, a receiver was appointed over the property of Dowland in May 2013 and Dowland was assigned into bankruptcy in June 2014.

In respect of its action against Dowland, Nelson brought an application in June 2016 for an order requiring Dowland to serve Nelson with its affidavit of documents within seven days, failing which Nelson would be at liberty to: (i) apply to strike out Dowland’s statement of defence and counterclaim; and (ii) apply for default judgment against Dowland.

The threshold issue was whether Nelson was prevented from pursuing its action against Dowland in respect of the Nelson liens by virtue of section 69.3 of the BIA which states: “69.3(1) Subject to subsections (1.1) and (2) and sections 69.4 and 69.5, on the bankruptcy of any debtor, no creditor has any remedy against the debtor or the debtor’s property, or shall commence or continue any action, execution or other proceedings, for the recovery of a claim provable in bankruptcy.

“(2) Subject to sections 79 and 127 to 135 and subsection 248(1), the bankruptcy of a debtor does not prevent a secured creditor from realising or otherwise dealing with his or her security in the same manner as he or she would have been entitled to realise or deal with it if this section had not been passed, unless the court otherwise orders, but in so ordering the court shall not postpone the right of the secured creditor to realise or otherwise deal with his or her security…. […]

“(2.1) No order may be made under subsection (2) if the order would have the effect of preventing a secured creditor from realising or otherwise dealing with financial collateral.”

Nelson argued that section 69.3 could not stay its action because it was a ‘secured creditor’ of Dowland, within the meaning of the BIA, for the portion of its claim relating to the Nelson liens or, in the alternative, because the funds paid into court did not form part of Dowland’s estate.

Justice Gower of the Supreme Court of Yukon dismissed Nelson’s application in its entirety. Section 69.3 of the BIA specifically prevents creditors from commencing or continuing any action against the debtor unless the creditor is a secured creditor of the debtor. The definition of secured creditor under the BIA required that Nelson hold a lien on or against “the property of the debtor”, i.e., property owned by Dowland. As is often the case, the Nelson liens were not filed against the property of Dowland but rather YHC. As a result, Nelson was found to be an unsecured creditor in the context of Dowland’s bankruptcy and was prohibited from pursuing the action against Dowland by virtue of both section 69.3 of the BIA and paragraphs 8 and 9 of the receivership order granted by Associate Chief Justice Rooke of the Court of Queen’s Bench of Alberta on 6 May 2013.

Justice Gower also held that the money paid into court to discharge the Nelson liens did not constitute property of Dowland. Such funds stood in substitution for the hospitals’ property, as the project owner, and for the in personam rights of Nelson that existed at the time of discharge. Therefore, any funds paid into court to discharge liens remain the property of the project owner and do not form part of an insolvent prime contractor’s estate.

As a result of the Nelson Drywall decision, lienholders dealing with the possibility of an insolvent debtor should be aware that they are only deemed to be secured creditors where they are both owed a debt by an insolvent debtor and hold a lien against the property owned by such party. Where a party is owed a debt by a contractor, but holds a lien against the owner’s property, such party is not a secured creditor of the prime contractor for the purposes of the BIA.

In order to obtain maximum recovery, lienholders should seek to take steps to enforce their security prior to the commencement of formal insolvency proceedings where they are able. Otherwise, their lien claims may be considered unsecured claims vis-à-vis the insolvent debtor.

When first in time does not mean first in priority

In KNC Holdings, the Saskatchewan Court of Queen’s Bench emphasised the importance of post-receivership record keeping and addressing the priority of lien claims early on in proceedings where section 22(2) of the Builders’ Lien Act (BLA) may apply. Section 22(2) provides a certain category of lien claims with priority over fixed charges even where such fixed charges are registered first in time at the Saskatchewan Ministry of Economy and the Information Services Corporation (registries). The Court in KNC Holdings held that where lien funds are commingled with general funds without adequate record, such lien claims will have priority over all funds in the general account.

On 6 March 2014, a receiver was appointed over the assets, undertakings and properties of Coast Resources Ltd., 101033165 Saskatchewan Ltd., Viewfield Oil & Gas Ltd. and Coast Services Inc. All of the debtor companies were established to invest in and operate oil & gas properties in Saskatchewan.

Between 2004 and 2014, Coast Resources entered into various loan agreements with its senior secured creditor, which registered its security in first priority at the registries. Over the course of the administration of the receivership estate, the receiver became aware that certain lienholders had registered several builders’ liens against the interests of one of the companies. At the request of the receiver, all of the lienholders filed a claim of lien pursuant to section 50(3) of the BLA and all were determined to be valid liens. Three out of the 18 lien claims filed were determined to have priority over the secured creditor and were paid by the receiver out of the estate. All of the remaining liens related to certain working interests in heavy oil properties near Luseland, Saskatchewan.

In late 2014, the receiver negotiated an agreement for the purchase and sale of the Luseland property for approximately $2m. In January 2015, Justice Nixon of the Alberta Court of Queen’s Bench granted an approval and vesting order for the sale of the Luseland property and the order provided for the discharge of the liens on the condition that the receiver held back approximately $500,000 pending the completion of its analysis and determination of the priority of the liens over the secured creditor’s first ranked security.

In July 2015, Justice Strekaf of the Alberta Court further ordered the receiver to retain the holdback funds on account of the lien claims pending a determination of the priority between the secured creditor and the lienholders and held that the priority dispute should be brought before the Saskatchewan Court of Queen’s Bench for resolution. One of the lienholders subsequently brought an application in Saskatchewan seeking, among other things, an order determining the priority among the parties to the holdback funds.

The lienholders argued, despite the fact that the secured creditor’s security was registered prior to the registration of the Sask liens, that the Sask liens took priority to the secured creditor’s security in respect of the Luseland property’s in situ oil, the extracted oil in possession of the receiver as at the date of appointment and/or any proceeds arising therefrom pursuant to section 22(2) of the BLA.

The secured creditor argued that it was the first ranking secured creditor with priority to the holdback funds pursuant to its first registered security interest. The secured creditor did not dispute that the Sask liens were valid liens pursuant to section 22(2) of the BLA, but argued that any dispute as to priority between it and the lienholders was resolved by the priority scheme set out in section 71 of the BLA. Further, it argued that the Saskatchewan Court of Appeal’s reasoning in Canada Trust Co v. Cenex Ltd (Cenex) had since been overtaken by the decision of the Alberta court in Smoky River Coal Ltd, Re, whereby a special lien created by builders’ liens legislation was determined not to have priority over all previously registered security and is instead subject to the priority regime set forth in the legislation.

Justice Labach followed the Saskatchewan Court of Appeal’s reasoning in Cenex and held that the lienholders had priority to all of the holdback funds in the general account. While noting that the Alberta court had chosen to depart from the reasoning in Cenex, Justice Labach found that Cenex had been upheld by Saskatchewan courts over the last several decades. Further, Justice Labach cited Boomer Transport Ltd v. Prevail Energy Canada Ltd for the proposition that a lienholder falling under sections 22(2)(d)-(f) had a priority lien on more than just the oil inventory in existence at the time the receiver was appointed.

The reading of s. 22(2) of the BLA makes it clear that the ‘mineral’ includes oil or natural gas because those wells are specifically referred to along with ‘mines’ in s. 22(2)(e) and (f). The reading of s. 22(2) also makes it clear that the lienholder as defined in s. 22(2) has a first claim upon not only the ore or its proceeds, but the oil lease and specified personal property. Just as s. 22(2)(d) and (e) cannot be read disjunctively, nor can s. 22(2)(f) of the BLA be so read. Thus, the liens extend to Prevail’s oil leases, its extracted oil at the time of the receivership appointment or the proceeds thereof, and the well assets.

Like in Boomer Transport, the priority afforded to the lienholders was held to extend to the oil leases in the Luseland property, its oil inventory at the time the receiver was appointed or the proceeds thereof and the well assets. However, as there was no breakdown between the revenue and operating expenses derived from the sale of oil & gas in inventory at the time the receiver was appointed and what was generated and incurred after appointment, there was no way of allocating the holdback funds for the purposes of establishing the priority of the entitlements of the lienholders.

The lack of an allocation or accounting of assets by the receiver did not diminish the lienholders’ entitlements under the BLA. As a result of being unable to allocate the holdback funds to the sources enumerated in section 22(2), Justice Labach held that lienholders had priority to the full amount of the holdback funds over the claims of the secured creditor, as well as the disbursements that were incurred by the receiver in the course of running the companies.

The KNC Holdings decision provides a number of important lessons for court officers and secured creditors operating in Saskatchewan seeking to avoid priority disputes with lien claimants, including the following:

First, Cenex remains binding law in Saskatchewan such that liens arising under section 22(2) of the BLA enjoy special priority over other types of fixed charges and security registered in priority to such liens.

Second, it is important to conduct an inventory assessment upon appointment and prepare a detailed list of assets where there is the potential for lien claims involving mineral rights, as a failure to do so may result in a broadening of the assets to which a section 22(2) lien claim can attach.

Third, secured creditors should consider whether it is cost effective to seek the appointment of a receiver over oil & gas assets located in Saskatchewan where there is the potential for multiple lien claims, as such claims may have priority to their otherwise first registered security interests.

Third, where there is the potential for a priority dispute involving lien claims, it is important to address such claims prior to a distribution. Implementing a claims procedure in order to have priorities adjudicated is common and can prevent priority disputes from arising after a distribution has occurred.

The KNC Holdings decision has been appealed to the Sask CA and is scheduled to be heard on 7 April 2017. It is uncertain whether the Sask CA will choose to overturn 40 years of settled law in Saskatchewan. In either event, the hope is that they deliver a clear decision that provides certainty to court officers and lenders seeking to do business in Saskatchewan.

Kelly Bourassa and Ryan Zahara are partners and Chris Nyberg is an associate at Blake, Cassels & Graydon LLP. Ms Bourassa can be contacted on +1 (403) 260 9697 or by email: kelly.bourassa@blakes.com. Mr Zahara can be contacted on +1 (403) 260 9628 or by email: ryan.zahara@blakes.com. Mr Nyberg can be contacted on +1 (403) 260 9707 or by email: chris.nyberg@blakes.com.

Kelly Bourassa, Ryan Zahara and Chris Nyberg

Blake, Cassels & Graydon LLP