The Priority Flip in Bankruptcy: What Judgment Creditors Need to Know

By Koby Kelln and Nicholas Conlon

The Bankruptcy and Insolvency Act¹ (the “BIA”) is the governing legislation for bankruptcy in Canada, and it supersedes provincial legislation in cases of conflict. Section 70(1) of the BIA establishes a “priority flip” that renders judgment creditors unsecured at the point of bankruptcy, and all priority entitlements they previously enjoyed under provincial legislation are subject to the priority rules contained in the BIA. Specifically, this section provides:

Every bankruptcy order and every assignment made under this Act takes precedence over all judicial or other attachments, garnishments, certificates having the effect of judgments, judgments, certificates of judgment, legal hypothecs of judgment creditors, executions or other process against the property of a bankrupt, except those that have been completely executed by payment to the creditor or the creditor’s representative, and except the rights of a secured creditor.

While s. 70(1) only mentions bankruptcy orders and assignments, the Ontario Court of Appeal in Toronto-Dominion Bank v Phillips has held that the priority considerations also apply to consumer proposals under Division II of Part III of the BIA². Moreover, a recent decision by the Alberta Court of King’s Bench affirms that the priority flip remains a valid concern for creditors³. The reason for this is the broad judicial interpretation of s. 66 of the BIA to mean that certain general provisions of the BIA, including s. 70(1), should be read to apply to consumer proposals even absent express reference.⁴

Another example of this “priority flip” is found in The Land Titles Act, 2000⁵. Section 173.3(9) of this Act states that “a trustee in bankruptcy of a judgment debtor succeeds to the interest of a judgment creditor under an enforcement charge registered before invocation of the bankruptcy.” This provision again provides that the federal structure found in the BIA supersedes all priority positions that judgment creditors may have occupied prior under provincial legislation.

When facing the prospect of a potential judgment debtor bankruptcy under the BIA and the resulting “priority flip”, judgment creditors may consider taking some practical steps to best protect their interests:

One option is to try to obtain a secured interest in the debtor’s property before the debtor files for bankruptcy or makes a proposal. This can be done by registering a security interest or a lien against the debtor’s assets, which would give the creditor a priority claim over unsecured creditors in the event of bankruptcy or proposal.
Another option is to closely monitor the debtor’s financial situation and to act quickly to enforce any judgments before the debtor files for bankruptcy or makes a proposal. This may involve seizing assets or garnishing wages before the debtor’s other creditors have a chance to assert their claims.

Finally, it may also be helpful for judgment creditors to consult with legal professionals who can advise them on the best strategies for protecting their interests under the BIA.

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