Canada: Pension Claims Update – Whose Rights Prevail?

Many Canadian companies entice prospective employees to join them by promising attractive pension plans. With a downturn in the market and declining revenues, these pension plans have become increasingly difficult to sustain. Indeed, many high-profile companies have massively underfunded plans.

These pension deficits can be extremely problematic when a corporation becomes insolvent and finds itself seeking the protection of the Bankruptcy and Insolvency Act (the "BIA") or Companies’ Creditors Arrangement Act (the "CCAA").

The market downturn and resulting increase in the number of restructurings have unfortunately coincided with a time when the Canadian population is aging. More and more employees are looking forward to retirement, feeling secure in the value they have amassed over the years in their pension plans. When their employer goes bankrupt or restructures, however, how much are their pension plans really worth?

In Ontario, an employer’s obligation to make contributions to a pension plan is enforced by a statutory lien under section 57(5) of the Pension Benefits Act (Ontario) (the "PBA") and by a deemed trust under the PBA sections 57(1), (3) and (4).

The Statutory Lien. The statutory lien under the PBA has priority and applies only to employer contributions that were due but unpaid at the time the security interest of a secured party arose. An additional statutory lien and charge on the assets of a pension plan sponsor may arise in the wind-up of a pension plan, but that lien ranks behind perfected security interests that existed at the time it arose.

The Deemed Trust. The more significant issue in determining priority is the deemed trust. Ontario’s Personal Property Security Act (the "PPSA") states that a security interest in an account or inventory and its proceeds is subordinate to the interest of a person who is the beneficiary of a deemed trust arising under the PBA. This priority does not apply against a perfected purchase money security interest in inventory or its proceeds. This section does not distinguish between deemed trusts that arose before or after the security interest was granted, so the deemed trust has a broader application than a statutory lien.

Under the PBA, the deemed trust applies to:

One. Employee contributions to a pension plan withheld by the employer.

Two. Employer contributions due and not paid into a continuing pension fund.

Three. In the case of a pension plan that is being wound up, employer contributions accrued to the date of the wind-up, but not yet due under the plan or regulations.

The PBA provides that these sections apply whether or not the money has been kept separate and apart from other money or property of the employer. So, employer and employee contributions in the ordinary course to a pension plan are subject to a deemed trust and, by virtue of the PPSA, these amounts have priority over a security interest in accounts or inventory.

While pensioners can look to the statutory protections available to them, these rights are limited, particularly in bankruptcy.

So, what happens to the deemed trust priority in bankruptcy? Many provincial statutes contain provisions that create deemed trusts. In general, cases have held that the deemed trusts created under provincial statutes do not have priority under the federal BIA. In a series of court decisions, however, the Supreme Court of Canada has held that these statutory provisions may not be applied in a manner that produces results inconsistent with the priorities that apply under the federal BIA.

The case law regarding the priority of pension plan contributions in bankruptcy has resulted in two divergent streams. In Continental Casualty Co. v. MacLeod Stedman Inc., the Manitoba Court of Appeal concluded the deemed trust for pension plan contributions under that province’s statute did not survive bankruptcy.

The appeal court held that the BIA contains a complete code of how the assets of a bankrupt are to be distributed. It said giving effect to a deemed trust in bankruptcy would be inconsistent with the requirements of the BIA, as it would give preferential treatment to employees over unsecured creditors.

The court also considered and followed the Supreme Court’s decisions and held that to allow provincially-enacted statutory trusts to fall under the ambit of the BIA would invite a different scheme of distribution on bankruptcy from province to province. The court re-articulated the Supreme Court’s six propositions cited in Husky Oil Operation Ltd. v. Minister of National Revenue, which provide a clear outline of the reasons for not permitting deemed trusts to take priority.

One. Provinces cannot create priorities between creditors or change the scheme of distribution on bankruptcy under s.136(1) of the Bankruptcy Act.

Two. While provincial legislation may validly affect priorities in a non-bankruptcy situation, once bankruptcy has occurred, section 136(1) of the Bankruptcy Act determines the status and priority of the claims specifically dealt in that section.

Three. If the provinces could create their own priorities or affect priorities under the Bankruptcy Act this would invite a different scheme of distribution on bankruptcy from province to province, an unacceptable situation.

Four. The definition of terms such as "secured creditor", if defined under the Bankruptcy Act, must be interpreted in bankruptcy cases as defined by the federal Parliament, not the provincial legislatures. Provinces cannot affect how such terms are defined for purposes of the Bankruptcy Act.

Five. In determining the relationship between provincial legislation and the Bankruptcy Act, the form of the provincial interest created must not be allowed to triumph over its substance. The provinces are not entitled to do indirectly what they are prohibited from doing directly.

Six. There need not be any provincial intention to intrude into the exclusive federal sphere of bankruptcy and to conflict with the order of priorities of the Bankruptcy Act in order to render the provincial law inapplicable. It is sufficient that the effect of provincial law is to do so.

The same issue was also considered by the Ontario Court of Appeal in Abraham v. Canadian Admiral Corp., a case that represents the second stream of law on this point. In Abraham, creditors petitioned the company into bankruptcy. The employees sought to recover vacation pay and accrued pension benefits that had not been paid prior to the company’s closure.

Employees asserted the Employment Standards Act and the PBA created a trust for their benefit. The court’s reasoning in this case was less complete than the Manitoba decision because the Ontario appeal court ultimately did not find it necessary to reach a final decision on the issue. However, it did comment that it agreed with the decision of the lower court that claims not specifically referred to in the BIA, such as pension claims, would retain the priority status they enjoyed outside bankruptcy.

The issue was considered again in GMAC Commercial Credit Corporation – Canada v. TCT Logistics Inc., a bankruptcy case where the dispute revolved around a deemed trust established under the Truck Transportation Act. Before the trucking company was placed into receivership, it had collected fees on behalf of its carriers. The carriers and a secured creditor of the company both claimed priority on those fees.

The court held that the BIA exempts any property held in trust by the bankrupts and any provision of a law of a province that creates a deemed trust is deemed to have the same effect and scope against any creditor, "however secured." This deemed trust, therefore, took priority over the general security agreement held by the secured creditor.

With respect, however, the court in this case appeared to have an incomplete view of the BIA. A more accurate analysis of the section is that a provincial law creates a valid deemed trust only where it mirrors a corresponding federal provision. The term "federal provision" is defined within the BIA to mean either section 227(4) or (4.1) of the Income Tax Act, section 23(3) or (4) of the Canada Pension Plan or section 86(2) or (2.1) of the Employment Insurance Act. For example, a valid deemed trust for the purposes of the BIA would be created if:

One. The province provided a comprehensive pension plan.

Two. The provincial legislation creates a deemed trust similar to that imposed by section 23(3) of the Canada Pension Plan.

Three. The deemed trust has as its sole purpose the ensuring of payment amounts required by provincial legislation to be deducted or withheld for the pension payment.

There is no reference in this case to any applicable federal legislation that would create a deemed trust similar to the one under the Transportation Truck Act. Had this reasoning been applied, it is possible that the case would have resulted in the opposite conclusion.

The Manitoba decision is a well-reasoned case from a policy standpoint. However, in light of the Ontario Court of Appeal decision in Abraham and subsequent case law, the issue is unsettled and there is continuing uncertainty over whether a deemed trust has priority over a security interest in bankruptcy.

Proceedings under the BIA and the CCAA have, as their focus, the rehabilitation of a company. To that end, the legislation and courts often have a flexible approach that allows creditors and the debtor company to come to an arrangement that allows the business to continue as a going concern.

The result of this is that pension plans are often no longer wound up, but continue in some form. Until a restructuring is complete and a successor purchaser of the company fully assumes its role as employer, there exists a period of uncertainty as to who exactly is responsible for continuing to fund the company’s pension plan.

Generally, if a trustee in bankruptcy sells all the assets of a bankrupt business to a third party that is not associated with the bankrupt, the purchaser would not likely be found to be a successor employer, according to the leading case law.

A more problematic decision that has not been laid to rest is the 1994 ruling by the Ontario Court of Appeal in Re St. Marys Paper Inc. The receiver, who was subsequently appointed the trustee in bankruptcy, continued the business and funding of the pension plan even though he was not an administrator. In doing so, the majority of the appeal court judges held that the trustee became an "employer" within the meaning of the PBA.

As a result, the trustee incurred the statutory payment obligations for unfunded liabilities that existed in the pension plans. The reasoning was that the PBA sets out minimum standards and the trustee could not circumvent them. While every trustee is not obligated to become an employer, where it does, the trustee assumes the concomitant responsibilities.

In this case, a dissent was written by one judge that may, in the long term, prove to be more acceptable. The majority decision is counter-productive in holding a court officer (the trustee) liable in this situation. The burden placed on the court officer is prohibitive and does not facilitate the sale of the business as a going concern. Indeed, in Re Royal Oak Mines Inc., the court characterized the result as "draconian." That said, it should be noted that the majority and the dissent in St. Marys agreed, in certain circumstances, a trustee in bankruptcy can become an employer bound by statutory requirements.

Since the St. Marys case, provisions that specifically state a court officer is relieved of certain responsibilities and limiting the obligations of trustees and/or receivers began to appear in court orders. So long as the role of the receiver is limited to the carrying on of the bankrupt’s business for the purpose of effecting a sale, these orders should stand.

The BIA and CCAA are now under review by Ottawa. The Standing Senate Committee on Banking, Trade and Commerce was authorized to examine and report on the administration and operation of the two statutes. The Committee received submissions from a number of interested parties in government, business and the labour movement.

A significant issue concerned the protection for pension plans in situations of employer insolvency. Some argued that current provisions under the BIA leave employees insufficiently protected. A proposed option was to grant a super priority status to any shortfall in the pension plan. Another option was to create a fund financed out of the Consolidated Revenue Fund or by employers and employees generally, from which any pension claims could be drawn.

The Senate Committee released its final report in late 2003 — Debtors and Creditors Sharing the Burden: A Review of the Bankruptcy and Insolvency Act and the Companies’ Creditors Arrangement Act. The Committee recognized the vulnerability of current pensioners, but did not believe changes should be made at this time. The Committee noted pensioners can access retirement benefits from the Canada/Quebec Pension Plan, Old Age Security and Guaranteed Income Supplement, and may have private savings and Registered Retirement Savings Plans that can provide income in retirement.

Further, the Committee believed the options for protection proposed by some of the interested parties would be "sufficiently unfair" to other stakeholders. A super priority status, for example, could unnecessarily reduce the money available for secured creditors, which could negatively affect the cost of credit and its availability in Canada. As well, a super priority status would mean creditors end up shouldering the entire pension deficit, instead of an even distribution of the burden among all stakeholders.

As for the creation of a protection fund, the issue of who should bear the burden of financing such a fund was controversial and the Committee believed it would be unfair for taxpayers, solvent employers and the employees of these employers to do so.

Outside bankruptcy, a pension plan enjoys some protection by virtue of the PBA and PPSA. It is clear, however, that the availability of this protection is much less certain in bankruptcy. While the Ontario courts appear willing to protect a pension by giving it the status of a deemed trust, the Manitoba line of reasoning offers the opposite result.

Pensioners are not the only parties, however, who face uncertainty in a bankruptcy. Uncertainty is also faced by court-appointed officers and purchasers of a business who may acquire the continuing obligations to fund the liabilities in a pension plan.

These priority issues are relatively new to the court system. Perhaps as high profile cases, such as the Air Canada and Algoma Steel restructurings, wind their way through the system, new answers and clarification will come.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.