The Anti-Deprivation Rule and the Enforcement of Contractual Terms in Bankruptcy

The Anti-Deprivation Rule Applies in Canada

On Friday, October 2, 2020, in the case of Chandos Construction Ltd. v. Deloitte Restructuring Inc., 2020 SCC 25, the Supreme Court of Canada confirmed that the anti-deprivation rule is part of the common law of Canada and is to be applied based on its effect, as opposed to the intent of the parties. The anti-deprivation rule renders void any provision in an agreement which provides that upon an insolvency (or bankruptcy), value is removed that would otherwise have been available to the insolvent party’s creditors.

RMRF LLP acted for the successful party, in this case, Deloitte Restructuring Inc. Our team included Shauna Finlay, Michael McCabe, K.C. and firm alumnus Victoria Merritt.

What the case was about

The case arose out of a subcontract between Chandos Construction and Capital Steel Inc. Capital Steel was to provide steel for a project where Chandos was the general contractor. However, Capital Steel filed an assignment in bankruptcy prior to completing the contract. The subcontract had a clause that allowed Chandos to claim any costs arising from Capital Steel’s failure to complete its contract. It also had a clause that required Capital Steel to forfeit 10% of the value of the contract in the event it failed to complete, including if such failure resulted from an assignment in bankruptcy. Deloitte, in its position as trustee in bankruptcy for Capital Steel, argued that this clause was void by virtue of the anti-deprivation rule, or it was an illegal penalty.

Lower Court Decisions

The Chambers Justice found that the clause was a liquidated damages clause and did not find it was void. The majority decision of the Alberta Court of Appeal reversed this decision and found the anti-deprivation rule did apply and was a part of the Canadian common law. They found the clause to be void. The dissenting judgement found that the anti-deprivation rule was not part of Canadian common law and that the rule against penalties should be amended. Chandos sought and was granted leave to appeal the Court of Appeal decision to the Supreme Court of Canada.

What the SCC found

The SCC denied the appeal (8-1), with Justice Rowe writing the majority decision and Justice Coté dissenting. Both decisions found that the anti-deprivation rule was a part of the common law of Canada. However, in his dissent, Justice Coté would have applied the rule using an intent-based test – based on the commercial reasonableness of the clause and the parties’ intent. Justice Rowe, writing for the majority, confirmed the test is to be applied based on the effect a clause will have, regardless of the intent of the parties.

Key Points

The Court confirmed the test to apply in order to determine whether the anti-deprivation rule applies. It is:

1. 1. is the relevant clause triggered by an event of insolvency or bankruptcy, and
   2. is the effect to remove value from the insolvent’s estate.

The application of the anti-deprivation rule supports one of the principles of the statutory regime which is to maximize the global recovery for all creditors in accordance with the priorities set out in the
Bankruptcy and Insolvency Act.

The Court also addressed examples where the rule may not apply. The Court found that the anti-deprivation rule may not apply to contractual provisions that remove property but not value from a bankrupt estate. It may not apply where the contractual provision is triggered by an event other than an insolvency or bankruptcy, and parties are free to protect themselves from the effects of an insolvent counterparty by taking security, acquiring insurance or requiring third-party guarantees.

The Court also confirmed that the law of set-off does not save debts triggered only by insolvency or bankruptcy. In this case, the 10% forfeiture was triggered solely by the insolvency. Therefore, it could not be set off against the amount owing by Chandos to the bankrupt estate of Capital Steel.

This was the first time the Supreme Court of Canada has considered the application of the anti-deprivation rule in Canada.

Effects of the Case

This case will have an important effect on the enforcement of certain clauses in agreements of all kinds, from construction contracts to agreements between shareholders, in bankruptcy and other insolvency proceedings. Parties to an agreement containing a clause that could meet the test set out above should be aware of how the anti-deprivation rule might affect the enforcement of their contract in insolvency proceedings.