What does the SCC’s anti-deprivation ruling mean for your contract?

  • November 03, 2020
  • Jason Buttuls and Yi Liu

The anti-deprivation rule is a principle of common law that renders void contractual provisions that remove value from the bankrupt’s estate upon bankruptcy (value which would be otherwise available to creditors). In Chandos Construction Ltd. v Deloitte Restructuring Inc., 2020 SCC 25, the Supreme Court of Canada deemed invalid a contractual provision which required a subcontractor to forfeit 10 per cent of the total subcontract price to the general contractor upon the subcontractor’s insolvency or bankruptcy.

Chandos Construction Ltd., a general contractor, subcontracted part of a project to Capital Steel Inc. One provision in the subcontract required Capital to forfeit 10 per cent of the total subcontract price to Chandos as an inconvenience fee should Capital become insolvent or bankrupt. Capital eventually became bankrupt and Chandos argued that it was entitled to rely on the insolvency clause to reduce the debt that it owed to Capital; in effect, the clause actually created a credit to Chandos payable by the bankrupt. Faced with the unique situation in that the insolvency clause would create a claim provable in bankruptcy in favour of Chandos instead of a debt owed to Capital, the trustee in bankruptcy applied to the courts for advice and direction.

The matter made its way through the courts. The Alberta Court of Appeal held by a majority that the insolvency clause was invalid. In an 8:1 decision, the Supreme Court of Canada dismissed the appeal from the Alberta Court of Appeal, upholding the decision by the Alberta Court of Appeal that the insolvency clause was invalid.

The majority of the SCC, in reasons written by Justice Rowe, held that unless it does so clearly and unambiguously, Parliament is presumed to intend not to change the existing common law. Sections 65.1, 66.34 and 84.2 of the Bankruptcy and Insolvency Act do not eliminate the anti-deprivation rule since those sections were implemented to protect the insolvent or bankrupt person, while the purpose of the anti-deprivation rule is to protect creditors.

The majority emphasised that the test for anti-deprivation rule is an effects-based test, not an intention-based test (as Cote J., dissenting, would have found). The two-part test is:

  1. Is the clause triggered by an event of insolvency or bankruptcy?
  2. If so, does it remove value from the insolvent’s estate?

If the answer is yes, then the clause violates the anti-deprivation rule.

Cote J., dissenting, agreed the anti-deprivation rule is applicable in Canada but would have upheld the clause on the basis that it satisfied a legitimate commercial purpose. The majority considered that this would create “new and greater difficulties,” such as the need for courts to assess intention after the fact, and the increased use of such clauses to create priorities for certain creditors “who can plausibly pretend to have bona fide intentions,” all of which would presumably detract from the efficient administration of corporate bankruptcies.

Contractors need to be wary of clauses which are triggered by an event of insolvency or bankruptcy which are intended to penalize the insolvent party as these clauses are likely to be unenforceable. This decision does not have an impact on standard clauses not triggered by insolvency or bankruptcy and typical rights of termination and recovery of legitimate damages are unaffected.

Jason Buttuls is a senior associate practising construction litigation and arbitration, and at the time of writing Yi Liu was an articling student at Borden Ladner Gervais LLP.

Although care has been taken to ensure accuracy, this article should not be relied on as legal advice.