Supreme Court of Canada Holds Pre-filing Claims can be Set Off in Proceedings Under the Companies’ Creditors Arrangement Act

In Montreal (City) v. Deloitte Restructuring Inc., a majority of the Supreme Court of Canada ruled that the Companies’ Creditors Arrangement Act (the “CCAA”) authorizes a court, though only in rare circumstances, to allow a creditor to set off a debt that the CCAA debtor owed it before filing for protection under the CCAA against a debt it incurs to the debtor after the filing (“pre-post set-off”).¹

The Supreme Court emphasized the importance of the stay of proceedings generally granted at the outset of a CCAA proceeding, and of the supervising judge’s exercise of discretion with respect to it. The stay would normally prevent a creditor from relying on set-off to withhold payments to the debtor for work done or goods supplied after the initiation of CCAA proceedings.  The Supreme Court held that a supervising judge may exercise discretion to refuse to stay a creditor’s right to exercise pre-post set-off, but cautioned that this would be appropriate only in exceptional circumstances, given the highly disruptive effect of allowing pre-post set-off in a restructuring. In doing so, the Supreme Court rejected the view expressed by the Quebec Court of Appeal in Quebec (Agence du Revenue) v. Kitco Metals Inc. (“Kitco”) that there is an absolute prohibition against a creditor exercising pre-post set-off in CCAA proceedings. 

The central issue in Montreal v. Deloitte Restructuring was whether the City of Montreal (the “City”) could withhold payment for work performed by SM Group (the “Debtor”), a consulting engineering firm that became subject to proceedings under the CCAA.  The City sought to set off debts owed by the Debtor to the City that arose before the CCAA filing against amounts owed by the City to the Debtor for work performed by the Debtor after the CCAA filing.  

The City’s pre-filing claim arose out of Quebec legislation creating a “voluntary reimbursement program” for the recovery of amounts improperly paid under public contracts (the “VRP Claim”).  The Debtor performed work for the City after the CCAA proceedings commenced, but the City refused to pay the Debtor, claiming a right to set off the pre-filing VRP Claim against the amounts it owed the Debtor for the work.  Deloitte Restructuring Inc., in its capacity as monitor (the “Monitor”), sought a declaratory judgment that the City could not apply set-off to the amounts it owed the Debtor for work performed post-filing. The City countered that, despite the absolute prohibition against pre-post set-off established in Kitco, it could apply any amounts owing to it in respect of the VRP Claim to reduce its payments to the Debtor because the claim related to the reimbursement of monies the Debtor had obtained by fraud. 

The Superior Court of Quebec granted the Monitor’s application for declaratory judgment, which the Quebec Court of Appeal upheld, applying Kitco.  The City appealed to the Supreme Court of Canada. 

In dismissing the appeal, the Supreme Court recognized that the broad discretion granted pursuant to sections 11 and 11.02 of the CCAA authorizes a court to stay the exercise of a creditor’s rights against a debtor. The Supreme Court held that this discretion is broad enough to authorize a stay of the right of a creditor to pre-post set-off, and that a prohibition against pre-post set-off generally flows from the initial stay order in a CCAA proceeding.  However, the Supreme Court expressly rejected the proposition that there is an absolute prohibition against pre-post set-off. Instead, the Supreme Court held that a supervising judge has the discretion to refuse to stay the right to pre-post set-off in exceptional circumstances. The Supreme Court emphasized that courts should be cautious in exercising this discretion, and should do so only rarely. 

The Supreme Court decided that section 21 of the CCAA, which protects a creditor’s right to set-off, only applies if both debts are incurred pre-filing. In the Supreme Court’s view, Parliament could not have intended for section 21 to apply to pre-post set-off, as this could derail the restructuring process. However, section 21 does not have the effect of prohibiting pre-post set-off. It remains within the discretion of a supervising judge to stay or allow a claim of pre-post set-off. 

The Supreme Court provided guidance regarding the exercise of this discretion, holding that a supervising judge must consider: (1) the appropriateness of the order being sought, assessed against the remedial purposes of the CCAA; (2) whether the applicant proceeded with due diligence; and (3) the good faith of the applicant.

Applying these principles to the facts at hand, the Supreme Court refused to allow the City to effect pre-post set-off. Among other things, the City had not demonstrated that the Debtor had committed fraud, and the City had not diligently raised its pre-post set-off claim, but rather had waited until long after becoming aware of the Debtor’s CCAA restructuring. 

For further information concerning Montreal v. Deloitte Restructuring, please contact any member of our Restructuring and Insolvency or Dispute Resolution Groups.