“Preferring” Taxes in a Bankruptcy: Attacking Payments of Income Tax as a Fraudulent Preference


This article has been contributed to the blog by Steven Golick and Martino Calvaruso. Steven Golick is a partner in the insolvency and restructuring group of Osler, Hoskin & Harcourt LLP, and Martino Calvaruso is an associate in the group.
Canadian insolvency law contains several methods of attacking transactions that a bankrupt has entered into prior to the bankruptcy. One of these methods is set out in the provisions of the Bankruptcy and Insolvency Act (Canada) (the “BIA”) relating to fraudulent preferences. A recent decision of the Manitoba Court of Appeal deals with the issue of whether a bankrupt’s payments of income tax to the Minister of National Revenue (the “MNR”) in the three month period prior to its bankruptcy can be attacked as fraudulent preferences.
Section 95 of the BIA provides (in part) that if a debtor has transferred property or made a payment to an arm’s length creditor: (a) within the three month period prior to the date of such debtor’s bankruptcy; (b) while being an “insolvent person” (as defined in the BIA); and (c) with a view to giving the recipient creditor a preference over the debtor’s other creditors, then such transfer or payment is void as against a trustee in bankruptcy. The party seeking an order from the court that a preference has been made need only establish a prima facie case in support of the three factors described above; following which, the onus shifts to the recipient creditor to rebut this prima facie case. If the payment or transfer has the effect of giving a preference, it is presumed to have been made with intent to prefer, absent evidence to the contrary.
In Andrews (Trustee of) v. Minister of National Revenue, the Manitoba Court of Appeal dismissed the appeal of the MNR from an order which declared that two payments of income tax made by Mrs. Andrews, a personal bankrupt (the “Bankrupt”), to the MNR within the three month period prior to her bankruptcy were preferences in accordance with Section 95 of the BIA. The Court of Appeal upheld the lower court’s decision that the MNR had not successfully rebutted the prima facie case made by the applicant trustee in bankruptcy.
The first two submissions of the MNR were fact specific. There was no dispute that the payments by the Bankrupt had been made within the applicable three month period. However, the MNR submitted that the court had erred in taking into account facts subsequent to the first payment of funds by the Bankrupt to the MNR. The second submission related to whether the court had given sufficient weight to the evidence of the Bankrupt. Both submissions were rejected by the Court of Appeal.
The third submission of the MNR is of particular interest. The MNR contended that a payment to a creditor cannot be considered a preference unless the debtor receives a quid pro quo from such creditor. The MNR’s position was that since it could not provide the Bankrupt with a quid pro quo, then the Bankrupt could not have had the intention to prefer the MNR over her other creditors. The Court of Appeal disagreed and was of the view that the receipt of a quid pro quo by a debtor is only a factor to be considered when determining if a debtor had the intention to prefer and is not itself determinative.
The MNR also argued that due to the fact that the two income tax payments were made prior to the date of the bankruptcy, they were not to be captured by the BIA and therefore subject to the Crown prerogative (of being paid in priority to other creditors of equal degree). However, according to the Court of Appeal, Section 4.1 of the BIA abrogates the Crown prerogative in Section 95 matters, as it provides that the BIA is binding on the Crown. Given that income tax is an unsecured claim under the BIA, it is to be treated in a manner consistent with the treatment of all other unsecured claims. As a result, the payment of income tax by a debtor in the three month period prior to the date of its bankruptcy is liable to be attacked as a preference pursuant to Section 95 of the BIA.
Although the decision is in connection with the bankruptcy of an individual, the Court of Appeal’s judgment in Andrews has implications when viewed in the context of corporate bankruptcies. As corporate income tax payments and other non priority payments to various levels of governments made in the three months preceding a bankruptcy can be substantial, trustees in bankruptcy and unsecured creditors may become more vigilant in investigating such payments and considering proceedings to recover such payments for the benefit of the bankrupt’s stakeholders. In these circumstances, one should expect that trustees in bankruptcy and unsecured creditors will to look to the Andrews decision as support when challenging the payment of income taxes and similar payments as preferences.

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