Stanley Kershman (Darren Brown, OBJ).

Who should get priority to pick through the financial wreckage of a bankrupt business to salvage what they are owed? Who deserves to lose the least? How much of the business owner's personal retirement savings should be anted up to mitigate others' losses?

However unpleasant, these are some of the tough questions Canadian bankruptcy legislation must address to ensure a business's unplanned demise is orderly and fair.

According to Ottawa bankruptcy lawyer Stanley Kershman, the federal government's Bill C-55, introduced by Industry Minister David Emerson on June 3, constitutes a major step forward for employees of firms that go bankrupt, but for businesses, the "new provisions coming into effect are going to cause them grief."

The proposed legislation includes a Wage Earner Protection Plan that would see employees given priority over other creditors, including lending institutions, to claim unpaid wages from a bankrupt company's cash inventory and accounts receivable to a maximum of $2,000 per employee.

This could mean changes to lending margins for businesses. Mr. Kershman says that "as small businesses go to borrow money from lending institutions, institutions will now put more safeguards in place to ensure that their position is not being eroded in the event there's a default by the business and the business closes up."

The result? In the short term, Mr. Kershman predicts an increase in the number of small business bankruptcies – a negative economic indicator that has already seen troubling increases in Ottawa over the past couple of years. Figures recently released by Industry Canada indicate that for April 2005, business bankruptcies in Ottawa totalled 27, up 125 per cent from 2004 levels. The first four-month period of 2005 witnessed a 30-per-cent increase in business bankruptcies over the same 2004 period.

"Once these provisions come into play, then the lending institutions will have to adjust accordingly and they may start calling in lines of credit or demand loans because they feel they're under-secured," Mr. Kershman said.

He acknowledged "it hasn't been easy for small businesses to borrow money in Canada as it is. If it becomes more challenging you're going to see a lot of small business either falter – if they exist now – or not get off the ground."

The longer term implications of the new provisions aren't clear, but Mr. Kershman said it may force businesses to become more efficient, more mindful of changing markets and simply better-managed, rather than relying on borrowing at rates that are "artificially low" to maintain profit levels. "In the long term, there may be fewer bankruptcies, but there may be fewer businesses borrowing money," he said.

Few would argue that a bankruptcy is anything but the final, often nasty 'lose-lose' stage of a failed business. However, insolvency procedures still need to be standardized to help all parties in a bankruptcy or restructuring know what to expect. Mr. Kershman says the proposed bill eliminates needless ambiguity and uncertainty.

"Under the (current) Companies' Creditors Arrangement Act, there's a lot of flexibility," he said. The proposed legislation would "provide some more structure to it so that when you go to court or you do a compromise or plan of arrangement, you know what you're going to have to deal with as regards to unpaid employees, securities, labour contracts, debtor-in-possession (DIP) financing."

André Piché, director of national affairs for the Canadian Federation of Independent Business, calls the bill "a mixed bag" for small business. "The reform is an attempt to make it fair for the most people, but it is very far from being a perfect tool to do the job," he said.

While Mr. Piché notes there are some positive aspects of the proposed bill, such as the provision to exempt from seizure an owner's RSPs, the negatives will have him arguing for changes when the legislation is referred to a House committee, probably this fall.

First, he echoes Mr. Kershman's view that the wage earner's protection provisions will affect a company's ability to borrow. "It will make it more difficult for the small business owner to get a loan from the bank," which he believes would view the small business owner as a higher risk.

More importantly, however, is the vulnerable position of a firm that is a supplier to a bankrupt company. He feels Bill C-55 offers no protection to the small business owner. "The government recognizes the system was unfair to workers who were not going to get paid, yet it begs the question: should you not be fair to unpaid small business owners, who have provided services to a bankrupt company? There's no protection for these people under the BIA as it is now, and under the proposed changes, it is not being addressed."

The reality, he says, is that "the business itself can go under just as the result of somebody else going bankrupt because they have no protection whatsoever."

"No matter how you cut it," Mr. Piché concluded, "it's pretty unfair to someone along the way because in bankruptcy cases, you know somebody's going to be short shrift. It's a question of how do you draw the blanket, and who's going to be left in the cold?"

By Jeff Esau

Special to the Ottawa Business Journal