Operational conflict settled

Employees of a bankrupt company are not the preferred creditors of the bankrupt principal

In British Columbia, section 96 of the Employment Standards Act (ESA) provides that directors and officers of corporations are personally liable for unpaid wages for up to two months’ for each employee. In the event of a bankruptcy by the corporation, employees still have recourse to recover some unpaid wages by operation of this section. But what happens if a director and/or officer of the corporation declares bankruptcy personally in addition to the bankruptcy of the corporation?

In three different corporate bankruptcies the trustees in bankruptcy disallowed the preferred claims filed by the director of employment standards on the unpaid employees’ behalf. Unfortunately for the employees, after the payment of the secured creditors and other priority claims there was insufficient funds in the companies’ estates to pay wage claims in full.

The corporate insolvency also resulted in financial problems for the principals of each company, necessitating claims for personal bankruptcy. Relying on section 96 of the ESA (s. 96), the director filed a claim for unpaid wages against each of the estates of the bankrupt principals on behalf of the employees.

In each case the director claimed as a preferred creditor by virtue of section 136(1)(d) of the Bankruptcy and Insolvency Act (BIA). This section provides that subject to the rights of secured creditors, wages for services rendered during the six months immediately preceding to the bankruptcy were a priority, up to a maximum of $2,000 per employee.

The trustees for these bankrupt estates were prepared to allow the director’s claims on an unsecured basis but not on the preferred basis as claimed by the director. The trustees argued that the persons on whose behalf the director was making the claim were employees of the bankrupt companies, not employees of the bankrupt principals.

The director appealed the decisions of the trustees in these cases. The matter proceeded together with a common issue: whether unpaid employees of failed companies could rank as preferred creditors, not only in the estates of the companies which had employed them, but also in the personal bankruptcy or proposal estates of the principals of the failed companies.

The matter was originally heard in chambers. The chambers judge allowed the director’s appeals finding that s. 96 does not change the order of priorities so as to intrude into the federal sphere of bankruptcy. Hence there was no operational conflict between the provisions of the federal statute (BIA) and the provincial statute (ESA). The trustees appealed the order of the chambers judge.

The trustees argued that giving priority to the director’s claims under s. 96 created an operational conflict. The director argued that the ESA and BIA share a common purpose in that both recognize that the payment of wages deserves protection. The director argued that, based on ordinary statutory interpretation and legislative history, s. 96 and s. 136(1)(d) of the BIA could be applied harmoniously.

The British Columbia Court of Appeal agreed with the position of the trustees. The director’s position would result in a situation where s. 96 claims would be treated as preferred claims under s. 136(1) of the BIA, thus effectively re-ordering the priorities contemplated by the BIA and therefore creating an operational conflict.

The purpose of the BIA is to remove the uncertainty and difficulties posed by bankruptcy by imposing an orderly system for the collection and distribution to the bankrupt’s creditors. The objectives of the ESA are to set out standards for employment and to ensure that employees are dealt with fairly. Section 96 protects the wages of employees of companies by imposing personal liability on the directors and officers of a company. However in the event of a bankruptcy the ESA cannot take priority over the BIA, a federal statute. To allow otherwise would be to permit an operational conflict.

The Court of Appeal allowed the appeal and set aside the orders of the chambers judge.

For more information:

British Columbia (director of employment standards) v. Todd McMahon Inc., 2002 BCCA 179.

Latest stories