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The fundamental operational question during a corporate bank ruptcy therefore rests on a judgment about whether economic value is best preserved by keeping the business going, albeit with a price to be paid in terms of restructuring, or whether to break it up and let its indi vidual assets dissipate, eventually finding new employment elsewhere in the economy. This judgment usually has to be made under stressful and hurried conditions, and is constrained by the equitable rights of the many parties to a bankruptcy. And the bigger the corporate failure, the more complex are the claims. One test of bankruptcy law is thus whether or not such judgments can be made and carried out coolly and objectively under conditions of great stress.

The way in which this crucial judgment is made depends on the me chanics of the judicial and administrative systems under which it takes place. Creditor friendly regimes, like that of the UK or Canada before 1992, generally put the assets of the failing firm in the hands of a trus tee who quickly liquidates them, possibly in a single sale, for the benefit of the creditors. Management, directors and shareholders bear an im mediate price. In such regimes there is a tendency for bankruptcy filing to occur rather later than economically optimal, as an increasingly des perate management with nothing to lose hazards ever larger bets with other peoples money. At the other end of the spectrum, the US Chap ter 11 procedure may be making it too simple for managements to use bankruptcy as an ordinary piece of business strategy. Delaney cites the cases of Manville, Continental Airlines and Texaco as examples201. Fur ther, judges operating under the US Chapter 11 procedure may be in sufficiently expert. Baird and Morrison argue202.

K.J. Delaney. Strategic bankruptcy: how corporations and creditors use Chapter 11 to their advantage, Berkeley, University of California Press, 1998.

D.R. Baird and E.R. Morison. Bankruptcy decision making, J. Law, Econ. & Org., 17:(2001): 3667.

Bankruptcy judges are imperfect substitutes for market actors.

Market actors have their own money on the line and this makes them intensely interested in making good decisions. Moreover, there is a natural sorting mechanism, as only those market actors who make good decisions survive. There is no similar competitive process or sort ing mechanism for bankruptcy judges. They are subject to reappoint ment only every 14 years and making the shutdown decision is a small part of their docket. Moreover, the people who make the reappointment decision (other federal judges) are not themselves well positioned to assess the bankruptcy judges performance.

In addition, once the Chapter 11 case starts, the judge must stand at a distance. Section 341 of the [US] Bankruptcy Code forbids the bank ruptcy judge from attending the meetings at which managers of the firm must turn over information to the creditors. Rules of judicial conduct limit the ability of the bankruptcy judge to gather information informally.

She cannot even talk to any of the players outside the presence of the others, nor can she conduct her own investigations.

The comments in the first paragraph could apply equally to Cana dian judges, most of whom (outside of Toronto) hear bankruptcy cases with no special expertise.

A key point is that making the delicate decision whether to reorgan ize or liquidate depends on the fullest disclosure of relevant informa tion, as well as experience and sagacity. Systems which force the early production of a great deal of information to all parties will tend to have better outcomes, in the sense that bargaining strategies in those cir cumstances are more likely to drive toward solutions where all parties are better off than they would be in situations of strong information asymmetry203.

Equity is the other great economic objective. Although its impulse is social, stemming from innate feelings about fairness and natural jus tice, especially for parties less able to protect themselves through ac cess to information or through good contracts, it too has a relation to economic efficiency. Only if claimants are dealt with fairly and reasona bly swiftly can the risks and costs of extending credit be minimized.

Prof. Davis, in a thoughtful but unpublished paper prepared for Industry K.E. Spier, Settlement with multiple plaintiffs: the role of insolvency, J. Law, Econ. & Org., 18:2(2002): 295.

Canada as part of its preparation for the next round of legislative amendments, notes that there are a number of possible definitions of both equity and efficiency, but that in practice they are mutually supportive204.

Davis goes on to note that an optimal bankruptcy system must take account of the size and industrial structure of the economy to which it applies. A country dominated by small enterprises in large places whose individual disappearance will cause few external costs may be best served by a swift, rules based system, whereas a country with a relative handful of large enterprises in small towns may need the flexi bility to tailor solutions to specific cases. Canada has both, which leads Davis to suggest that the co existence of a rules based system to gether with one based on more general standards may suit its require ments better than the uniform Bankruptcy Code of the United States205.

In addition, there is ambiguity about whether a specialized bankruptcy court is better than having such cases heard by judges having broad responsibilities206.

7.2. The Canadian system Canada is a confederation of the British North American colonies left over after the revolutionary departure of the United States. Most were colonies by settlement, meaning that, in general, all English law then in force and applicable to the circumstances of the particular colony were continued in colonial practice. Newfoundland, despite subsequent transfers between English and French sovereignty, was in 1583 the original British colony by settlement. One colony, Quebec, became English by conquest in 1759. In such cases the imposition of English law over the pre existing regime, while still generally favoured, was strongly affected by the nature of the new territory. In the case of Quebec, with its French law and language and its strongly Catholic religious base, caution and magnanimity both led to the Quebec Act of 1774 in which K. Davis, An economic analysis of the differences between Canadian and American commercial insolvency laws, Industry Canada, March 2002, 66 p.

Cf. L. Kaplow, Rules versus standards: an economic analysis, Duke Law J., 42(1992):

557; P. Povel, Optimal soft or tough bankruptcy procedures, J. Law, Econ, & Org.

15:3(1999): 659684.

Davis, op. cit., pp. 2126.

many of the legal traditions of the French regime were continued. This English statute is now part of the constitution of Canada.

Four colonies (Upper and Lower Canada, corresponding to Ontario and Quebec today, plus New Brunswick and Nova Scotia) were united as Canada by the British North America Act of 1867, an act now re ferred to as the Constitution Act, 1867. Ruperts Land, essentially the present Prairie provinces, the Arctic and the Hudson Bay lowlands, was included as the North West Territories in 1870, with the new province of Manitoba carved out. Prince Edward Island and British Columbia joined in 1871, and the present map was completed with the admission of Newfoundland in 1949.

Early statutes dealt with debt, seizure, insolvency, and the relief of debtors in the several colonies before Confederation207. Typically based on English statutes going back to the Renaissance, they applied only to traders and required the surrender of a debtors property to a court appointed official (curator), who would distribute the bankrupt estate among the creditors. Many types of debt survived bankruptcy, however, and no provision was typically made for the bankruptcy of individuals farmers, for example or types of firms other than traders. In many re spects the inheritance from the Napoleonic Code civil was superior, especially in that it included detailed procedures for the administration of the bankrupt estate. Concepts from that legal tradition entered Brit ish and later Canadian law through the monumental work of revision and codification208 of Quebec law following 1857.

The first attempt at a post Confederation statute was The Insolvent Act of 1875, which repealed the mass of pre existing colonial laws and applied a uniform structure to all the provinces. Coverage was broad ened somewhat from traders and trading partnerships, and voluntary assignments were dropped in favour of creditor initiated processes when a debtor generally failed to meet his liabilities as they became due. Creditors, however, had the alternative remedy of applying to the Court for a writ of attachment under which the property of the debtor 207 rd L. Duncan and J.D. Honsberger, Bankruptcy in Canada, 3 ed., Canadian Legal Au thors, Toronto, 1961, ch. 2, pp. 514.

208 rd L. Duncan and J.D. Honsberger, Bankruptcy in Canada, 3 ed., Canadian Legal Au thors, Toronto, 1961, ch. 2, p. 10.

was seized209. However, although it was amended in 1876 and 1877, the Act was repealed in 1880 and for forty years there was no general bankruptcy law in force in Canada. There was dissatisfaction with the method of administration [a strength of the Code civil], and the con stant irritation caused by ill considered legislative tinkering with so im portant a piece of legislation brought to a head the movement for the repeal of the Act210.

Three statutes presently govern bankruptcy in Canada. All are fed eral statutes, since Section 91(21) of the Constitution Act, 1867 as signed the subject to the federal level of government211. The basic stat ute, used for both commercial and personal bankruptcies, is the Bank ruptcy and Insolvency Act (BIA), first enacted in 1919 and amended in 1949, 1992 and 1997212. Based on the 1904 United Kingdom statute, the 1919 Bankruptcy Act focused (until the amendments of 1992) on 209 rd L. Duncan and J.D. Honsberger, Bankruptcy in Canada, 3 ed., Canadian Legal Au thors, Toronto, 1961, ch. 2, p. 16.

210 rd L. Duncan and J.D. Honsberger, Bankruptcy in Canada, 3 ed., Canadian Legal Au thors, Toronto, 1961, ch. 2, p. 17.

Section 92(13), however, assigns to the provinces the exclusive right to make laws in th relation to property and civil rights. As in other areas where this sometimes vague century statute of Westminster creates potential conflicts between the two levels of gov ernment, the courts resolve the conflicts by considering the pith and substance of the legislation. If the primary object or pith and substance falls within one of the enumer ated subjects of section 91, it will be considered to be within the federal power notwith standing that it may incidentally affect a subject matter which has been assigned to the provinces. Therefore, while the powers of the federal government in respect of bank ruptcy and insolvency include the power to enact ancillary legislation to give effect to its legislation on bankruptcy and insolvency, these matters are limited to those matters which, in pith and substance, fall within the definition of bankruptcy and insolvency. Sean F. Dunphy, Bankruptcy and insolvency, reorganization and winding up, chapter 12 in M.E. Grottenthaler, ed., Doing business in Canada, Stikeman Elliott, Montreal, 1997. In addition, the BIA provides that the decisions of one provincial court are enforceable by any other, and all are required to act in aid of each other. In these ways, through the slow piling up of case law and through administrative cooperation, conflicts between the spe cific federal jurisdiction over bankruptcy and the much broader provincial responsibility for property and civil rights are managed with remarkably little friction.

There had been Insolvency Acts in 1869 and 1875, but these were repealed in 1880.

The current (1997) Act is reproduced with substantial annotations in two well known th books: F. Bennett, Bennett on Bankruptcy, CCH, Toronto, 7 ed., 2002, and L.W. Houlden and G.B. Morawetz, The 2003 annotated Bankruptcy and Insolvency Act, Carswell, To ronto, 2002 (annual). The bare text of the Act may be found (July 2003) at http://laws.justice.gc.ca/en/B 3/text.html.

liquidation rather than reorganization. In 1992, Part III was broadened to expand the powers of debtor companies to effect proposals and super vised reorganizations.

A second statute, the Companies Creditors Arrangement Act (CCAA), was enacted in 1933 in response to the grim economic condi tions of the Depression213. A brief, reorganization oriented statute, it gave judges latitude to make broad compromises, suiting outcomes to the peculiar circumstances of the time. It was not much used until the 1980s, when enterprising lawyers discovered it could be useful in the complex situation of large corporate bankruptcies. It was amended in 1997 to make it more consistent with the BIA.

The final statute in the trio, the Winding up and Restructuring Act (WUA)214, applies primarily to insolvent banks and insurance companies;

unlike the other laws, which fall to the responsibility of the Minister of Industry, WUA is jointly administered by the Ministers of Finance and Industry. It is rarely used215. In addition it is possible conjointly to use the corporate organization statutes of either the federal (Canada Business Corporations Act, or CBCA) or provincial governments (such as the On tario Business Corporations Act) to effect a restructuring of share capi tal where the company is insolvent216.

The Bankruptcy and Insolvency Act (BIA). The BIA is the basic stat ute. Its scheme is that, following an act of bankruptcy, the assets of an insolvent corporation are transferred to a trustee, who liquidates them for the benefit of the creditors. A company may be reorganized or sold as a going concern, with its basic contractual structure intact, or its as sets may be sold in pieces. Creditors are paid according to a set order of priorities (Annex C).

Under the BIA a company can go bankrupt on its own motion, or its creditors may petition the court to have it declared bankrupt. In the first Both Bennett and Houlden & Morawetz (note 11) include annotated texts of the CCAA.

The bare text is available on http://laws.justice.gc.ca/en/C 36/text.html.

Text available at http://laws.justice.gc.ca/en/W 11/text.html.

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