WHO GETS THE BANKRUPT'S PRE-BANKRUPTCY EARNINGS?

Robert A. Klotz, Klotz Associates, Toronto.

Do pre-bankruptcy wages fall within s. 68 of the Bankruptcy and Insolvency Act?

Pre-bankruptcy income may in many circumstances not be paid until after the date of bankruptcy. This can occur in several scenarios:

• Wages may have been paid into court or into the hands of the Sheriff by virtue of a creditor's pre-bankruptcy garnishment proceedings that were not completed before the bankruptcy filing;

• Pre-bankruptcy earnings may have not yet been paid out by the bankrupt's employer, perhaps due to a dispute or an accounting delay;

• A dismissed employee may be claiming wrongful dismissal where part or all of the notice period relates to the pre-bankruptcy period;

• An ongoing tort claim, such as a motor vehicle accident, may incorporate a claim for lost pre-bankruptcy earning;

• The bankrupt may be entitled to a tax rebate under his or her pre-bankruptcy income tax return.

There are many other ways in which this circumstance can arise. Who is entitled to these monies? Does the trustee take all, only 20% [the Ontario exemption under the Wages Act], or none?

What makes this topic confusing is the utilization by the courts, in different cases, of three separate conceptual treatments of pre-bankruptcy earnings. Some cases apply the provincial exemption laws (the "exemption" approach). Others, of lengthy pedigree, treat unpaid pre-bankruptcy earnings as monies accruing due in their entirety to the trustee for distribution to creditors (the "vesting" approach). Finally, some recent cases conclude that BIA s. 68 applies not only to post-bankruptcy wages, but to pre-bankruptcy wages also (the "s. 68" approach). It is difficult to reconcile these different approaches.

The first of these treatments, the "exemption" approach, applies provincial wage exemption laws to analyze the priority issues. The terminology used in these cases is often difficult to follow. For simplicity's sake, the portion of wages that is exigible to all creditors under provincial wage legislation (in Ontario, 20%) shall be called the "exigible piece". The balance, if any, that is left to the debtor after deducting the exigible piece is the "exempt piece" (in Ontario, 80%). Normally the size of these respective pieces can be adjusted upward or downward by court order.

In Dudgeon v. Dudgeon,⁽¹⁾ the Alberta court considered the effect of a basic statutory exemption of $460 per month which was expressly inapplicable to garnishment for spousal or child support. In other words, the "exigible piece" was anything over $460 per month, and the "exempt piece" (though not exempt against the wife's support claim) was $460 per month. The wife had succeeded in having two full wage payments garnisheed into court, whereupon the husband filed for bankruptcy. The court concluded that the wife took priority over the "exempt piece". The trustee was entitled to the balance, being the exigible piece. The bankrupt husband received nothing. Likewise, in Droit de la famille -- 82,⁽²⁾ the wife garnisheed the husband's salary under a support order, resulting in a payment into court. The husband promptly filed for bankruptcy, resulting in a priority dispute over the pre-bankruptcy wages standing in court. The wife conceded that the trustee had priority over the exigible piece. The court was called upon to determine priority over that portion of the exempt piece which lost its exemption due to the wife's support claim. Applying Dudgeon, the wife was granted priority.⁽³⁾

The second line of authority - the "vesting" approach - characterizes pre-bankruptcy earnings, and anything deriving therefrom, as amounts accruing to the trustee without limitation. These cases are based on the view that BIA s. 68 applies only to post-bankruptcy wages, and that consequently pre-bankruptcy wages constitute property of the bankrupt estate, vesting entirely in the trustee, for distribution among creditors. The policy rationale for this view is that the pre-bankruptcy wages ought to accrue to the creditors who presumably went unpaid, or whose debts were presumably increased, as a result of the inability of the debtor to access those wages before the bankruptcy. The technical justification for this view is that s. 68 applies by its terms to the revenue of the "bankrupt" - since the status of "bankrupt" begins only upon the date of bankruptcy, the section is applicable only for the period following that date, when there is indeed a bankrupt.⁽⁴⁾ Recent cases have applied this approach to: pre-bankruptcy wage loss claims resulting from motor vehicle accident lawsuits;⁽⁵⁾ pre-bankruptcy accumulation of sick pay not paid until after bankruptcy;⁽⁶⁾ reimbursement after bankruptcy of pre-bankruptcy out-of-pocket relocation expenses;⁽⁷⁾ commissions earned but not yet paid by the date of bankruptcy;⁽⁸⁾ income tax⁽⁹⁾ and disability tax⁽¹⁰⁾ refunds applicable to the pre-bankruptcy period; severance and vacation pay arising from a pre-bankruptcy termination of employment;⁽¹¹⁾ and a pension surplus which accumulated during the pre-bankruptcy period but became payable after bankruptcy.⁽¹²⁾ Since these amounts vest in the trustee upon bankruptcy by force of law under this line of authority, there is no room for consideration of the bankrupt's needs or those of his dependents. Until the recent Supreme Court of Canada cases discussed below, this approach was the generally accepted one.

The third line of authority -- the "s. 68" approach -- grants a liberal and purposive interpretation to BIA s. 68, extending its application to the pre-bankruptcy period. To the extent that this analysis applies, the bankrupt is entitled to all of these pre-bankruptcy earnings except to the extent that the court orders otherwise under s. 68 or an agreement is reached with the trustee. Provincial wage exemptions are inapplicable - and unnecessary - since s. 68 is a complete code. The Supreme Court of Canada has left several ambiguous clues in a trilogy of cases which suggest the applicability of this approach.

In Marzetti v. Marzetti,⁽¹³⁾ the Supreme Court was dealing with post-bankruptcy earnings in the form of a post-bankruptcy income tax rebate. However, its broad formulation of the scope of s. 68 was not temporally restricted to the post-bankruptcy period. The court determined that s. 68 was a complete code in respect of a bankrupt's salary, wages, or other remuneration. The decision proceeded on the footing that "anything called 'wages' will not vest automatically in a trustee".⁽¹⁴⁾ Furthermore, the court's broad policy statements do not sit comfortably with a limited scope for s. 68. For these reasons this author concluded, perhaps too hastily, that the decision extended the scope of s. 68 to pre-bankruptcy earnings.⁽¹⁵⁾

However the Supreme Court clarified, or perhaps retreated from, its broad view in a subsequent case, Ramgotra (Trustee of) v. North American Life Assurance Co.⁽¹⁶⁾ First, the court made it quite clear, in its brief discussion of BIA s. 68, that this section deals specifically with after-acquired remuneration.⁽¹⁷⁾ Secondly, the court undermined the "vesting" approach above, by establishing that where s. 68 does not apply, the vesting of property in the trustee does not preclude or overcome the application of provincial exemption laws. In effect, Ramgotra established that s. 68 does not apply to pre-bankruptcy wages, and hence all of the pre-bankruptcy income indeed vests in the trustee. However, the provincial wage exemptions continue to apply, and thus the trustee is unable to retain more than the exigible piece; the balance of the pre-bankruptcy wages must be returned to the bankrupt in due course as exempt property. If Ramgotra represents the law, the "exemption" approach applies to pre-bankruptcy earnings.

The third member of this Supreme Court trilogy is Wallace v. United Grain Growers Ltd.⁽¹⁸⁾ Mr. Wallace was fired from his employment while he was an undischarged bankrupt. He sued for wrongful dismissal while still undischarged. His employer defended in part on the basis that as an undischarged bankrupt, he had no standing to assert the claim. Wallace won in the Supreme Court of Canada. The court held that his wrongful dismissal claim did not vest in his trustee in bankruptcy because it fell with BIA s. 68 as "salary, wages or other remuneration of the bankrupt".

The facts of the case involved post-bankruptcy, not pre-bankruptcy, income. However the Supreme Court's reasoning suggests that this distinction is irrelevant. The Court concluded, on broad public policy grounds, that Wallace retained his right to sue for severance "not because of the timing of the acquisition of such property, but rather, because of the nature of the property in question."⁽¹⁹⁾ Thus if the property has the character of wages, its status in bankruptcy is not dependent upon when the claim arose. Wallace won not because his claim was after-acquired property, but because it derived from wages and thus fell within s. 68.

The court's policy rationale underscores that it is the character of the asset, not the accident of timing, that determines whether or not it falls into the bankrupt estate:⁽²⁰⁾

"Until alternative employment has been obtained, the wrongly dismissed employee will require funds to support him- or herself and his or her family. A damages award will satisfy this need, in essence, filling the pocket that would otherwise have been filled by salary or wages. If such an award is considered property divisible among a bankrupt's creditors that vests in the trustee, the bankrupt and his or her family may be deprived of essential income during a time of need. In my opinion, to remain true to the spirit of the Act, the words "salary, wages or other remuneration" in s. 68(1) must include an award of damages for wrongful dismissal. The same policy rationales that exempt salary, wages and other remuneration from automatically vesting in the trustee surely must operate in the wrongful dismissal context as the function of such damages is equivalent to wages or salary earned in the course of ongoing employment. To hold otherwise would run contrary to Parliament's intention to put the needs of families ahead of those of creditors."

In other words, the court's broad, needs-based interpretation of s. 68 is not likely to be defeated by a technicality. It is impossible to reconcile this passage with a conclusion that, for example, the bankrupt is automatically divested of a severance entitlement if he or she were fired long before bankruptcy.

Several cases have followed the suggestion in Wallace and have explicitly applied s. 68 to pre-bankruptcy remuneration.⁽²¹⁾ The most recent of these cases at the time of writing is Charron, Re,⁽²²⁾ where the court concluded that a pay equity settlement paid after the date of bankruptcy, but relating to the pre-bankruptcy period, falls within s. 68.⁽²³⁾

"Section 68, as amended in 1998, still constitutes a complete and exhaustive code pertaining to the total revenue of the bankrupt received after the date of bankruptcy. The payments arising from the debtor's wage adjustments retain their character as wages (of whatever nature or source) according to the objects of this section, whether for services rendered before or after the bankruptcy or for the wages 'that a bankrupt is in receipt of, or is entitled to receive from her employer...' and until the debtor's discharge. Unpaid wages and tax refunds received after the bankruptcy are only two examples of wages for services rendered in the years before bankruptcy. These wages, just like salary adjustments, must be governed by s. 68." [author's translation]

In conclusion, it appears that the "vesting" approach -- under which the trustee accrues 100% of the pre-bankruptcy wage entitlement -- is no longer defensible, despite its eminent pedigree. One cannot be unhappy about this, because that approach has the effect of depriving the bankrupt of all of his or her unpaid pre-bankruptcy income, without regard to need or family responsibility. If Marzetti, Wallace and the cases that follow them are applied (the "s. 68" approach), no part of the pre-bankruptcy wage entitlement vests in the trustee unless and until s. 68 is invoked. Otherwise, if Ramgotra governs, the "exemption" approach will apply, as a result of which only the exigible piece, as defined by provincial exemption legislation, will accrue to the trustee for distribution to creditors.⁽²⁴⁾ Of these two alternatives, the exemption approach appears to be the least problematic. This approach is consistent with the public policy goals of Marzetti and Wallace; it allows the trustee to acquire, as of right and without procedural impediment (i.e. without undue expense), the exigible piece already earmarked for creditors by provincial legislation; and special cases of hardship, or its reverse, may be addressed through an application to the bankruptcy court to vary the exemption.

Robert A. Klotz

KLOTZ ASSOCIATES, Barristers & Solicitors

405 - 121 Richmond St. West, Toronto, Ontario M5H 2K1

(416) 360-4500, fax (416) 360-4501, Email: bobklotz@klotzassociates.com

ENDNOTES:

1. (1980), 17 R.F.L. (2d) 204, 34 C.B.R. (N.S.) 308, 33 A.R. 434, 112 D.L.R. (3d) 633 (Alta. Q.B.)

2. [1983] C.S. 1099, 50 C.B.R. (N.S.) 91 (sub. nom. Re D.A.) (Que S.C. in Bkcy)

3. See also Landry (Re), [1999] O.J. No. 3381 (Ont. S.C.J., Chadwick J.): S. 68 applies to pre-bankruptcy wages, but does not displace the 80% provincial wage exemption.

4. Re Riel (1992), 9 C.B.R. (3d) 241, 8 O.R. (3d) 475 (Gen. Div.), aff'd 17 O.R. (3d) 458 (C.A.); Belham v. Strider Fishing Co. (1985), 57 C.B.R. (N.S.) 171 (Fed. T.D.). This interpretation harmonizes with other case law holding that a discharged bankrupt is not a "bankrupt": Quinn v. Official Trustee (1996), 137 A.L.R. 501 (Federal Ct. of Australia, on appeal)

5. Trustee entitled to pre-bankruptcy lost wages component of MVA claim: Lang v. McKenna (1996), 40 C.B.R. (3d) 187 (Ont C.A.); Sauve (Re), [1995] A.J. No. 1583 (Alta. Registrar Quinn); Vasquez v. Walitko (Unreported, Ont. S.C.J., Juriansz J., April 20 2000, Toronto #94-CQ-51230CM - thanks to Peter Danson for this case). Ord v. Upton, [1999] E.W.J. No. 6511 (Eng. C.A.): Pre- and post-bankruptcy lost income in MVA claim vest in trustee.

6. Demers, Re (1996), 42 C.B.R. (3d) 101 (C.S. Que., Baker J.); Trépanier (Syndic de), Re, [1993] R.J.Q. 485 (C.S. Qué., Dec. 21 1992, Sévigny J.)

7. Roberts, Re, [1997] O.J. No. 2507, 72 A.C.W.S. (3d) 28 (Ont. Gen. Div., June 11 1997, Kozak J.)

8. Re Riel, supra, note 4.

9. Re Wagner (1980), 35 C.B.R. (N.S.) 309 (Ont. S.C.); Re Sihler (1982), 43 C.B.R. (N.S.) 49 (Ont. S.C.)

10. Sobieski (Bankrupt), Re (1997), 117 Man. R. (2d) 27, 45 C.B.R. (3d) 272 (Registrar Lee), affd. sub nom Sobieski v. Sobieski (Trustee of) (1997), 2 C.B.R. (4th) 70 (Man. Q.B., Kennedy J.)

11. Re Clifford (1997), 46 C.B.R. (3d) 132 (Ont. Dep. Registrar Stevens)

12. Sykes, Re (1998), 1 C.B.R. (4th) 77 (B.C.S.C., Thackray J.)

13. [1994] 2 S.C.R. 765, 5 R.F.L. (4th) 1, 26 C.B.R. (3d) 161, 169 N.R. 161, 20 Alta. L.R. (3d) 1, [1994] 7 W.W.R. 623 (S.C.C.)

14. Ibid., ¶68, p. 185 C.B.R.

15. See R. Klotz, Bankruptcy and Family Law (1994, Carswell) at p. xii

16. [1996] S.C.R. 325, 37 C.B.R. (3d) 141, 132 D.L.R. (4th) 193, [1996] 3 W.W.R. 457, also cited as Royal Bank of Canada v. North American Life Assurance Co. (S.C.C.)

17. See Mr. Justice Gonthier's comments, speaking for the court, at ¶47, pp. 166-67 C.B.R.

18. (1997), 152 D.L.R. (4th) 1, 3 C.B.R. (4th) 1, [1999] 4 W.W.R. 86 (S.C.C.)

19. Ibid., ¶59

20. Ibid., ¶69

21. BDO Dunwoody Ltd. v. Swanson (1997), 47 C.B.R. (3d) 126 (Ont. Gen. Div., Kozak J.): S. 68 applies to shares payable in lieu of salary for services rendered before bankruptcy; Grier, Re, [1998] M.J. 422, 82 A.C.W.S. (3d) 847 (Man. Registrar Harrison): Pre-bankruptcy lost income component of pending MVA claim does not vest in trustee; Parkinson, Re (1998), 9 C.B.R. (4th) 61, 135 Man. R. (2d) 155 (Q.B., Registrar Sharp): S. 68 applies to pre-bankruptcy wages - here, a retroactive pay equity settlement - applying Marzetti [Note: This decision was reversed in an oral judgment of Degraves J., August 31 1999 on the basis that s. 68 does not apply to the pre-bankruptcy period; the bankrupt was unrepresented and, according to trustee's counsel Richard Schwartz, did not put up much of a contest]; Landry (Re), [1999] O.J. No. 3381 (Ont. S.C.J., Chadwick J.): S. 68 applies to pre-bankruptcy wages, but does not displace 80% wage exemption. Cf. Sykes, Re (1998), 1 C.B.R. (4th) 77 (B.C.S.C., Thackray J.): "The authorities, including Wallace, are consistent that s. 68 pertains [to] only after-acquired income and that it does not operate where the entitlement in issue arises prior to the effective date of bankruptcy." (p. 89)

22. (C.S. Qué., 22 février 2000, Tingley J., Montréal #500-11-013202-003). Thanks to Jean Fortin of Montréal for bringing this case to my attention.

23. Ibid., p. 4-5, ¶9-10

24. However the applicable provincial exemption statute may permit the bankrupt or the trustee to apply to increase or reduce the exemption, depending on the circumstances.