Tuesday, July 13, 2010

NOT ALL LEGAL HYPOTHECS ARE RENDERED UNENFORCABLE BY BANKRUPTCY

A judgment creditor for a sum of money has a right to seize and sell its debtor’s property to get paid, but it has no real right in the debtor’s property and no priority over other creditors.

It is possible to register a judgment against the debtor’s immovable property in order to create a legal hypothec, which is a real right in the property itself, and thereby obtain security and a preference over competing creditors. However, if the debtor becomes bankrupt, the legal hypothec becomes unenforceable as a result of Section 70 of the Bankruptcy and Insolvency Act.1

In a recent decision, the Quebec Court of Appeal was called upon to decide whether
Article 70 would apply to render a legal hypothec unenforceable when a mortgage
created after the legal hypothec resulted in the foreclosure of the debtor’s property prior to the date of bankruptcy.2

In November of 2003, Jacyno registered a legal hypothec on the debtor’s property for the sum of $200,000.00. In 2006, Québec Inc. made a loan to the debtor in the amount of $300,000.00 which was secured by a mortgage on the debtor’s property. When the debtor defaulted on the loan, Québec Inc. foreclosed on the mortgage and became the owner of the property retroactive to October 24, 2006. The property was still subject to the legal hypothec which had been registered in November 2003.

On March 23, 2007, the debtor made an assignment in bankruptcy. Québec Inc., now the
owner of the property, applied to the Court to have the legal hypothec cancelled and
removed from its property arguing that the effect of Section 70 of the Bankruptcy and
Insolvency Act was to render the legal hypothec unenforceable. Moreover, Quebec Inc.
argued that since the legal hypothec is an accessory to the monetary condemnation, which is cancelled by the bankruptcy, the legal hypothec, as an accessory to the debt, must also be cancelled.

In rebuttal, Jacyno argued that Section 67 (1) (c) of the Bankruptcy and Insolvency Act expressly limits the application of bankruptcy law to the property that was owned by the bankrupt at the date of the bankruptcy. Consequently, since Quebec Inc. foreclosed on the property and became the owner prior to the date of bankruptcy, the Bankruptcy and Insolvency Act would not apply. It was also argued that the Bankruptcy and Insolvency Act should be interpreted so as to achieve the objectives of the legislator namely, the administration of the assets of the bankrupt, the priority between creditors, the liquidation of their claims and the modalities of the discharge of the bankrupt.

Although previous court decisions, even of the Quebec Court of Appeal, were divided on this issue, the Court of Appeal unanimously adopted the second argument namely, that when the debtor no longer owned the property at the date of bankruptcy, the legal hypothec would continue to be enforceable. In addition, the Court of Appeal noted that Québec Inc. foreclosed on the property with full knowledge of the existence of the legal hypothec, which had been duly published at the Land Registry office. In the circumstances, Quebec Inc. had various available legal options which it presumably rejected, such as having the property sold at justice and the proceeds of sale distributed according to law, instead of choosing to become the owner of the property or it could have waited for the debtor to become bankrupt in which event, the property would have been subject to the Bankruptcy and Insolvency Act and the legal hypothec would have become unenforceable and cancellable.

But what of the legal argument that once the claim is extinguished by the bankruptcy, the legal hypothec can no longer exist? The Court of Appeal answered that the effect of the bankruptcy is not to “extinguish” claims but to render them unenforceable. In civil law, an unenforceable claim may still constitute legal and valid consideration for the performance of an obligation. Such obligations fall into the category of moral or natural obligations which a debtor could validly decide to pay even after the statute of limitations period had expired or which were not enforceable as a result of bankruptcy.

In summary, although the extinction of an obligation that is guaranteed by a hypothec
results in the extinction of the hypothec itself, there is an exception in the circumstances of this case. Although the bankrupt debtor could not be sued for the debt that was subject to the bankruptcy, the debt continued to exist in law and the legal hypothec continued to subsist until payment or the expiry of the statute of limitations period. Therefore, the discharge of the bankrupt does not automatically signify that third parties who may also be held to pay the claim are also discharged.

1 R.S.C. 1985, C. B-3
2 3095-7252 Québec Inc. vs. Mickeck Jacyno, 2010 QCCA 940 (CanLII)

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