Bankruptcy and Insolvency Act Section 38 – Creditors Taking Matters Into Their Own Hands

For lawyers who do not practice regularity in bankruptcy and insolvency matters, with the next few email updates we hope to shed light on a few of the interesting provisions in the Bankruptcy and Insolvency Act (“BIA”) that are used quite regularly by the Insolvency Bar but may be unfamiliar to those practicing in other areas.

The first section we wish to discuss is BIA section 38. Essentially, section 38 allows a creditor to realize on an asset, whether it be a pre-bankruptcy preferential payment or transfer or other chose in action or ongoing litigation for which the bankrupt is a named plaintiff where a Trustee confirms that it has no intention to pursue that asset. Section 38 provides the ability of a specific creditor (or a group of creditors) to pursue assets that may not otherwise be realized upon in a bankruptcy administration. Of course, the risk of the pursuit belongs to this creditor, however, and more importantly, the reward also belongs solely to the creditor should the creditor be successful in converting the asset to cash. BIA section 38(1) is summarized below.

Where a creditor requests the trustee to take any proceeding that in his opinion would be for the benefit of the estate of a bankrupt and the trustee refuses or neglects to take the proceeding, the creditor may obtain from the court an order authorizing him to take the proceeding in his own name and at his own expense and risk, on notice being given the other creditors of the contemplated proceeding, and on such other terms and conditions as the court may direct.

In many instances the reason a Trustee would not pursue potential assets is because there are insufficient funds to pay its fees and disbursements (including legal fees) and it does not care to take on unnecessary collection and/or litigation risk. Set out below is recent practical example of when section 38 would come into pay.

An insolvent company was petitioned into bankruptcy. The applicant creditor was aware that the bankrupt company was the plaintiff in several actions which the applicant creditor believed had value. The only material assets of the bankrupt company were these actions. The Trustee sent notice to all creditors that it would not be pursing the actions and that if any creditor wished to pursue these actions it may seek leave of the court to do so pursuant to section 38.  The applicant creditor brought a motion in bankruptcy court to take the proceeding in his own name and at his own expense and risk, which order was granted. The applicant creditor was then able to continue the litigation.

In summary, BIA section 38 is a useful tool in situations where a creditor wishes to pursue an asset at its own cost and benefit, when the Trustee refuses or neglects to do so.