Bankruptcy Doesn’t Invalidate Existing Contracts, BCSC Rules

Just because a company has gone bankrupt doesn’t mean its contracts are unenforceable, the Supreme Court of British Columbia has confirmed.

On July 5, B.C.’s Supreme Court rendered its decision in 9019235 Canada Inc. v Coast Fraser Enterprises Ltd., 2022 BCSC 1132 (CanLII), a case that involved a trustee attempting to collect outstanding debts from the former clients of EncoreFX, a B.C.-based financial services firm that filed for bankruptcy in March, 2020.


EncoreFX provided foreign exchange risk management services and cross-border payment services to small and medium enterprises. Its services included foreign exchange spot transactions, foreign exchange derivative contracts (including forward contracts and options) and payment processing services.

The market value of EncoreFX’s derivatives products fluctuated every second of every day due to movements in underlying foreign exchange (“FX”) rates. At any given time, the market-to-market value of each of the derivative contracts may have been “out-the-money” (“OTM”), “in-the-money,” or “at-the-money.” An OTM position meant the FX rate and other factors had moved against the customer and if the contract were to be liquidated, the customer would owe EncoreFX an amount equal to the OTM position.

In order to be competitive within its industry, EncoreFX offered a credit facility to certain customers that booked derivative contracts. The credit allowed the customer to be in the OTM position up to a stated credit limit without having to pay margin calls that would otherwise have been payable each time the customer was in the OTM position or a new contract was booked.  EncoreFX had the right to terminate the credit facility at any time in their sole discretion.

EncoreFX’s Bankruptcy

Due to market volatility during the start of the COVID-19 pandemic, a number of EncoreFX’s customers (and its subsidiaries’ customers) were OTM on their transactions and subject to margin calls. EncoreFX attempted to work with its OTM customers to address the outstanding margin calls, but many of these customers were unable to make margin payments.

As a consequence of customers who were unable to pay margin calls, EncoreFX was left OTM with its third-party banking counterparties and was required to pay significant margins to cover the value of its OTM contracts with those counterparties.

In March 2020, EncoreFX determined that its short-term liquidity was insufficient to meet its obligations and it filed for bankruptcy. In March 2021 EncoreFX’s bankruptcy was continued as a restructuring proceeding pursuant to the Companies’ Creditors Arrangement Act, which we wrote about here.

Realization of OTM Positions

EncoreFX’s trustee in bankruptcy (the “Trustee”), Ernst & Young Inc. (“EY”), determined that EncoreFX could no longer extend credit to customers. The Trustee therefore cancelled the credit facilities and informed customers that their current OTM positions were due and owing as a margin call. Customers who failed to pay the margin call had all of their open transactions terminated and their accounts closed out.

Where a close-out resulted in an amount payable by the customer to EncoreFX (an OTM position), the Trustee demanded payment of that amount. In some cases, customers made payments or made arrangements to settle the OTM position. However, most customers either failed to respond or refused to make payment.

In July 2020, the Trustee began formal collection proceedings against approximately 260 customers that had an unpaid OTM position. These collection efforts included sending the customers repeated demand letters. The Trustee then commenced litigation against approximately 90 customers that failed to make payment or negotiate a reasonable settlement. By the end of 2020, the Trustee had resolved the vast majority of the unpaid OTM positions.

In April 2021, EY as Monitor attended mediation with 13 OTM customers whose combined OTM position exceeded $7.5 million. The mediation occurred before the Right Honourable Beverley McLachlin, former Chief Justice of the Supreme Court of Canada. Her invaluable insight and guidance resulted in settlements with all 13 customers.

Subsequent to the mediation, EY continued to successfully resolve many of the remaining OTM disputes. By early 2022, approximately two years after EncoreFX filed for bankruptcy, only one OTM customer (of the approximately 260 OTM customers) continued to refuse to make payment or enter into a reasonable settlement. In July 2022, EY brought a summary trial application in the Supreme Court of British Columbia against this remaining customer.

Court Validates Trustee’s OTM Collection Efforts

A key issue throughout the OTM collection efforts and at the summary trial was whether the Trustee could terminate the credit facilities, issue margin calls and close out transactions for failure to pay the margin calls.

The Court agreed with the Trustee’s approach and position, finding that the Trustee expressly affirmed the derivative contracts and confirmed its intention to complete all outstanding contracts, assuming there was no breach by the customer (i.e., if  the customer made the margin call). The Court also found that the Trustee had adequately assured customers that any margin call paid by them would be held in trust, so they would not be treated as an unsecured creditor.

Most importantly, the Court found that the Trustee had the right to unilaterally cancel the customer’s credit facility at any time under the terms of the various agreements between the parties. Once the credit facility was terminated, the Trustee also had the right to cancel any “buffer” or room the customer had to avoid paying margins when the customer’s credit facility was eliminated. Accordingly, the Trustee was entitled to issue a margin call and close out all outstanding transactions when the margin call went unpaid.

The Court rejected the customer’s argument that EncoreFX had not suffered any losses because the customer would have been “in-the-money” had the contracts been closed out at the maturity date of the existing contracts. Relying on settled law that damages are typically calculated at the time of breach, the Court agreed with the Trustee that whether the customer may have been “in-the-money” in the future was irrelevant.

Key Takeaways

The Court’s comments are a good reminder that a bankruptcy does not automatically invalidate all existing contracts. Where a trustee chooses to affirm existing contracts, compliance with the terms of the contracts by all parties is expected. Any breach may entitle the trustee to terminate the contract, in accordance with the terms and conditions of the contract, and seek damages for any losses resulting from the breach.

Vancouver lawyer William E. J. Skelly was pleased to act as counsel to Ernst & Young in this case. The MLT Aikins insolvency and restructuring group comprises 18 lawyers practising in six offices across all four western Canadian provinces. Our experience helps clients preserve value, capture business opportunities and resolve disputes across various sectors of the western Canadian economy. If you require help navigating bankruptcy and restructuring proceedings, please contact a member of our team.

Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.