Financial services lawyers Timothy Dunn and Stephen Skorbinski's article "The pandemic and municipal insolvency: Part one" was published by The Lawyer's Daily.

In the article, they discuss Canada’s economic and financial challenges due to COVID-19, Canadian insolvency regulations, and the advantages they offer for financially distressed municipalities.

The article was published on January 20, 2021. To read it in The Lawyer’s Daily, visit: https://www.thelawyersdaily.ca/articles/23868/the-pandemic-and-municipal-insolvency-part-one-

The pandemic and municipal insolvency: Part one

The COVID-19 pandemic has had a devastating impact on the Canadian economy. The federal deficit is projected to exceed $380 billion in the fiscal year 2020-21, which exceeds the Parliamentary Budget Office’s initial projection released in April 2020 by more than $100 billion. These deficit figures should come as no surprise given the partial shutdown of the Canadian economy over the course of the last 10 months and the financial measures adopted by all levels of government to limit the pandemic’s financial impact on Canadians.

Much of the focus regarding the pandemic’s impact has been on the federal and provincial governments. However, municipalities are not immune to the pandemic’s resulting economic challenges. Most municipal employees and services have been deemed essential. At the same time, municipalities have been forced to close certain revenue generating facilities and many have offered property tax deferrals. Under these circumstances, municipalities are struggling to find the resources to meet their financial obligations. Recently released data by the Federation of Canadian Municipalities (FCM) found that cities across Canada are facing a minimum shortfall from anywhere between $10 billion to $15 billion as a result of the pandemic.

Municipalities have limited revenue-generating tools available to them and are constrained by provincial legislation which, among other things, prohibits budgetary deficits. Not surprisingly, municipalities have been actively lobbying for additional provincial and federal financial support, with some mayors, including the mayor of Vancouver, suggesting that if they do not receive financial assistance that their cities are at risk of going bankrupt. Due to the lobbying efforts of municipalities, the federal government recently set aside $3.8 billion to be distributed evenly to municipalities based on population. However, failing provincial intervention, municipalities are still projected to have a shortfall based on FCM’s projections.

Due in large part to the aforementioned financial constraints placed on municipalities, Canada has not had any notable municipal bankruptcies to date. That said, Canadian municipalities have experienced insolvency in the past. During the 1930s, several municipalities, including higher-profile cities such as Windsor, York and Burnaby, defaulted on payments to creditors. In these cases, the municipalities either restructured their financial affairs outside of the formal restructuring processes available under insolvency legislation or amalgamated with smaller adjoining cities.

Municipalities will likely encounter unprecedented economic losses as a result of the pandemic. What happens if a city is unable to restructure its financial affairs outside of the formal regimes established under Canada's insolvency legislation? What legal remedies are available to municipalities? The answer, as it turns out, is somewhat unclear.

Legislation pertaining to financially distressed municipalities

Legislative authority in Canada is divided between the federal and provincial governments based upon subject matter. While bankruptcy and insolvency is a federal responsibility, municipal governance falls within the exclusive jurisdiction of the provinces.

A number of provinces have enacted legislation that deals with the management of distressed municipalities. For example, Ontario, Quebec, and several other provinces have passed legislation that places distressed municipalities under the control of municipal boards. The municipal boards are responsible for conducting inquiries and managing the financial affairs of distressed municipalities. To date, there is no evidence to suggest that these boards have been relied upon in any meaningful way.

While many provinces have enacted legislation dealing with the management of insolvent municipalities, bankruptcy and insolvency falls under the purview of the federal government. Municipalities could potentially benefit from the formalized restructuring regimes under Canada’s insolvency legislation. However, there is some uncertainty as to whether municipalities can rely on Canada’s insolvency legislation.

Can financially distressed municipalities rely on insolvency legislation?

For the most part, Canadian municipalities have been fiscally healthy since the mid-20th century. As a result, there is no recent case law that deals with the issue of whether insolvent municipalities can rely on existing bankruptcy legislation.

Notably, in early case law dating to the mid-1930s, the courts held that insolvent municipalities could not rely upon the Bankruptcy and Insolvency Act (BIA), the principal federal legislation governing bankruptcy in Canada. One of the reasons that the courts held that municipalities could not rely on the BIA was that municipal corporations did not fall within the narrow definition of “corporation” under the BIA, which, prior to amendments in 1997, required that the corporation be incorporated for the exclusive purpose of “carrying on business.” As municipalities are not incorporated for the exclusive purpose of “carrying on business,” it followed that they did not fall within the definition of “corporation” as it was then defined in the BIA.

However, the 1997 amendments to the BIA removed the requirement that the corporation be incorporated for the exclusive purpose of “carrying on business.” Although it has yet to be determined by the courts, there is an argument to be made that municipal corporations now fall under the scope of the BIA, which would allow insolvent municipalities to restructure their affairs through a formalized process.

This is part one of a two-part series. In the following article, we will discuss the advantages available to municipalities if it is determined that they can rely upon Canada’s insolvency legislation to restructure their affairs.

Re-printed with permission from The Lawyer's Daily - originally published on January 20, 2021.

If you have any questions regarding this article or have financial, bankruptcy, or insolvency inquiries, contact Timothy Dunn at tdunn@mindengross.com, or contact Stephen Skorbinski at sskorbinski@mindengross.com.