Under the Canadian Bankruptcy and Insolvency Act (BIA), if a Licensed Insolvency Trustee (LIT) demands you return money paid to you by a bankrupt debtor, this is known as a preference claim. You can defend this by proving the payment was made in the ordinary course of business or was part of a realistic plan to stay in business. However, commercial pressure is not a valid legal defence. Hiring a commercial lawyer is strongly recommended to protect your funds.
When a struggling business or individual finally files for bankruptcy in Canada, the Licensed Insolvency Trustee (LIT) meticulously reviews their recent financial transactions. If the bankrupt person paid off a specific supplier or a family member right before filing, the LIT may view this as unfair to the other creditors. 📍
This scenario is called a “preference payment.” The goal of the federal BIA is to ensure that all unsecured creditors are treated fairly and receive an equal percentage of whatever funds are available. If you recently received a large cheque from someone who subsequently went bankrupt, the LIT can legally demand that you return the money. This guide outlines how to respond to a preference claim and defend your legal rights. 💼
Step-by-Step Process in Canada
Receiving a demand letter from a Trustee can be incredibly stressful, but it is not an automatic guilty verdict. You have the right to challenge their assessment, and most creditors choose to work with a local law firm to build a strong defence. ⚔️
Step 1: Review the Trustee’s Demand Letter
The first step is carefully reading the demand sent by the LIT. The letter will outline exactly which payments are being challenged, the total amount in CAD, and the legal basis for the claim under Section 95 of the Bankruptcy and Insolvency Act. Do not ignore this letter, as ignoring it could lead to default court judgments against you. 📜
Step 2: Determine the Arm’s Length Relationship
The timeframe for a preference claim depends heavily on your relationship with the bankrupt debtor. If you are a standard supplier (arm’s length), the LIT can only look at payments made within 3 months prior to the bankruptcy. If you are a family member, business partner, or close friend (non-arm’s length), the look-back period extends to a full 12 months. 📈
Step 3: Gather “Ordinary Course of Business” Evidence
Your strongest defence is proving that the payment was completely normal and not a special favour. You need to gather old invoices, historical payment logs, and emails. If the debtor always paid your invoices 60 days late, and this final challenged cheque was also paid 60 days late, you can argue it was simply the ordinary course of business. 💰
Step 4: Assess the Debtor’s Intent and Rebutting the Presumption
For an arm’s length transaction to be a preference, the LIT must establish that the debtor was insolvent at the time and that the payment had the effect of preferring you. Under Section 95(2) of the BIA, if a payment is made within the 3-month look-back window, a statutory presumption of preferential intent is triggered. Crucially, commercial pressure from a creditor-such as aggressive collection efforts, threats of litigation, or cutting off supply-cannot be used as a legal defence to rebut this presumption. The law explicitly states that the presumption applies even if the payment was made under pressure, and evidence of such pressure is inadmissible to support the transaction. This was firmly upheld by the Court of Appeal for Ontario in RPG Receivables Purchase Group Inc. v. American Pacific Corporation, 2025 ONCA 371. Instead, you must prove the payment was made in the ordinary course of business or was part of a realistic, objectively reasonable plan to continue operations that would benefit creditors generally (the “staying in business” defence). 🏦
Step 5: Negotiate or Attend Court
Most preference claims do not end up in a full trial. Your commercial lawyer will present your evidence to the LIT and attempt to negotiate a settlement. If the LIT insists on pursuing the full amount and you refuse to pay, the matter will be scheduled for a hearing at your provincial superior court. 📑
How Much Does it Cost to Defend?
Defending against a preference claim requires weighing the cost of legal fees against the amount the Trustee is demanding. Here are the average costs you can expect in CAD: 💵
- Commercial Lawyer Fees: Lawyers handling insolvency litigation typically charge between $350 and $800 per hour.
- Initial Review and Response: Having a lawyer analyze the claim and write a formal defence letter generally costs $1,500 to $3,500 CAD.
- Settlement Costs: It is common to negotiate a settlement where you return a percentage (e.g., 30% to 50%) of the disputed amount to avoid trial costs.
- Court Costs: If the matter proceeds to a full hearing, legal fees can easily exceed $10,000 to $25,000 CAD.
How Long Does the Process Take?
Trustees usually give you 15 to 30 days to respond to their initial demand letter. If you provide strong evidence that it was an ordinary transaction, the LIT might drop the claim within a few weeks. However, if the matter requires negotiation or court intervention, resolving a preference dispute can take anywhere from 6 to 18 months. ⏱️
Arm’s Length vs. Non-Arm’s Length Preferences
| Feature | Arm’s Length (e.g., Standard Supplier) | Non-Arm’s Length (e.g., Family Member) |
|---|---|---|
| Look-Back Period | 3 months before bankruptcy filing. | 12 months before bankruptcy filing. |
| Burden of Proof | LIT must prove intent to prefer. | Intent to prefer is automatically presumed by law. |
| Common Defence | Ordinary course of business or a realistic, objectively reasonable plan to continue operations (the “staying in business” defence). Commercial pressure is not a valid defence. | Extremely difficult to defend; usually requires proving debtor was solvent at the time. |
| Scrutiny Level | Standard review of business accounts. | Highly scrutinized by the Trustee and the OSB. |
Frequently Asked Questions (FAQ)
Can the Trustee freeze my business bank account?
No, the LIT cannot unilaterally freeze your bank account just by sending a demand letter. They would need to formally sue you and win a court judgment before they could attempt to garnish your accounts.
What if I already spent the money?
Unfortunately, spending the money is not a valid legal defence against a preference claim. If the court rules that the payment was an unfair preference, you are legally required to repay the estate, even if you have to borrow the funds.
Does a preference claim mean I committed a crime?
No. A preference payment is a civil commercial matter under the BIA, not a criminal offence. The goal is simply the fair redistribution of assets, not punishing you for accepting a payment you were rightfully owed.
Can I just ignore the LIT’s letters?
Ignoring the LIT is highly dangerous. If you fail to respond, the LIT can apply to the court for an undefended default judgment against you, which will force you to pay the full amount plus their legal costs.
Will returning the money reinstate my claim as a creditor?
Yes. If you return the preference payment to the Trustee, you are essentially put back in your original position. You can then file a Proof of Claim for the full amount you are owed and receive your pro-rata dividend like the other unsecured creditors.
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