Not for Profit Bankruptcy Case Shows the Law in the Area is Clear as Mud
by Adam Aptowitzer - July 2010

In our practice we are periodically faced with the unfortunate situation when a charity or not for profit is forced into bankruptcy or receivership. Unfortunately, giving clear advice in the area is complicated by the relative lack of applicable law. In one circumstance we were confronted with a situation as to whether a going concern operating as a charitable trust could make a proposal in bankruptcy. So it is with some interest that we read of the recent case of Corporation of the City of Peterborough v. Kawartha Native Housing Society Incorporated et al. ("KNHS") heard at the Court of Appeal for Ontario on September 13th, 2009.

While the KNHS case is unique in a variety of aspects perhaps the most fundamental is that in this case the corporation was placed under receivership because of defaults under certain agreements with the Province. (In due course the province was replaced by the City of Peterborough in the litigation). Predictably, the corporate Board litigated the appointment of the receiver and hired lawyers to represent this position in court. As part of the litigation, the Board sued to have the lawyer's fees paid from the assets of the charity. In an odd twist, because the corporate funds were advanced by the City of Peterborough or the Province under the original agreements, the funds to pay the lawyer's fees would be paid by the same parties trying to appoint the receiver in the first place!

Interestingly, amongst other arguments made by lawyers for the corporation, was an argument based on KNHS' not for profit status and that:

"Since the Corporations are "not-for-profit, community-owned, social purpose enterprises", the clear goal of the receivership should be that the affairs of the Corporations are put in such good condition that the receiver can depart as soon as possible and return the management and operation of the Corporations to a community-based board of directors".

On the other hand, the City argued that the nature of not for profit housing corporations, and the terms of the agreement with the government, should in fact give the Receiver more control over the not for profit than in a usual commercial receivership situation.

In its analysis, the Court found that not for profit companies are unique and that case law regarding the receivership of share capital (i.e. for profit) corporations may be analogous, but not necessarily precedential for non share capital corporations. In the result, the Court allowed the corporation to pay some of the legal expenses. 

In considering the issue on appeal Justice Blair found that to give a corporation the constitutional right to defend itself but not to give it any ability to hire counsel would be to effectively deny it the right to defend itself in court. This, along with the fact that KNHS' debts were gradually diminishing under the control of the Receiver, led the Court to agree that under these circumstances KNHS could retain counsel paid out of the corporate funds.

The case is interesting for reasons that surpass its various unusual aspects. In particular, it brings into sharp relief the general lack of guidance which exists when non share capital corporations are forced into bankruptcy or similar situations. While the current grey area of the law was a problem before, the fact that the Court found that cases involving for share corporations are not precedential arguably creates even less law in the area than there was previously. While non share capital corporations do not often venture into bankruptcy waters, from time to time it happens, and as this case shows it may be extremely difficult to give such entities clear advice about the application of the law.