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Note:In order to appeal a tax assessment by the province of Ontario, Canadian Airlines International, Ltd. caused its banks to issue three LCs totaling CA$ 1,248,324.84 and naming the provincial revenue authority as Beneficiary. When the airline filed for insolvency protection under the Companies' Creditors Arrangement Act (CCAA) subsequently, it listed the Revenue Authority as a creditor, but stated that the amount owed was zero, failed to serve the authority with notice of the filing, and delayed in sending a voting package which was ultimately sent but to the wrong office of the Authority.

When the Revenue Authority attempted to file a late claim, it was refused. Accordingly, the Revenue Authority applied to extend the time to file the claim which was granted. The claim was for CA$ 2,064,444.19, an amount in excess of the balance of the LCs. The reorganization plan did not mention the LCs.

The Revenue Authority petitioned the Alberta Queen's Bench for a declaration to the effect that the plan did not compromise the debt it was owed. The Airline contended that the LCs should be applied to pay the portion of the debt allocated to the Revenue Authority, 0.14 cents per CA$ 1.00 of debt. The Revenue Authority, on the other hand, argued that it was entitled to draw on the LCs and that the proportionate allocation of 0.14 cents applied only to the deficiency. Romaine, J., granted the Revenue Authority's application and concluded that the plan compromised only the portion of the debt not secured by LCs.

The airline argued that the letters of credit were not security interests in its assets of the Revenue Authority, but separate contracts between the Revenue Authority and the various banks that issued the LCs. Further, it contended that the fact that the Revenue Authority accepted them in lieu of cash characterized them as more of a "guarantee" that Beneficiary would receive its money rather than as a security interest.

The court did not agree, citing the legislation under which the tax was payable to the Revenue Authority, which characterized the LCs as a security, though subject to certain conditions. The court found that "forbearance by [the Revenue Authority] in recognition of the possibility of [Applicant's] appeal of the assessment may be successful is not the equivalent of acceptance of the risk of [Applicant's] intervening insolvency."

The court noted that bankruptcy cannot "deprive the [Beneficiary] from having resort to the security for which it bargained in order to protect itself in the case of the very kind of eventuality which has occurred." Therefore, a beneficiary should be able to call upon a letter of credit "when the event for which the security was given occurs, without regard to the circumstances existing between the parties to the underlying transaction." The court concluded that the purpose of an LC is to "secure anticipated payments in a manner which would not rely upon the will, status, or financial faith of the applicant."

The airline submitted that since the Revenue Authority's claim was unsecured, the plan must be interpreted as affecting the claim in its entirety, not just that which would be left over after the application of the letters of credit. The court found that "[c]ompromising the entirety of [the Revenue Authority's] claim, which in effect deprives [it] from much of the value of its security is inconsistent with the general concept of the Plan." It held that the airline's interpretation "results in anomalous treatment of a secured creditor and tax claimant under the Plan" by treating a secured creditor like an unsecured creditor. The court held further that there was no evidence that any other tax claimant was secured but deprived of that security in the manner in which the airline proposed to deprive the Revenue Authority.

While the court was not persuaded by all of Revenue Authority's assertions, it found that the plan "can and should be interpreted as excluding secured claims from the compromise." Interpretation of the plan in this way would not unnecessarily enhance Revenue Authority's rights or special treatment, but would "honor the clear security arrangements made prior to the CCAA proceedings and [treat] the deficiency in a manner identical to the unsecured claims of all affected creditors."

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