(TMA International Headquarters)
Reflecting on the results of the Great Recession last year, The Economist newspaper described Canada as having the “least-bad rich-world economy.” Indeed, according to the Royal Bank of Canada, the Canadian economy has outperformed the U.S., the United Kingdom, and the European Union in real GDP growth since the trough of the recession in mid-2009. While Canada did experience a rush of restructuring and insolvency activity during the downturn, its economy as a whole has fared better and recovered faster than much of the rest of the world.
In the midst of the downturn in 2009,significant amendments to Canada’s restructuring and insolvency laws were proclaimed into force. These amendments introduced certain changes to how companies and their stakeholders approach formal restructuring proceedings. This article reviews the most significant of the amendments and discusses their practical impact on restructuring practices in Canada.
As a result of the changing appetite of lenders to support a full financial restructuring of companies and the comparatively small Canadian market, these new waters have only begun to be tested over the past two years. The cases to date that have considered the amendments have provided useful guidance on how they will likely be interpreted by the courts in the future and serve as important guides for restructuring professionals.
Canada has two primary federal statutes that deal with formal restructuring and insolvency: the Bankruptcy and Insolvency Act (BIA) and the Companies’ Creditors Arrangement Act (CCAA). Both statutes provide a formal process for companies to propose a reorganization plan akin to a Chapter 11 proceeding in the U.S., either through a plan of arrangement under the CCAA or a proposal under the BIA. Increasingly, companies are also pursuing opportunities to reorganize under the arrangement provisions of the Canada Business Corporations Act or similar provincial corporate statues.
In addition to offering a restructuring option, the BIA also governs the bankruptcy and liquidation of companies, much like a Chapter 7 proceeding in the U.S. It also sets out a process for secured creditors to realize value for their collateral through a court-supervised liquidation proceeding via the court appointment of a receiver.
In both the CCAA and BIA restructuring processes, an officer of the court provides independent oversight of the proceedings. This officer must be a licensed trustee in bankruptcy who is a financial advisor rather than a lawyer and who is subject to the oversight of the Office of the Superintendent of Bankruptcy, the federal regulators.
Both statutes set out a range of duties and powers of the officer. For example, in a CCAA proceeding, a monitor who is selected by the debtor and approved by the court reviews the debtor’s cash flow statements and financial affairs, reports any material adverse changes during the course of the restructuring, and advises on the reasonableness of a plan of arrangement made to creditors, among other duties. In addition, a monitor may also act in an independent advisory capacity to a debtor to assist in facilitating a restructuring or turnaround of the business.
In a BIA proposal, the debtor selects a proposal trustee with whom to file its proposal; that trustee has certain powers to investigate the affairs of the company and report to its creditors.
The amendments to the BIA and CCAA were originally passed by the Canadian Parliament in 2005 but were not fully proclaimed into force until September 18, 2009. Among other things, the amendments were intended to encourage the restructuring of viable businesses as an alternative to liquidation and to increase predictability and consistency in restructuring proceedings while retaining a degree of flexibility for individual situations. Further, the amendments sought to provide rights and protections to a debtor seeking to restructure under the BIA proposal proceedings similar to those that are available to a debtor in a CCAA proceeding, including the ability to obtain interim [debtor-in-possession (DIP)] financing and to disclaim or resiliate contracts.
While many of the amendments served to codify existing common law and practice, certain new amendments represented substantial new law and have not yet been subject to significant jurisprudence. Some of the more significant changes affecting the practicalities of formal corporate restructuring proceedings are addressed in the remainder of this article.
Interim (DIP) Financing
The amendments to the CCAA in relation to interim financing (commonly referred to as DIP financing) and its associated priority charge for the most part have codified pre-amendment common practice and case law. The related amendments to the BIA bring the two acts into alignment and make clear that such financing can now also be obtained in BIA proposal proceedings with an accompanying priority charge. The amendments do not expressly provide what priority a DIP charge is to obtain in any particular case, only that the DIP charge may be granted priority over pre-existing security interests on notice to those creditors affected.
Historically, companies sought the court’s approval of interim financing as part of their initial application for protection under the CCAA, often with little or no notice given to creditors. The amendments make clear that such an application must be made on sufficient notice to secured creditors who are likely to be affected by the priority charge given to this financing. Similar to the U.S. process, if timing and liquidity are significant issues but sufficient collateral value exists, the DIP lender may be prepared not to seek to prime existing security interests and Crown liens or deemed trusts initially in order to meet the notice requirements and obtain approval of the DIP financing on day one. Otherwise, the DIP financing would need to be delayed until proper notice had been provided. This points to the need for prudent planning on the part of debtors.
The amendments require that evidence of the need for such financing in a restructuring be given to the court, which places an onus on companies to make their need explicit under the circumstances. Pursuant to the amendments, the court is to consider, among other things: (a) how long the company is expected to be in creditor protection, (b) how the business is to be managed during the proceedings, (c) whether management has the confidence of its major creditors, (d) whether the loan enhances the prospects of a viable proposal, (e) the nature and value of the company’s property, (f) whether any creditor would be materially prejudiced by the granting of the charge, and (g) the report of the monitor or proposal trustee setting out their views on these points.
In the CCAA proceedings of Canwest Global Communications Corp (Canwest Media), the Ontario court confirmed that notice must be given to secured creditors likely to be affected by the DIP priority charge. It also confirmed that the amount granted under the DIP facility must be appropriate and required with regard to the debtors’ cash-flow forecast.
The court in Canwest Media also confirmed that the DIP charge should not and does not secure an obligation that existed before the order was made. That said, based on two recent CCAA filings, one in Alberta and the other in British Columbia, it would appear that this restriction does not prohibit paying prefiling secured claims over time during the CCAA proceedings from the debtor’s post-filing receipts rather than in one lump sum from the proceeds from the DIP financing.
The importance of notice requirements was further reinforced in the recent Ontario Court of Appeal decision in Indalex Limited (Re). In that case, the appellate court indicated that notice of the application for the DIP charge should have been given to the pension beneficiaries of the defined benefit plans. The difficulty in locating and providing notice to all pension beneficiaries, or in appointing representative counsel raises significant timing, and therefore liquidity, issues that parties must consider in similar proceedings in the future.
Initially, the factors to be considered by the court in approving DIP financing as set out in the amendments appeared to provide clarity to the lending market on what was required for the approval of a DIP charge. However, as discussed later, the Indalex
decision creates some uncertainty for DIP lenders in CCAA proceedings with respect to the priority of the DIP charge in cases in which the debtor has defined benefit pension plans.
Assignment, Disclaimers, or Resiliation of Agreements
Pursuant to the amendments, a company can assign, disclaim, or resiliate a wide range of agreements on notice to affected parties in either a CCAA proceeding or a BIA proposal. These amendments are largely a codification of pre-amendment common law developed under the CCAA, and they now make this option available to debtors seeking to restructure through a BIA proposal.
Unlike under Chapter 11 in the U.S., the new disclaimer provisions in the BIA and CCAA are not expressly limited to “executory contracts,” and the company is not under prescribed time constraints to elect to accept or reject certain contracts (other than aircraft leases). The amendments provide a level of objectivity to the process by requiring the monitor or proposal trustee, as applicable, or the court to approve any proposed disclaimer or resiliation. Subject to the requirements set out in the BIA and CCAA, all agreements, other than certain specified agreements, can be disclaimed. These specified agreements include collective agreements; eligible financial contracts, such as a swap or a hedge; and a financing agreement if the debtor is the borrower and a lease of real property if the debtor is the lessee.
Both the CCAA and BIA amendments provide that the court may review a debtor’s proposed disclaimer or resiliation of an agreement when either the monitor or proposal trustee, as applicable, has not approved the proposed disclaimer or resiliation, or when a counterparty to such an agreement objects within the prescribed notice period to the action being taken. In those circumstances, the court is to consider, among other things: (a) whether the monitor or proposal trustee, as applicable, has approved the proposed disclaimer or resiliation, (b) whether the disclaimer or resiliation would enhance the prospect of a viable compromise or arrangement being made, and (c) whether it would cause significant financial hardship to a party to the agreement. These factors provide some measure of protection from abuse of the provisions and mean that debtors should be prepared to demonstrate their bona fide need to disclaim or resiliate an agreement.
As collective agreements cannot be disclaimed, there is no significant ability for the courts to assist in restructuring efforts between an insolvent debtor and its union. While the court in certain circumstances can provide an order authorizing a company to serve a notice to bargain, the court does not have authority to unilaterally impose an amended collective agreement in an insolvency proceeding.
Licensees of intellectual property received protection in the amendments analogous to those found in Section 365(n) of the U.S. Bankruptcy Code. If the debtor has granted a right to use intellectual property to another party, the disclaimer or resiliation does not affect the party’s right to use the intellectual property during the remaining term of the agreement, as long as the party continues to perform the obligations under the agreement in relation to the use of the intellectual property.
The amendments provide a company with the ability to obtain court approval, subject to certain restrictions, to unilaterally assign certain agreements. Prior to the amendments, common practice was that assignments required the consent of the counterparty. As a result of the amendments, with certain exceptions, the court can order the assignment of an agreement over the objections of a counterparty, which may facilitate the restructuring process.
In considering whether to order an assignment of an agreement, the court is to consider, among other things: (a) whether the monitor or proposal trustee, as applicable, approved the proposed assignment, (b) whether the person to whom the rights and obligations are to be assigned would be able to perform the obligations, and (c) whether it would be “appropriate” to assign the rights and obligations to that person. The court may not make an order approving an assignment unless it is satisfied that all monetary defaults and related cross-defaults will be remedied.
As well, certain agreements cannot be assigned, including collective agreements, eligible financial contracts, post-filing agreements, and agreements that are “not assignable by their nature.” The amendments do not articulate what kind of agreement is “not assignable by its nature” or what makes an assignment “appropriate.” Based on very limited case law to date, the courts have given a fairly narrow interpretation to the former and a fairly broad interpretation to the latter.
Suppliers to companies in CCAA proceedings are required by statue to honor preexisting contracts, but they also are entitled to choose not to extend credit and can therefore enforce cash-on-delivery (COD) terms for post-filing goods or services. The ability of the court to designate a vendor as a “critical supplier” in CCAA proceedings was introduced by the amendments but differs substantially from the designation used in Chapter 11 proceedings. Parties designated as critical suppliers under the CCAA can be required to continue to supply goods or services to the debtor but do not have a statutory right to receive payment for pre-filing invoices. This designation is not available in a BIA proposal proceeding.
The new provisions allow the court to declare a party to be a critical supplier if the court is satisfied that the party is a supplier of goods or services that are critical to the debtor’s continued operations. A critical supplier may be compelled by the court to continue to supply any goods or services on terms consistent with the existing supply relationship or on other terms the court considers “appropriate.” In exchange for this, a charge over the debtor’s assets up to the value of the goods or services supplied is to be granted. The court may order that this charge rank in priority over the claims of any other secured creditors; however, notice must be provided to affected creditors.
The designation of critical suppliers can benefit the debtor by compelling continued supply while minimizing the cash-flow impact (by arrears remaining unpaid and eliminating cash-in-advance or COD payment requirements for post-filing goods or services). Debtors must weigh the short-term benefit of attempting to force continued supply in this manner against the impact on its operations post-restructuring and the longer term relationship with those suppliers.
A recent example of the use of this provision is found in the CCAA filing of Priszm Income Fund. In that case, the debtors obtained the court’s approval to designate more than 200 suppliers as critical suppliers, including providers of goods and services, as well as utilities. The suppliers were grouped by service type, and payment terms were set out for each category. Under the circumstances, the court was satisfied that any interruption of supply by these suppliers “could have an immediate material adverse impact” on the debtors’ operations and so compelled them to continue supplying the debtors. The court approved a critical supplier charge that ranked behind the court-ordered administration charge but ahead of the DIP charge.
In the Canwest Media
proceedings, critical suppliers were not compelled to provide post-filing goods or services (and so no critical supplier charge was sought or granted), but the debtor was permitted by the court to pay pre-filing arrears owing to those suppliers. The court held that it was not precluded from authorizing such payments to secure continued supply. As such, this remains an alternative approach.
Sales of Assets
While sale transactions in Canadian restructuring proceedings can take a variety of forms, dispositions of assets outside the ordinary course are subject to court approval. A stalking horse process is one of the sale process options available, but sales by auction, tender, or other methods are appropriate as long as they can be demonstrated to be reasonable in the circumstances. The amendments to the CCAA and BIA have largely codified previous case law on the approval process for sale of assets, which focussed on whether a sales process had been fair and reasonable, considering the interests of all parties.
In determining whether to approve a proposed sale of assets, the court is to consider, among other things: (a) whether the process leading up to the sale was reasonable and, in a CCAA proceeding, if the process was approved by the monitor, (b) whether the sale is more beneficial than a bankruptcy to creditors, (c) the extent to which the creditors were consulted, (d) the effect of the sale on creditors and interested parties, and (e) whether the consideration to be received is fair and reasonable, taking into account their market value. If the sale is to a non-arm’s-length party, the court will consider whether good faith efforts were made to sell to persons not related to the debtor and if the consideration received was superior to any other offer made by entities in the sale process. Case law to date indicates that the court is likely to strictly interpret these requirements, particularly that good faith efforts were made to sell to nonrelated parties.
Neither the CCAA nor the BIA prescribe any statutory outline for a sale process, except that the process be “reasonable.” A sale process is typically approved by the court, and in doing so it will consider the report of the monitor or the proposal trustee to obtain their views on the rigor involved in developing the sale process. Accordingly, the monitor and proposal trustee are typically involved in developing the sale process from the outset to ensure that the tests to be applied by the court can be satisfied. If a person has any issues with the sale process, it is important that any such concerns be raised early on; in the CCAA proceedings for Canwest Media
and White Birch Paper Holding Company
, issues that were raised at the sale approval motion were considered to have been brought up too late.
The amendments repealed the existing Canadian legislation for recognition of foreign insolvency proceedings and replaced it with structured legislation based on the UNCITRAL Model Law. While the full Model Law was not adopted, the resulting provisions are similar to the recognition provisions in Chapter 15 of the U.S. Bankruptcy Code. These provisions provide for the recognition of foreign proceedings and coordination of Canadian proceedings with those in other jurisdictions where “foreign main proceedings” have been commenced. Similar consideration is given by courts to the “centre of main interest” of debtors as in other Model Law-based proceedings in determining whether those foreign proceedings meet the test of “main proceedings.”
In Canada, as part of the recognition proceedings, the debtor (through its “foreign representative”) generally seeks the appointment of an information officer. This role is not prescribed by statute, nor was it codified in the amendments, but the powers of the information officer are generally limited to assisting the foreign representative in its duties as set out in the statute and reporting to the court on the status of the proceedings.
The restructuring community is continuing to evaluate the impact of the amendments on new restructuring proceedings, as the volume of cases has not yet tested them fully. From the time the amendments were proclaimed in force in September 2009 through early July 2011, fewer than 70 new CCAA proceedings had been commenced across Canada. The court has provided guidance in the larger restructuring cases on how some of the amendments are to be applied; for example, in the Canwest Media proceedings, which were commenced shortly after the amendments were proclaimed in force, the court provided extensive reasons as part of its endorsement of the principal orders in the proceedings to illustrate its considerations with respect to DIP financing and the sale approval process.
The Indalex decision mentioned earlier may potentially have a significant impact on larger restructurings in Canada. The Ontario Court of Appeal overturned a lower court decision and held that, on the wind-up of a defined benefit pension plan, the Pension Benefits Act (Ontario) creates a deemed trust (akin to a statutory security interest) over the employer’s assets for the amount necessary to fund the deficiency on the wind-up of a defined benefit pension plan. Further, the court held that on the specific facts of the case, citing a number of procedural matters, the DIP charge was not effective to grant priority over the deemed trust.
The court also found that with respect to a second defined benefit pension plan that was not wound up, Indalex had a conflict of interest because it was wearing two hats, even though that fact situation is not unusual and was not previously a concern under applicable case law. The directors of Indalex had a duty to act in the best interest of the corporation. But the company was also the plan administrator and had a duty to act in the pension plan beneficiaries’ best interests. The Court of Appeal held that this conflict of interest resulted in a breach of fiduciary duty by the debtor and, as a consequence, the beneficiaries of that second defined pension plan were also given priority over the DIP charge.
The Ontario Court of Appeal did confirm that in the right circumstances, a DIP charge could be granted in priority to the Ontario Pensions Benefits Act deemed trust, but that would require several procedural and structural changes to existing practices in these proceedings in Ontario.
This determination on the priority of the pension plan deficit may have a significant impact on the restructuring of companies with defined benefit pension plans. It remains to be seen how the decision in Indalex
, which is very fact-specific, may be applied or distinguished in other proceedings. Leave to appeal the Indalex
decision to the Supreme Court of Canada has now been sought, but the leave application probably will not be heard until later this year.
On the Horizon
With the recovery seen so far in the Canadian economy and the increased availability of credit and capital on both sides of the border, a significant number of large restructuring cases that will further test the impact of these amendments may not be seen in the short term. Many of the larger Canadian companies that were considered likely restructuring candidates have already completed formal restructurings, restructured out of court, entered into amended facilities, or been able to access additional funding sources that were not previously available during the global credit crisis. In many cases, companies are implementing the restructuring through a prearranged CCAA or receivership proceeding. A free-fall bankruptcy is likely to continue to be a rare occurrence in Canada.
Despite the economic recovery, the past 12 months have brought an increase in restructuring and insolvency activity in the Canadian mid-market (companies with debt between C$10 million and C$50 million). When formal filings have been required, they often have taken the form of receiverships led by secured creditors. This is likely to continue over the next 12 months as well.
Additionally, the Canadian market has started to experience an increase in BIA proposals. Among other reasons, this can be a lower-cost alternative to effect a restructuring for smaller companies that do not wish to deal with the uncertainty and increased cost associated with a CCAA filing but want to avail themselves of many of the benefits of a CCAA proceeding. As a result of the amendments, debtors making a BIA proposal now have many of the same rights and protections as are available to debtors under the CCAA.
The last two years have brought significant change for distressed companies in Canada and their stakeholders. The amendments brought into force have codified common practices and in some cases provided new tools to be used in restructurings. The impact of these amendments will continue to become clearer, and their scope will undoubtedly be challenged as companies seek to effect creative solutions through financial restructuring.
The authors express their gratitude to Milly Chow and Steven Weisz of Blake, Cassels & Graydon LLP for their legal perspective and input in the development of this article.
 Canada does not have bankruptcy courts as in the U.S., but each province has a court that has jurisdiction over insolvency matters, to which the references to “court” in this article pertain.
 The BIA proposal process is generally a less costly and more statute-driven process than the CCAA process, with strict timeframes, rules, and guidelines as set out in the BIA. Unlike the CCAA process, there is no minimum debt threshold. As a consequence, smaller companies seeking to restructure are more likely to use the BIA proposal process.
 Certain of the 2005 amendments relating to eligible financial contracts and wage and pension priorities were previously proclaimed into force.
 See CCAA proceedings of Angiotech Pharmaceuticals, Inc.,
(British Columbia) and Cow Harbour Construction Limited
(Alberta). There are separate provisions for disclaimers of real property leases by lessees in the BIA and CCAA.