2013 Mid-Market Commercial Insolvency Update

By David R.M. Jackson on 2013/06/10

[This paper was prepared for the Annual CAIRP Insolvency & Restructuring Forum, Winnipeg,  May 2, 2013.]

From the vast assortment of insolvency cases reported this past year, this paper culled out an even dozen for the purposes of this CAIRP Mid-Market Commercial Insolvency Update: two from the Supreme Court; two from Manitoba; and eight others from across the country.

Some years are easier than others for spotting themes or trends. The two Supreme Court decisions continue the trend of the Federal Paramountcy Doctrine enabling our insolvency regime to trump provincial jurisdiction in pensions and the environment. Or so it seems. While ostensibly these decisions turn on the Federal Paramountcy Doctrine, it may well be that the result breathes life back into the residual provincial jurisdiction which will complicate restructuring efforts for years to come. The local Manitoba cases are always interesting, particularly since we have some knowledge of the players involved. These decisions are practical and provide us with useful guidance for future filings. The balance of the cases selected cover a miscellany of different commercial restructuring issues with dicta that illuminate, inspire creativity and should hopefully prove to be of value in your endeavours.

The read should repay the effort.

1. Déjà vu All Over Again? Paramountcy v. Provincial Liens and Trusts

Sun Indalex Finance, LLC v. United Steel Workers 2013 S.C.C. 6

Back in April, 2011 the Ontario Court of Appeal handed down its decision in Re Indalex Limited 2011 ONCA 265 and unleashed a storm of controversy.[i] The Ontario Court of Appeal ruled, amongst other things, that beneficiaries under salaried and executive defined benefit pension plans were entitled to the proceeds of sale of the company’s asset to cover shortfalls of their underfunded pension plans under provincial deemed trust legislation in priority to Indalex’s debtor in possession (“DIP”) lender notwithstanding the express priority granted in Indalex’s Initial CCAA Order. While the SCC overturned the Ontario Court of Appeal decision on February 1, 2013, by acknowledging a CCAA Court’s jurisdiction to grant priority charges over deemed trusts it has generated additional uncertainty and controversy.[ii]

Indalex was a wholly owned Canadian subsidiary which manufactured aluminium extrusions. In 2009 a combination of high commodity prices and the economic recession plunged Indalex and its related companies into insolvency. On March 20, 2009 the U.S. parent filed for Chapter 11 protection. On April 3, 2009 the Ontario Court granted Indalex’s Initial Order in CCAA. On April 8, 2009 the Initial Order was amended authorizing Indalex to borrow over $24 million U.S. from a group of DIP lenders and granted the usual priming charge over all other creditors, trusts, etc. Indalex’s obligations under the DIP loan were guaranteed by the U.S. parent.

Indalex was also the sponsor and administrator of two underfunded defined benefit pension plans – one for salaried employees, the other for executives. The salary plan was in the process of being wound-up prior to the initial CCAA filing.

On July 20, 2009 Indalex sought Court approval to sell its assets on a going-concern basis. At that hearing the pension plan beneficiaries sought and obtained an Order requiring the Monitor to retain $6.75 million of the sale proceeds (the approximate amount of the pension deficiencies) pending further Order of the Court. The remaining proceeds of sale were insufficient to repay the DIP lenders and the U.S. parent co. was required to satisfy the deficiency balance to the DIP lenders pursuant to its guarantee, whereupon it took the position that it was subrogated to the super priority charge of the DIP lender under the CCAA Order. There were no other secured creditors with charges on the Canadian company’s assets.

The pension plan members moved for a declaration that they were entitled to a deemed trust equal to the amount of the unfunded pension liabilities against the sale proceeds under the provisions of the Ontario Pension Benefits Act (“PBA”) and s. 30(7) of the Personal Property Security Act which, inter alia, subordinates security interests in accounts and inventory to beneficiaries of deemed trusts under the PBA[iii]. In addition to the statutory priority arguments, they submitted that Indalex breached its fiduciary duties to the plan members when it filed for CCAA and sought a DIP charge in priority to their interests. Although the plan member’s motion was dismissed by Campbell, J. at first instance, Indalex had also brought a motion to assign itself into bankruptcy to invert priorities which the motions Court Judge determined was moot after dismissing the pension priority. The Ontario Court of Appeal allowed the plan members’ appeal holding, inter alia, that:

a)       That deemed trusts created by s. 57(4) of the PBA apply to all amounts due with respect to plan wind-up deficiencies;

b)       Although it was likely that no deemed trust existed for the Executive plan on the plain meaning of the statutory provisions, it declined to address that question because it found that the Executive plan’s members had a claim arising from Indalex’s breach of fiduciary obligations in failing to adequately protect the plan member’s interests;

c)       Imposing a constructive trust was an appropriate remedy for Indalex’s breach of fiduciary obligations and was prepared to utilize it to impose a constructive trust for the benefit of the plan members. The remedy did not harm the DIP lenders who had been paid out – only Indalex’s U.S. parent. Coincidentally, the breach of fiduciary duties flowed not only from seeking a priority charge for the DIP but in seeking a lift stay to voluntarily assign into bankruptcy to invert priorities; and

d)       It also found that the deemed trust had priority over the DIP charge because the issue of federal paramountcy had not been raised when the amended Initial Order was issued.

As noted above the Supreme Court ultimately held that by virtue of the Doctrine of Federal Paramountcy the CCAA Court’s granting of priority to the DIP lenders subordinated the claims of all other stakeholders including the pension plan members. Unfortunately, that is not the end of the matter.

Although the 7 Supreme Court Justices panelled to decide Indalex were unanimous as to the Court Ordered priority based on CCAA over the claims of other stakeholders, they divided on the three other issues that had been presented for the Court’s consideration. In particular:

a)       Does the provincial deemed trust provided for in the PBA apply to wind-up deficiencies in CCAA?

By 4 to 3 majority the SCC upheld the Ontario Court of Appeal’s finding that the provincial deemed trust extended to wind-up deficiencies for the salaried plan. (All of the judges concurred that the deemed trust was not available for the executive plan given that it was not being wound up and therefore did not technically comply with the statutory requirements). While the Court readily acknowledged that if Indalex had been liquidated under the Bankruptcy and Insolvency Act R.S.C. 1985 c.B-3 (“BIA”) the priority for underfunded pension liabilities would not have been recognized, the same result does not necessarily occur in CCAA. The Appellants strongly argued that claims should be treated similarly under CCAA and BIA and relied upon the recent Supreme Court decision in Century Services v. Canada 2010 SCC 60. Deschamps, J. (Moldaver, J. concurring) at para. 51 concluded:

In order to avoid a race to liquidation under BIA, Courts will favour an interpretation of the CCAA that affords creditors analogous entitlements. Yet this does not mean that Courts may read bankruptcy priorities into the CCAA at will…Parliament did not expressly apply all bankruptcy priorities either to CCAA proceedings or to proposals under the BIA. Although the creditors of a corporation that is attempting to reorganize may bargain in the shadow of their bankruptcy entitlements, those entitlements remain only shadows until the bankruptcy occurs…this was not a case in which a failed arrangement forced a company into liquidation under the BIA. Indalex achieved the goal it was pursuing. It chose to sell its assets under the CCAA, not the BIA.

[52] The provincial deemed trust under the PBA continues to apply in CCAA proceedings, subject to the Doctrine of Federal Paramountcy…the Court of Appeal therefore did not err in finding that at the end of a CCAA liquidation proceeding, priorities may be determined by the PPSA’s scheme rather than the federal scheme set out in the BIA.

As noted in the Case Comment provided by Edward A. Sellers and Michael De Lellis[iv] these comments did not form a part of the stated rationale for the ultimate priority judgment. That said, the Supreme Court may well have re-opened the door to enforceability of provincial deemed trusts or other statutory priorities, at least in CCAA.

b)       Did Indalex have fiduciary obligations to the plan members when making decisions in the context of the insolvency proceedings?

The SCC was also unanimous in holding that Indalex given its role as administrator of the pension plans, had indeed breached its fiduciary duties to the plan beneficiaries. Unfortunately the panel split on how the conflict of interest between Indalex acting in its corporate capacity and Indalex acting in its pension plan administrator role could be handled. For example, Deschamps, J. wrote at para. 66:

“When the interests the employer seeks to advance on behalf of the corporation conflict with interest the employer has a duty to preserve as plan administrator, a solution must be found to ensure that the plan members’ interests are taken care of. This may mean that the corporation puts the members on notice, or that it finds a replacement administrator, appoints representative counsel or finds some other means to resolve the conflict. The solution has to fit the problem and the same solution may not be appropriate in every case.”

Deschamps, J. concluded that Indalex’s decision to file CCAA was not a breach of fiduciary duty, however, she agreed that the decision to seek a priority DIP charge did give rise to a conflict and at the very least the plan beneficiaries were entitled to notice. It was the failure to give notice that the constituted the breach of duty.

Similarly Cromwell, J. (McLachlin CJC and Rothstein, J. concurring) agreed that simply commencing insolvency proceedings was not a conflict of interest but failure to deliver notice of the application for the DIP charge to the pension beneficiaries did give rise to a conflict. That said, Cromwell, J. took the view that Indalex’s breach was not so much failing to avoid a conflict of interest but “failing to manage the conflict to ensure the plan beneficiaries’ interests were protected.

LeBel, J. (Abella, J. concurring) took the more drastic view that Indalex was in a conflict of interest “from the moment it started to contemplate putting itself under protection of the CCAA and proposing an arrangement to its creditors.”

c)       Did the Court of Appeal properly exercise its discretion in imposing a constructive trust to remedy the breaches of fiduciary duties?

A 5 to 2 majority of the SCC overturned the Court of Appeal decision and concluded that the constructive trust on Indalex’s assets in favour of the pension plan beneficiaries was not an appropriate remedy. Writing for the majority, Cromwell, J. held that a remedial constructive trust for breach of fiduciary duty is only appropriate where the subject of the trust is directly related to the wrong arising from the breach. In this case the wrong – the failure to give notice – did not result in a deprivation to the pension plan members.

Coincidentally, the decision or decisions in Indalex do pass comment on other topics of interest to insolvency practitioners. For example, the Doctrine of Equitable Subordination. Counsel for the plan members brought up the Doctrine of Equitable Subordination as a basis on which to gain priority. Deschamps, J. noted at paragraph 77:

“The Court discussed the Doctrine of Equitable Subordination in Canada Deposit Insurance Corp. v. Canadian Commercial Bank [1992] 3 S.C.R. 558, but did not endorse it, leaving it for future determination (page 6 of 9). I do not need to endorse it here either.”

Whether the corporation’s voluntary assignment into bankruptcy would be a conflict of interest was also a subject of comment. As noted previously, the Ontario Court of Appeal had taken the position that Indalex’s motion to lift stay to assign itself into bankruptcy and thereby invert the priorities was in breach of its fiduciary duties to the plan members. Cromwell, J. at para. 221 thought otherwise:

“It was certainly open to Indalex as an employer to bring a motion to voluntarily enter into bankruptcy. A pension plan administrator has no responsibility or authority in relation to that step. The problem here is not that the motion was brought, but that Indalex failed to meaningfully address the conflict between its corporate interests and its duties as plan administrator.”

Cromwell, J.’s decision was supported by McLachin CJC and Rothstein, J. The judgment of Lebel, J. (supported by Abella, J.) determined that such filing was a conflict. Deschamps, J. (Moldaver, J. concurring) did not address the point. As such, there is no conclusive answer as to whether the company should assign itself into bankruptcy. That said, such conflict does not apply to creditors who may bring a motion to lift the stay and permit filing of a bankruptcy for the purposes of inverting priorities.

2. Compromising Regulatory Orders in CCAA

Newfoundland and Labrador v. AbitibiBowater Inc. 2012 SCC 67

Two months prior to rendering its decision in Indalex, the Supreme Court issued its landmark ruling on treatment of environmental claims in CCAA. This decision provides the profession with guidance on the circumstances where regulatory Orders may be compromised in restructuring proceedings.

Some stakeholders have painted this decision as an unfortunate example of the paramountcy doctrine enabling the federal insolvency regime to steamroll over the province’s jurisdiction for maintaining our environmental well-being and otherwise usurping the “polluter pay principle”.[v] The facts reveal an extraordinary power struggle between big business and provincial government.

Abitibi was one of North America’s largest forest products corporations and for more than 100 years had operated industrial sites in Newfoundland and Labrador. It appears that there had been a history of public disagreements between Abitibi and the province which accentuated with the industry downturn. In 2008 Abitibi announced closure of its last operating facility in the province. In apparent retaliation the province enacted the Abitibi-Consolidated Rights and Assets Act which, inter alia, expropriated most of Abitibi’s property in Newfoundland to the province without compensation, cancelled all pending legal proceedings instituted by Abitibi against the government and denied Abitibi access to the province’s judicial system to annul the law or seek compensation.

In April, 2009 Abitibi filed for creditor protection under CCAA and Chapter 11 in the United States. Under the CCAA regime a claims process was implemented.

In November, 2009 Newfoundland issued five environmental clean-up orders under its Environmental Protection Act (“EPA Orders”). These EPA Orders related to various former Abitibi industrial sites, three of which had been expropriated and one of which had not been in operation for 50 years. No quantum was ever attributed to the potential clean-up costs but the CCAA Court estimated costs to run from a mid to high 8 figures to several times higher. The province sought a declaration from the CCAA Court that the CCAA claims procedure did not bar the province from enforcing EPA Orders. It was Newfoundland’s requested declaratory relief that worked its way through the Quebec Courts and ultimately up to the Supreme Court of Canada.

In the meantime, Abitibi’s restructuring efforts continued, restructuring plans were approved in late 2010 and Abitibi emerged from proceedings changing its name to Resolute Forest Products Inc.

It is generally recognized that there is a distinction between a regulatory obligation aimed at the protection of the public and monetary claims that can be compromised in the insolvency process. CCAA Section 11.1(2) confirms that no stay of proceedings affects a regulatory body’s investigative powers or any acts or proceeding by or before the regulatory body “other than the enforcement of a payment Order by the regulatory body or the Court”. To the extent that regulatory Orders are not monetary in nature, they are not stayed nor capable of compromise under the CCAA regime.[vi] Indeed the model template CCAA Order typically provides that “nothing in this Order shall…exempt the Applicant from compliance with statutory or regulatory provisions relating to health, safety or the environment”. The idea being that the insolvency process does not provide the Applicant with a licence to pollute Deschamps, J. at para. 41 in the majority decision shared a more colourful proposition:

“To quote the colorful analogy of two American scholars, “debtors in bankruptcy have-and should have-no greater license to pollute in violation of a statute than they have to sell cocaine in violation of a statute”.

The idea being that the reorganized debtor will continue to comply with all environmental regulations in the same way as any other person.

Notwithstanding those platitudes, in a 7 to 2 ruling the majority of the Supreme Court found that the EPA Orders were “claims” that could be affected under a CCAA plan of arrangement. Although the EPA Orders in question were not monetary in form, the Court was prepared to look at the substance behind the regulatory facade. More specifically, the SCC confirmed that a non-monetary Order issued by a regulatory body could be considered a provable claim and thus compromised in the CCAA. In particular, the Court stressed that the definition of “claim” in both BIA and CCAA was to be interpreted broadly and “includes contingent and future claims that would be unenforceable at common law or in the civil law”.[vii] For those of us who have become used to references to the “fresh start” principle in consumer matters, Deschamps’ explanation for the reason for broadly interpreting claims had a familiar tone:

“The rationale is slightly different in the context of a corporate proposal or reorganization. In such cases, the broad approach serves not only to ensure fairness between creditors, but to allow the debtor to make as fresh a start as possible after a proposal or an arrangement is approved.”[viii]

Deschamps articulated a three part test to be met to determine whether a non-monetary regulatory Order amounted to a claim that could be compromised under CCAA. Although based on the classic three part test in BIA[ix], its application in CCAA was modified as follows[x]:

1.       Has the regulatory body exercised its enforcement power against the debtor?

2.       Has the debtor’s obligation arisen prior to the time limit for inclusion in the insolvency process (say for example, before the debtor has exited the insolvency proceedings)?

3.       If there is “sufficient certainty” that the regulator will pay for and perform the remediation itself, which would otherwise entitle it to assert a monetary claim to have the remediation costs reimbursed, then the Order may be determined to be a monetary Order. This is a factual analysis.

In reviewing the extraordinary facts in this case the Court noted that the target sites of the EPA Orders were for the most part no longer in Abitibi’s possession and that Abitibi had no means to perform the remediation during the reorganization process. Similarly, the abbreviated timetable set by the province for Abitibi to comply with the EPA Orders led the Court to infer that the province never truly intended or expected Abitibi to perform the remediation work itself.

Interestingly, as the Court dismissed the declaratory relief it sought Newfoundland was left without the ability to file a claim and thereby even receive a pro rata payment out of the CCAA plan as the claims bar date had passed and the plan of reorganization already implemented.

3. Court Approval of Receiver’s Sales – Don’t Wait to Complain

Business Development Bank of Canada v. Paletta & Co. Hotels Ltd. 2012 MBCA 115

This case involves the Hecla Island Resort Complex in Manitoba. While the reported decision cited above results from the application before the Court of Appeal to lift the automatic stay arising from an appeal to enable a Receiver sale to close, the more interesting aspects of the decision stem from the unreported Reasons for Decision of Dewar, J. of November 20, 2012.

Most Manitobans are familiar with the Hecla Island Resort. Although it boasts one of our province’s best golf courses it has had a notorious history of mismanagement and financial loss at the hands of various provincial administrations. There was some guarded optimism a few years ago when the Paletta family negotiated an agreement with the Province to lease this facility. Unfortunately, the Palettas did not succeed and on November 18, 2010 Lazer Grant Inc. was appointed BIA Receiver by Court Order. Without repeating the litany of problems with the receivership, it should be sufficient to state that it was almost two years before the Receiver was able to come back to Court for approval of an Asset Purchase Agreement. Initially when the property was listed for sale with the realtor the asking price was $6.5 million. At the time of Court approval BDC had already advanced $1.2 million to the Receiver for not only its costs but to maintain the vacant and deteriorating property. Estimated costs to get through the approaching 2012-2013 winter, including Receiver’s fees would be an additional $450,000.00.

The somewhat procedurally interesting change of events is that in the unreported Reasons for Decision of Dewar, J. it is clear that the purchase price received from Lakeview was subject to a Sealing Order. By the time the matter was heard by Scott, C.J.M. in the Court of Appeal there seemed to be no qualms about disclosing that the price for the assets being purchased consisting of chattels and equipment, was only $350,000.00 – the leased property, including the resort premises, was to be dealt with separately. It was also disclosed by Lakeview with the province after the hearing before Dewar, J., and prior to the Court of Appeal Chambers motion, that a company related to Paletta tendered a letter of intent proposing a purchase price of $500,000.00 for the same asset, conditional upon a 60 day inspection. Paletta’s counsel confirmed that Paletta was not willing to fund the upkeep and maintenance for the resort during the due diligence period.

Before Dewar, J., the Palettas opposed the sale for various reasons including the price not being fair market value. There were various procedural fairness issues raised and a suggestion that the assets should be subject to a further bidding process before the drastically low Lakeview offer could be accepted.

After deliberation, Dewar, J. approved the sale and identified three “realities” which impacted the marketability of the resort:

1.       The resort was situated on land leased from the Province of Manitoba and any purchaser would need to make separate and satisfactory arrangements on a lease.

2.       The resort continued to be empty and that the costs of servicing the property over another winter was significant – indeed as later disclosed, exceeded the ultimate purchase price.

3.       The property had been listed for sale with a reputable realtor for at least a year and a half without producing a better offer.

The only practical thing for the Court to do was to approve the Lakeview deal.

Certain key parts of the decision of Dewar, J. were repeated in the reported decision of Scott, CJM of the Court of Appeal including at para. 12:

“What is particularly important to me and my assessment of this matter is that the Paletta group have been served with materials for every application which the Receiver has made during the course of this receivership and have been present at many, if not most of them….if the Receiver is doing something that is inappropriate or not commercially reasonable, there was ready access to the Courts to complain and to convince the Court to put the Receiver back on track….I do not accept that a party who claims to be a stakeholder can sit quietly back and then come in at the last minute and say that the publicized process is all wrong. At best, the Paletta group has simply stuck their heads in the sand. At worst, they wanted to see what someone else would offer and then try to arrange for someone else or themselves to do better. Neither extreme nor anything in between is reasonable for me to interfere with the process which has been undertaken by the Receiver with the knowledge of all concerned….it is not the Court’s function to make its Receiver, nor the major creditors, take unnecessary risks and there being no one prepared to fund, it is time to move on or at least give Lakeview and the government the opportunity to work out their plans”. (Emphasis added)

As the Receiver in this instance had been appointed pursuant to the provisions of the BIA, the mere filing of a Notice of Appeal of the decision of Dewar, J. resulted in an automatic stay under BIA s. 195. To conclude the Lakeview deal it was necessary for the Receiver to have the Court of Appeal lift the stay. Based upon the Reasons for Decision of Dewar, J., Scott, C.J.M. concluded that Paletta did not have “an arguable case or a reasonable prospect of success” and cancelled the stay.

4. Approval of Monitor’s Reports Not Claims Bar

The Puratone Corporation et al, Unreported Court of Queen’s Bench, November 8, 2012, Queen’s Bench File No. CI 12-01-19231

It has become common practice in most CCAA proceedings throughout the country to seek the presiding CCAA Judges’ approval of Monitor’s reports and activities described therein on an on-going basis. Typically such approval is pro forma and is included as part of every Extension Order. This has certainly become accepted Ontario practice and had been adopted in previous Manitoba CCAA proceedings without incident.[xi]

When counsel appeared before Dewar, J. on the First Extension Motion for Puratone this Fall, His Lordship was reluctant to grant the approval order, particularly given that the first report had only just been circulated to the service list. The matter was adjourned sine die to be brought back before the Court on appropriate notice. Subsequently, the matter was brought on by separate motion of the Monitor. After deliberating on the matter His Lordship was prepared to grant the approval but provided a caution as to exactly what the Court officer and the stakeholders could make of it:

“That does not mean that the Monitor can necessarily bank on this approval for any challenge that might arise in the future….I simply caution that the Monitor should not necessarily feel that no subsequent challenge can be successfully made simply because I grant the Order in the form which it is being sought. It is not like a bar Order which stops any further challenge. It is, however, an acknowledgement that the report has been read and there does not appear anything untoward about the activities of the Monitor or on its face.” (Emphasis added)

The Court also set out some guidance with respect to what the best practice might be on seeking such Court approval. Firstly, it was recommended that it be the Monitor who filed a specific Notice of Motion seeking the approval rather than piggy-backing it on extension motions brought by the Applicants. Furthermore:

…if a Court Officer wishes a clear mandate, it is to specifically set out in the report, those particular activities for which protection is being sought and if ratification is requested to set out the reasons why the judgments were made or the activities carried out. The Monitor should also clearly delineate in the motion the specific activities for which it seeks approval. In that way, both the Court and any third party who is reading the report might more readily understand why and what specifically is being approved and the Order which ultimately issues would be more clear and specific, and therefore, less likely for future equivocation.”

Forewarned is forearmed.

5. Pre-Packaged Receivership Sales

9 – Ball Interest Inc. v. Traditional Life Sciences Inc. (2012) ONSC 2788

Pre-packaged receivership sales are one of those subject areas that our industry acknowledges can be a useful and practical tool but many others view with suspicion and, at times, derision. Pre-pack sales are frequently associated with the classic “quick flip” frowned upon by Industry Canada and other stakeholders as “technically legal” but of doubtful commercial morality. That said, in smaller to mid-size businesses where liquidation values are less than the secured debt, industry perception is that a pre-pack sale is more likely to result in a better return to the secured creditors and a good chance of the business being able to carry on for the benefit of the new owner, the trades and, in particular, the employees. Research on pre-pack sales from the United Kingdom in comparing pre-packs with going-concern sales negotiated and arranged after the commencement of insolvency proceedings reveals that[xii]:

a)       All employees were transferred to the purchaser in 92 percent of pre-pack cases but only 65 percent in traditional cases; and

b)       Recovery to secured creditors was 42 percent in pre-packs compared to 28 percent with the traditional approach.

That said, Courts do not like pre-pack receivership sales. While in the undersigned’s experience, Judges will, reluctantly, grant such Orders where they are satisfied that it is the best and typically only solution, but it is a difficult situation for a Judge to deal with. There are now a number of cases[xiii] which counsel can point to Court to in support of pre-pack receiver sales. 9-Ball v. Traditional Life Sciences is a good example of where Courts will not provide approval.

Traditional Life Sciences (“TLS”) was an internet health supplements business. In keeping with the “virtual” nature of the business it did not have any salaried employees (just two contract staff people from marketing and IT support) and a 300 square foot office. TLS did have three key contracts including a trademark license and distribution agreement. Its total unsecured debt was in excess of $1.7 million which included in excess of $600,000.00 of convertible debt in favour of 9-Ball. 9-Ball and TLS were both owned and controlled by the same individual, Robert Carscadden, who coincidentally also provided management services to TLS under contract. In early 2012 9-Ball decided that it would only advance further funds for working capital to TLS on a secured basis. Accordingly, on February 21, 2012 9-Ball and TLS entered into a Loan Agreement to fund up to $500,000.00 in tranches of $25,000.00 which was secured by a GSA. 9-Ball was the only secured creditor of TLS. 9-Ball advanced $125,000.00 to TLS over the two week period commencing March 21 through to April 4, 2012.

Coincidentally, on February 14, 2012 TLS engaged restructuring professionals to review its options. The restructuring firm was then re-engaged by 9-Ball to market TLS for sale – this was a few days before 9-Ball began to advance funds to TLS on a secured basis. The sales process set up by the restructuring firm involved the following:

a)       It placed an ad in the March 19, 2012 edition of the Globe & Mail stipulating an April 2 offer deadline;

b)       It provided 10 of the 13 parties who responded to the ad with a confidential information package;

c)       Three of those parties conducted limited due diligence over the telephone;

d)       None of the 13 Respondents submitted an offer to purchase;

e)       It contacted 5 strategic purchasers that they had identified directly, none of whom submitted an offer to purchase.

On April 2 the only offer received was from a newly incorporated numbered company owned by Carscadden.

On April 23, 2012 9-Ball made demand upon TLS and issued the applicable BIA s. 244 notice. TLS waived the 10 day notice period.

The proposed price was filed with the Court on a confidential basis (with the idea that it would be subject to a Sealing Order). The Judge did note that the proposed purchase price exceeded the reported book value of the purchased assets as well as the secured debt owing to 9-Ball.

The report from the restructuring professional firm indicated that it did not believe any further or enhanced sales process would result in a better offer and recommenced it as preferable to a forced liquidation. The report confirmed that there would not be sufficient proceeds after professional costs for any realization to the unsecured creditors.

In considering the application D.M. Brown, J. cited Morawetz, J. in Tool-Plas Systems Inc. for the proposition that:

“…(Although a) “Quick Flip” transaction is not the usual form of transaction by a Receiver, in certain circumstances it may be the best, or only, alternative. In such circumstances Courts will have applied the principles set out in Royal Bank v. Soundair Corp.: a Court should consider i) whether the Receiver has made a sufficient effort to get the best price and has not acted improvidently, ii) the interest of all parties, iii) the efficacy and integrity of the process by which offers are obtained, and iv) whether there has been unfairness in the working out of the process period”

But as the Court stressed at paragraph 30:

“Part of the duty of a Receiver is to place before the Court sufficient evidence to enable the Court to understand the implications for all parties of any proposed sale and, in the case of a sale to a related party, the overall fairness of the proposed related transaction.”

The Court concluded that there was insufficient evidence placed before it to assess properly either the request to appoint a Receiver or the request for the approval of the Asset Purchase Agreement. In particular:

a)       It appeared that TLS granted 9-Ball a security interest in its assets at a time when it was likely insolvent. While Carscadden deposed that new consideration was granted there was no supporting documentation. Although the restructuring firm had obtained a legal opinion that 9-Ball’s security was properly perfected, it had not “gone behind the security documents to satisfy itself that 9-Ball had advanced the funds”;

b)       The restructuring professional firm reported that a BIA proposal was not a viable option because 9-Ball, as the security creditor was unwilling to compromise its secured debt. Given that this secured debt was an issue, the restructuring firm should have demanded a greater level of factual transparency;

c)       There was no valuation of the assets of TLS filed with the Court application nor did the restructuring firm explain why it decided not to secure such valuations from liquidators.

In the circumstances, the Court refused to appoint either the Receiver or approve the sale though coincidentally it did issue the sealing order on the proposed purchase price.

6. Why Sealing Orders are Necessary on Sale Approval Motions

MNP Ltd. et al v. Mustard Capital Inc. 2012 SKQB 325

This is a good example of the mischief that can arise when the contents of an offer to purchase are not placed under seal as part of a pending sale approval motion.

Mustard Capital Inc. (“MCI”) initially filed a Notice of Intention to Make a Proposal (“NOI”) under the BIA and initiated a sales and investor’s solicitation process. Ultimately, the NOI was allowed to expire, MCI deemed bankrupt and MNP appointed Receiver. Unfortunately, no reasonable offers were received in response to the solicitation process whereupon the Receiver contacted five auctioneers for their proposals. Three of the auctioneers provided offers which the Receiver treated as “confidential”. A motion was brought to Court for approval of the sale of the assets to Grasswood Auctions as the auctioneer with the best offer. The motion also sought a sealing order with respect to the Grasswood Auctions offer.

MCI’s landlord, Bissma, attended the approval hearing. It had previously made an offer to the Receiver for some of MCI’s equipment but the price was inadequate. Bissma opposed the sealing order and was successful in having the contents of the Grasswood Auctions offer disclosed and the main approval motion adjourned to a later date. Prior to that hearing, a company affiliated with Bissma, Memphis Strand, submitted an unsolicited offer which the Receiver acknowledged to be “better” than that received from Greenwood Auctions. Both Greenwood Auctions and Memphis Strand made submissions to the Court. The Receiver did not take a position other than requesting the Court decide which offer to accept and attended Court possessing two draft Orders to accommodate either alternative.

While Grasswood Auctions spent considerable time challenging Memphis Strand’s standing, Smith, J. found it “not necessary” to address that issue. The Court summarized the applicable case law regarding the Court’s attitude to consideration of subsequently filed higher bids including:

a)       Cameron v. Bank of Nova Scotia (1982) 38 CBR (NS) 1 (NSCA) at para. 36:

“In my opinion if the decision of the Receiver to enter into an agreement of sale, subject to Court approval, with respect to certain assets is reasonable and sound under the circumstances at the time existing, it should not be set aside simply because a later and higher bid is made….on the contrary, they would know that other bids could be received and considered up until application for Court approval is heard – this would be an intolerable situation.”

b)       Re Selkirk (1987) 64 CBR (NS) 140 at 142:

“The Court will not lightly withhold approval of a sale by the Receiver….only in a case where there seems to be some unfairness in the process of the sale of where there are substantially higher offers which would tend to show that the sale was improvident will the Court withhold approval.”

c)       D & H Farms Ltd. v. Farm Credit Canada (2002) SKCA 88 at para. 40:

“If the law were otherwise, over the long term, persons bidding at judicial sales would play a waiting game to determine what offers had been made and make subsequent bids.”

Without reservation, Smith, J. approved the original offer with the following observations:

“[31] In this instance, Bissma/Memphis Strand came into the knowledge of the precise bid submitted by Grasswood Auctions and accepted (subject to Court approval) by the Receiver. Bissma/Memphis Strand then bested that bid. If I allow the Memphis Strand bid to prevail, I am of the view that any reasonable observer would not regard the process as fair and reasonable or one characterized by integrity.

[32] It is worth reiterating that Bissma was involved at all times throughout this process and could have submitted any number of bids. It submitted one, it was rejected. Bissma/Memphis Strand then through a Court application for disclosure placed itself in a situation where it knew precisely the bid it had to better. Respectfully, to allow it to defeat Grasswood Auctions by reason of a Court Order disclosure process would not, in my opinion, yield a principal result.”

7. Who Can View the Sealed Documents?

Romspen Investment Corp. v. Hargate Properties Inc. 2012 ABQB 412

Continuing with the theme of sealing orders in Court sale processes, this case provides some insight as to who may have access to the sealed materials. It involves the recent receivership of the Chateau Lacombe Hotel in Edmonton. The Receiver sought a sealing order for its report on the on-going sale process including realtor’s marketing reports and an appraisal. Counsel for both the first secured creditor and the second mortgagee had previously been provided with the report on a confidential basis and supported the Receiver’s motion to seal. Two other creditors which did not have security on the hotel opposed the sealing order. These creditors did have a security interest in a separate 20 acre development parcel which had previously been sold and for which there was not only a priority dispute but the potential for a marshalling argument which could provide them with a claim to the proceeds of the hotel property sale.

Lee, J. acknowledged that the classic Sierra Club[xiv] test had been met justifying the sealing order on the Report. However, it was necessary for the Court to “consider whether reasonable alternatives to the confidentiality order are available as well as to restrict the order as much as reasonably possible while preserving the commercial interest in question”. The Court pointed out that there had been no adverse consequences by the limited confidential disclosure to counsel for the first two secured creditors and ordered that the solicitors for the objecting creditors could have the same confidential access. In particular:

It is in everyone’s financial interest amongst this group…to see that the Chateau Lacombe Hotel property is sold for the most monies. The release of the requested sales process and appraisal reports is not reflection that there is anything deficient in the present sales efforts which appear to have been conducted quite efficiently. It is only a recognition of the legitimate financial interests in this process [of the objecting creditors]. (Emphasis added)

8. Payment of Pre-Filing Claims in CCAA

Re Futura Loyalty Group Inc. 2012 ONSC 6403

This case deals with the somewhat sensitive issue of payment of pre-filing obligations in CCAA. Typically when a company files for CCAA, the Initial Order will prohibit the payment of most unsecured pre-filing claims. Prior to the 2009 amendments, Courts would occasionally provide the Applicants with discretion to pay certain pre-filing obligations to maintain service from critical suppliers. The 2009 amendments and specifically Section 11.4 of the CCAA now provides the Court with express authority to order critical suppliers to continue supplying goods and services post-filing in exchange for a priority charge as compensation. That charge only covers post-filing liabilities. Notwithstanding the legislative amendments creating the critical supplier’s charge, Re Canwest Global Communications Corp. 2009 CanLII 55114 at paras. 41, 42 and 43 confirmed that the CCAA Court retains its inherent jurisdiction to authorize discretionary payments for pre-filing obligations to third parties.

After the initial CCAA Order in Futura was granted the company sought permission to pay Aeroplan for the miles earned by Prepaying Merchant Customers by virtue of payments made prior to the Initial Order. Futura provided a “Loyalty” program for its Merchant Customers which involved selling Aeroplan miles to its Merchants for their customers. The reality was over 75 percent of the company’s revenues were generated through this program. Its Merchant Customers typically paid the Applicant monthly, in arrears, for the Aeroplan miles that they had issued to their customers in that month. Prior to the CCAA filing Futura had offered its merchant customers the opportunity to buy Aeroplan miles at a volume discount in return for pre-payment. With the CCAA filing and the standard prohibition against paying pre-filing unsecured debts, Futura found itself in the difficult position where it would alienate the Merchant Customers that had prepaid. The company filed materials with the Court confirming that the amount of this pre-filing obligation was only $108,000.00 and payment was necessary in order to maintain the status quo. More specifically, payment for and provision of the Aeroplan miles to the Merchant Customers was considered essential to the continuing on-going operation of the business and preservation of the Applicant’s brand. They anticipated that this would enhance the going-concern sale and maximize value for the stakeholders.

D.M. Brown, J. reviewed the case law on payment of pre-filing obligations not involving critical suppliers.[xv] He concluded that there is jurisdiction for the CCAA Court to authorize payment of pre-filing obligations to non-critical suppliers where necessary to “prevent disruption of the operations of the Applicant and to maximize the value of the business for the purposes of the reorganization or realization process”. Ultimately, whether or not a Court should authorize such payments should come down to a “proportionality or cost-benefit analysis, weighing the costs of the prepayments against the benefit to be the estate as a whole”. After conducting this cost benefit analysis, as well as considerations of the absence of any opposition thereto, the Order was granted.

Coincidentally, the Courts’ liberal continence of the paying of pre-filing obligations did not extend to the Applicant’s motion to defer giving notice of the CCAA proceedings to the Merchant Customers. Notwithstanding the standard provisions in this Initial Order (as well as CCAA s. 23(1)(a)), requiring notice of the proceedings to be provided to every known creditor, such notice had not been sent to the Merchant Creditors. The company requested that the Court authorize the waiver of the notice as it feared the Merchant Customers might cancel their participation in the Loyalty Program – detrimentally affecting the on-going operation and value of the business. Given that the Court was prepared to authorize payment of their pre-filing obligations in any event, what was the harm in deferring notice? In declining this request D.M. Brown, J. at paras. 22 and 23 stressed the need for transparency and disclosure:

“I am not prepared to vary the Initial Order to excuse the Monitor from providing the requisite creditor notice to the Pre-paying Merchant Customers….transparency is the foundation upon which CCAA proceedings rest – a debtor company encounters financial difficulties; it seeks the protection of the CCAA to give it breathing space to faction a compromise or arrangement for its creditors to consider; in order to secure that breathing space, the CCAA requires the debtor to provide its creditors, in a Court proceeding, with the information that they require in order to make informed decisions about the compromises or arrangements of their rights which the debtor may propose. As a general proposition, open windows, not closed doors, characterize CCAA proceedings.”

9. Pay to Play for a BIA Stay

Re SWP Industries Inc. 2012 NBQB 397 and 2012 NBQB 400

The fact that a primary secured creditor strongly opposes a debtor’s motion to extend the stay pending the filing of a BIA proposal does not mean the extension will not be granted. Various recent cases have disregarded a secured creditor’s unequivocal assertion that it will never support a proposal and extended the stay to give the debtor time to restructure.[xvi] However, where there is evidence of a quantifiable erosion of security during the stay, it may be necessary for the debtor to put his money where its mouth is before an extension will be granted.

SWP was a small New Brunswick manufacturer of wood fences and other forestry products with 24 employees. After years of accumulating losses it filed a Notice of Intention to Make a Proposal. Prior to expiry of the 30 day stay it brought its motion to extend the stay to allow it additional time to “finalize” a proposal. The Bank of Nova Scotia contested the extension. It pointed out that the deficiencies in the working capital meant that it was already exposed to serious losses and, more practically speaking, each day that the business continued, the losses were to increase in the range of $5,000.00 to $6,000.00. It was the Bank’s submission that such increasing losses would be materially prejudicial to it. As such, the company did not satisfy the material prejudice test under the BIA s. 50.4(9)(c).

The company submitted that it was not only trying to get a proposal together but had already “got the money”. The evidence adduced disclosed that it had not only provisionally obtained $500,000.00 in additional financing from BDC but that the existing shareholders would be advancing an additional $250,000.00. As such, they had already raised $750,000.00 of the $1 million of additional capital that the company anticipated was necessary to make the proposal. The Applicant submitted it would be able to make a viable proposal if the extension was granted and as such no creditor, not even the Bank of Nova Scotia, would be materially prejudiced if the stay was granted. SWP recited the cases that supported it was in the public interest to allow corporations an opportunity to restructure and reorganize themselves for the benefit of all stakeholders as well as the community at large. The Bank was sceptical as to whether the investment was really committed or the proposal would be viable.

In weighing the competing interests, McLellan, J. worked through the facts to reach a practical solution:

“16. Against this background the most positive and encouraging news in all the material is that two of the principals of SWP believe in its future. Stephen Crabbe and Robert Williams have each indicated a willingness to pay $125,000.00 for a total of $250,000.00 to improve the capital of the company and keep it going.

17. Counsel for SWP is so positive about that that it uses expressions like “SWP has got the money” or “has got the money”.

18. It seems to me that those principals, Mr. Crabbe and Mr. Williams, by their willingness to invest further in the company are showing real faith in it.

19. It is my view, now is the time for them to show their good faith and help SWP show its good faith under Section 50.4(9) to show that there are people who really believe that SWP is going to be viable.”

Following which he told the Applicant that the only way it would be appropriate to extend the stay is if these two individuals put up $150,000.00 “in real money” or its equivalent to cover the Bank’s losses for the period of the extension. The shareholders were given three days to make the appropriate commitment to the Bank to cover its losses for the extension. As McLellan, J. further noted at para. 23:

“If that money is put up then I will take that as an indication of the good faith of SWP and the likelihood that they will be able to get a viable proposal together and that will overcome the material prejudice to the Bank. If it is not put up, I will be forced to the opposite conclusion.”

When the parties returned to Court after the three days the shareholders were not prepared to guarantee the Bank’s losses whereupon the motion to extend the stay was dismissed.

10. Expanding Monitors Powers – Can Not Terminate Management

Re Landdrill International Inc. 2012 NBQB 355

It is not unusual in CCAA proceedings for the Monitor’s powers to be expanded beyond that provided for in the standard template Order and CCAA 23(1). For example, in the last two CCAA proceedings in Manitoba, Arctic Glacier Income Fund et al[xvii] and the Puratone Corporation[xviii], the Monitor’s powers were enhanced to accommodate the special needs of each case. To provide the secured creditors in Puratone with comfort the sales process was not just a “stall”, the Monitor was effectively given control over the sale. To the extent that the assets and undertaking of these businesses were sold and substantially all employees transferred to the successor corporation, it was reasonable for the Monitor to be provided with additional authority to wind down business operations. In these cases the additional Monitor’s powers were negotiated and agreed to by the company and the principal stakeholders. But what happens when the company and the stakeholders do not agree?

In Landrill the principal secured creditor moved to vary the powers under the Initial Order to authorize the Monitor to make and implement decisions relating to continued employment, termination, lay off and/or rationalization of personnel including senior management. It also sought to give the Monitor authority to exercise sole and exclusive authority to wind up, discontinue or downsize the business. Apparently the company’s CEO had interfered with the sales process – from the Monitor’s perspective – and in particular, he informed the Monitor that the company intended to oppose the proposed sale. This prompted the secured creditor’s motion which would have effectively given the Monitor power to remove the CEO and assume managerial control.

While CCAA 23(1)(k) does contemplate the Court ordering the Monitor to perform “other functions” than those set out in the Act, there is no express authority in the Act which would allow the Court to remove or replace management with the Monitor. Although the secured creditor was able to provide the Court with other precedents where the Monitor was given power to operate the business[xix], David Smith, CJQB distinguished the case law on the basis that in those instances the company had “acquiesced” to the Monitor being granted additional powers – that was not the case with Landrill. He concluded that there was neither statutory authority nor inherent jurisdiction to remove management. He then adopted the reasoning of the British Columbia Court of Appeal in Re Jameson House Properties Ltd. 2009 BSSC 844 at 25:

“No Receiver, liquidator or Trustee in Bankruptcy has been appointed. The Court Appointed Monitor in this case is in a materially different position from those parties. Unlike a Receiver, liquidator or Trustee, the Monitor has no control over the management of the business. That remains in the hands of the Petitioners.”

The secured party’s motion was dismissed.

11. Can you Convert Unsecured Debt into Secured by Taking an Assignment of a             secured Party’s Position?

Eagle Eye Investments Inc. v. CPC Networks 2012 SKCA 118 (affirming 2011 SKQB 436)

As any bankruptcy Trustee will freely admit, the ability of otherwise unsecured creditors to conjure up a “security” position can be quite amazing. Having said that, the technical creativity of both lawyers and accountants to spin boiler plate security terms to mean what they want them to mean goes beyond fiction and common sense – which is probably why it is necessary for Bankruptcy Courts to also be Courts of Equity.

Eagle Eye had its origins in a shareholder dispute that ultimately grew into an oppression application, digressed temporarily into an interim receivership before it morphed into a very creative security enforcement lesson.

Without digressing into all of the facts, suffice it to say that the debtor previously had a $150,000.00 loan with Business Development Bank of Canada (“BDC”) and granted a security interest to BDC over all of its present and after acquired property and assets through execution of one of its standard form General Security Agreement. The debtor also owed $465,000.00 on an unsecured basis to Eagle Eye, a corporation controlled by one of its shareholders. Subsequently, a corporation controlled by one of the other shareholders (“Black Dove”) purchased the BDC loan and its security for the then indebtedness of $106,000.00. Black Dove purported to then privately appoint that shareholder as “Interim Receiver” of the debtor. In a previous Court application, this interim Receiver appointment was vacated whereupon the debtor and Black Dove negotiated a repayment schedule on the former BDC loan.

The debtor later received notice that Black Dove had assigned the BDC loan and its security to Eagle Eye. In providing formal notice of assignment, Eagle Eye, demanded Bank statements, financial information, details of equipment and current customer list which it claimed to be entitled to under the terms of the BDC security. When the debtor inquired about paying out the BDC loan it was advised by Eagle Eye that the amount of the debt was now almost $750,000.00, particulars of which were:

BDC Loan                               $  57,500.00

Eagle Eye Loan                      $465,556.00

Costs                                       $140,590.59

Interest                                    $  85,709.91

Total:                                      $749,356.50

The debtor sought relief from the Court of Queen’s Bench of Saskatchewan.

The Court had to determine whether or not the BDC General Security Agreement assigned to Eagle Eye could now charge the previously unsecured debts owed to Eagle Eye. The Security Agreement contained the usual language found in most GSA’s including obligations secured:

“This Security Agreement…shall be a general and continuing security for the payment and performance of all indebtedness, liabilities and obligations of the borrower to BDC….”

and assignment:

“BDC may, without notice to the borrower, at any time assign or transfer, or grant a security interest in, all or any of the Obligations, the Security Agreement and the security interest. The borrower agrees that the assignee, transferee or secured party, as the case may be, shall have all of BDC’s rights and remedies under the Security Agreement….”

While the Motions Court Judge determined on a clear reading of the General Security Agreement, in relation to the loan agreement, that the GSA only secured the BDC loan and not loans of the third parties, there was a very thorough review of the limited authorities on the subject of rolling the assignee’s unsecured claims into an assigned security position. The Motions Court Judge at paragraph 28 quoted Ronald C.C. Cuming et al Personal Property Security Law (Toronto: Irwin Law Inc., 2005) for the proposition that Personal Property Security Statutes are silent on the issue, but that as a matter of common law:

“…Courts have been unwilling to permit an assignee to claim the benefit of an all obligations clause in respect of obligations incurred by the Assignee before the assignment. It is not entirely clear whether these Courts have decided that this outcome is impossible as a matter of law, or if they have simply determined that the clause used in the agreement was not sufficient to produce this result. In England, Australia and New Zealand, the Courts have embraced the former argument and have held that only the clearest of language in the Security Agreement would permit an unsecured creditor to obtain secured creditor status by taking an assignment of a Security Agreement that contains an all obligations clause.”

After reviewing American and Commonwealth authorities the Motions Court Judge identified two previous Canadian authorities:

a)       Canamsucco Roadhouse Food Co. v. Lngas Ltd. (1991) 2 PPSAC (2d) 203 (reversed on other grounds) (1997) 12 PPSAC (2d) 227 (Ont.C.A.) where the Court held that an assignee was not entitled to tack on other indebtedness to the assigned debt; and

b)       In Near Horbay Inc. v. Great West Golf & Industrial Inc. 2000 ABQB 861 where the Alberta Court refused to permit an assignee of security to tack on unsecured debt.

The Motions Court Judge confirmed that Eagle Eye could not tack on its unsecured claim to the assigned BDC security and, referencing the aptly titled article of Roderick J. Wood, “Turning Lead into Gold: The Uncertain Alchemy of All Obligation Clauses” (2004) 41 Alta. L.Rev. 801 at 809 cited three reasons why Courts should refuse to convert unsecured claims into secured claims in any security assignment:

a)       It would be unfair to the debtors;

b)       It would have a destructive impact on the principle of pro rata sharing in bankruptcy law;

c)       It would have a disruptive effect on the PPSA priority regime with a subsequent loss of predictability.

This matter was taken to the Saskatchewan Court of Appeal. Although the appeal was dismissed, Jackson, J.A. was careful to point out that while the thorough review of the legal issues carried out by the Motions Court Judge was “for the most part” correct, it was important for the Saskatchewan Court of Appeal to “caveat” the decision and in particular stated at paragraph 29:

“…it is not necessary to answer the question whether a security agreement can ever secure the previously unsecured debts owing by the debtor to the assignee. Assuming that the priority system in bankruptcy and under PPSA is not affected and the assignee behaves in a commercially reasonable manner, what rule of law prevents a debtor from agreeing to an assignable, all obligations clause? The ratio of this decision should not be that, as a matter of contract law or secured transactions law, a debtor and a secured creditor can never agree to an assignment of an agreement containing an all obligations clause permitting secured party to assign the security to a third party, who holds a prior unsecured debt, and thereby secure that past unsecured indebtedness.”

And at para. 31:

“A court must be concerned about the fairness and the effect on bankruptcy and other priorities, but if the contract will have no affect on priorities, there may well be nothing preventing an assignee from converting unsecured debt into secured debt, if that is the intention of the contracting parties.” (Emphasis added)

Although the Saskatchewan Court of Appeal was careful to caveat its ultimate decision so as to comply with principals of contract law and interpretation thereof, the ultimate result remains the same.

12. Forbearance Agreements Not a Panacea

Lewis v. Central Credit Union Limited 2012 PECA 9

Forbearance Agreements have become common place over the past decade or so but it is rare that they receive consideration by the Courts. We have witnessed more Forbearance Agreements being included as exhibits to both CCAA Initial Applications and receivership proceedings where they are generally accepted as the best evidence of the parties’ intentions.[xx] However, the jurisprudence is not entirely positive. For example, in Bank of Montreal v. Maple City Ford 2002 CanLII 23166 at para. 142-3; affirmed 2004 CanLII 36048 (ONCA) the Court very narrowly construed the enforcement terms of a Forbearance Agreement. In Lewis v. Central Credit Union Limited, the PEI Court of Appeal has now disregarded a Forbearance Agreement entirely.

Lewis was a situation where two mortgages the lender sought to enforce contained inherent defects which the court refused to enforce notwithstanding the subsequent execution of a Forbearance Agreement which acknowledged the security.

 Lewis was a classic farm problem. When Orville Lewis’ potato farm experienced financial difficulties in 2004 the Credit Union sought additional security to shore up its existing position on the farm loan. Orville owned an additional 100 acre parcel jointly with his 80 year old mother. They both readily granted the mortgage. The Credit Union insisted that the elderly Ella Lewis obtain independent legal advice before executing the mortgage that was done. In or about 2008, Orville discontinued potato operations and started growing carrots. This required more credit. When the Credit Union insisted upon additional security before granting the loan Orville offered another parcel of land, this being 68 acres in his name but subject to a life interest for Ella. Ella signed the consent to the mortgage but the Credit Union did not request and Ella did not obtain independent legal advice. That said, the mortgage was provided, duly registered and the Credit Union advanced additional credit.

The conversion from potato to carrot farming turned out to be disastrous: Orville lost his crop and had no crop insurance. The Credit Union issued its Notices of Intention to Realize on Security and the parties went through the federal Farm Debt Mediation process without success. Eventually, the Credit Union and the Lewis’ entered into a Forbearance Agreement and Ms Ella Lewis did obtain independent legal advice before executing this document. When the standstill period under the Forbearance Agreement expired, the Credit Union proceeded with mortgage enforcement. The Lewis brought application for injunctive relief to prevent mortgage sale.

As should have been anticipated, any court case involving a financial institution, an 80 year old mother and defective ILA will not go well for the lender. Ultimately, the majority of the PEI Court of Appeal (McQuaid, J.A. dissenting) came to the following conclusions:

1.       Notwithstanding the ILA obtained for Ella on the 2004 mortgage, as the Credit Union did not advance new monies under the mortgage and it was thereby granted only for past consideration, it was unenforceable.

2.       The 2008 mortgage was not enforceable as against Ella Lewis’ life interest as she had not been provided with independent legal advice before executing the consent.

3.       With respect to the impact of the Forbearance Agreement executed by Ella Lewis with the benefit of independent legal counsel, the court concluded that it was “moot”.

The reasons for decision are somewhat murky on the Forbearance Agreement as well as to its specific terms[xxi] but the court appears to have taken the position that as the forbearance period had already expired before the Credit Union commenced security enforcement the Forbearance Agreement had no relevance to the mortgage validity issues. The court also seemed to frown upon whatever else may have been contained in the Forbearance Agreement given that there were discrepancies between the form of the agreement Ms Lewis received the ILA on and the version ultimately signed by the parties.

While Lewis may be a case of “hard facts making bad law”, it does suggest that if lender’s counsel relies solely upon the security acknowledgement set out in a forbearance agreement to support defective security, the court may choose to disregard that document in its deliberations. As such, it is imperative for lender’s counsel to ensure that all i’s are dotted, t’s are crossed and to effect whatever other “belt and suspenders” approach that can be taken to rectify any existing security of questionable integrity.

[i] See for example Indalex pension decision has far reaching implications, Globe & Mail April 7, 2011; CAIRP Chairs Newsletter, Issue No. 4, June, 2011; Marc S. Wasserman et al “Ontario Court of Appeal Grants Retirees Priority Over Secured Creditors” 23 Commercial Insolvency Review 49.

[ii] See for example “High Court Ruling Places Creditors before Pensioners”, The Globe & Mail, February 1, 2013; Edward A. Sellers and Michael De Lellis, Case Comment on Indalex, Houlden & Morawetz, Bankruptcy and Insolvency Law Newsletter, February 18, 2013; R. Graham Phoenix and Aubrey E. Kauffman “Indalex, Shmindalex Part II: The Revenge!” (2013) National Insolvency Review Volume 30 No. 2 page 17.

[iii] The Manitoba PPSA does not have an equivalent provision to Ontario PPSA s. 30(7) subordinating security interests to deemed trusts under the PPSA on inventory and receivables.

[iv] Supra, p. 4.

[v] ecojustice “Supreme Court Decision Leaves Tax Payers with the Bill for Cleaning Abitibibowater’s Pollution” ecojustice March 21, 2013; “Top Court: N.L. Can’t Force Abitibibowater Clean-Up” The Chronicle Herald December 8, 2012.

[vi] Abitibi, Supra for example see paras. 43 and 74.

[vii] Ibid. para. 34.

[viii] Ibid. para. 35.

[ix] Deschamps, J. classified the three part test to prove a claim in bankruptcy as follows: 1) there must be a debt, liability or an obligation to a creditor; 2) the debt, liability or obligation must be incurred before the debtor becomes bankrupt; 3) it must be possible to attach a monetary value to the debt, liability or obligation. (see para. 26).

[x] Ibid. paras. 27-36.

[xi] See for example, Arctic Glacier Supra; and the Monitor’s websites for Winnipeg Motor Express, DeFehr Furniture and Wilson Auto.

[xii] S. Frisby, “A Preliminary Analysis of Pre-Packaged Administrations, R3 Association of Business Recovery Professionals, see HTTPS://www.r3.org.uk/media/document/publications/press/pre-packs_briefing pdf.

[xiii] Re Tool-Plas Systems Inc. (2008) 48 C.B.R. (5th) 91; Fund 321 Ltd. Partnership v. Samsys Technologies Inc. (2006) 21 C.B.R. (5th) 1; Textron Financial Canada Ltd. v. Beta 2007 Carswell Ont. 89. In addition, there have been various pre-pack sales in Manitoba either by way of Court Appointed Receiver or through the BIA proposal mechanism. We are unaware of any reported or unreported Reasons for Decision but include Simply Natural Canadian Springs Water Corp. BK 03-01-75207; CIBC v. Sunjin Genetics Inc. CI 04-01-37220; CIBC v. Greymac Genetics Ltd. CI 04-01-39139.

[xiv] Sierra Club of Canada v. Canada 2002 [2 S.C.R. 522] at para. 53.

[xv] See for example: Re Eddie Bauer of Canada Inc. 2009 Carswell Ont. 3657; Re Earth First Canada Inc. 2009 ABQB 78.

[xvi] See for example: Re Integrity Wind Systems Inc. 2009 PESC 25; Cantrail Coach Lines Ltd. 2005 BCSC 351.

[xvii] see: Initial and subsequent Orders at the Monitor’s website: www.alvarezandmarsal.com/arcticglacier.

[xviii] see: Initial and subsequent Orders at the Monitor’s website: www.deloitte.com/ca/puratone.

[xix] 843504 Alberta Ltd. 2003 ABQB 1015 for example.

[xx] See for example Alexander v. 2025610 Ontario Limited 2012 ONSC 3486.

[xxi] Counsel for the lender has advised the author that the Forbearance Agreement would have contained recitals acknowledging the mortgages to be enforced.

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